Acting as the director of a company is a serious responsibility. You have a duty to act in the best interests of the company and its shareholders, but this isn’t always simple.
When things go wrong, directors may be held personally liable for certain types of company debt. This can place serious strain on your personal finances, and may even lead to outcomes like personal Bankruptcy.
In this article, we’ll discuss when and why directors can be held personally liable for company debts, as well as your duties as a director.
What is Director Personal Liability?
The directors of a company can be held personally liable for company debts in certain circumstances. This is called director personal liability.
In Australia, companies are their own legal entities. Debts incurred by the company are the responsibility of the company in most situations. However, to prevent dishonest or reckless trading, ASIC may hold directors personally liable for some types of debts.
When Can Directors Be Personally Liable for Company Debts?
Directors can be held personally liable for company debts in a range of circumstances. Generally speaking, you’ll only be held liable for company debts if you have breached your duties as a director, or if you have acted dishonestly.
Common scenarios where directors are held personally liable for company debts include:
1. Trading While Insolvent
Company directors have a duty to prevent insolvency and insolvent trading under Section 588G of the Corporations Act 2001.
If you knowingly trade while insolvent, you can be held liable for any new debts that:
- Are incurred after the company becomes insolvent
- Cause the company to become insolvent
In certain circumstances, you may be protected from claims of insolvent trading by Australia’s Safe Harbour legislation. This is covered in more detail below.
2. Personal Guarantees
It’s common for directors to provide personal guarantees against company debts. For instance, the director of a company may use their personal residence to secure a business loan.
Directors are liable for any personal guarantees made to a creditor. You are required to fulfil your guarantee if the company can’t repay the debt for any reason, or if the company becomes insolvent.
3. Tax Debts and Superannuation Obligations
Directors have a duty to comply with taxation and superannuation obligations. You can be held personally liable for the following:
- PAYG withholding
- GST
- Super Guarantee Charge (SGC)
These amounts are referred to as director penalties. The ATO can issue a Director Penalty Notice (DPN) to recover unpaid tax and superannuation debts.
4. Phoenix Activity
A “Phoenix Business” is one that rises from the ashes of a previous company.
This occurs when a company is failing, and the directors set up a new entity to avoid paying its debts. Assets are then transferred from the old company to the new company for little to no payment. The old company is deregistered, and the new company resumes its operations under a new name.
Illegal phoenix activity doesn’t prevent directors from being held personally liable for company debts. If you start a new business to avoid paying debts, you can be personally liable to repay those debts, even after the original company is deregistered.
5. Directors’ Loans and Company Credit Cards
A company may show “director’s loans” on its books for a variety of reasons. If the company enters Liquidation, the director is personally liable to repay any outstanding loan amounts.
Similarly, you may be held personally liable for outstanding debits on a company credit card. While the credit card is paid by the company, the card itself is usually issued to an individual (such as a director or other company officer).
If the company fails to pay the balance, the credit card company may pursue the card holder for the outstanding amount.
6. Unfair Preference Payments
An unfair preference payment is a payment made to a creditor that unfairly disadvantages other creditors during Liquidation.
Under Section 588FF(1) of the Corporations Act, it’s possible for directors to be held personally liable for money that was paid as part of an unfair transaction.
This includes scenarios where a company enters Liquidation and pays the ATO in preference of other creditors. Section 588FGA of the Act requires directors to indemnify the ATO against any loss resulting from an unfair preference payment.
In this case, the director(s) can be held personally liable for the unfair payment made to the ATO.
7. Underpaying Employee Wages and Entitlements
A director may be held personally liable for underpayment of employee wages and entitlements. The Fair Work Act 2009 makes it illegal to knowingly underpay workers. Under Section 550, a director may be fined up to $187,800 for breaching this requirement. In a case from 2023, the directors of a company were also held personally liable for underpayments made to staff.
8. Breaching Your Duties as a Director
Generally speaking, directors can be held personally liable for company debts if you have breached your duties as a director. Things like insolvent trading and acting against the best interests of the company can lead to personal liabilities for company debts.
