Positive Cash Flow and Director’s Liabilities:
How can one affect the other?
As published in B2B
By Craig Painter
There are a number of reasons why, as a director and business owner, you work towards a positive cash flow. This article cannot hope to provide you with all reasons for a positive cash flow but it intends to set out the reasons how a positive cash flow can limit your liability as a director.
The Corporations Act requires all directors to prevent their company from incurring debts that cannot be paid. In short, if a company incurs debts that cannot be paid when they fall due, the company is technically insolvent. The Act provides for personal liability of directors if they allow their company to trade whilst insolvent. In general, before a new debt is incurred a director must consider whether, as a result of that debt, the company may become insolvent. If insolvency is a possibility, there is a positive duty upon a director to not allow the company to trade. This duty also extends to directors who are not involved in the day to day running of the company.
There are serious consequences for directors of companies that trade insolvent:
- Civil penalties up to $200,000.00.
- Compensation proceedings which are limitless and may lead to the director being personally bankrupt.
- Irrespective of an agreement between the director and creditors, ASIC may take action to recover damages.
- Criminal charges with fines up to $220,000.00 or imprisonment up to 5 years or both.
There are few defences that the director can rely on if insolvent trading occurs. In a recent landmark Federal Court ruling, the Judge exercised his discretion under the Corporations Act by relieving the director from any penalty following a finding of insolvent trading. The Judge did so on the basis that:
- The director sought advice from a suitable expert about the position of the company.
- The director took active steps to expand the operation of the company.
- The business was continuing to increase its earnings.
- When the director was advised that the company’s financial position was not strengthening he took active steps to engage an insolvency practitioner.
The above decision reinforces the need for directors to be active in monitoring the affairs of their company and, where they suspect insolvency, to actively seek out professional advice.
Notwithstanding the potential for a defence for directors for insolvent trading, the recent decision is a one-off and it is unclear whether it will be followed in the future.
For advice on protecting yourself or on director’s obligations please do not hesitate to contact Craig.
- email Craig at: cpainter@elringtons.com.au
- call Craig on: 02 6128 1337
