Becoming a company director comes with many benefits – power, connections, and good compensation befitting the role. However, the position comes with responsibilities, and when things go wrong, a company director can be personally liable for the company’s debts, and legal action can be taken against them for certain defaults. Here we will discuss several areas of personal liability for a director.
Common Liabilities for a Company Director
A company is a separate entity from the directors and members so typically speaking, if a company breaches a contract or incurs debts or liabilities, the company will be responsible rather than its members or directors. A “corporate veil” exists that separates the company and its members and directors.
Furthermore, directors cannot be held liable for any decisions they made on behalf of the company provided that they had acted reasonably, honestly, and in the company’s best interests. This is known as the “business judgment rule”.
However, there are exceptions to the rule as directors can be personally liable for the company’s debt in where the company has incurred debts whilst insolvent, in cases of fraud and breach of duty, and other exceptional circumstances.
A fundamental duty of any director is to ensure that the company does not trade while insolvent. If a director disregards this, they may be acting illegally and be in breach of criminal and civil provisions of the Corporations Act 2001. Directors would need to assess their company’s cash flow and financial standing to determine if they can continue to trade and pay their debts as and when they fall due. Common indicators of insolvency can include low operating profits, issues with paying creditors and suppliers on time, problems with meeting loan repayments on time, difficulty keeping within overdraft limits, and trade suppliers refusing to extend credit.
Breaching of duties
Another way in which a director can become personally liable is when the director has caused the company to suffer some form of loss as a result of breaching duties or acting illegally.
A director may also be liable for breaches of other laws administered by other agencies. This can include becoming personally liable for any outstanding tax obligations of the company under the Australian Taxation Office’s “director penalty” regime, where the company has employees or staff. If the company has not met its responsibility in the meeting, for example, its Pay As You Go (PAYG) and Superannuation Guarantee Charge (SGC) obligations, a director may become personally liable for a fine equal to the amounts owed.
Loans or debts
Directors are personally liable for company loans or debts when personal guarantees are provided. If the guarantees are enforced it can expose the director’s assets which might include private properties and share portfolios. Financiers will often seek the controllers of the company to provide personal guarantees in order to enhance the security available to the financier in the event of a default in repayment of the loan by the company.
If a company is acting as a trustee for another entity, that director may also be personally responsible for liabilities incurred by the company if there is a breach of trust by the company. Moreover, if the trustee company acts outside its designated role, or if the terms of the trust deny or limit the trustee company’s rights to be indemnified against the liabilities.
Illegal phoenix activity
Directors may be held responsible in the case of illegal phoenix activity, whereby a new company is set up to continue the business of an existing company that has been deliberately closed down and transferred its assets to the new company to avoid paying outstanding debts, including taxes, creditors and employee entitlements. A director may be setting out to intentionally avoid paying debts by transferring assets to another company without paying the true market value. Therefore, a director’s intentions would be considered dishonest, and their conduct might be deemed illegal.
Directors must not use their position or information gained by virtue of being a director to create a gain for themselves or cause detriment to the company. Directors in breach of these duties can be guilty of criminal offences and face monetary penalties or imprisonment, or both. They may also be personally liable to compensate the company or any other party for any loss or damage they suffer and may also be prohibited from managing futures companies.
In conclusion, the law can generally protect directors through the separation of entity principle to prevent any liability of the company from being attached to the director. However, directors should not abuse their position as there are laws in place to prevent directors from hiding behind the corporate veil should they attempt to escape liability when fraud has been carried out.
Seek immediate legal advice if you have any questions about company liabilities or business laws. As one of the top law firms in Melbourne, our services at Nevett Ford ensure that your interests are protected and that you are supported every step of the way. In addition, we are also a renowned immigration law firm specialising in strategic immigration solutions for intending migrants. Contact us at +61 3 9614 7111 or visit our website for more details.