Trading While Insolvent in Australia — Director Liability Explained

The Director's Duty to Prevent Insolvent Trading

Section 588G of the Corporations Act imposes a clear obligation on directors: you must not allow your company to incur a debt if you have reasonable grounds to suspect the company is insolvent at the time, or will become insolvent by incurring that debt.

This isn't a technicality. It's one of the most enforced provisions in Australian corporate law. Liquidators are required to investigate insolvent trading when a company winds up — and if they find it, they can sue directors personally to recover the losses creditors suffered.

This article explains the legal test for insolvency, the indicators to watch for, the defences available, and why clean financial records are your first line of protection.

The Legal Test: What Is Insolvency?

Under s95A of the Corporations Act, a company is solvent if — and only if — it can pay all its debts as and when they become due and payable. If it cannot, it is insolvent.

Australian courts apply this primarily as a cash flow test: can the company actually pay its bills when they fall due? The balance sheet test — whether assets exceed liabilities — is secondary. A company can be technically balance-sheet-solvent but still be legally insolvent if it cannot convert assets to cash quickly enough to meet obligations.

This distinction matters. Many small businesses in financial trouble think they're fine because they have assets — equipment, receivables, property. But if those assets can't be liquidated quickly, they don't prevent insolvency.

14 Indicators of Insolvency (ASIC's List)

ASIC identifies 14 common indicators that a company may be insolvent. Courts consider these when assessing whether a director should have known their company was in trouble:

• Ongoing losses
• Poor cash flow
• Inability to borrow further funds
• Overdue tax obligations
• Outstanding creditors outside normal payment terms
• Dishonoured cheques or declined transactions
• Suppliers requiring cash on delivery or refusing credit
• Special payment arrangements with creditors
• Solicitors' letters, statutory demands, or judgment debts
• Creditors threatening to wind up the company
• Unable to produce timely financial statements
• Payroll difficulties
• Problems with paying rent, utilities, or key suppliers
• Directors lending money to the company to cover shortfalls

None of these alone proves insolvency. But the more of them that apply, the harder it becomes for a director to argue they had no reason to suspect a problem.

Consequences for Directors

If a liquidator determines that a director allowed the company to trade while insolvent, the consequences can include:

• Civil penalty — up to $200,000 per contravention
• Compensation order — the liquidator can recover from the director the amount of the debt incurred while insolvent; this is the most common enforcement action and can run into hundreds of thousands of dollars
• Criminal charges — in serious cases where dishonesty is involved, criminal prosecution with fines or imprisonment
• Disqualification from managing corporations — courts can ban directors from managing companies for a set period

Resignation as a director does not avoid liability. The claim relates to the period during which you were a director and the debts were incurred — not your status at the time of liquidation.

Defences Available Under s588H

The Corporations Act provides defences, but they require active steps — not ignorance:

• Reasonable grounds for solvency — the director had reasonable grounds at the time to expect the company was solvent and would remain solvent after incurring the debt
• Reliance on advice — the director relied on information from a competent person (e.g. an accountant or bookkeeper) that satisfied them the company was solvent
• Illness or absence — the director was ill or had another good reason for not participating in management at the relevant time
• All reasonable steps taken — the director took all reasonable steps to prevent the debt being incurred

The "reliance on advice" defence is only available if the director actually received that advice — not if they simply failed to look at the books. This is why accurate, up-to-date financials matter: they are the foundation for any advice given, and the advice can only be relied upon if it was genuinely sought and acted upon.

Safe Harbour: Protection While You Work on a Solution

In 2017, Australia introduced "safe harbour" provisions under s588GA. These protect directors from insolvent trading liability while they are actively working on a restructuring plan — provided:

• They are taking advice from a suitably qualified advisor (such as a restructuring practitioner or accountant)
• Employee entitlements are being paid
• Tax lodgements are up to date
• The company is keeping adequate books and records
• The plan being developed is reasonably likely to lead to a better outcome than immediate liquidation

Safe harbour does not protect a director who is simply hoping things will improve. There must be a genuine, documented plan in development. It also stops applying immediately if the company enters voluntary administration or liquidation.

What to Do If You're Concerned About Solvency

If any of the 14 indicators above apply to your business, the time to act is now — not after a statutory demand arrives. Your options reduce significantly the longer you wait. Early steps include:

• Get your books current so you have an accurate picture of your position
• Seek advice from a registered insolvency practitioner or restructuring advisor
• Consider whether you qualify for the Small Business Restructuring process
• Review your cash flow forecast for the next 30–60 days
• Engage a CFO-level advisor who can assess your options and document the process

See also: Liquidator vs debt restructuring in Australia