Safe Harbor Carve-Out for Directors for Insolvent Trading Liability in Australia and Its Implications

Abstract

The Issue of Personal Liability for Insolvent Trading is important for existing and prospective company directors. Under section 588G of the Australian Corporations Act 2001 (hereinafter “Corporations Act 2001”), directors of a company have the duty to prevent insolvent trading. Failure to do so will lead to the directors incurring personal liability. “Insolvent trading involves the incurring of debts when circumstances of insolvency in relation to a company exist and the subsequent winding up in insolvency of the company. It has been theoretically disputed whether there is a need to protect creditors by legislative means when a company nears insolvency. Various policy justifications have been invoked for a rule against insolvent trading. These policy justifications appear to be robust, but not without their critics. However, these criticisms have not had much traction in shifting the policy and legislative choices drastically. That said, the practical impact of a stringent approach to insolvent trading in Australia had recently culminated in prompting the enactment of an amendment to section 588G of the Corporations Act 2001 by providing a safe harbor to directors who take a “course of action reasonably likely to lead to a better outcome for the company” and the company’s creditors. The carve-out for directors who intend to use the safe harbour whilst not getting rid of the insolvent trading prohibition does have a significant impact for those who genuinely attempt to turn around the fortunes of their companies. This paper examines the implications of the reform for the personal liability of directors for insolvent trading in Australia.