In response to a degree of uncertainty as to a director's statutory duty to prevent insolvent trading, the Australian Securities and Investments Commission
(ASIC) has released a consultation paper containing a number of proposals on this fundamental duty (Consultation Paper 124: Duty to prevent insolvent trading: Guide for directors). Importantly for directors, the consultation paper (which contains a draft Regulatory Guide) identifies the factors ASIC considers when deciding to commence an investigation in relation to possible insolvent trading.
Recent experience and anecdotal evidence is that a number of boards (as well as individual directors) of both private and public companies are seeking advice on the critical elements of their positive duty to prevent insolvent trading under section 588G of the Corporations Act 2001 (Cth) (Corporations Act). The impact of the Global Financial Crisis and the approach of lenders has no doubt increased directors' anxieties in this regard. ASIC's guidance should assist in developing a greater level of understanding in the Australian business community of the practices that directors should adopt to monitor their company's solvency.
ASIC's four principles
In addition to setting out the legal background to the duty to prevent insolvent trading, ASIC has enunciated four principles which it considers directors should follow in order to comply with their duty. ASIC contends that a director is less likely to breach their duty to prevent insolvent trading if they take into account these principles in carrying out their role. In particular, ASIC has indicated that directors who can show that they have followed the principles are more likely to be able to demonstrate that they took reasonable steps to comply with their obligations. This, in turn, is likely to assist a director who is defending a claim for breach of this duty and is endeavouring to establish one or more of the defences under section 588G(2).
ASIC's four principles are set out below, together with some tips for directors to adhere to the principles.
Directors must keep themselves informed about the company's financial affairs, and regularly assess the company's solvency
This is an obligation for both executive and non-executive directors and primarily requires that directors ensure that proper company records are kept and maintained and relevant financial information is prepared. ASIC reminds directors that, without a good reason, they will not be excused from actively participating in the management of their company. Some examples of the activities that directors may undertake to remain actively engaged in their company, and to ensure that they are aware of its financial position from time to time, include:
- being involved in or overseeing the preparation of profit and cash flow budgets and regular management accounts, and monitoring actual results against budget expectations;
- reviewing the company's ability to collect debts owed to it and to realise other current assets, including stock, on a regular basis;
- monitoring when creditors are due to be paid and the company's ability to comply with normal terms of trade; and
- reviewing the current level of bank lending facilities and the ability to access additional funding if required.
Directors should investigate financial difficulties immediately they identify concerns about the company's financial viability
ASIC emphasises the importance of directors taking positive steps to confirm their company's financial position and assess the company's options for dealing with situations of financial difficulty. Most importantly, in times where there is uncertainty regarding the company's solvency or future solvency, directors must assess the company's financial position before incurring any new debt. What constitutes the 'incurring of a new debt' can be difficult legally, therefore directors should seek legal advice in such circumstances to understand what they can and cannot do with lenders, creditors and other counterparties.
The draft Regulatory Guide also contains an appendix of factors that ASIC suggests a reasonable person should take into account when monitoring a company's financial position and assessing solvency.
Directors should seek appropriate professional advice to help address the company's financial difficulties
Directors should consider obtaining advice from appropriate professional advisers (including lawyers and accountants) when there are reasonable grounds to suspect that their company is in, or approaching, a position of financial difficulty.
Hall & Wilcox has a great deal of experience in assisting a range of companies and directors in situations of financial distress, including:
- assisting directors to understand when their company will be regarded as being legally insolvent, or approaching insolvency;
- as noted above, advising on situations that will be taken to constitute the incurring of a debt for the purposes of the insolvent trading provisions of the Corporations Act;
- advising on the alternatives available to deal with existing debts and debt facilities;
- assisting with debt restructures and liaising with lenders and their legal advisers;
- and advising directors of their potential liability and how the defences that are available might be satisfied.
Directors should consider and act appropriately on the advice received, in a timely manner
ASIC's draft Regulatory Guide emphasises that it is not enough for directors to merely obtain professional advice, but that appropriate action must then be taken by the directors if there are serious doubts over the company's solvency or if the company is already insolvent.
ASIC has sought submissions in response to its consultation paper by 22 January 2010. We will provide a further update when and if the draft Regulatory Guide is issued in final form in the new year.
In the meantime, please contact a member of our team if you have any queries or concerns regarding the operation of the insolvent trading provisions in the Corporations Act, your company's solvency or your duties and responsibilities as a director.