A Quick Guide to Insolvency and Insolvent Trading
Running a business on the Sunshine Coast is a dream for many, but as any seasoned business owner knows, the tide can turn quickly. When the numbers stop adding up, two terms often start flying around: insolvency and insolvent trading. While they sound similar, they represent different legal realities. At Bradley & Bray, we believe that understanding these concepts isn’t just for accountants; it’s also a vital survival skill for every director.
What is Insolvency?
In Australia, the law uses a cash flow test. Your company is solvent if it can pay all its debts as and when they become due and payable. If it can’t, it is insolvent.
It’s important to note that insolvency in business isn’t always about your balance sheet. You might own a million dollars’ worth of equipment, but if you don’t have the cash in the bank to pay your staff this Friday or settle an ATO bill that was due yesterday, your company is technically insolvent. It’s a matter of timing and liquidity, not just total wealth.
What is Insolvent Trading?
This is where things get serious for company directors. Insolvent trading occurs when a company continues to incur new debts while it is already insolvent, or becomes insolvent by taking on that debt.
Directors have a positive legal duty to prevent their company from trading while insolvent. If there are reasonable grounds for suspecting that the company can’t pay its way, but you keep ordering stock, signing new leases, or taking out loans, you are likely trading while insolvent in Australia.
The Personal Risk: Why Directors Should Care
Unlike many other areas of corporate law, insolvent trading in Australia can “pierce the corporate veil.” This means the usual protection of a “Pty Ltd” company disappears, and directors can be held personally liable for the company’s debts.
If a liquidator proves you were involved in an insolvent trading, you could be ordered to pay those debts out of your own pocket—putting your family home or personal savings at risk. Beyond the money, there are also civil penalties, disqualification from managing companies, and even criminal charges if there was an element of dishonesty involved.
What is the Insolvency Process?
If you suspect your business is in trouble, it’s vital to understand what the insolvency process is. It’s not an immediate “game over.” Instead, it’s a series of legal pathways that can either save the business or wind it down fairly.
Voluntary Administration: An independent expert (an administrator) takes the wheel to see if the business can be saved or if a Deed of Company Arrangement (DOCA) can be made with creditors.
Small Business Restructuring: A newer, simpler process for eligible small businesses to negotiate a plan with creditors while directors stay in control.
Liquidation: If the business can’t be saved, a liquidator sells the assets to pay back creditors as fairly as possible.
Receivership: Usually triggered by a bank or secured creditor to recover a specific debt.
What Happens After Insolvency?
Many people ask, “What happens after insolvency?” The answer depends on the path taken. In a successful restructure, the company emerges leaner and more stable. In a liquidation, the company eventually ceases to exist and is deregistered by ASIC.
For directors, the focus after insolvency is often on the liquidator’s investigation. They will look for preferential payments (where you paid back your brother but not the ATO) and, of course, evidence of whether you were trading while insolvent in Australia before the professional help arrived.
The “Safe Harbour” Lifeline
The law isn’t just about punishment; it’s also about encouraging directors to try and save their businesses. Australia has “Safe Harbour” provisions that can protect directors from personal liability for insolvent trading if they are actively pursuing a course of action that is reasonably likely to lead to a better outcome for the company than immediate liquidation.
To access this, you generally need to keep proper records, pay employee entitlements, and, most importantly, seek professional advice from a qualified business lawyer and accountant.
Frequently Asked Questions About Insolvency
What is the difference between bankruptcy and insolvency?
While often used interchangeably, there is a distinct legal difference. Insolvency is a financial state—it’s the umbrella term for when a person or a company cannot pay their debts on time. Bankruptcy, on the other hand, is a specific legal process that applies only to individuals. Companies in Australia don’t go “bankrupt”; they instead enter liquidation or administration. However, if a director is held personally liable for company debts (like through insolvent trading), that personal debt could eventually lead to their own bankruptcy.
Can I be held liable for debts if I didn’t know the company was insolvent?
The law uses a “reasonable person” test. You cannot simply claim you didn’t look at the books. If a reasonable person in your position as a director should have suspected the company was in trouble, you can still be held liable for insolvent trading in Australia. This is why keeping up-to-date financial records is not just good business—it’s your legal shield, too.
What is a Director Penalty Notice (DPN)?
A DPN is a notice issued by the ATO that makes a director personally liable for the company’s unpaid tax debts, specifically PAYG withholding, GST, and Superannuation Guarantee Charges. There are two types: “Traditional” (which gives you 21 days to take action to avoid liability) and “Lockdown” (which makes you automatically liable if company lodgements are more than three months late). In 2026, the ATO is increasingly proactive with these, so timely lodgement is non-negotiable.
What are the “red flags” that I should be looking for?
Insolvency rarely happens overnight. Common warning signs include:
Consistently defaulting on tax or superannuation payments.
Suppliers are moving you to cash on delivery (COD) terms.
Making round sum payments to creditors rather than paying specific invoices.
Overdraft facilities are constantly at their limit.
Legal demands or letters from solicitors are starting to pile up.
Does insolvency always mean the business has to close?
Not at all. What happens after insolvency depends on how quickly you act. Options like Small Business Restructuring or Voluntary Administration are designed specifically to give viable businesses a chance to reset and continue trading. Many iconic Australian brands have survived insolvency by using these legal pathways to restructure their debt.
Can I resign to avoid liability for insolvent trading?
Resigning does not wipe the slate clean. If you were a director at the time the debt was incurred while the company was trading while insolvent, you remain liable for that specific debt even after you leave. In fact, resigning during a crisis without ensuring the company is being properly managed can sometimes be seen as a breach of your director’s duties.
The Golden Rule: Act Early
One of the most common reasons businesses fail to survive insolvency is that professional advice was sought too late. If you’re worried about your company’s ability to meet its debts, don’t wait for a statutory demand to land on your desk.
At Bradley & Bray Lawyers, we provide clear, strategic commercial advice to help Sunshine Coast directors navigate financial distress. We can provide industry referrals and support to help you through the process. Reach out to us today.
Disclaimer: This article is general in nature and does not constitute legal advice. If you require legal advice in relation to your personal circumstances, you must formally engage our firm, or another firm to provide legal advice in relation to your matter. Bradley & Bray lawyers take no responsibility for any use of the information provided in this article.
