Directors' Duties and How to Avoid Insolvent Trading

Your duties as director are usually to your shareholders. However, if your company is insolvent (or may be insolvent in the near future) those duties expand to include creditors such as trade creditors, the Australian Tax Office (ATO), banks and employees.

General Duties

General duties imposed by the Corporations Act on directors and officers of companies include:

• Care and diligence – taking steps to ensure you’re properly informed about the financial position of the company, and ensuring it doesn’t trade if it’s insolvent.
• Good faith – making decisions in the best interests of the company and its creditors.
• Not using your position to gain an advantage for yourself or someone else, or to cause detriment to the company.
• Not improperly using information obtained through your position to gain an advantage for yourself or someone else, or to cause detriment to the company.

Duty to Not Trade While Insolvent

As well as the general directors’ duties, you also have a duty to prevent your company trading if it’s insolvent (i.e. unable to pay all of its debts and bills as they fall due). For more information on insolvent trading and see our insolvent trading page.

The penalties for trading while insolvent include any of the following:

• civil penalties of up to $200,000
• compensation proceedings that could lead to bankruptcy
• criminal charges leading to fines of up to $200,000 and/or imprisonment for up to 5 years.

To find out if your company may be insolvent, fill out our checklist of insolvency indicators.

Duty to Keep Books and Records

Having well-maintained and accurate books and records is a vital part of your business arsenal. Not only does it give you the information you need to improve your business, it can also keep you on the right side of the law.

Here are two very good reasons to stay on top of your business’ books and record-keeping.

The ‘carrot’: First, there are the business benefits:

• You’ll have the financial data you need to operate more efficiently and increase your profitability.
• They’ll give you a complete picture of your business’ assets, liabilities, income and expenses, which you can use to compare your business with others in the same sector and discover your strengths and weaknesses.
• Good records are essential for preparing your end-of-year returns and financial statements, not to mention maintaining good relations with your bank.
• They’ll make your accountant’s job a lot easier, which could mean lower accounting fees/costs.
• You’ll be better placed to make informed decisions quickly.
• You can relax, knowing you’re fully compliant with your taxation and other legislative obligations.

As you can see, properly maintained books and records plays a crucial role in a business’ success. Unfortunately, businesses often fail to keep them up to date, which can get them into trouble. And if the business goes bad, it can make things very difficult for those managing the fallout.

The ‘stick’: Then there are the legislative requirements:

Failing to maintain proper books and records can prove restrictive, and may even constitute an offence under the Corporations Act 2001 or taxation legislation. And this can lead to penalties from the Australian Securities and Investments Commission (ASIC) and/or the Australian Taxation Office (ATO).

Companies are legally required to maintain written financial records that:

• correctly record and explain its transactions, and financial position and performance
• would enable true and fair financial statements to be prepared and audited.

What’s more, they need to be retained for seven years after the transactions they cover have been completed.

Section 262A of the Income Tax Assessment Act 1936 also states that records must be retained for five years after they’ve been prepared, obtained, or the transactions completed (whichever occurs last). And if there’s a specific tax matter (such as capital gains tax), they may need to be kept even longer.

You can store your financial records electronically, and many accounting software packages can help you do this. But you must be able to produce hard copies in a reasonable time frame and make them available to anyone entitled to inspect them.

Both ASIC and the ATO have guidelines on what records you should keep.

If your business is struggling, see how we can help with our Instant Online Assessment.