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Solvent or Insolvent - The Fine Line

The impact of the GFC and the tougher approach taken by lenders has led to concern among directors about their obligation to prevent insolvent trading.  Many directors, particularly in small to medium sized enterprises, often find it difficult to implement in practice their duty to prevent insolvent trading.  

With corporate insolvencies expected to remain high as a result of the economic conditions we have faced over the past year, ASIC recently released a Consultation Paper which sets out the key principles directors need to take into account so they comply with their duty to prevent insolvent trading.  It also sets out tips to help directors follow the principles.  

ASIC’s four principles are as follows:  

  • Directors must keep themselves informed about the financial affairs of their company and regularly assess the company’s solvency.  In assessing this, ASIC will look at the systems and processes that a director has put in place and used to allow them to actively monitor the solvency of their company.  For example, to what extent a director has obtained regular reports of key items such as cash at bank, lists of debtors and creditors and profit and loss reports.   
  • Directors should investigate financial difficulties immediately when they identify concerns about their company’s financial viability.   ASIC will look to see whether there were indicators of potential insolvency that a reasonable director would have taken into account in determining whether the company was insolvent.  For example, if the company is experiencing cash flow difficulties and whether the company has reached the limits of its funding facilities.  
  • Directors should obtain appropriate advice from a suitably qualified person to help address their company’s financial difficulties.   ASIC will look at whether the director gave full, complete, accurate and up to date information to the adviser and what steps the director took to act on the advice once it was received.  
  • Directors should consider and act appropriately on the advice received in a timely manner.   If there is a potential issue of insolvency, ASIC will expect to see evidence of timely and genuine steps taken by the director to prevent debts being incurred.  

While following this guidance will not guarantee action won’t be taken against a director for insolvent trading, it will help to minimise the risk that directors have breached their duty.  

ASIC is seeking feedback on its Consultation Paper by 22 January 2010.  Following that, we expect ASIC to release a Regulatory Guide setting out its final position.

Please contact Lynne Grant on 03 8319 1866 or at lynne.grant@bsglegal.com.au for further information.



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