Insolvent trading: director liability, warning signs and defences

Insolvent trading happens when a company incurs a debt while it is insolvent, or becomes insolvent by incurring it, and a director had reasonable grounds to suspect that. Under section 588G of the Corporations Act 2001, the director can then be personally liable to repay that debt. The claim is usually brought by a liquidator, who has six years from the start of the liquidation to sue. A company is insolvent when it cannot pay all its debts as and when they fall due.

What counts as insolvent trading

Three things must come together for a director to breach the duty in section 588G:

1. The company incurs a debt. This covers ordering stock, taking on services, signing a lease, or receiving goods or services on credit.
2. The company is insolvent at that time, or becomes insolvent because of the debt.
3. There are reasonable grounds to suspect insolvency. The test is objective: what a reasonable director in the same position would have suspected, not what this director actually believed.

“Insolvent” is a cash-flow test. A company can own valuable assets and still be insolvent if it cannot pay its debts on time. A company with net liabilities can still be solvent if it can pay as debts fall due, for example because a lender continues to support it.

Warning signs that point to insolvency

ASIC’s Regulatory Guide 217 lists indicators that a court may treat as reasonable grounds to suspect insolvency. Common ones in small businesses include:

• overdue ATO debts, or BAS and super lodged but not paid;
• suppliers paid outside their trading terms, or moving the company to cash on delivery;
• legal letters, statutory demands, judgments or warrants from creditors;
• dishonoured payments, or special payment arrangements with selected creditors;
• continuing trading losses and cash-flow shortfalls;
• no access to further finance from the bank or shareholders; and
• financial records that are incomplete or not up to date.

One sign alone does not prove insolvency. Several together usually mean a director should get advice straight away.

What directors can be liable for

• Compensation. Under section 588M, a liquidator can recover from the director the amount of loss the creditors suffered on debts incurred while the company was insolvent. In limited circumstances, creditors can bring the claim themselves.
• Civil penalties. ASIC can seek a civil penalty, a compensation order and disqualification from managing companies.
• Criminal liability. Insolvent trading becomes a criminal offence only where the director’s failure to prevent the debt was dishonest.

Directors who have given personal guarantees face a separate risk. A guarantee lets the creditor pursue the director personally whether or not there was insolvent trading.

The defences

Section 588H sets out four defences. The director must prove them.

1. Reasonable grounds to expect solvency. At the time, the director had reasonable grounds to expect, and did expect, that the company was solvent and would stay solvent. Expecting goes further than hoping or not suspecting.
2. Reasonable reliance on a competent person. The director reasonably relied on a competent and reliable person, such as a CFO or external accountant, for information about solvency, and expected solvency on that basis.
3. Illness or other good reason. Because of illness or another good reason, the director did not take part in managing the company at the time.
4. All reasonable steps. The director took all reasonable steps to prevent the company incurring the debt. Taking steps to appoint an administrator is a relevant consideration.

Separately, directors who meet its conditions can rely on safe harbour under section 588GA while pursuing a genuine turnaround plan.

How to reduce the risk

1. Know the numbers. Keep a 13-week cash-flow forecast and an aged list of creditors, and review them at least monthly.
2. Keep the records up to date. If the company has not kept proper financial records, a court can presume it was insolvent.
3. Stay current on wages, super and ATO lodgements. They are central to safe harbour, and unpaid super and PAYG withholding can lead to a Director Penalty Notice.
4. Act on the warning signs. Get advice from a qualified restructuring adviser early, while there are still choices.
5. Write decisions down. Every defence depends on being able to show what the director knew and did at the time.

Your options if the company is already struggling

Appointing an administrator or liquidator stops new debts being incurred, which caps further insolvent trading exposure. Waiting rarely improves the position. For a side-by-side view, see voluntary administration, SBR or liquidation.

How Greengate Advisory can help

If you are worried the company may already be insolvent, talk to us before taking on more debt. Our registered liquidators can assess solvency, explain your exposure and the defences available, and set out the realistic options. The first consultation is free and confidential, and we can explain things in English, Mandarin, Cantonese or Korean. Sydney (02) 8318 3699, Brisbane (07) 3868 1888.

Frequently asked questions

What is insolvent trading?

When a company incurs a debt while insolvent, or becomes insolvent by incurring it, and a director had reasonable grounds to suspect insolvency. The director can then be personally liable for that debt.

Can a director be personally liable for company debts?

Yes, for debts incurred while the company traded insolvent. A liquidator can recover the creditors’ loss from the director under section 588M. Personal guarantees and Director Penalty Notices create separate personal liability.

How long does a liquidator have to bring an insolvent trading claim?

Six years from the beginning of the liquidation.

Is insolvent trading a crime?

Only where the director’s failure to prevent the debt was dishonest. Otherwise it is a civil matter, involving compensation and possible civil penalties and disqualification.

What are the defences to insolvent trading?

Reasonable grounds to expect solvency; reasonable reliance on a competent person for solvency information; not taking part in management because of illness or another good reason; and taking all reasonable steps to prevent the debt. Safe harbour is a separate protection.

Does appointing an administrator stop insolvent trading?

It stops further exposure, because the company stops incurring new debts under the directors’ control. It does not remove liability for debts already incurred.

Sources: Corporations Act 2001 (Cth) ss 95A, 588E, 588G, 588GA, 588H and 588M; ASIC Regulatory Guide 217 Duty to prevent insolvent trading. This page is general information, not advice about your circumstances. Last reviewed: 1 October 2026.