S588H Defences To Insolvent Trading For Company Directors

Running a company comes with a lot of moving parts - cash flow, suppliers, payroll, tax, customer demand, and (sometimes) unexpected curveballs. If you’re a director of an Australian company, one risk that can sneak up quickly is insolvent trading.

Under the Corporations Act 2001 (Cth), directors can become personally liable if their company incurs debts while insolvent (or becomes insolvent by incurring those debts). That sounds scary - and it can be - but the law also recognises that directors often have to make fast decisions based on imperfect information.

That’s where s588H comes in. Section 588H of the Corporations Act sets out several key defences that can protect directors from insolvent trading liability, if the right circumstances apply and you can support them with evidence.

In this guide, we’ll walk you through what s588H is, how it works in practice for small businesses, and what you can do to reduce your risk before things become critical.

What Is Insolvent Trading (And Why Directors Should Care)?

Insolvent trading is broadly where a company continues to incur debts when it is insolvent, or where it becomes insolvent by taking on new debts.

In simple terms, a company is generally insolvent if it cannot pay its debts as and when they fall due.

Why does this matter for you as a director?

• Personal liability: directors can be made personally responsible for some of the company’s debts incurred during insolvent trading.
• Claims and investigations: insolvent trading issues commonly arise during liquidation, administration, or disputes with creditors.
• Flow-on risk: insolvency events can lead to employment issues, contract disputes, and regulatory scrutiny.

Many directors assume that incorporating a company automatically protects their personal assets in all scenarios. While a company structure can offer limited liability in many situations, insolvent trading is one of the big exceptions - and it’s why you need to understand your obligations early.

What Does S588H Of The Corporations Act Actually Do?

Section 588H of the Corporations Act sets out defences to a claim that a director is liable for insolvent trading. In other words, if you’re accused of insolvent trading (usually because the company incurred debts while insolvent), s588H gives you potential legal pathways to defend yourself.

These defences are not automatic. They depend on what you knew (or reasonably should have known), what steps you took, and the evidence you can produce.

At a high level, s588H recognises that directors may not always be aware of insolvency in real time - especially in smaller companies where people wear multiple hats and financial reporting isn’t always perfect.

However, it also expects directors to be proactive. If you “hope for the best” without taking reasonable steps, it can be difficult to rely on s588H later.

It’s also worth noting that s588H is not the only protection in this area. Separate to s588H, directors may also have access to the “safe harbour” protection under s588GA in certain restructuring circumstances. Safe harbour has its own requirements and is not automatic, so it’s important to get advice if you think it may apply.

The Key S588H Defences Explained In Plain English

There are several defences under s588H. Which ones may apply depends on your company’s circumstances and your role as a director.

1. You Had Reasonable Grounds To Expect The Company Was Solvent

One of the main s588H defences is where you can show that, at the time the debt was incurred, you had reasonable grounds to expect the company was solvent (and would remain solvent).

Two points matter here:

• Expectation is stronger than hope: it’s not enough to “feel optimistic”. You usually need a factual basis (like cash flow forecasts, debtor reports, confirmed funding, or up-to-date financial statements).
• Reasonable grounds: your belief has to be objectively reasonable, not just personally believed.

For small businesses, this defence often depends on how well the company’s finances were monitored. If you’re making decisions without current financial info, it becomes harder to show you had reasonable grounds.

2. You Relied On Information From A Competent Person

Another key defence under s588H is where you relied on information provided by someone else, and that reliance was reasonable.

This is particularly relevant if your company has:

• a CFO, finance manager, or bookkeeper providing regular financial updates
• external accountants providing financial information or reporting
• another director with primary responsibility for financial management

However, “reliance” doesn’t mean you can completely disengage. As a director, you still need to take an active interest in the company’s financial position. If there are red flags (for example, persistent overdue liabilities, unpaid suppliers, or dishonoured payments), it may not be reasonable to rely on reassurance without verifying the numbers.

3. You Were Absent From Management Due To Illness Or Another Good Reason

S588H also recognises that a director may not take part in management for a valid reason, such as illness or other circumstances.

In practice, this defence can be complex. It’s not a “get out of jail free” card - especially if you remained formally appointed as a director but didn’t take steps to resign (if appropriate), ensure the company had proper oversight, or address known financial risks.

If you’re not able to participate in management, it’s worth getting advice early about your options and your ongoing responsibilities.

4. You Took All Reasonable Steps To Prevent The Company From Incurring The Debt

This defence focuses on what you did once you suspected (or should have suspected) insolvency.

Examples of “reasonable steps” may include:

• requesting updated financial reports and cash flow forecasts
• calling director meetings and documenting decisions
• insisting on cost reduction measures
• seeking restructuring advice
• attempting to renegotiate payment terms with major creditors
• refusing to approve certain purchases or contracts

For many directors, this is the defence that becomes most practical: if you see warning signs, you start taking active steps to stop (or tightly control) new debts being incurred until solvency is clear.

How To Tell If Insolvency Risk Is Building In Your Business

A big challenge with insolvent trading is that insolvency is not always obvious on day one. Many businesses can look “busy” while still being unable to pay debts as they fall due.

Here are common warning signs directors should take seriously:

• suppliers moving you to cash-on-delivery (COD) or demanding shorter payment terms
• overdue BAS, PAYG, superannuation, or other tax-related liabilities
• you’re constantly juggling which bills get paid first
• repayment arrangements that keep being broken
• regular dishonours or returned direct debits
• increasing reliance on personal loans or director contributions to cover operating expenses
• inability to obtain finance, or finance only available at “last resort” rates

If you’re seeing several of these at once, it’s a good time to step back and get clarity fast - because your personal exposure as a director can increase every time the company takes on a new debt.

