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Insolvent trading tips for directors

This year has been nothing short of a puzzle. It feels like each month, or each day in some areas of law, a new piece is revealed and slowly we have been completing the puzzle and seeing the full picture of the post-COVID-19 world.

This is particularly the case for the insolvency area.

With the temporary measures that were introduced to help reduce the financial pressure on businesses and the temporary relief against personal liability for directors likely coming to an end on 31 December 2020, and a new regime modifying small business restructures and insolvencies commencing on 1 January 2021, it is important that directors take the time now to consider the position of their companies, their own potential exposure, and put measures in place to manage any identified risks.

With all the changes in this area, it is understandable that directors may find it hard to know where to start.

We have previously discussed demystifying safe harbour in a COVID-19 era and demystifying small business insolvency, we encourage you to read these articles also to get a fuller picture of safe harbour and the proposed small business protections.

This bulletin seeks to provide some guidance to directors so they can be aware of high level issues relevant to:

  • Assessing where their company stands given financial circumstances and the current laws.

  • Assessing if they might have some potential personal exposure.

  • How to go about managing these issues as we move into 2021[1].

The new regime: what we know so far

The insolvency reforms will introduce three elements:

  1. A new formal debt restructuring process for small businesses which provides financially distressed but viable businesses with a quicker and simpler mechanism to restructure debts and survive.

  2. A new simplified liquidation pathway for small business to allow faster and less costly liquidation.

  3. Complementary measures to ensure the insolvency sector can respond effectively to the needs of small businesses in both the short and long term.

These measures will commence on 1 January 2021, subject to the provisions of the actual legislation passed.

What we know is that to be eligible for the process you need to be an incorporated business with liabilities of less than $1 million. This requirement has recently been more thoroughly explained in the draft regulations[2] which state that the total liabilities of the company must not exceed $1m, on the day the restructuring begins. It is proposed that ‘liability’ will be defined as any liability or obligation that is not contingent, the threshold will include secured debt and related-party debt.

The proposal also adopts a ‘debtor in possession’ model, which unlike the traditional regime, means that eligible businesses can keep trading under the control of its owners while a debt restructuring plan is developed.

A small business restructuring practitioner (SBRP) (with the appropriate registration) will help determine if a company is eligible and support the company to develop its plan. According to the draft regulations, the restructuring will begin on the date of the appointment of the SBRP and the SBRP will most likely be a registered liquidator. This recognises the critical expertise that registered liquidators have in this area but further adds to concerns that insolvency practitioners will be overburdened in 2021.

The recent draft regulations say that it is proposed that secured creditors will only be bound by a restructuring plan to the extent of their unsecured debt. If the entire amount of their debt is secured (that is, the value of their security is equal to or greater than the value of the debt), the secured creditor will only be bound to the extent that it consents to be bound by the plan, and will be able to realise their security, subject to some qualifications. This position is therefore like that of a secured creditor in relation to a deed of company arrangement in voluntary administration.

Once the small business insolvency reforms have been passed, we will publish a further article with the details.

Minimum requirements of plan

The recent draft regulations indicate that a restructuring plan will need to include all of the following terms and will be void to the extent that it does not:

  • All admissible debts and claims rank equally.

  • The debts and claims will be paid proportionately (assuming the total amount to be paid under the plan is insufficient to meet those debts and claims in full).

  • A creditor is not entitled to receive, in respect of an admissible debt or claim, more than the amount of the debt or claim.

  • The amount of an admissible claim will be ascertained as at the time immediately before the restructuring began (i.e. immediately before the appointment of the SBRP).

  • If a creditor is a secured creditor, for the purposes of working out what they will be paid under the plan, they are a creditor only to the extent that their debt exceeds the value of their security (or, if they realise their security interest while the plan is in force, the extent of their shortfall after net realisation).

The new regime: what we don’t know

Importantly, there are some things we don’t know yet about the new regime such as:

  1. Can personal guarantees from Directors be compromised? We know that creditors are prohibited from enforcing personal guarantees given by directors during the reorganisation process, but what occurs after the process has been completed?

  2. What happens if the plan fails? We know that small businesses can only avail themselves of the restructuring plan once during a seven-year period but we don’t know whether the business will automatically go into administration or liquidation if the plan fails.

  3. Will Small Business Restructuring Practitioners have the same power to pursue directors for insolvent trading as liquidators do?

How to access the new regime

To be eligible for the new regime, at this stage a business needs to meet the following criteria:

  1. Liabilities of less than $1 million

  2. Exclusion period of seven years

  3. All of the company’s tax lodgments must be up to date

  4. All employee entitlements that are due and payable must be paid.

Of course, these criteria are subject to change until the legislation has been passed.

