The Dangers of Trading While Insolvent in Malaysia
For company directors, one of the most significant legal risks during times of financial difficulty is 'trading while insolvent' or 'wrongful trading'. This is a serious breach of directors' duties under the Companies Act 2016 and can lead to severe personal financial consequences. This article explains what insolvent trading is, the potential penalties, and how directors can protect themselves.
What Constitutes Insolvent Trading?
Insolvent trading occurs when a company continues to incur debts at a time when its directors have reasonable grounds to believe that the company is insolvent or would become insolvent by incurring that debt. The key test is whether the company can pay its debts as and when they fall due (the 'cash flow test').
The Legal Framework: Section 539(3) of the Companies Act 2016
The primary provision governing insolvent trading in Malaysia is Section 539(3) of the Companies Act 2016. This section states that a director who knowingly allows the company to incur a debt without any reasonable or probable ground of expectation of the company being able to pay that debt, can be found guilty of an offence.
Severe Consequences: Personal Liability for Directors
If found liable for insolvent trading, the consequences for a director can be severe:
- Personal Liability: The court can declare that the director is personally responsible for the payment of the whole or any part of that debt. This means the director's personal assets, such as their home and savings, are at risk to repay the company's debt.
- Criminal Penalties: Insolvent trading is also a criminal offence. A convicted director may face imprisonment for a term not exceeding five years or a fine not exceeding RM500,000, or both.
- Disqualification: A conviction can also lead to being disqualified from acting as a director or being involved in the management of a company for a period of time.
How to Avoid Insolvent Trading: A Director's Defence
To defend against an allegation of insolvent trading, a director must be able to prove that they took reasonable steps to prevent the company from incurring the debt. Proactive measures are a director's best defence:
- Stay Informed: Regularly monitor the company's financial position. Insist on receiving timely and accurate financial information, including cash flow projections.
- Hold Regular Board Meetings: Discuss the company's financial situation openly and ensure that these discussions and any decisions made are properly minuted.
- Seek Professional Advice Early: If you suspect the company is in financial difficulty, immediately seek advice from a licensed insolvency practitioner or a qualified accountant. Document this advice.
- Do Not Incur New Debts: If insolvency is suspected, stop incurring new debts. This includes placing new orders with suppliers or taking on new projects.
- Consider Formal Insolvency Options: If the company is insolvent and cannot be saved, directors should promptly consider formal insolvency proceedings like liquidation or judicial management to prevent the situation from worsening.
How We Can Help
At Saifudin & Co., we provide urgent and strategic advice to directors of companies facing financial distress. We can help you:
- Understand your duties and responsibilities under the Companies Act 2016.
- Assess the company's solvency and provide a clear, independent opinion.
- Develop strategies to mitigate the risk of personal liability for insolvent trading.
- Guide you through the available corporate recovery options.
Don't wait until it's too late. If you have concerns about insolvent trading, contact us immediately for confidential advice.