Directors can be forced to put their company into administration prematurely to avoid being held personally liable for trading while insolvent, according to the Australian Institute of Company Directors (AICD).

It is arguing for adoption of a “business judgement rule” defence in insolvency law, which would give directors greater protection and enable more companies to trade out of difficulty.

The AICD makes the argument in response to a Treasury options paper on reforming insolvency regulation.

It raises concerns about proposals to streamline disqualification of directors, aimed at reducing phoenix activity when companies go broke and the owners continue the business in another guise.

The AICD argues against automatic disqualification of directors after a company failure.

“History shows that some of the world’s most successful products and services have emanated from entrepreneurs whose companies had failed previously and on numerous occasions.”

The institute also argues for greater protection for directors who try to rescue the company.

“A regime which forces directors to prematurely place their business into external administration to avoid any risk of personal liability prevents the best stakeholder outcomes from being achieved,” the submission says.

A business judgement rule or “safe harbour” defence inserted into insolvency laws could protect directors who make decisions in good faith.

The AICD has campaigned on the issue for some time, believing the fear of being held personally liable is making directors overly cautious and discouraging people from joining boards.

It also argues that shareholders and other stakeholders can be disadvantaged if directors feel forced to put the company into administration.

“Each director faces being held personally liable for any further debts incurred unless the company is placed in external administration, leading in many cases to a worse outcome for its shareholders and other stakeholders than would be obtained by allowing the company to trade out of its difficulties.”