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In circumstances where a company is or may be insolvent, the question can arise as to whether the directors of the company can be held personally liable for company debts. The answers to this question are not straightforward and depend on circumstances, this guide goes through a few common situations.
The General Rule of Liability is that any debts incurred by a company are the company’s debt and are not automatically the director’s personal debts. It is only under specific circumstances that a company’s debt also becomes the personal debt of the director. This is called becoming personally liable.
No. Limited Liability means a company’s shareholders (sometimes the same as directors but not always) can only be held liable for company debts to the extent that their shares remain unpaid. More often than not, company shares are fully paid, and shareholders cannot be held liable for company debts at all.
There are a lot of legal provisions that a director needs to consider in a situation where their company is possibly insolvent. We have provided below some of the relevant sections of the Corporations Act and other director’s duties that are developed through case law, Corporations Act and the Tax Act. But this is a very complicated area so after you’ve had a read of the information below, we strongly recommend that you call us for specific advice. Mentioned below are some of the more important sections of the Corporations Act, Tax Act and general case law:
Insolvent trading is the law under the Corporations Act section 588G that says that if a company is insolvent and a director allows the company to incur a new debt, then the director can be personally liable for the new debts incurred. The law makes directors responsible for ensuring that their company does not trade while insolvent. See our guide on the topic for more information: https://www.dissolve.com.au/definitions/insolvent-trading/.
A personal guarantee is a specific agreement between a director, or some other guarantor, and a particular creditor. The usual provision is simply that if the company that incurred the debt cannot or does not pay the liability then the creditor can seek payment from the guarantor personally. So personal guarantees are sometimes requested by suppliers as part of their standard Credit Agreement and by Banks when providing any form of finance.
Often a company’s financial accounts will show “directors’ loans”. That is an amount owing by a director to the company. So, it is an asset of the company that is recoverable by a company or the company’s liquidator. The history will be that:
If the company enters any form of insolvency administration, such as liquidation or voluntary administration, then a liquidator will require the amount to be repaid to the company. Options available include the following:
A sometimes-overlooked personal liability for a director and their staff is in regard to company credit cards. Most credit cards are issued to individuals and, as a result, even if that credit card is usually paid by the company, the credit card company will look to the individual to pay the amount due under the credit card. Further, even where a credit card is issued to a company, standard terms and conditions are that the holder of the credit card is personally liable for the debts as well as the company. Unfortunately, there is no “magic pill” to solve this problem. The best prevention is to ensure that the credit card is paid off regularly by the company so that the balance is usually low.
Company directors are not automatically personally liable for all company tax, but there are certain circumstances where the ATO can chase a director with a Director Penalty Notice. A Director Penalty Notice (DPN) is a Notice that the Australian Tax Office (ATO) can send a director that can make that director personally liable for three types of tax debts of a company – Pay As You Go (PAYG), Superannuation Guarantee Charge (SGC) liabilities and Goods and services tax (GST). See our guide on the topic for more information: https://www.dissolve.com.au/definitions/director-penalty-notice/
In the liquidation process, the liquidator examines the company’s recent transactions to see if one creditor has been paid in preference to others. If a preference is detected, the liquidator can claw that payment back. If that creditor held a personal guarantee from the director, the liquidator could seek repayment from the director.
A Phoenix Company is a company that “rises from the ashes” of a failed company. The most common scenario is when:
The situation as described is a bad thing for two main reasons. Firstly, there is the financial loss suffered by the creditors of the OldCo when they go unpaid. Secondly, the situation is grossly unfair for the competitors of the Phoenix Company – if a company is not paying its tax debts or trade creditors then its cost base is lowered, usually to such an extent that a competitor can’t match its pricing. Whilst we can all agree that the Phoenix Company described above is a bad thing, there are situations that contain some of the elements described above but then vary in crucial aspects that may make it more difficult to describe the situation as a Phoenix. For example, what if the situation was as described above except that when assets are transferred a full market price was paid from NewCo to OldCo. In that situation the position is much less clear. Directors can be prosecuted under several areas of the corporation’s act for undertaking such activity. Sale of Assets at Undervalue is a key one. A Liquidator will investigate the removal of assets from a company in liquidation and determine if fair value was received by the company for the assets. If not, the director can be held personally liable for the shortfall. Criminal penalties are also possible for serious offences.
