ASIC Insolvent Trading and Safe Harbour

In the complex landscape of corporate governance, company directors bear significant responsibilities, particularly when their company faces financial distress. Among the most critical of these is the duty to prevent insolvent trading.

Section 588G of the Corporations Act 2001 (Cth) (Corporations Act) prohibits directors from incurring debt if insolvency is suspected.While breaches can lead to personal liability, the law allows flexibility for directors attempting to restructure a struggling business. This is where the 'safe harbour' provisions come into play, offering protection to directors who are genuinely developing courses of action reasonably likely to lead to a better outcome for the company than immediate administration or liquidation.

Our insolvency lawyers explore the key principles surrounding the duty to prevent insolvent trading and provide guidance on how directors can effectively navigate these obligations while utilising safe harbour protections.

NOTE: Australian Securities and Investments Commission (ASIC) is the corporate regulator responsible for enforcement of the Corporations Act in Australia.

What is Insolvent Trading?

Insolvent trading occurs when a company incurs a debt while insolvent or becomes insolvent by incurring that debt and the director knew or had reasonable grounds to suspect that such insolvency has occurred.

Under the Corporations Act, a company is insolvent if it is not able to clear its debts as and when they are due.

Common warning signs of Insolvency

The key indicators of insolvency include:

1. Ongoing cash flow shortage;
2. Overdue tax liabilities like unpaid taxes owned to the ATO (Australian Tax Office) and payroll tax;
3. Inability to obtain finance;
4. Incomplete financial records or poorly maintained accounting procedures; and
5. Dishonoured cheques or unpaid employee entitlements.

A director who ignores these indicators may face serious legal consequences later.

Director duties for insolvent trading

Did you know: A director is not simply a person formally appointed under the Corporations Act. A person could also be said to be a director if they act in the position of a director (including de facto and shadow directors)and such persons owe the same legal duties.

When a company is solvent, directors primarily owe duties to shareholders. However, once insolvency arises or is reasonably suspected, those duties extend to creditors and employees with unpaid entitlements.

What are the key duties of a Director?

General duties

1. To exercise powers with reasonable care and diligence, including staying informed about the company's financial position, including available funds, budgets and debts.
2. To act in good faith and in the best interest of the company.
3. To avoid misusing their position or information to gain a personal advantage or cause harm to the company.

Duty to prevent insolvent trading

Directors must ensure the company does not incur debts while it is insolvent or where incurring the debt would lead to insolvency. For this, the directors must be aware of the company's financials and not annual financial reviews alone.

Duty to maintain books and records

Directors of companies must ensure accurate financial records are maintained. Failure to do so may lead to a statutory presumption of insolvency; thereby exposing directors to personal liability.

Penalties for insolvent trading

ASIC has the right to investigate and take action against directors for insolvent trading. Consequences may include:

1. Civil penalties and pecuniary fines;
2. Compensation orders to repay all the creditors;
3. Disqualification from managing corporations; and
4. Criminal prosecution in serious cases.

What is the safe harbour defence?

Safe harbour is a statutory defence that shields directors from personal liability for insolvent trading. It is applicable in situations when directors take genuine, reasonable steps to improve the company's position (a better outcome) instead of placing it immediately into liquidation. The specific legislation lies with section 588GA of the Corporations Act.

When does safe harbour apply?

Safe harbourmay apply if:

1. You begin to suspect the company is insolvent or on the verge of insolvency;
2. You start developing one or more course of action that is reasonably likely to have a better outcome than immediate liquidation; and
3. Any debts incurred are connected to that plan or arise in the ordinary course of business.

ASIC's Regulatory Guide 217 (RG 217) provides guidance on how directors can rely on this defence.

Examples of valid actions

Here are some examples of what may constitute 'safe habour' under section 588GA of the Corporations Act:

1. Restructuring business operations;
2. Negotiating with creditors;
3. Selling assets;
4. Raising funds; and
5. Appointing professional advisers or preparing for voluntary administration.

What is a 'better outcome'?

A 'better outcome' can be defined as an outcome that is better than placing the company straight into administration or liquidation. the following are assessed to determine if a company may be in the position of a 'better outcome':

1. The financial position and challenges of the company; and
2. Whether the director's decision making is ongoing, informed, reasonable, and properly documented.

Please Note: The strategy has to be realistic and reviewed regularly.

When is safe harbour not applicable?

Safe harbor defence is not applicable if the director:

1. Does not act within a reasonable time period;
2. Fails to maintain proper books of accounts and financial records;
3. Incurs debts that he/she is aware cannot be repaid;
4. Ignores professional advice;
5. The strategy or plan stops being workable or no longer offers a better outcome or there is less scope of it being successful,;
6. Fails to fulfil obligations like paying tax; and
7. Conducts any reckless or dishonest activity.

What role does ASIC play in Insolvent Trading Matters?

The Australian Securities and Investments Commission (ASIC)is responsible for:

1. Investigating suspected insolvent trading;
2. Penalising the director (civil or criminal penalties) if found guilty; and
3. Issuing an order or applying for court order to disqualify the director from their position.

ASIC often times determines whether directors have genuinely made an attempt to restructure the business before allowing debts to accrue. In this assessment, clear documentation, professional advice and proper financial records play an important role.

Seeking early legal advice

Time is ofthe essence. Directors who secure legal assistance early are significantly better positioned to:

• Assess insolvency risks accurately

• Structure a compliant turnaround strategy

• Preserve safe harbour protections

• Minimise personal liability

Any delay or denial intaking action often removes the ability to rely on statutory defences.

Take Control of Your Legal Position Today

Navigating insolvency requires precision and deep commercial understanding. By engaging with our experienced insolvency lawyersteam, you ensure that your rights are protected and your strategy is legally sound. We provide clear, practical advice tailored to your specific circumstances, helping you manage risk and achieve the best possible outcome.

Contact PCL Lawyers insolvency team today for a confidential consultation and secure your business's future.

Frequently Asked Questions

What does insolvent mean in law?

In simple words, being insolvent means a company is no longer able to pay its debts as and when they are due. In other words, it means the liabilities of a company exceeds assets or that cash reserves are not sufficient to pay off urgent or due debts/obligations.

Who can be held liable for insolvent trading?

Usually, the directors of the company may be held liable for insolvent trading. However, in some situations, shadow or de facto directors may also be held liable.

What are the penalties imposed by ASIC for insolvent trading?

ASIC may impose civil penalties, compensatory orders, disqualification of director(s) and criminal prosecution in serious cases.

Does safe harbour protect all company debts?

No, safe harbour is only applicable to those debts which are incurred directly in connection with the restructuring or turn around efforts. It simply does not safeguard unrelated or reckless debts.

Can directors rely on safe harbour automatically?

No, director shave to actively show that they took proper, informed, reasonable steps toward restructuring and acted in good faith and in the best interest of creditors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.