Personal asset protection is often touted as a major benefit of operating through a company rather than as a sole trader or in a traditional partnership. Despite this, there are a significant and growing number of liabilities and obligations for which a director can be personally liable. Whether you are the sole director and shareholder of a small company, or a board member of a much larger organisation, it is crucial to consider your personal exposure when you consent to act as a director.
The simple view is that because a company is a separate legal entity, the debts and obligations of the company are with the company and not the responsibility of the director. This is true to a limited extent. For example, debts owed to suppliers and contractors will generally not be the personal responsibility of the director. The usual exception to this is where the director has signed a personal guarantee for a specific purpose. Such voluntary guarantees are a separate topic and will be addressed in a future article.
Despite this, the following categories of liability can be personally carried through to the director automatically by operation of law:
- PAYG and Superannuation
- Insolvent trading
- Phoenix activity
- Breaches of directors’ duties
- Debts incurred by the company whilst acting as a trustee
- Laws administered by specific agencies
PAYG and Super
Directors of a company are personally liable for the company’s failure to comply with Pay As You Go (PAYG) withholding and the Superannuation Guarantee Charge (SGC) obligations. This personal liability does not normally extend to wages and other entitlements generally.
Directors have an obligation to prevent the Company from trading whilst insolvent (section 588G of the Corporations Act 2001 (the Act). In this context, insolvency occurs when a Company is unable to pay its debts when they become due and payable. If a director fails to act competently and recognise when the company is insolvent, that director can be personally liable for civil penalties and compensation. Criminal charges may also apply if the breaches are dishonest.
Urgent legal advice should be sought if a director becomes aware that the company is unable to pay its debts on time. Often the indicators of insolvency commence some time before the company is actually insolvent and the earlier advice is sought the more time there is to plan and react lawfully.
Illegal Phoenix activity
Phoenix activity occurs where directors register a new company to take over a failing business or to conduct a very similar business. Because the new company is a separate legal entity, the debts of the original company are isolated in original company. Often the creditors of the original company are never fully paid, and that company is externally administered and wound up.
In extreme cases, a director may intentionally use a phoenix arrangement to defeat creditors by running up large tax and trade debts while operating at unsustainable prices with the plan to place the company in external administration and commence trading in a new company.
Not all cases of phoenix activity are illegal, and there are legitimate reasons and ways to engage in phoenix activity depending on the circumstances. This is a complex and evolving area – legal and accounting advice is essential before considering any arrangement that even resembles phoenix activity.
There are also other potential issues for individuals who have operated multiple companies that have been wound up – those persons may be subject to disqualification under Section 206F of the Act.
Breaches of Directors’ Duties
Directors owe a number of significant obligations to the company including but not limited to the following:
- to act in good faith in the best interests of the company and for a proper purpose;
- to exercise care and diligence;
- not to use position or information for personal benefit or to the detriment of the company; and
- other ‘fiduciary’ obligations at common law.
Although these duties are owed to the Company there are circumstances in which other shareholders or liquidators, may be able to commence such actions on behalf of the company. The offending director may be personally liable to compensate the company for any loss or damage incurred as a result of the breaches.
Debts incurred by the company acting as trustee
Under certain conditions, if a company acts as trustee of a trust a director may be personally liable for the debts of the company acting in its capacity as trustee. If your company acts as trustee for a trust you should seek legal advice about the trust deed for the trust to determine if you have any personal exposure.
Laws administered by specific agencies
There is a myriad of other state and federal laws that impose personal liability on directors – some examples in Queensland include:
- Animal Care Protection Act 2001
- Building Act 1975
- Environmental Protection Act 1994
- Food Act 2006
- Liquor Act 1992
- Queensland Building and Construction Commission Act 1991
- Sustainable Planning Act 2009
- Vegetation Management Act 1999
- Water Act 2000
- Work Health and Safety Act 2011
The above list is a small selection of statues in Queensland that impose personal liabilities. There is a raft of other state and federal legislation that can apply.
Directors should make themselves familiar with all sources of personal liabilities in their industry and seek legal advice if in doubt.
About the Author
Daniel Dash is part of the commercial law team and has significant exposure working with business owners on a range of matters including business sales, shareholder agreements, intellectual property, litigation and taxation matters.