For years, company directors were shielded under the blanket of limited liability for a company’s debts. While in principle, directors are protected by this blanket, in practice however company directors usually fall into a handful of liability traps.
It is quite rare for a company to enter into an agreement or debt without a personal guarantee from the company directors. Unfortunately, by personally guaranteeing a debt, company directors expose themselves to now being directly liable for the company’s debts.
Other traps for directors include insolvent trading, director’s duties, director penalty notices (DPNs), director loan accounts, indemnity provisions to the Australian Taxation Office (ATO) and the inability to distinguish between the company’s and director’s finances.
Insolvent trading and director’s duties
Under s588G of the Corporations Act (Act) directors have a positive duty to prevent the company trading while insolvent. If the duty is breached, directors can be pursued and are personally liable for the value of the debts incurred (ss588J and 588M). In the event the debts are incurred dishonestly, criminal liability will also arise.
Furthermore, under the Act and in common law, directors in Australia owe the company a number of core duties. Directors are required to act:
- with reasonable care, skill and diligence (s180);
- in good faith in the best interests of the company (s181);
- for a proper purpose (s181);
- without any conflict of duty or interest that results in a personal advantage or detriment to the company (s182); and
- without improperly using the company’s information to gain a personal advantage or cause detriment to the company (s183).
Breach of these duties may result in a number of disciplinary and or recovery actions brought against the director.
Since June 1993, the ATO has had the power to issue DPNs to company directors. What these notices mean is that if you are a director or a former director of a company which does not meet its pay as you go (PAYG) withholding, goods and services tax (GST) or super guarantee charge (SGC) obligations, the ATO may recover these amounts from you personally as a director of the company. Personal liability remains even where the company is placed into administration or liquidation.
Where a director has taken drawings from a company’s accounts, but which have not been deducted as PAYG withholding tax, the amounts drawn are recorded as a loan given to the director by the company. Director loans must be paid back, and if it is not and the company becomes insolvent, the loan is recoverable by a liquidator.
Indemnity provisions to the ATO
This is a little-known indemnity provision, but it is an automatic indemnity given by a company director to the ATO. Under s 588FGA of the Act, if a liquidator is successful in recovering an amount from the ATO due to unfair preference payments, each person who was a director of the company is liable to indemnify the ATO in respect of any loss or damage resulting from the order.
Take home message
There are many duties and liabilities imposed on company directors. The above briefly discussed a few instances where the blanket of limited liability can be removed. While the impact of COVID-19 on businesses and the ability of companies to remain solvent is greatly significant, company directors still need to adopt a thorough and careful approach to risk management, compliance, and business judgement.