Company directors have a wide range of duties and obligations, and the breach of one or more of these can result in a director’s liability for company debts. As a matter of general law, a company is an entity with a distinct existence from its owners. A company has ‘legal personality’ – it can sue and be sued and it can incur debts. A company is managed by its officers – directors and company secretaries who are also separate legal personalities from the company.
There are, however, a number of circumstances that can arise that can make directors personally liable for matters relating to their role as director. These include:
Directors can become personal liable for certain types of taxation obligations owed by a company. Companies have taxation obligations with respect to their employees – both for unpaid and unreported Pay As You Go (PAYG) tax and for superannuation guarantee charge (SGC) amounts. If a company does not meet its PAYG or SGC liability by a due date the directors become personally liable for a penalty equivalent to the unpaid amounts. The Australian Taxation Office is entitled to issue directors with director penalty notices which authorise them to take recover action against the directors personally.
This issue is particularly important for new directors of companies, who should ensure that they are aware of the company’s taxation obligations (and in particular the company’s PAYG and SGC obligations) before they accept appointment as a director.
Company directors have a fundamental duty to ensure that a company does not trade while insolvent, and directors can become personally liable for any debts incurred by the company while it is insolvent.
Pursuant to the Corporations Act 2001 (Cth) a company is insolvent if it cannot pay all of its debts as and when they become due. The Act gives no guidance about how to determine whether debts can be paid by a company, however the courts have often applied a cash flow or commercial reality test.
“Many cases have addressed the question of solvency by reference to a cash flow assessment of the relevant company’s situation, paying primary regard to its current assets and current liabilities, sometimes described as commercial solvency or insolvency. Whether the company has an overall net surplus or deficiency of assets over liabilities is treated as a matter of secondary importance. Instead, close attention is paid to the ratio of current assets to current liabilities as an important indicator.”1
Recent amendments to the Corporations Act 2001 (Cth) have carved out some of the existing insolvent trading regime to offer some protection to directors and encourage restructures of at risk companies rather than simply placing a company into liquidation. Known as the ‘safe harbour’ regime, directors can limit their personal liability for insolvent trading debts if they:
- take certain steps after they suspect the company may be, or may become, insolvent; and
- the debts is incurred directly or indirectly in connection with the steps taken above.
Breach of directors’ duties
When a company suffers loss because a director has breached their duties, the director may be personally liable for those losses. In addition to the liability for losses, there may also be other consequences of a breach of directors’ duties, including civil penalties, criminal sanction (including imprisonment) and prohibition from future involvement as a company officer.
Some of the key directors’ duties are:
- the duty to exercise powers with the care and diligence a reasonable person would have, including taking steps to ensure that the director is properly informed about the financial position of the company;
- the duty to exercise powers and duties in good faith and in the best interests of the company and for proper purpose; and
- the duty not to improperly use the director’s position to gain an advantage for themself or someone else or cause a detriment to the company
Directors can have a contractual liability for a company’s debts. Most commonly this type of liability arises when a director is asked to provide, and does provide, personal guarantees over the company’s obligations. A personal guarantee is a contractual promise that the company will comply with its obligations, and that if it doesn’t, the guarantor will be personally liable for those obligations.
Obligations under a guarantee can continue long after a person stops being a director, and we recommend that directors maintain a personal register of guarantees that they have provided, so that they can arrange for appropriate releases in the event they cease to be directors.
Accepting appointment as a director is a serious obligation and carries a level or risk that the director may have liability in relation to the company’s obligations. If you would like to discuss this or any other matter regarding corporations law or trust law, pleas
, please contact us (please book a free telephone consultation with one of our lawyers) to arrange a time to discuss and we can provide you with a fixed quote and timeframe.
Call us on (07) 5606 7332 if you have any questions.