In section 588G of the Corporations Act 2001 (Cth) (Act), there is a table specifying the time a debt is deemed to have been incurred, depending on the type of action taken by a company.
Directors of a company contravene this section if they fail to prevent the company from incurring the debt if:
• they are aware that there are grounds for suspecting the company is insolvent; or
• a reasonable person in the same situation as the director would be so aware.
Offence creating provision
Section 588G(3) of the Act provides that a person commits an offence if:
• a company incurs a debt at a point in time;
• that person is a director when the debt is incurred;
• the company is insolvent ...view middle of the document...
Section C of RG 217 provides a list of “Factors to take into account in considering whether a company is insolvent“. Examples cited include:
• a history of continued losses;
• the company is unable to produce accurate financial information;
• the company has defaulted or is about to default on an of its financing facilities;
• legal action is being threatened against the company.
Each of these factors when examined individually may not prove insolvency. When examined cumulatively they may put the directors on notice that the company may be insolvent.
Directors may avail themselves of various defences to allegations of trading whilst insolvent. For example:
Reasonable grounds to expect solvency
Section 588H(2) provides for a defence whereat the time the debt was incurred the director has reasonable grounds to expect that the company was solvent and would remain so even if it incurred the debt.
To establish the requisite “expectation of solvency” a director must establish more than a mere hope of solvency, but must prove the grounds on which the view was formed the view as to the company’s solvency considering the circumstances.
The seminal case on whether there are reasonable grounds to indicate solvency is the case of Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 (Friedrich), which, among other things, explored this issue.
In Friedrich, a director who failed to be part of a compromise after the trial commenced, was held personally liable for $96,704,998 pursuant to the precursor of section 588G of the Act. The Court held that the director was liable for debts incurred by the company that he had failed to prevent.
It was found that, as a director, he should have known of the contents of the accounts and the auditor’s report at the time of the...