It’s also a good time to tighten your commercial arrangements. Clear documentation can help you control spending, renegotiate terms, and reduce disputes later. Depending on your business model, that may include improving your Terms of Trade so payment terms and enforcement rights are crystal clear.

Important: This article is general information and not tax advice. If you have BAS, PAYG, GST, superannuation or other tax-related concerns, you should speak with a registered tax agent or accountant about your specific situation.

Practical Steps Directors Can Take To Reduce Insolvent Trading Risk

The best time to think about insolvent trading is before things become urgent. Once you’re under serious pressure from creditors, your options narrow quickly.

Here are practical, director-friendly steps that can support both compliance and a potential s588H defence later (if you ever needed it).

Keep Financial Reporting Frequent And Useful

For small companies, “annual accounts” are not enough to safely steer the business.

Consider implementing:

• weekly or fortnightly cash flow tracking
• aged receivables and payables reports
• profit and loss reporting with real explanations (not just numbers)
• a clear view of tax and super obligations

If you’re relying on others, ask for reporting in a format you can actually understand and challenge. Directors are allowed to ask questions - and you should.

Document Key Decisions And Board Discussions

When solvency is uncertain, documentation matters.

Minutes, written resolutions, and emails confirming decisions can help show what you knew at the time and what steps you took. If your company governance documents are out of date or unclear, it may also be worth reviewing whether your Company Constitution supports effective decision-making (especially if you have multiple directors or shareholders).

Be Careful About Incurring New Debts

This is the heart of insolvent trading risk: new debts.

In practice, “debts” can include a wide range of payment obligations the company becomes legally committed to. Depending on the circumstances, this may include:

• new supply orders (including orders placed on credit terms)
• new leases or ongoing lease commitments
• contractual obligations to customers or suppliers that create payment liabilities
• employment-related liabilities (such as wages and super)

If you’re continuing to trade during a rough patch, it’s worth pressure-testing the assumptions: “What money is coming in, when will it land, and what must we pay before then?”

Check Your Contracts So You Can Act Quickly

Good contracts don’t “fix” insolvency, but they can make it easier to manage cash flow and risk when things tighten.

Depending on your business, that may include:

• Customer contracts: clear payment terms, scope, and limitation of risk
• Supplier agreements: certainty on delivery, payment terms, and termination rights
• Employment documentation: correct classification, pay terms, and termination processes

If you employ staff, having the right Employment Contract helps you manage obligations properly - and reduces the risk of disputes that can become especially costly during financial stress.

Be Realistic About Personal Funding And Director Loans

Many small business directors prop up companies with personal funds. That can be a legitimate short-term strategy, but it also creates legal and financial complexity.

If you’re lending money to your company (or withdrawing money), make sure you understand how it will be recorded and repaid. Misunderstandings here can become a serious issue later.

As a starting point, it helps to understand director loans and how they’re typically treated.

Get Advice Early If You’re Unsure

Directors often wait too long because they’re trying to “solve it internally” first. That’s understandable - but it can increase personal risk if the company continues to incur debts while insolvent.

Legal advice can help you:

• understand whether you’re approaching the insolvency line
• set a plan for trading safely (or stopping, if necessary)
• document decisions appropriately
• review the contracts and structures that affect your exposure

If you have multiple owners, it can also be important to clarify responsibilities and decision-making power. A tailored Shareholders Agreement can reduce internal conflict at exactly the time you need everyone aligned.

Common Director Mistakes That Can Undermine A S588H Defence

Even when directors are acting in good faith, certain patterns can make it harder to rely on s588H if insolvent trading allegations arise later.

Here are some common pitfalls we see in practice:

• Not looking at the numbers: directors who don’t engage with financial information often struggle to show “reasonable grounds” for solvency expectations.
• Relying on optimism instead of evidence: “We’ll land a big contract soon” isn’t enough without signed agreements and clear payment timelines.
• Ignoring tax and super: overdue statutory liabilities are classic insolvency indicators and can quickly escalate (and you should get accounting/tax advice early).
• Continuing to sign new deals without reassessing solvency: each new debt can create a new point of exposure.
• Poor documentation: if key decisions aren’t recorded, it can be difficult to prove what you knew and what you did.

The goal isn’t to run your business in fear - it’s to build habits that reduce risk and improve decision-making, especially when times are tough.

Key Takeaways

• Section 588H of the Corporations Act sets out key defences directors may rely on to avoid insolvent trading liability, but those defences depend heavily on facts and evidence.
• Insolvent trading risk can increase quickly when a company keeps incurring new debts while struggling to pay existing debts as they fall due.
• Common s588H defences include having reasonable grounds to expect solvency, relying reasonably on a competent person, being absent from management for a good reason, or taking reasonable steps to prevent the debt.
• Practical steps like frequent financial reporting, careful decision-making, and strong documentation can reduce risk and help support a defence if issues arise later.
• Clear contracts and governance documents (like employment contracts, terms of trade, and shareholder arrangements) can help you control risk and act faster when cash flow tightens.
• If you’re seeing insolvency warning signs, getting advice early can protect both your business and your personal position as a director.

If you’d like a consultation about insolvent trading risk, director duties, or how s588H may apply to your situation, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.