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Insolvent Trading and Director's Liability

Date: October 12, 2007

Authors: LAC Lawyers

Directors may be liable, personally, under the Corporations Act, Trade Practices Act,  and the OH & S Act, among other legislation.  A Director may also be personally liable for non payment of taxes.

Under the Corporations Act, a Director is personally liable for those debts that have been incurred while the company was insolvent.

Common Law Test of Insolvency

In Bank of Australasia v Hall (1907) 4 CLR 1514 Griffith CJ opined:

“The question is not whether the debtor would be able, if time were given to the company to pay its debts out of its assets, but whether he is presently able to do so with monies actually available.  The most favourable construction that could be put on the words ‘his own monies’ is that they include any monies of which the debtor can obtain in immediate command by sale or pledge of his assets.”

Griffith CJ opined that the interpretation of being able to pay debts as they became due was not a matter of simply referring to the balance sheet of the debtor and determining whether the assets exceeded liabilities.

In Rees v Bank of New South Wales (1964) 111 CLR 210 Barwick CJ considered whether a trader was able to pay its debts as and when they fell due and said:

"It is quite true that a trader, to remain solvent, does not need to have ready cash by him to cover his commitments as they fall due for payment, and that in determining whether he can pay his debts as they become due regard must be had to his realisable assets.  The extent to which their existence will prevent the conclusion of insolvency will depend on a number of surrounding circumstances, one of which must be the nature of the assets and in the case of a trader, the nature of his business.”

In Sandell v Porter (1966) 115 CLR 666 a leading authority recognised that a company’s inability to pay its debts as and when they fall due would not simply be a function of having insufficient cash flows.  The reference that the Court made to the overall financial position of the company was a reference to its balance sheet, rather than to its income account.  Further the Court opined that it was important not to confuse insolvency with a temporary lack of liquidity. 

The notion of “ready cash” was no longer viewed as the most appropriate determining indicator of insolvency.  His Honour suggested that a temporary lack of liquidity, if viewed in isolation from the surrounding circumstances, might give rise to an inaccurate conclusion of insolvency.  This was affirmed in Hymix Concrete Pty Ltd v Garritty (1977) 13 ALR 321 at 327.

Insolvency Under Section 95A

In Melbase Corporation Pty Ltd v Segenhoe Ltd (1995) 17 ACSR 187 the Federal Court interpreted Section 95A as follows:

“Section 95A of the Law states a 'cash flow test' rather than a 'balance sheet test' of insolvency."

While Section 95A refers to the payment of debts as they become due and payable, the Section is not purely a reference to cash flow insolvency.  Pirntubola Pty Ltd v Melville Forrest Productions Pty Ltd (unreported NTSC decision number 90 of 1994-www.austlii.edu.au).

Should you require competent legal advice about any Business or Commercial Law matter please call LAC Lawyers Pty Ltd for immediate assistance.

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