S588H Corporations Act: Defences to Insolvent Trading

If you’re a director of an Australian company, the thought of “insolvent trading” can be worrying - and for good reason. Company directors can be held personally liable if the company incurs new debts while insolvent. That’s a serious risk for any small business, especially during cash flow crunches.

The good news is that the Corporations Act 2001 (Cth) includes specific defences for directors under s588H. If you take the right steps and keep proper records, you may be able to rely on one of these defences if your company hits trouble.

In this guide, we’ll unpack s588H in plain English, outline the practical steps you can take now to protect yourself, and explain how it sits alongside “safe harbour” and your other director duties. Our goal is to give you clarity and confidence so you can lead your business responsibly - and reduce your personal risk.

What Is s588H And Why Does It Matter To Small Businesses?

Section 588G of the Corporations Act creates the duty to prevent insolvent trading. In short, directors must stop a company from incurring debts when it is insolvent (unable to pay its debts as and when they fall due), or when there are reasonable grounds to suspect insolvency.

Section 588H is the flip side: it provides the statutory defences a director can rely on if the company did incur a debt that is later challenged. These defences recognise that directors often make decisions with imperfect information, and that diligent, proactive steps should be protected.

Why it matters to small businesses: when times are tight, directors are often close to the numbers and making quick decisions about credit, payroll and supplier terms. Understanding s588H helps you put the right processes in place now - board oversight, forecasting, external advice and documentation - so you have a stronger position if your judgment is later questioned.

It’s also wise to keep your broader governance in order - from adopting a clear Company Constitution to regular board processes - because those structures support better decisions and better evidence.

When Does Insolvent Trading Risk Arise?

The risk generally arises where:

• The company is already insolvent, or there are reasonable grounds to suspect it’s insolvent; and
• The company incurs a new debt (for example, ordering stock on credit, taking a loan, signing a new lease, or entering an expensive contract).

“Reasonable grounds” is judged objectively. It’s not about whether you personally felt confident - it’s whether a reasonable person in your position would have expected the company could pay its debts as they fall due.

Warning signs might include persistent late payments, demands from creditors, bounced payments, maxed-out facilities, or forecasts showing no capacity to meet upcoming liabilities like BAS or super.

As a director, you should also be across your ongoing governance obligations - for example, the board’s annual resolution about solvency. Keeping on top of your solvency resolution processes (and the reasoning behind them) can be powerful context if your decision-making is scrutinised later.

The s588H Defences: How Do They Work?

There are four main defences in s588H. Each has its own elements, but they all depend on what you knew (or reasonably believed) at the time, and what steps you took in the circumstances. Good records are essential.

1) Reasonable Expectation Of Solvency

You can defend a claim if, at the time the debt was incurred, you had reasonable grounds to expect the company was solvent and would remain so. This is more than a “hope” - it means a rational basis backed by information.

Helpful evidence includes up-to-date cash flow forecasts, rolling 13-week cash reports, budgets approved by the board, and recent creditor reconciliations. Minutes showing the board considered liquidity, covenants and contingencies also help show you were acting on reliable information, not guesswork.

2) Reasonable Reliance On A Competent Person

This defence applies where you reasonably expected solvency based on information provided by a competent and reliable person (for example, your CFO or an external accountant), and you reasonably believed that person was responsible for providing accurate financial information.

To use this defence, show the person’s qualifications, the scope of their engagement, the reports they provided, and how the board considered those reports. The business judgment rule complements this approach - document the information you relied on, the alternatives you weighed, and why the decision was in the company’s best interests at the time.

3) Illness Or Good Reason For Non-Participation

If you didn’t take part in management at the relevant time because of illness or another “good reason,” you may have a defence. This is narrow - it doesn’t excuse disengagement. You’ll need evidence that you were genuinely unable to participate (for example, medical records) and that the non-participation was reasonable in the circumstances.

4) All Reasonable Steps To Prevent The Debt

Where you were aware of potential insolvency, you may still avoid liability if you took “all reasonable steps” to prevent the company incurring the debt. This can include calling urgent board meetings, escalating concerns, insisting on cash-on-delivery terms, pausing new purchases, seeking new equity, or pushing for a formal restructuring process.

Board papers that show you advocated risk controls or opposed risky commitments are valuable. So are Directors’ Resolution records that capture decisions and dissent.

How To Build Evidence For A s588H Defence (Practical Steps)

Even if your business is healthy, putting these practices in place now will help you manage risk - and prove your position if it’s ever challenged.

• Run rolling cash flow forecasts: Maintain a 13-week cash flow model with weekly updates, sensitivity analysis and assumptions. Include upcoming BAS, super, loan repayments and ATO plans.
• Schedule regular board reviews: Ensure the board reviews liquidity, debtors, bank covenants and creditor aging at every meeting. Record the discussion and decisions in minutes and a simple Directors’ Resolution.
• Obtain timely financial reports: Formalise responsibilities for management accounts, forecasts and KPIs. If you rely on your CFO or accountant, document their role and qualifications.
• Keep governance current: Adopt and follow your Company Constitution, set clear delegations, and ensure board packs are circulated in advance. Good governance supports good decisions.
• Seek independent advice early: If warning signs appear, get restructuring or insolvency advice promptly. Evidence that you engaged qualified advisors and acted on their advice supports several defences.
• Document the basis for key decisions: Capture why you believed the company would remain solvent when entering new credit terms, leases or large orders. Keep emails, board packs, lender correspondence and scenario planning.
• Control commitments: Introduce approval thresholds for new debts, tight purchasing policies, and cash-before-delivery where needed. These are “reasonable steps” if things deteriorate.
• Revisit solvency regularly: Don’t treat solvency as a once-a-year tick box. Your annual solvency resolution is important, but so is ongoing monitoring and recording your rationale.

