Directors' Duties and the Insolvent Trading Question
In March 2024, a construction company with 12 employees and a $2.1 million turnover missed a payroll. Its two directors, Ahmed and Priya, received a management report showing a cash shortfall of $400,000 and an unresolved dispute with a major client over $900,000 in unpaid invoices. They continued trading, hoping the dispute would resolve. In June 2024, the company went into voluntary administration. The administrator reports that debts of $1.3 million were incurred after March 2024. Ahmed had relied on Priya, who handled finances, and did not read the report. Priya believed the client would pay because of a verbal assurance from the client's project manager. The company had no formal solvency monitoring and no board minutes after March 2024.
1. Assess whether Ahmed and Priya may be liable for insolvent trading under the Corporations Act 2001 (Cth).
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Section 588G of the Corporations Act 2001 (Cth) imposes a duty on directors to prevent insolvent trading. A director contravenes s 588G if the company is insolvent at the time of incurring a debt, or becomes insolvent by incurring it, and there are reasonable grounds for suspecting insolvency, and the director is aware of those grounds or a reasonable person in their position would be aware. The administrator's report shows a $400,000 cash shortfall and a $900,000 disputed receivable, which are reasonable grounds for suspecting insolvency. Both directors were aware of the report, or should have been. Ahmed cannot rely on ignorance of the report; directors are expected to keep themselves informed. Priya's reliance on a verbal assurance from a project manager is unlikely to be reasonable, especially without verification. The s 588G defence in s 588H requires the director to have had reasonable grounds to expect solvency, or to have taken all reasonable steps to prevent the debt being incurred, or to have been absent from management. Neither director is likely to satisfy these defences. The administrator may bring proceedings under s 588M to recover compensation for the debts incurred while insolvent, and ASIC may pursue disqualification under s 206C.
2. What practical steps should the directors have taken in March 2024, and what evidence would support a defence?
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The directors should have convened a board meeting, obtained a solvency report from an independent accountant, and considered appointing a voluntary administrator or restructuring adviser. They should have documented the client dispute, pursued the unpaid invoices, negotiated payment terms with creditors, and monitored cash flow weekly. To support a defence under s 588H, they would need evidence of reasonable grounds to expect solvency, such as a written confirmation from the client, a binding payment plan, or an independent solvency assessment. They should have kept board minutes recording their deliberations and the steps taken. Ahmed's failure to read the report undermines any defence based on reasonable expectation of solvency. Priya's reliance on a verbal assurance is weak without written confirmation. The absence of board minutes after March 2024 is damaging because it suggests no proper monitoring. The directors should also consider whether they can rely on the business judgment rule in s 180(2), but that rule applies to the duty of care and diligence, not to insolvent trading, and requires the judgment to be made in good faith and for a proper purpose.