The Duties of Company Directors in Australia
Private and publicly traded companies have a duty to act in the best interests of their shareholders. As such, the directors of companies are expected to fulfil certain general duties.
In Australia, company directors have the following responsibilities:
- To act for a proper purpose – Directors must use their powers to act for a proper purpose. Directors cannot use their powers to give themselves a personal advantage.
- To act in good faith – Directors must act in the company’s best interests. Directors must act honestly, reasonably and ethically.
- To act with care and diligence – Directors must act with care and diligence. This includes staying aware of the company’s financial situation, understanding how the company operates, and acting as a “reasonable person” would.
- To avoid conflicts of interest – Directors must not enter into any agreements where they have personal conflicts. Directs must notify the company of any personal conflicts that relate to transactions the company is making.
- To prevent insolvent trading – Directors must prevent the company from trading while insolvent.
- To fulfil administrative duties – Directors must fulfil certain administrative duties. This involves tasks like ensuring tax obligations are met, keeping proper financial records and communicating with shareholders.
Breaching your duties as a director can result in civil and criminal penalties. The exact penalty depends on the nature of the director’s actions.
Doesn’t Limited Liability Protect Directors from Personal Liability?
No. A “limited liability” company protects shareholders from personal liabilities. Directors have a duty of care to the company. As such, they can still be held personally liable for company debts, even if the director is also a shareholder.
Director Penalty Notices (DPNs)
A Director Penalty Notice (DPN) is a notice issued by the ATO that allows them to recover unpaid taxes and superannuation amounts. The ATO may issue a DPN if your company has unpaid amounts in relation to:
- Pay As You Go withholding
- Goods and Services Tax
- Super Guarantee Charge (SGC) liabilities
If you receive a traditional DPN, you have 21 days to respond if you want to avoid personal liability. If you receive a “lockdown” DPN, you can be made automatically liable for company tax debts if the company’s tax returns are not lodged within 3 months of the due date.
Contact Business Savers immediately if you receive a DPN. It’s important to respond quickly to avoid personal liability.
Does Safe Harbour Protect Against Personal Director Liabilities?
Australia’s Safe Harbour laws may protect directors from personal liabilities that arise due to insolvent trading claims. This only applies if the personal liability is incurred while making a genuine attempt to save the business from financial distress.
For instance, if a director notices that the company is about to become insolvent, they could use Safe Harbour to restructure the business in an attempt to save it. Even if the attempt is unsuccessful, the director won’t be held personally liable for debts incurred while trying to save the company.
There are strict requirements surrounding Safe Harbour. Speak to a Restructuring Practitioner immediately if you are attempting to save your company from insolvency and want to claim Safe Harbour.You can read more about Safe Harbour on our website.
What Happens if a Director Can’t Pay their Personal Liabilities?
Company debts are often large in scale. This means it’s common for directors to be unable to pay personal liabilities. When this happens, directors can become personally insolvent, and may need to enter Bankruptcy to resolve the debt.
During Bankruptcy, a Registered Trustee will gather and sell your assets. The Trustee will use any proceeds from the sale to repay your debts.
While most director personal liabilities are discharged under Bankruptcy, Bankruptcy can have a significant impact on your life. You will also be disqualified from acting as the director of a company for the duration of the Bankruptcy (typically 3 years and 1 day).
Manage Director Personal Liabilities with Help From Business Savers
Personal liabilities can be one of the most daunting aspects of managing a company. While there are many circumstances where you can be held personally liable for company debts, staying abreast of the company’s situation can significantly reduce the risk.
If you are concerned about your personal liabilities as a company director, speak to the team at Business Savers as soon as possible.
Business Savers specialises in personal and corporate insolvency. We’re a team of Registered Liquidators and Restructuring Practitioners that can help you navigate any financial situation.
The best thing you can do to avoid personal liabilities is to act honestly and in good faith, and to seek advice at the first signs of financial difficulties. Acting quickly can protect you from issues like insolvent trading and improve the chances of your company’s survival.
Book a confidential consultation with our team to find out more.
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