19 Feb 2008

Can a company indemnify a director against liability for insolvent trading debts?

A director of failed reinsurer New Cap has failed to get an indemnity for a potential insolvent trading liability.

The Court held that the company's standard director indemnity clause did not - and could not - cover a director's personal liability for insolvent trading by the company.


New Cap's liquidator was pursuing an insolvent trading claim against Mr Williams under section 588G of the Corporations Act. Section 588G makes a director personally liable for debts incurred by his company while it is insolvent, if the director has failed to prevent the incurring of the debt. That personal liability will arise when a court, on a liquidator's application, orders the director to pay the company an amount equal to the debt.

New Cap's corporate constitution contained a fairly standard indemnity clause. This indemnified its directors and officers "against all cost losses and expenses which any such Director, Manager, Secretary or other officer may properly incur or become liable to pay by reason of any contract properly entered into or other act or thing properly done by him as such officer or in any way to the discharge of his duties and it shall be the duty of the Directors to pay the same out of the funds of the Company."

Mr Williams claimed that any potential liability under section 588G was covered by this indemnity.

Contravention of section 588G not "acting properly"

The Court held that accruing personal liability by allowing one's company to incur an insolvent debt did not fall within the terms of the indemnity, for two reasons:

  • not part of a director's duties - the indemnity only covered things done by a director "in the discharge of his duties". The Court said that contravening section 588G was not part of a director's duties;
  • not acting properly - the indemnity also referred to things "properly" done by directors. The Court said that a director who contravened section 588G was not acting "properly".

Indemnity illegal

Even if New Cap's indemnity had been drafted to cover insolvent trading liabilities, Mr Williams would not have been able to rely upon it.

Section 199A(2) of the Corporations Act prohibits a company from indemnifying its officers against liabilities owed to the company.

The Court said that this would apply to a liquidator's insolvent trading claim against Mr Williams. Once an order was made against him:

"A liability will then and thereby be owed to [New Cap] by Mr Williams since, in terms of the court’s order, a debt will be due to [New Cap]. There will thus exist, in terms of s 199A(2)(a), a liability owed by Mr Williams to [New Cap]. That being so, s 199A(2) will forbid any action by [New Cap] to indemnify Mr Williams against that liability."


The reason why insolvent trading is a bogeyman for directors is that it is very hard to escape liability once the company has incurred the debt. There are a limited number of defences, but these are very difficult to establish.

In effect, therefore, insolvent trading is close to a strict liability provision. The Court's decision in this case reinforces that harsh economic reality.

Another aspect of the case worth noting is the ruling on the effect of section 199A(2) - that directors' insolvent trading liabilities are owed to the company.

Although the Court didn't refer to them, there have been a number of decisions about the precise nature of monetary recoveries by a liquidator. In dispute has been the issue of whether that money is the company's or the liquidator's. It has been argued that, if it's the company's money, it should be caught by a floating charge and hence payable to secured creditors.

More interesting, however, is the possibility of a private insolvent trading claim. Although insolvent recovery actions are primarily the province of liquidators, individual creditors are allowed to pursue insolvent trading claims against directors (with the liquidator's permission). In that situation, the director is ordered to pay money directly to the creditor.

In such a situation, it is debatable whether section 199A(2) would apply, since the director's liability would not be "owed to the company".

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.