Not all small businesses will be able to access the process immediately on 1 January 2021. During the transition as small business restructuring practitioners are registered and businesses adapt to the new process, an eligible small business will need to declare its intention to access the new regime. Once the declaration is made, the business is able to continue accessing the temporary relief for a maximum period of 3 months, which includes the relief for directors from personal liability for insolvent trading for debts incurred from 1 January 2021.

It is understood that the ability for a business to declare its intention to access the new regime will be available until 31 March 2021. It is not understood whether the temporary insolvency relief is accessible to businesses who make declarations retrospectively i.e. if a business makes the declaration to its creditors on 4 March 2021, whether the temporary insolvency relief is available to them for the period 1 January 2021 to 31 March 2021, or only for the period 4 March 2020 to 4 June 2020 (being a maximum of three months).

Director liability for insolvent trading

A director has a duty to prevent its company from trading while insolvent. This duty is detailed in s.588G of the Corporations Act 2001 (Cth).

If a person is a director at the time the company incurs the debt and the company is insolvent at that time or becomes insolvent by incurring the debt and there are reasonable grounds for suspecting that the company is insolvent or would become insolvent, then the person commits the offence of trading while insolvent.

With the arrival of the global pandemic came uncertainty across almost every industry and business. While directors still have the traditional safe harbour protection available to them, given the drastic impact that COVID-19 had, in March 2020 the government announced a temporary defence against insolvent trading.

This legislation defence provides that s 588G does not apply to a person and a debt incurred by a company if the debt is incurred:

  • in the ordinary course of the company’s business; and

  • during a period of at least six months from 25 March 2020 to 31 December 2020.

This legislative change gives directors protection against all debts incurred in the ordinary course of business during the period of COVID-19 uncertainty. Debts incurred in the ordinary course of the company’s business include loans taken out to move a business online or to pay employees. If the debt is not incurred in the ordinary course of the company’s business, directors will need to rely upon the traditional safe harbor regime and take the steps necessary to protect themselves and the company under the original regime.

The debts incurred by a company that fit these requirements are still due and payable by the company in the normal way. This means that the director is only protected by the temporary defence to insolvent trading if the debts have been repaid by 1 January 2020, a plan to repay the debts has been established by 1 January 2020 or, if the company cannot pay its debts, the company is put into administration or liquidation prior to 31 December 2020.

All companies, and their directors, who have traded during the COVID-19 period in reliance on the protections are encouraged to urgently consider the application of this risk to their circumstances and take advice.


The matters that directors now need to consider to properly understand their position and consequences are complicated and in some respects opaque. The interaction between the obligations and possible actions contained in the patchwork of legislation is in many cases unknown.

Somewhat unfairly, the position seems to be that directors must take into account now the effect of changes proposed from 1 January 2021, without the benefit of knowing all of the detail of what those changes will actually be.

A director of a company struggling with solvency right now, will need to consider:

  • The company’s financial position and how best to manage that.

  • Their own exposure for insolvent trading in the period up to 31 December 2020.

  • The likelihood of the company maintaining financial viability into 2021.

  • The merit of a voluntary administration, liquidation or safe harbor regime now, before 31 December 2020, in order to gain protection from personal liability for insolvent trading for debts incurred in that period.

  • The possibility that the new small business regime will provide an ability to restructure so that all of the debts of the company (including pre-31 December 2020) are dealt with, thereby managing any personal exposure for the pre-31 December 2020 period.

  • The possibility that despite action taken by the company in 2021 under the small business regime, debts pre-dating 31 December 2020 remain unpaid in a liquidation event, giving rise to potential personal exposure for insolvent trading in any event.

Our insolvency and restructuring team can help…reach out to the team at Bartier Perry for tailored advice and assistance.

Note: This publication has been prepared from the initial information provided by the Federal Government of Australia as at the date of publication and may be subject to change following the passing legislation to give effect to the Small Business Insolvency regime.


[1] This article should not be used in substitution for legal advice that is specific to your business and circumstances. We encourage everyone to consider seeking proper legal advice as soon as possible to ensure they are prepared for the new regime or properly set up to use the traditional regime.

[2] On 17 November 2020, Treasury released an Exposure Draft of the Corporations Amendment (Corporate Insolvency Reforms) Regulations 2020 (Draft Regulations) and Insolvency Practice Rules (Corporations) Amendment (Corporate Insolvency Reforms) Rules 2020 which provides the first real insight into how the new small business restructuring process is intended to work in practice.


Authors: Gavin Stuart and Emma Boyce