In December 2024, ASIC released an update to its guide to Insolvent Trading and Safe Harbour for the benefit of Directors and their advisors, registered liquidators, and creditors. This 45-page document updates several previous guides on this issue. Whilst the guidance is certainly appreciated, it struck me that the law in this area was incredibly (and unnecessarily) complex. It caused me to consider if the existing legislation was fit for purpose.  

Unfortunately, I do not think it is, and I will explain why. 

Let me take you back to 1993, in a world immediately before the Corporate Law Reform Act (“CLRA”) 1993 and the Harmer Report on which it was based. Pre-Voluntary administrations, pre-Deeds of Company Arrangement, and pre-the existing insolvent trading provisions contained in Section 588G (although something very similar did exist in the form of Section 592).  

The opportunities for a business to restructure were minimal. There were Schemes of Arrangement (court-driven, expensive, and only suitable for the big end of town) and Official Management, which was inflexible and required a dividend of 100 cents in the dollar to be paid to creditors over time. It was unsurprising then that the Harmer Report suggested a low-cost, out-of-court alternative for restructuring businesses of all sizes. 

Let me say up-front that I think that Ron Harmer and his team (including Professor Richard Fisher) were brilliant, and the VA/DOCA concept has served us well and will continue to do so, but VA’s and DOCAs were only one side of the equation.  

Upon the introduction of the CLRA there was a lot of talk about the carrot and the stick approach. On the one hand, we had this new debtor-friendly process where Directors could choose their own practitioner, continue to trade, and offer a flexible proposal to deal with their creditors, which resulted in a fresh start for the business. That was the carrot. On the other hand, we had these new provisions (Section 588G), which would make Directors personally liable for debts if they were incurred whilst the Company was insolvent. Section 588G (3) even provided for criminal liability. This was the substantial stick. 

When questioned by Senator Wong at a parliamentary hearing on 17 September 2003 about encouraging Directors to take early steps toward rehabilitation, Mr Harmer said,  
“We endeavoured to do that in the report by doing two things – firstly, offering this type of system, and secondly, imposing what we hoped would be a more compelling personal liability on Directors if they failed to take relatively early and remedial steps. That was the so-called stick, and the carrot was the user-friendly system.” 

Unfortunately, the practical application of Section 588G has turned out to be more of a twig than a stick, and the criminal aspect is more like a feather. 

The problem with Section 588G 
The principal problem I have with Section 588G is the time and money required to progress a claim. Even in circumstances where a Director holds personal assets or there is an insurance policy available to meet the claim, it is not uncommon for reasonably sized claims to be uncommercial to pursue. Once litigation funding is factored in, the commerciality issue becomes even more difficult to justify. Why is it so expensive? Well, it is expensive because it is complicated and uncertain. I accept that all litigation is expensive, but let’s make it easier on ourselves by having law that is clear and concise and remove some of that uncertainty.. 

Let's start with the definition of insolvency. Section 95A of the Corporations Act says: 

It's not exactly clear-cut. And, on top of considering what assets the Company might have had to meet its liabilities, consideration needs to be given to: 

All of these require analysis by an independent expert or two, or maybe a referee. And it is usually necessary to conduct public examinations of the relevant parties to obtain a picture of who knew what and when, all of which are increasingly costly. 

The safe harbour defence 
Then there is consideration of the defences that may be available to a director, which brings me back to Regulatory Guide 217 and the additional Safe Harbour defence. There are so many concepts here that are unclear and will remain unclear for some time in the absence of a considerable body of judicial analysis. 

Some examples include: 

Obviously, the regulatory guide seeks to provide some assistance in this area. Still, these issues will add to the cost and complexity of an already expensive insolvent trading claim once we begin to see this defence raised. 

The role of ASIC 
Not all insolvent trading claims are going to be commercial to pursue. And we still need that “stick” to ensure compliance with the law and to encourage early action by Directors. This is why ASIC is empowered to take action against Directors for insolvent trading, including criminal proceedings pursuant to Section 588G (3) if thought fit. 

Since Section 588G was introduced in 1993, I have calculated that approximately 250,000 companies have entered external administration. In a news article by the ABC on 26 October 2023, it was reported that based on reports lodged by Liquidators for construction companies in the 21/22 financial year, 74% of those companies were suspected of trading while insolvent.  

The article went on to say that: 
“an ASIC spokesperson admitted that no criminal or civil action had been taken against a builder or construction company Director in Australia over the misconduct.“ 

In that same article, Geoffrey Watson SC, a former counsel assisting NSW’s Independent Commission Against Corruption, said. 
“What message does it send when nobody is prosecuted?” 

My own research has identified 4 instances in the last 30 years where ASIC has taken action against a director for insolvent trading. There may be more that I have missed, but there aren’t 20; there probably aren’t even 5. 

When pressed on this issue, the former ASIC regional commissioner Pamela Hanrahan said that acting against home builders suspected of insolvent trading was a “huge sore point” for ASIC and went on to say  
“if ASIC wants to prosecute the small end of town to protect very vulnerable people who pay deposits and lose them, ASIC should go back to government and ask for more money.”  

In a surprising admission, she also said, 
“But ASIC doesn’t want to publicly say we’ve got Buckley’s chance of prosecuting you.” 

I hear you Pamela, but how about ASIC becomes pro-active in trying to fix the system? It’s clearly broken, and while I don’t want to see ASIC spend money chasing prosecutions they can’t obtain, I also don’t want Directors taking creditors and the ATO for a ride, knowing full well that there will be no consequences (or at best a banning order). 

What is the solution 
Plenty of work needs to be done to fix the current insolvency system, so I have long been part of the chorus calling for a “root and branch” review.  

Insolvency reform is rarely at the top of a government agenda as it is unlikely to be a vote winner. Still, the ATO and small creditors are losing billions annually to Directors who innocently or deliberately fail to pay their creditors, which is cause for action. 

I’m no Ron Harmer, but a possible fix to this particular problem would be simplifying the basis on which a director’s personal liability would arise.  

We already have a presumption of insolvency in circumstances where adequate books and records have not been maintained. A checklist of issues that are prima facie evidence of insolvency could be created. 

For example, significant non-payment of superannuation liabilities for the preceding 6 months (also setting a threshold for significant) or significant non-payment of PAYG obligations for a defined period. Or maybe even calculating a threshold of trade creditors being paid outside required terms. There are several things that could be considered, anything that might provide certainty (for both sides) to avoid this lengthy and expensive litigation and make sure that Directors become accountable for reckless or deliberate insolvent trading. 

Please ASIC, support the profession in seeking to obtain legislation that is fit for purpose. We are in this together.