Directors of a company owe a range of statutory and legal duties to the company, and the scope of a director’s potential personal liability is strict (see our articles about that here). If the company is insolvent or is facing a real risk of insolvency, a director’s duties expand to encompass duties to creditors.
Duties which specifically come into play where a company is facing insolvency include:
- The duty to prevent creditor-defeating dispositions. Commonly part of “phoenixing” activity, a creditor defeating disposition involves the disposition of company property for less than market value or the best price reasonably obtainable, and which prevents that property from being realized for the benefit of creditors in the liquidation of the company.
- The duty to prevent insolvent trading. A company is insolvent if it is unable to pay its debts as and when they fall due. If a company incurs a new debt at a time it is insolvent, or it becomes insolvent by incurring the debt, and there were reasonable grounds to suspect the company was at that time insolvent, the director may breach their duty. “Incurring a debt” is not limited to the company incurring a debt to a third party but can also extend to other actions of the company such as paying dividends, reducing share capital, buying back shares, or entering into uncommercial transactions.
A company is required to keep adequate written financial records to correctly record and explain its transactions and financial position. If it does not, then it will be presumed to be insolvent for the period adequate records are not maintained, and moreover, it may be very difficult for a director to defend an insolvent trading claim in such circumstances.
- An expansion of the scope of a director’s core duties. The core statutory and legal duties of a director include that the director:=
- must act with reasonable care, skill and diligence;
- must act in good faith in the best interests of the company, and for a proper purpose; and
- must not improperly use their position or information they have obtained by virtue of their position as a director, to gain an advantage for themselves or someone else or cause detriment to the company.
When a company is solvent, a director’s duty to the company will primarily be measured with reference to the interests of shareholders. However, when a company is facing insolvency, a director’s duty to act in good faith in the bests interests of the company must be discharged with regard to the interests of creditors and those interests must not be prejudiced in the exercise of the director’s powers.
A director in breach of their duties may face civil or criminal penalties, and/or liability to compensate the company for losses or even disqualification from acting as a director or managing companies.
A director should be continually aware and on top of the company’s financial position, always be meticulous and careful in their management and cognisant of their expanded duties if the company is facing financial difficulty.
This publication has been carefully prepared, but it has been written in general terms and should be viewed as broad guidance only. It does not purport to be comprehensive or to render advice. No one should rely on the information contained in this publication without first obtaining professional advice relevant to their own specific situation.
 S. 588GAB Corporations Act 2001 (Cth)
 S. 588FDB Corporations Act 2001 (Cth)
 S. 588G Corporations Act 2001 (Cth)
 S. 286 Corporations Act 2001 (Cth)
 S.588E Corporations Act 2001 (Cth)
 S. 180 Corporations Act 2001 (Cth)
 S. 181 Corporations Act 2001 (Cth)
 Ss. 182 – 183 Corporations Act 2001 (Cth)