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Essential Reading for Directors: ASIC’s regulatory guide ‘Duty to Prevent Insolvent Trading: A Guide for Directors’

As a director of an independent school, understanding your legal obligations is crucial to ensuring the financial health and sustainability of your school, and managing exposure to personal civil and criminal liability.

The Australian Securities and Investments Commission (ASIC) has published Regulatory Guide 217, titled “Duty to Prevent Insolvent Trading: Guide for Directors”. It provides comprehensive guidance on directors’ duties under section 588G of the Corporations Act.

Overview of RG217

RG217 is designed to help directors understand and navigate their duty to prevent insolvent trading. It outlines the legal background, key principles for directors, safe harbour protections, and ASIC’s approach to assessing compliance. It is essential reading for directors (including alternate directors and shadow directors).

The guide has several key sections:

Section 1: Overview of Director’s Duty to Prevent Insolvent Trading

This section briefly explains the legal obligations of directors to prevent their company from incurring debts if it is insolvent or would become insolvent by incurring the debt. It also details the consequences of breaching this duty, including civil penalties, compensation orders, criminal liability, and disqualification from managing a corporation.

Section 2: Key Principles for Directors:

There are four key principles for directors to follow to comply with their duty:

1. Actively monitor company solvency
2. Investigate financial difficulties
3. Obtain advice from professional advisers where necessary
4. Act in a timely manner

Section 3: Safe Harbour Protection

This section provides guidance on how directors can protect themselves from liability by developing and implementing a course of action reasonably likely to lead to a better outcome for the company than immediate liquidation.

Section 4: ASIC’s Approach to Insolvent Trading and Safe Harbour

ASIC explains the factors it will consider when assessing whether directors have breached their duty or can rely on safe harbour protection.

Key Takeaways for Directors of Independent Schools

As a director of an independent school, it is vital to apply the principles outlined in the guide to your decision-making process and to demonstrate your compliance with your duty to prevent insolvent trading.

Here are some practical takeaways:

1. Actively Monitor School Solvency: Regularly review, and have effective systems in place to review, the school’s financial position, including cash flow, budgets, and financial statements. Ensure that the school maintains proper financial records and prepares relevant financial information. This proactive approach will help you identify potential financial difficulties early and take corrective action.
2. Investigate Financial Difficulties: If you suspect that the school is facing financial challenges, take immediate steps to confirm its financial position. This may involve reviewing financial records, assessing the school’s ability to meet its obligations, and considering options to address the difficulties. For example, if the school is experiencing cash flow issues, you might explore options such as renegotiating payment terms with creditors or seeking additional funding.
3. Obtain Professional Advice: When faced with financial difficulties, seek advice from qualified professionals, such as accountants, insolvency practitioners or legal advisers. These advisers can provide valuable insights into the school’s financial position, help you understand your legal obligations, and help you develop a plan to address the challenges. Ensure that the advice is based on accurate and up-to-date information.
4. Act in a Timely Manner: Promptly act on the advice received and take necessary steps to prevent further debts if insolvency is suspected. Delaying action can exacerbate financial problems and increase the risk of breaching your duty to prevent insolvent trading.

Indicators of Insolvency in the Context of a School

ASIC’s guide lists several indicators of potential insolvency that directors should be aware of. Here are some examples and how they might apply to a school’s operations:

• Cash Flow Difficulties: If the school is struggling to pay its bills on time or has insufficient funds to cover payroll, this could indicate potential insolvency.
• Unpaid Creditors: If the school is unable to pay suppliers or service providers within agreed terms, it may be a sign of financial distress.
• Legal Actions: Receiving legal notices or court summonses related to unpaid debts can be a red flag.
• Inability to Produce Financial Information: If the school cannot produce accurate and timely financial statements, it may indicate underlying financial problems.

ASIC’s Assessment of Evidentiary Matters

RG217 sets out some factors that ASIC may take into consideration when considering if directors have complied with their duty. Therefore, to manage your duty effectively, it is essential to incorporate proper documentation into your decision-making process. Here are some steps you can take:

1. Document Financial Reviews: Keep detailed records of financial reviews, including cash flow forecasts, budgets, and management accounts. This documentation will provide evidence that you are actively monitoring the school’s financial position.
2. Record Professional Advice: Document any advice received from professional advisers, including the basis for their recommendations and the actions taken in response. This will demonstrate that you sought and acted on appropriate advice.
3. Maintain Meeting Minutes: Ensure that board meeting minutes accurately reflect discussions about the school’s financial position and any decisions made to address financial difficulties. This will provide a clear record of the steps taken to comply with your duty.
4. Develop and Document Action Plans: If you develop a course of action to address financial difficulties, document the plan and regularly review its progress. This will help you demonstrate that you are taking proactive steps to achieve a better outcome for the school.

Conclusion

ASIC’s Regulatory Guide 217 provides essential guidance for directors on their duty to prevent insolvent trading. By actively monitoring the school’s financial position, investigating financial difficulties, obtaining professional advice, and acting in a timely manner, you can better manage your legal obligations and help ensure the financial health of your school. Remember to document your decision-making process and seek appropriate advice when needed. By doing so, you will be better equipped to navigate financial challenges and protect the interests of your school and its stakeholders.

For further information on your responsibilities as a director, please contact David Ford, Lucy Han or Stephanie McLuckie.