What Are the Director’s Duties When Facing Insolvency?
When a company begins to experience serious financial distress, directors are legally and ethically obligated to act in the best interests of the company’s creditors. These obligations are not optional; they are core responsibilities under Australian law that escalate when insolvency is on the horizon.
In this article, we explore the key duties of company directors when facing insolvency, what the law requires, and the steps you can take to protect yourself and your business.
Understanding Insolvency and the Shift in Duties
A company is insolvent when it cannot pay its debts as and when they fall due. In Australia, the Corporations Act 2001 sets out a director’s general duties. When insolvency becomes likely, directors must prioritise the interests of creditors because the company’s financial position means creditors effectively become the main residual claimants.
This is a critical turning point. Directors who continue to operate while insolvent can be held personally liable for debts incurred during this period.
Key Director Duties When Facing Insolvency
Duty to Prevent Insolvent Trading
Section 588G of the Corporations Act imposes a duty on directors to prevent their company from incurring debts while insolvent or where they have reasonable grounds to suspect insolvency. Breaching this duty can result in civil penalties, compensation orders, and, in serious cases, criminal charges.
Duty of Care and Diligence
Under section 180, directors must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise. This includes being fully informed about the company’s financial position and taking early, proactive steps to deal with emerging risks.
Duty to Act in Good Faith and in the Best Interests of the Company
As insolvency approaches, the meaning of “best interests” shifts. Directors must consider the impact of their decisions on creditors and act to minimise harm, even if this means winding up the company.
Duty Not to Improperly Use Position or Information
Sections 182 and 183 prohibit directors from misusing their position or access to confidential company information, including when a company is struggling financially. Directors must not act to gain an advantage for themselves or cause harm to the company, its creditors, or other stakeholders.
Duty to Keep Proper Books and Records
Maintaining accurate financial records is not just good practice — it’s a legal requirement under section 286 of the Corporations Act. Poor record-keeping can make it impossible to determine whether a company was insolvent and may expose directors to greater liability in the event of external administration.
Steps Directors Should Take if Insolvency Is Suspected
Seek professional advice early from a qualified insolvency lawyer or accountant.
Stop incurring further debt unless you’re certain the company can repay it.
Review and document decisions, including board discussions and financial assessments.
Explore safe harbour protections, which may shield directors from insolvent trading liability if they’re actively developing a viable turnaround plan.
Consider voluntary administration or liquidation if recovery is not realistic.
What Happens if You Breach Your Duties?
If ASIC or a liquidator determines that a director breached their duties, they may pursue civil penalties, disqualification from managing companies, compensation claims, or, in extreme cases, criminal prosecution.
The consequences can be severe, and they don’t just affect your current business. They can impact your ability to serve as a director in the future and your personal financial position.
Director’s Duties and Insolvency: Key Takeaways
When financial distress hits, directors have a legal responsibility to act carefully, ethically, and decisively. The earlier you act, the more options you have. Ignoring red flags or continuing to trade without a clear recovery plan can result in personal liability and long-term damage.
At Gear & Co Lawyers, we help directors across Queensland navigate the complex legal landscape of insolvency and restructuring. Whether you’re uncertain about your obligations or facing external administration, our team is here to support you with expert legal advice and timely action.
For related information, you may wish to read our articles on Survival through Small Business Restructuring, 7 Signs of Insolvency in your Business or Understanding Director Penalty Notices.
If you’re unsure about your company’s solvency or need advice on what steps to take, get in touch with our commercial and insolvency team. Contact Gear & Co Lawyers on (07) 3709 2547 or info@gearandco.com.au.
While attempts have been made to ensure the currency of information contained in this publication, it is not guaranteed. This publication is intended to provide only general information on matters of interest. It is not intended to be comprehensive and does not constitute and must not be relied upon as legal advice. You should seek legal or other professional advice that is specific to your circumstances.
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