# LAW-0003 - Directors' duties and insolvent trading

*This is a benchmarking hypothetical, not legal advice. Law stated as at FY2025-26 (Commonwealth of Australia).*

## Short answer

| Requirement | Answer |
| --- | --- |
| (a) Controlling Act | **Corporations Act 2001 (Cth)** |
| (b) Directors' duties provisions engaged | **s 180** (care and diligence), **s 181** (good faith / proper purpose), **s 182** (use of position), **s 183** (use of information). Plus the general-law fiduciary duties these statutory duties sit alongside (preserved by **s 185**). |
| (c) Insolvent trading provision | **s 588G** (director's duty to prevent insolvent trading) |

## The facts and the law

### (a) The controlling Act

The conduct of a director of an Australian proprietary company is governed by the **Corporations Act 2001 (Cth)** (the "Corporations Act"). It is administered by the Australian Securities and Investments Commission (ASIC). A "small proprietary company" is itself a creature of that Act (s 45A). All of the duties and the insolvent-trading liability below are provisions of this single Act.

### (b) The directors' duties provisions engaged

A director is an "officer" who owes the statutory duties in Part 2D.1 of the Corporations Act. On these facts the following are engaged:

- **Section 180 - Care and diligence.** A director must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise in the director's position. **Key concept:** the objective standard of the reasonable director. Continuing to trade and incur new credit while warned by the bookkeeper that the company looks insolvent, with no realistic funding prospect, is the paradigm of failing to act with reasonable care and diligence. (s 180(2) provides the business-judgment-rule safe harbour, but it is unavailable here because a decision to keep ordering stock on credit when insolvent is not made on an informed, rational, good-faith basis in the company's best interests.)

- **Section 181 - Good faith and proper purpose.** A director must exercise their powers and discharge their duties in good faith in the best interests of the company and for a proper purpose. **Key concept:** loyalty - the director must act for the company, not against it. Diverting a profitable customer contract away from the company to a separate company the director personally owns is a clear breach: it is not in the company's best interests and serves an improper (personal) purpose. This is the statutory counterpart of the general-law fiduciary duty to avoid conflicts and not to misappropriate corporate opportunities.

- **Section 182 - Improper use of position.** A director (or other officer/employee) must not improperly use their position to gain an advantage for themselves or someone else, or to cause detriment to the company. **Key concept:** no improper personal advantage from the office. Using the directorship to steer the company's profitable contract into the director's own separate company is an improper use of position to gain an advantage for the director (and that other company) and to the detriment of the company.

- **Section 183 - Improper use of information.** A person who obtains information because they are (or were) a director or officer must not improperly use that information to gain an advantage or cause detriment to the company. **Key concept:** no improper personal advantage from corporate information. Knowledge of the customer relationship, terms and value - obtained through the directorship - used to capture that contract for the director's own company engages s 183.

- **Section 185** preserves the parallel **general-law (fiduciary and equitable) duties** - the duty to act bona fide in the company's interests, to avoid conflicts of interest and duty, and not to misuse corporate opportunities. The diversion of the contract breaches those fiduciary duties as well as the statutory ones (the "corporate opportunity" doctrine; cf. *Cook v Deeks* [1916] 1 AC 554; *Regal (Hastings) Ltd v Gulliver* [1967] 2 AC 134).

**Nature of liability for ss 180-183:** these are **civil penalty provisions** (Corporations Act s 1317E). A contravention can attract a declaration of contravention, a pecuniary penalty, disqualification from managing corporations (s 206C), and a compensation order (ss 1317H, 1318). Dishonest breaches of ss 181-183 can also be **criminal offences** (s 184).

### (c) The insolvent trading provision engaged

- **Section 588G - Director's duty to prevent insolvent trading by the company.** **Key concept:** a director must not let the company incur a debt when it is insolvent (or would become insolvent by incurring it) if, at the time, there are reasonable grounds to suspect insolvency.

  The duty bites where (s 588G(1)): the person was a director when the company incurred a debt; the company was insolvent at that time or became insolvent by incurring it (insolvency tested by the **cash-flow test** in s 95A - unable to pay all debts as and when they become due and payable); and at that time there were reasonable grounds to suspect the company was (or would become) insolvent.

  The director **contravenes** s 588G(2) if they were aware there were such grounds for suspecting insolvency, or a reasonable person in a like position in the company's circumstances would have been so aware. On the facts, the company **has stopped paying its debts as they fall due** (strong indicator of cash-flow insolvency), has **no realistic prospect of new funding**, and the director **was expressly warned by the bookkeeper** that the company looks insolvent - so the "reasonable grounds to suspect" element and the director's awareness are squarely met. Each new order of stock on credit is a fresh **debt incurred** while insolvent.

  **Consequences:** s 588G(2) is a **civil penalty provision** (penalty, disqualification, and - critically - a **compensation order** under ss 588J/588M for the loss suffered by unsecured creditors in respect of the insolvently incurred debts). Where the director's failure to prevent the debt was **dishonest**, s 588G(3) creates a **criminal offence**.

  **Defences (s 588H)** include reasonable grounds to expect solvency, reasonable reliance on a competent person providing information about solvency, absence from management for a good reason, and taking all reasonable steps to prevent the debt (e.g. moving to appoint an administrator). None is available here: the director was warned, had no reasonable basis to expect solvency, and kept ordering stock rather than stopping or appointing an administrator. (The **safe harbour** in s 588GA - for debts incurred while developing a course of action reasonably likely to lead to a better outcome - also does not assist: there is no genuine restructuring plan, no realistic funding, and the director is simultaneously stripping value out of the company.)

## How the two limbs interlock on these facts

- **Continuing to trade and order stock on credit while insolvent** -> s 588G (insolvent trading), and is also a breach of the s 180 care-and-diligence duty.
- **Diverting the profitable customer contract to the director's own company** -> ss 181, 182 and 183 (and the parallel fiduciary duties preserved by s 185), because it is a disloyal, improper-purpose use of the director's position and corporate information/opportunity for personal advantage and to the company's detriment.

These point in the same direction - they aggravate the position of the company's unsecured creditors - and would commonly be pursued together by a liquidator and/or ASIC.

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## Approach

The task is a self-contained Australian corporations-law hypothetical, so I answered it directly from the controlling legislation rather than from any repository content. I mapped each fact to its statutory hook: the trade-on-credit-while-insolvent facts (stopped paying debts, no funding, bookkeeper warning) to the director's duty to prevent insolvent trading (s 588G, with the s 95A cash-flow insolvency test and the s 588H defences/s 588GA safe harbour noted as unavailable), and the diverted-contract facts to the Part 2D.1 directors' duties (ss 180-183, plus the general-law fiduciary duties preserved by s 185). I named the controlling Act (Corporations Act 2001 (Cth)), gave the key concept behind each provision, and noted the civil-penalty / compensation / criminal consequences and why the standard defences and safe harbour do not apply on these facts.