Revised guidance offers key advice around insolvent trading

This article was current at the time of publication.

Following a review and stakeholder submissions, including from CPA Australia, the Australian Securities & Investments Commission (ASIC) has recently updated its regulatory guide for directors and professional advisers on their duty to prevent insolvent trading.

Trading while insolvent can have serious consequences under the Corporations Act 2001, potentially leading to civil penalties, compensation proceedings and criminal charges.

ASIC’s updates to Regulatory Guide 217 (RG 217 Duty to prevent insolvent trading: Guide for directors) follows industry consultation and requests to simplify its guidance, clarify the professional advice process, and to improve guidance for directors of small-to-medium enterprises (SMEs). 

How safe harbour works

The revised RG 217 explains the duties of directors to prevent insolvent trading and provides further guidance on how they may be able to protect themselves from civil liability by establishing a “safe harbour”.

For example, safe harbour protection may apply if a director takes active steps once they suspect a company may become or be insolvent, such as immediately appointing a small business restructuring practitioner or liquidator.

The 2017 introduction of “safe harbour” provisions under the Corporations Act is one of several developments that have influenced the need for updates to RG 217. 

In 2021 Treasury’s “Review of the Insolvent Trading Safe Harbour” called for an updated RG 217 that provides plain English “best practice guidance” that included references to the safe harbour provisions.

The current RG 217 provides examples of safe harbour and what factors ASIC will consider when assessing if a director is able to establish safe harbour protection against personal liability of insolvent trading.

ASIC provides more details on safe harbours, directors’ duties, the consequences of insolvent trading, and on the warning signs of insolvency in Information Sheet 42.

What are the warning signs?

Shabnam Amirbeaggi FCPA, managing partner of insolvency specialists Crouch Amirbeaggi, notes: “Insolvent trading is a complex area of law, where investigations are often lengthy and the cost of recovery actions can easily escalate when litigation is commenced.

 “ASIC’s RG 217 provides detailed commentary intended to help directors understand and comply with their duty to prevent insolvent trading.”

In the guidance Amirbeaggi signals out the comprehensive list of indicators and factors ASIC may consider when considering an action against a director for insolvent trading.

Warning signs include ongoing losses, poor cash flow, absence of a business plan, incomplete financial records, or disorganised accounting procedures, and increasing debt.

Ask the experts

A creditor, ASIC or a liquidator can take legal action against a director for insolvent trading. Where it can be shown a company failed to keep adequate financial records for a period, the company will generally be presumed to have been insolvent throughout that period.

Amirbeaggi says ASIC’s guidance is careful to convey that the contents of RG 217 do not affect the legal rights of a liquidator or creditor of a company to pursue a claim against a director for insolvent trading, even if ASIC does not commence proceedings.

“And, throughout the 45-page document, ASIC encourages directors to seek advice from qualified experts regarding their obligations to prevent insolvent trading, if their company is faced with possible insolvency issues,” she notes.

Implications for directors

Amirbeaggi notes that the law around insolvent trading and directors’ duty to prevent insolvent trading is not new.

“Most directors and their accountants will be aware of the ability for a liquidator to pursue a director for insolvent trading, even though the application of the law and principles around determining the date of insolvency and the quantum of the liability may be complicated,” she says.

Amirbeaggi believes that the window of opportunity that safe harbour and small business restructuring brings may not be so widely known by directors, or their accountants. 

She sees it as an opportunity to “take a breath, seek advice, and consider whether there is a plan that will reasonably provide a better outcome for the company than that which would be achievable from the immediate appointment of a liquidator or voluntary administrator”.

Talking points for clients

RG 217 provides accountants with a good summary of the insolvent trading provisions, the availability of safe harbour protection for directors, and the implications of small business restructuring.

The list of insolvency indicators gives accountants good talking points to raise awareness of possible insolvency with their clients.

However, the guidance continuously encourages directors (and their accountants) to seek expert advice from a qualified person, or persons, for example, a registered liquidator.

“Each situation may be different, and the complexities of determining when a director may be in breach of his or her duty regarding insolvent trading requires detailed, and sometimes forensic, analysis,” says Amirbeaggi. 

“Obtaining advice from an expert with the required skills, experience, and qualifications is essential.”