Insolvent trading and your duties as a director

As a company director, you must stop the company from taking on new debts once it can’t pay its debts as they fall due. This is the duty to prevent insolvent trading under section 588G of the Corporations Act 2001. If you breach it, a court can order you to personally compensate creditors for debts the company incurred while it was insolvent.

The duty is triggered by suspicion, not certainty. The question is whether there were reasonable grounds to suspect the company was insolvent when it took on a debt. So the time to act is when the pressure starts, not when you are sure. Directors who act early have defences and options that directors who wait do not.

When is a company insolvent?

Under section 95A of the Corporations Act, a company is solvent if it can pay all its debts as and when they become due. If it can’t, it is insolvent. It is a cash-flow test: a company can have assets worth more than its debts and still be insolvent if it can’t pay its bills on time. A short, temporary shortfall the company can genuinely cover differs from an ongoing one.

Insolvency rarely happens overnight. These are the warning signs ASIC and practitioners look for:

• ongoing trading losses
• ATO debt building up, or PAYG, GST or super falling into arrears
• suppliers moving the company onto cash-on-delivery or stopping credit
• paying creditors well outside their terms, or choosing which ones to pay
• no further finance available
• statutory demands, legal action or judgments for unpaid debts
• financial records that aren’t current enough to show what the company owes

No single sign proves a company is insolvent. Several together are a reason to get a clear view of the numbers, and advice, now.

What the duty requires

For a claim to succeed against a director, four things generally have to be shown:

1. You were a director when the company incurred the debt.
2. The company was insolvent at that time, or became insolvent by incurring the debt.
3. There were reasonable grounds to suspect the company was insolvent, or would become insolvent.
4. You were aware of those grounds, or a reasonable person in your position would have been.

The last point matters most. The law doesn’t ask whether you knew the company was insolvent. It asks whether a reasonable director in your position would have suspected it. Not looking at the numbers is not a defence.

Records matter too. If the company hasn’t kept proper financial records, a liquidator can presume it was insolvent for that period. Keeping the books current protects you and the company.

When is a debt incurred?

A debt is generally incurred when the company commits to it, not when the invoice arrives or the money leaves the account. That includes signing a contract or placing an order, entering a lease, employing staff and declaring a dividend.

In practice, the duty is about new commitments. Once there are reasonable grounds to suspect insolvency, each new order, contract or hire is a debt the company may not be able to pay.

What happens if the duty is breached

There are four possible consequences, and they are not the same thing.

Compensation. This is the most common outcome. Once the company is in liquidation, the liquidator can claim compensation from a director equal to the loss creditors suffered on debts incurred while the company was insolvent. The claim must be brought within six years of the winding up beginning. A creditor can bring a claim in limited circumstances, generally with the liquidator’s consent or the court’s permission.

Civil penalty. On ASIC’s application, a court can order a director to pay a penalty of up to the greater of 5,000 penalty units (about $1.82 million at the current penalty unit of $364) or three times the benefit obtained. This is separate from any compensation.

Disqualification. A court can disqualify a director from managing companies, which for an owner-operator can be the consequence that matters most.

Criminal charges. These apply only where a director’s failure to prevent the debt was dishonest. The maximum is a fine of 2,000 penalty units (about $728,000), up to five years’ imprisonment, or both. An honest mistake in business is not dishonesty.

What about the house?

A compensation order is a personal debt. Like any other debt, creditors can enforce it against your personal assets, and an unpaid judgment can lead to bankruptcy. Two other exposures often matter more for SME directors, and they apply whether or not there is ever an insolvent trading claim:

• Personal guarantees. If you guaranteed a lease, an overdraft or a supplier account, you are personally liable for that debt under the guarantee.
• Director penalty notices. The ATO can make you personally liable for the company’s unpaid PAYG withholding, GST and super under the tax law. Our guide to director penalty notices explains how.

Resigning doesn’t remove liability for debts the company incurred while you were a director.

Defences and safe harbour

The Corporations Act gives directors four defences to an insolvent trading claim. You may have a defence if:

• you had reasonable grounds to expect, not just hope, that the company was solvent and would stay solvent
• you reasonably relied on a competent and reliable person to keep you informed about the company’s solvency, and expected the company to be solvent on that information
• because of illness or another good reason, you did not take part in managing the company at the time
• you took all reasonable steps to prevent the company incurring the debt, which can include appointing a voluntary administrator

Separately, safe harbour (section 588GA) protects a director from liability for debts incurred while they develop a course of action reasonably likely to lead to a better outcome for the company than immediate administration or liquidation. It has conditions, including paying employee entitlements (super included) and keeping tax lodgements up to date. In practice, it also means proper records and appropriate advice. Safe harbour is a structured turnaround process, not a general excuse to keep trading.

What to do if you’re worried

1. Stop taking on new commitments the company may not be able to pay. Hold off on new orders, contracts and hires until you know where you stand.
2. Get current numbers: a short-term cash flow forecast, a list of creditors and the company’s ATO position.
3. Keep lodging BAS on time, even if you can’t pay the tax, and keep super paid where you can. On-time lodgement prevents director penalties from being triggered, and current lodgements and employee entitlements are conditions of safe harbour.
4. Don’t move assets out of the company or pay some creditors ahead of others. A liquidator can recover those payments and transfers.
5. Get advice from a Registered Liquidator early, while the options are widest.

Those options depend on whether the business is viable. They may include a turnaround with safe harbour protection, small business restructuring, voluntary administration, or, if the business can’t be saved, an orderly liquidation. If a business can be saved, we’ll say so, and if it can’t, we’ll say that too.

For accountants and advisers

You are often the first to see it: lodgements slipping, the ATO balance climbing, a client funding the business out of pocket. You don’t have to tell a client they are insolvent to raise the question. Pointing out that the duty is triggered by reasonable grounds to suspect, and that early advice keeps safe harbour and restructuring options open, is often enough to start the conversation.

We can give you and your client a confidential second view of the position, attend with you or work behind the scenes, and keep you informed throughout. See how we work with accountants and advisers.

How Rapsey Griffiths can help

If cash is tight and you’re not sure whether the company can keep trading, Rapsey Griffiths can give you a confidential view of where it stands: what the warning signs mean, what your personal exposure is and which options are realistic for the business and for you. You’ll deal directly with Mitch Griffiths or Chad Rapsey, Registered Liquidators, Trustees and Chartered Accountants, and we can work alongside your accountant. Book a free confidential chat with our team today.

Last updated 11 November 2026. This is general information, not advice for your situation.