When can a director be liable for a company’s debts?

April, 2015

By Harry Kay, Senior Associate.

Just because your business operates as a Company, there are some circumstances where a director may still face personal liability for the debts of a company. The main areas of potential liability for a director are for:
1. insolvent trading compensation claims;
2. unreasonable director related transactions;
3. taxation debts and superannuation claims; and
4. personal guarantees.

In this blog post, Harry Kay, Senior Associate at Mills Oakley, discusses what a company director needs to know about his/her liability for company debts.

Broad definition of a “company director”

The Corporations Act 2001 (Cth) (the “Act”) provides a definition of “director” and that definition is not just limited to those named or appointed as directors to a company. A person may be a de facto or shadow director, if that person acts in the capacity of a director, even if not named or appointed as such. Essentially, a person does not have to be formally appointed as a director to potentially be liable for the claims identified above.

Duty of a director relating to debt

The Act provides that a director has a duty to prevent a company from trading whilst insolvent. Insolvent trading occurs when a company incurs a debt that it cannot or does not pay, at a time when the director either knew, or ought to have known, that the company was insolvent. If such a debt is incurred by the company, the Act makes a director personally liable to pay to the company an amount of compensation equal to the amount of the insolvent trading debt.

A director may defend a claim for insolvent trading brought by a liquidator of a company on a number of grounds, including:
• The director had reasonable grounds to expect that the company was solvent;
• The director did not participate in the management of the company due to illness; or
• The director took all reasonable steps to prevent the company from incurring the debt.

What constitutes ‘unreasonable director related transactions’?

Earlier, I referred to ‘unreasonable director related transactions’ being one of the main areas of liability for a director. An unreasonable director related transaction is one involving the director, or a close associate (including family members) of the director and which was entered into not for the benefit of the company. The types of transactions which mat be held to be unreasonable director related transactions include payments of money by the company, issue of securities by the company, and transfers of company property.

A personal guarantee

A personal guarantee given by a director with regard to the obligations of the company will also make a director personally liable for the company’s debts, to the extent they are covered in the guarantee. Usually, personal guarantees are signed by directors when the company enters into a credit agreement with a supplier, or in respect of any funding with a bank or other financial institution. Nothing that happens to the company, such as its winding up, will disrupt the operation of the guarantee.

Tax debts

A director can also be held personally liable for a company’s taxation debts if the company fails to remit PAYG withholding tax or superannuation contributions by the due date. Where a company fails to pay its PAYG or superannuation obligations, the director becomes automatically liable to a penalty at the end of the day on which the company is due to meet those obligations. The Australian Taxation Office may issue Director’s Penalty Notices (“DPNs”) seeking the recovery of the Company’s obligations, and may commence recovery proceedings after 21 days from the service of a DPN to a director.

 

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