It’s also prudent to consider director protection in your wider risk framework. Many companies put in place a Deed of Access & Indemnity and D&O insurance. A properly drafted Deed of Access & Indemnity helps ensure access to company books for defence purposes and sets out indemnity rights (noting statutory limits).

Safe Harbour vs s588H: What’s The Difference?

Directors often hear about “safe harbour” and wonder how it connects to s588H. They are related but different tools.

• Safe harbour (s588GA) protects directors from insolvent trading liability if, after suspecting insolvency, they start developing and implementing a course of action that is reasonably likely to lead to a better outcome for the company than immediate administration or liquidation. It’s forward-looking and requires ongoing compliance (like paying employee entitlements and taxes on time).
• s588H is a set of defences you may raise later if a specific debt is challenged. It looks at what you knew and did at the time the debt was incurred (reasonable expectation of solvency, reliance on a competent person, illness/good reason, or all reasonable steps to prevent the debt).

You can use safe harbour proactively to create breathing space for a turnaround. s588H is more about explaining and evidencing why a particular decision was reasonable at the time. In practice, a well-run safe harbour process often generates strong documentation that also supports s588H-style arguments.

Common Pitfalls And How To Reduce Personal Exposure

When cash is tight, pressure builds - from lenders, suppliers and within the team. Here are common traps and practical ways to reduce risk while staying compliant.

• Avoid informal assumptions: Verbal assurances about future funding or sales often don’t eventuate. Insist on written funding commitments and update forecasts before taking on new debts.
• Don’t ignore tax and super: Falling behind on PAYG, GST or super is a red flag and can create personal exposure under other regimes. Escalate these issues early.
• Be cautious with personal guarantees: Offering fresh guarantees to suppliers or lenders when the business is under stress can amplify your personal risk. Understand the implications of any new Personal Guarantee and consider alternatives like cash-on-delivery terms.
• Check security documents: New finance may come with a General Security Agreement over company assets. Ensure the board understands covenants, events of default and cash implications before signing.
• Don’t “set and forget” forecasts: Update your cash flow weekly and compare actuals to forecast. If performance deteriorates, revisit spending and commitments immediately.
• Address conflicts: If a director is also a creditor or related party, manage conflicts properly. Record disclosures and ensure decisions are made in the company’s best interests.
• Resigning isn’t a cure-all: Stepping down doesn’t remove liability for debts incurred while you were on the board. If you must resign, ensure an orderly handover and that your concerns are clearly recorded.
• Paper the process: Keep board packs, minutes, emails and advice files organised and accessible. If a claim arises years later, your ability to produce contemporaneous records is crucial. A clear Company Constitution and board protocols make this easier in practice.

FAQs About s588H For Small Business Directors

Is a “reasonable expectation” the same as optimism?

No. A reasonable expectation of solvency should be supported by reliable data - current cash flow forecasts, debtor reports, funding agreements and board analysis. Optimism without evidence won’t satisfy the test.

Can I rely on my CFO or accountant?

Yes, if your reliance is reasonable. The person must be competent, responsible for the relevant information, and you should actually consider and question the information provided. Document the scope of their role and the reports you relied on.

What counts as “all reasonable steps” to prevent a debt?

It depends on the context, but examples include pausing non-essential purchases, switching to COD terms, escalating issues to the board, engaging turnaround advisors, pursuing equity or formal restructuring, and opposing risky commitments - and recording those steps in minutes and Directors’ Resolutions.

How does D&O insurance fit into this?

Directors & Officers insurance can help with defence costs and some liabilities (subject to the policy and legal limits). Combine it with a robust Deed of Access & Indemnity and strong governance to maximise protection.

Key Takeaways

• s588H provides four key defences to insolvent trading allegations: reasonable expectation of solvency, reasonable reliance on a competent person, illness/good reason for non-participation, and taking all reasonable steps to prevent the debt.
• These defences rely on what you knew and did at the time - strong, contemporaneous records (forecasts, board minutes, advisor reports) make all the difference.
• Implement practical habits now: rolling cash forecasts, board reviews, documented decisions, and early external advice when warning signs appear.
• Safe harbour (s588GA) is complementary but different - it’s a proactive framework to pursue a turnaround while limiting insolvent trading exposure.
• Be careful with new commitments under stress (leases, guarantees, supplier credit) and make sure the board understands the financial and legal implications before proceeding.
• Good governance - from your Company Constitution to regular solvency resolutions and clear Directors’ Resolutions - supports better decisions and stronger s588H positions.

If you’d like a consultation about s588H, insolvent trading risk and director protections for your company, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.