Here’s a guide to when the most common forms of personal liability might crop up for company directors:
While each guarantee is different, personal guarantees are generally continuing guarantees and have no time limit stated in the guarantee. In practice, they’ll be limited to 6 years by Law. A creditor can only pursue a director under a personal guarantee when the principal contract is in default. Liquidation may accelerate this process. A creditor is not obliged to await the outcome of the company’s liquidation to pursue a guarantee – they can pursue the debt immediately through enforcing the personal guarantee given by the director, regardless of any proposed distribution from the liquidation. On the other hand, in circumstances where the company is placed into voluntary administration, the creditor cannot exercise or seek to enforce a personal guarantee given by the company’s directors or spouse, de-facto or relative of a director whilst the company remains in voluntary administration. Once the voluntary administration is complete, the creditor has the right to pursue any guarantees that it obtained from the director of the company or any related party as the case may be. Ceasing to act as a director of a company does not terminate a guarantee. You will need to either pay the amount due under the guarantee or negotiate with the creditor to have the guarantee terminated. On practical level, not all creditors will pursue a director under a personal guarantee even where the company has defaulted. Many creditors will use the guarantee as a negotiating tool but will be reluctant to actually take a legal action against a director. For example, large retail landlords will not pursue a director under a personal guarantee provided the director was cooperative in exit from the premises. Trading Whilst InsolventInsolvent trading works like this: When a company enters liquidation, it provides its books and records to the liquidator. The liquidator goes through those records and decides a date where the company first became insolvent. If the records show any debts incurred after that date, the directors can be held personally liable for those debts. This decision is made once the liquidation has progressed a little, you are unlikely to receive a demand for insolvent trading debt in the first month of the liquidation, but it can happen at any stage. You do not know if you are in the clear, until you see the liquidator has lodged their final return for the liquidation. Loans and DrawingsLike Insolvent Trading, a demand to repay a loan from the company or drawings arises from the investigation phase of the liquidation where the liquidator looks through all collected books and records. A director’s loan or drawings stand out a little more than insolvent trading, so you may receive a demand to repay a loan or drawings at any stage once the liquidator has looked at company records. Again, you can’t be sure you are in the clear until you see the liquidators final return has been lodged. Credit Cards nearly always carry a personal guarantee. Even if they are in the company name, whomever signed up usually provides the guarantee. Banks are probably a little more likely to wait to see the outcome of a liquidation (but don’t have to – see personal guarantees above) before enforcing a guarantee. Company Tax Debts & Director Penalty NoticesCompany Directors can become personally liable for company tax debts through the Australian Tax Office’s (ATO) Director Penalty Notice (DPN) regime. Under a DPN, the ATO can make a director personally liable for unpaid Pay As you Go withholding, Superannuation and GST. The timeframes for when and how they can send a DPN depends on how current tax (and super) reporting has been over the company’s lifespan. The rule is if a debt was not reported or reported more than 3 months late you can be pursued at any stage, even if you put the company into liquidation. If the debt was properly reported but remains unpaid, then the ATO must issue a Director Penalty Notice that gives 21 days’ notice of pending liability. If the debt is settled or the company placed into liquidation or administration before the 21 days expire, the director avoids liability. Amendments affect the reporting date by the way, if a debt was reported on time, but that return was amended outside the 3-month grace window, it is considered to have been reported late. Not many people know you must report unpaid Superannuation to the ATO. If a company cannot pay Superannuation when it is due, they must submit a Superannuation Guarantee Charge Statement to the ATO within 3 months of the due payment date. Failure to do this will cause the ATO to classify the debt as unreported and allow them to enforce personal liability at any time as described above.
Under Safe Harbour protection, directors are not personally liable for debts incurred after the date of insolvency (S588G Insolvent Trading) if they can show they were incurred in connection with a course of action reasonably likely to lead to a better outcome for the company and its creditors as a whole, rather than proceeding to immediate administration or liquidation. So, the Safe Harbour operates to carve directors out from the civil insolvent trading provisions of section 588G (2). What about Directors and Officers (D&O) Insurance?Directors and Officers (D&O) Insurance may indemnify directors for some losses but read your policy carefully, some policies do not cover any event arising from Insolvency. What does a Director Penalty Notice do?A Director Penalty Notice (DPN) is a Notice that the Australian Tax Office (ATO) can send a director that can make that director personally liable for three types of tax debts of a company – Pay As You Go (PAYG), Superannuation Guarantee Charge (SGC) liabilities and Goods and services tax (GST). What does a Statutory Demand do?A Creditors Statutory Demand for Payment is a formal demand for payment sent by a creditor who either already has or intends to enforce their claim in court. A Stat Demand gives the recipient a 21 period to satisfy the sender that the debt has been or will be paid. If the creditor remains unsatisfied after 21 days, they are then clear to apply to court to have a liquidator appointed to the company.
For information on avoiding personal liability in your particular circumstances, give us a call for a free consultation.
It’s not uncommon for us to receive a call from a Director in a dispute with their business partner. The caller wants to commence a liquidation but isn’t sure if they can. We tell them the cheapest and easiest way to get a company into liquidation is if all directors and shareholders agree, and sign the liquidation documents. If not all parties agree, it depends who the dissenter is. If a majority of Directors agree and all shareholders – no problem. If some shareholders don’t agree, it becomes complicated. Option 1 is to call a General Meeting of the company and put the liquidation to a vote. To call a general meeting written notice must be sent to all shareholders giving 21 days notice of the meeting. At the meeting a Special Resolution to put the company into liquidation must be passed. A special resolution requires 75% of the shareholding (calculated by the number of shares each individual holds) that cast a vote in the meeting (so not 75% of the total shareholding, just 75% of those who vote on the day. For example if only one shareholder votes – they carry 100% no matter how many shares they actually hold) to vote in favour. This is the cheapest option, but often the 21 day delay is not attractive. Option 2 is to put the company into Voluntary Administration. If a majority of the directors of the company agree, the company can be placed into Voluntary Administration straight away. This option does not require the agreement of the shareholders. If a deal to creditors is not proposed in the Voluntary Administration period (usually 30 days) the company automatically progresses to Liquidation. This is a faster, but more expensive option. Voluntary Administration for a small company that is no longer trading costs about twice the price of a standard liquidation. But if it is the difference between becoming personally liable for company tax debt or not, it can be preferable. |