Directors and personal liability: when might I be at risk?

When talking about asset and business structuring, lawyers and financial advisors often focus on the benefits of a limited liability structure for clients to protect themselves and their family assets from the risk of doing business.  The most common asset protection structure utilised for business is the company, which provides a limited liability structure which what many consider to be a less risky alternative than doing business within a partnership or as a sole proprietor.

However, what can often be overlooked or not considered is that limited liability does not mean no liability.  For directors of companies, there are some circumstances where the “company veil” can be lifted and directors can be held personally liable. Directors should know and understand these risks in order to be able to mitigate against them.

What are some of the potential circumstances I may be facing personal liability as a director?

Acting as guarantor

Often when entering into commercial transactions, including leases, sale and purchase of businesses, franchise arrangements, loan agreements and other types of contracts or arrangements between parties, one party will require the other party to secure their obligations and payments due under the arrangement by way of a guarantee.  Most often this guarantee will be provided by the directors of a company or the corporate trustee of a trust, however guarantees may also be sought from the shareholders of a company or beneficiaries of a trust.

A guarantor’s role in a transaction is to guarantee the performance of obligations by that party, and the payment of monies under the contract or arrangement by them. If that party does not meet obligations under the contract, then the other party can take action against both the primary contracting party and its guarantors.  Most often a contract will provide that the non-defaulting party is not required to exhaust all avenues against the defaulting part prior to taking action against guarantors but can pursue the guarantors and the defaulting party simultaneously.

Guarantees are a common part of commercial transactions and as such it is often the case that a director will sign up to act as a guarantor with little or no concern as to the potential consequences if things go wrong.  This is because we often only consider that fair weather scenario, in assuming that the contacting party will be able to carry out its obligations and the guarantee will never be called on.  Very often that is the case, however guarantees are in place for when the unexpected does happen, and when it happens the director may not just be facing issues within their company, but also potential personal liability under any and all guarantees they have signed in the course of business, which she or he thought his company trust or business would otherwise have been able to meet.

Director’s duties

The most common area of liability which people think about when they think about directors, is probably director’s duties. This is often the first thing we look at when directors of new companies ask about their risk and can often be a focus where there is a dispute with or within a company board.

The director’s duties are set out in sections 180-184 of the Corporations Act and are further detailed here. They apply to all directors, even where that director may not actively be involved in the company operations and in some limited circumstances can also apply to other controllers of the company.

In summary, the risk to a director of a company who does not meet those directors’ duties is that they may be facing one or more of the following (if either ASIC or the shareholders of the company take action):

1. Be held personally liable to compensate the company, its shareholders or other persons for any loss or damage suffered as a result of the breach of duties;
2. Be found liable for contravening the Corporations Act (civil provision) and be liable for a significant fine of up to $200,000;
3. Be found guilty of a criminal offence and receive a fine or imprisonment; and/or
4. Be prohibited from managing a company in the future.

Director Penalty Notices

In situations where a business operated by a company has not met its payment obligations in relation to tax liabilities related to PAYG withholding tax, superannuation guarantee charges and GST, the Australian Taxation Office (ATO) has special powers to take action against directors personally.

In these circumstances, the ATO can issue what are called ‘director penalty notices’ (DPN), against current or former directors of a company (where that former director was a director at the time the debt was incurred).  In circumstances where the company has relevant tax liabilities outstanding, the ATO follows a process, where essentially it issues a DPN to the director, which may be a warning notice or a personal liability notice, depending on circumstances.  The director will have different options related to a warning notice as compared to a personal liability notice, and there are some defences to a DPN. However, the receipt of a DPN is a serious issue for a director.  Most importantly, the only effective way to remove a DPN is to ensure the debt is paid, and the ATO is not concerned whether that is through the company or through a director’s personal assets.

Post-COVID, there appears to have been a significant increase in the number of businesses and companies with outstanding tax liabilities owing to the ATO.  As a result of this situation, the ATO has recently begun issuing DPNs in a more rigorous action to recover company tax liabilities.

Insolvent Trading

Finally, a director can also potentially be made liable for debts incurred by a company where that company was trading while insolvent.

In summary, the test for determining whether a director may be held personally liable for insolvent trading is where:

1. the debts were incurred at a time that the company was insolvent, or became insolvent by incurring the debt; and
2. at that time, there were reasonable grounds for suspecting the company was insolvent or would become insolvent, in incurring the debt.

There are some defences and protections for a director where a company may have been insolvently trading, including what are known as the safe harbour provisions, however, if a defence cannot be established, a director may be personally liable for these debts as incurred.

Further details about liability for trading while insolvent, as well as the safe harbour regime can be found here.

So, what can I do as a director to best protect myself from personal liability?

Risk is part of doing business.  However proactive management of personal and business assets can assist a director to minimise the risk of personal liability in doing business and protect themselves and their families from a situation where their assets may be available to creditors or regulators.

Consider your personal asset structuring

When starting a business, establishing a company or entering into a new business venture, it is important for a director to also consider and take advice on personal asset structuring.  This is particularly important where a director may have a family whose family home and lifestyle may be at risk if something goes wrong in business.

Your financial and legal advisors can assist to make recommendations based on your personal circumstance to ensure that, if the worst does happen and you find yourself personally liable for debts of the company, the risk to your family and personal assets is minimised.

Stay involved and engaged

A director who understands the company’s financial position and the company’s risk profile at any one time is a director who can be fully informed of any risks they may have in entering into any transaction (whether it be on behalf of the company or as a personal guarantor).

While risk can never be entirely mitigated, a director who is properly advised, and in good faith actively engage in management and decision-making processes within a company is far less likely to be in a situation where they are in breach of director’s duties, undertaking insolvent trading or giving guarantees that may be called upon.

Engage early if there are issues

If you, as a director, become aware of concerns or issues within the company, for example, that the company may be at risk of insolvency or is in arrears to the ATO, should take steps to engage as early as possible with these problems.  Waiting and hoping the problem will not be noticed or will resolve in time will only increase the risk of you being personally liable at a later stage.

If a company is in financial stress, legal and financial advisors, and insolvency experts/liquidators can provide assistance and advice to a company to understand its position and to explore options for the future.  If a debt is owed to the ATO, engaging early and discussing a payment plan which can be met by the company can protect against the ATO issuing DPN later down the track.  Again, financial and legal advisors are there to assist in those processes and the earlier they are addressed, the better outcome can be achieved for all parties.

Seek independent legal advice

If you as a director, believe you may be at risk of being chased personally by a creditor or a regulator, you should obtain legal advice promptly.

While the company’s financial and legal advisors can provide advice to you in your role as director, where there is personal liability at stake, a director is best protected by a third-party legal advisor, particularly if the company’s position / the position of other directors may be different to, or in conflict with your position.

Seeking independent legal advice can assist you to understand your position in connection with the company’s position and to understand what steps you can take to minimise your personal risk based on your own circumstances.

In summary

While directors cannot entirely mitigate the risk of personal liability in relation to a company and its business, taking action in relation to the above can help mitigate that risk and leave you in a position where you feel comfortable in your role as a director and confident about the decisions you make.

If you have concerns about your potential personal liability in relation to a business, company or trust or want to discuss whether your current personal and business structuring is best for your situation, please contact us.