Am I personally liable for the debts of my company? Could I lose my house or other assets if my company is in trouble?
If you’re a director of a company or have been one for a while now, the chances are that not knowing the answers to such questions often give you nightmares.
There’s no doubt that being a company director is exciting (and) tricky at times. You’re essentially the mind of the company, and with this comes a lot of responsibilities that you need to keep track of continuously.
However, being unaware of the risks can prevent you from growing your company.
Want to learn more about how to keep yourself and your company safe? Read along as we share everything you need to know to keep your Australian business safe. We deep dive into the liabilities of directors, how to mitigate risks, and share some frequently asked questions.
Let’s dive in!
Directors’ duties- What duties do I owe as a director?
When directors first set up a company, there is an option for directors not to pay the company’s debts. This is because, by law, a company exists as a separate legal entity.
If you meet your legal duties as a company director, any debts or liabilities of directors will be the company’s responsibility and not yours personally.
The Corporations Act 2001 (Cth) is a piece of legislation that sets out the duties you have as a director. The 6 duties all company directors must abide by are the duties to:
- Act in good faith and for a proper purpose
- Act with reasonable care and diligence
- Prevent insolvent trading and become solvent
- Prevent an improper use of position
- Avoid all misuse of information
- Prevent conflicts of interest
Other general duties
Besides the director duties, there are other general duties such as:
- Not trading while insolvent
- Properly disclosing your interests
- Statutory regimes- As a director, you can be personally liable for unpaid ‘Pay As You Go’ (PAYG) tax.
- Personally liable for Superannuation Guarantee Charge (SGC) for the amounts a company hasn’t paid under the Australian Tax Office’s (ATO) Director Penalty Regime.
So put simply, you need to understand how your company operates to ensure you meet your company’s interests.
For example, say you don’t have all the information for a particular area in your company. Can you pass on that responsibility to your employee? The short answer is no. It will be your responsibility to:
- Investigate the topic
- Seek advice
- Take the necessary steps to resolve any issues
If you take proactive steps to ensure your company doesn’t get into any trouble, you’ll be fine.
However, sometimes the reality is that directors may not seek help, which could mean being held personally liable.
Let’s go through what that means together to ensure it doesn’t happen to you.
What is limited liability?
Limited liability allows one or more persons to set up a company without incurring personal liability for the company’s debts.
In simpler terms, you will not be personally liable for your company’s debts if something goes wrong.
For example, let’s say that you and 2 friends open up a nail salon in the city. You have all put your money together and incorporated your business. If your business goes under, you will not be personally liable to pay for the company’s debts.
However, there are some situations where the rule of limited liability may no longer protect you. Therefore, you may become personally liable for the debts of your business.
When can company directors be personally liable?- Liabilities of directors?
Generally speaking, there are many instances where you can be personally responsible for your company’s debts, even if you are a limited liability company.
Let’s go through them.
Trading while the company is insolvent
The Corporations Act 2001 (Cth) section 588G requires directors to ensure their company does not operate while they’re insolvent.
What this means is if you have reasonable grounds to suspect that your company will become insolvent and continue to trade, this is a breach.
If your company continues to incur debt when it can’t pay back its outstanding amounts, you will be failing your duties as a director.
Failing your duties can result in:
- Various criminal penalties and civil penalties
- Australian Securities and Investment Commission (ASIC) and the Australian Government will hold you responsible for your actions
- You will be personally liable to compensate the company.
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Engaging in Phoenix Activity – Illegal conduct
Phoenix activity is where the company director that is struggling will purposely place themselves into liquidation. The purpose of this is so they can avoid paying its debts.
They then continue the same business and will transfer company assets to another entity. However, under a completely new company name. Phoenix activity is illegal, and you will be liable if you engage in this activity as a director.
Still unsure what this means? It would be best to seek professional advice, so why not hire a Lawpath lawyer to learn more.
Personal guarantees
You will also be personally liable for your company if you are a personal guarantor (Director’s Guarantee) of your company’s debts.
Singing a directors guarantee means that you agree to be personally liable for your company’s debts. Why would you even do this in the first place?
- You may be requested to provide a guarantee supporting your company’s obligations in various contexts. For example property leases, sale of good contracts, or simply a bank loan
- Providing a directors guarantee can bolster your company’s credit rating
- Assures the company’s debtors
On the flip side, a directors guarantee also means that you will be personally liable when your company becomes bankrupt and there are debts.
If you don’t have the money to repay a loan, this may result in you having to file for bankruptcy. So as a director, carefully consider what you are exposing yourself to.
Best ways to reduce risks of personal liability
Directors and Officers (D&O) Insurance
Directors’ and Officers’ Insurance (D&O Insurance) works as a protection for a director or officer for being personally liable if the company experiences any difficulty.
This protection is offered to directors and extends to employees and non-executive directors as well.
Having D&O insurance (warranty) cover will protect you against liabilities that aren’t mentioned in the Deed of Indemnity. However, this insurance will not cover directors if they engage in illegal conduct.
Deed of Indemnity
As a director of your company, you can also protect yourself from personal liabilities if you have a Deed of Indemnity, also known as a ‘Deed of Access & Indemnity’ and ‘Deed of Insurance’ in place.
A Deed of Indemnity is a legal agreement between the company and a company director, and it sets out:
- Scope of liabilities of directors protection
- Access to relevant documents
- Directors and officers insurance (D&O Insurance Policy)
Although the Deed of Indemnity offers some protection against personal liabilities of directors, it’s limited in the following ways:
- It won’t protect you if you breach your director’s duties
- It won’t protect you against fraudulent, dishonest or criminal behaviour
- It won’t protect you if you breach other legal obligations under the Corporations Act 2001 (Cth)
Manage your finances
As a director, you have a lot to think about to stay on top of your financial obligations. If you stay on top of your finances, you can prevent having an insolvent company and trading, which means that you won’t be personally liable if something goes wrong.
So understanding how to manage your finances from the very beginning is worthwhile.
We’re sure that you have accountants and banks to assist you in your company’s day to day finances. This is common, but you’re still responsible for ensuring that everything runs accordingly.
How do I do this, you ask? It’s simple. Here are some tips:
- Record keeping of – Financial statements (invoices, cash flow statements, balance sheets), deeds, minutes of meetings
- Monitor your stock levels
- Manage outstanding accounts
- Review your payment methods
- Reduce your overheads
- Regularly check your company’s financial position
Although it’s not realistic to check your company’s finances every hour of every day, you need still to have a good understanding of your company’s finances to take action when required.
Frequently asked questions (FAQs)
In what circumstances might a director be held personally liable for the debts of the company?
You may be personally liable for:
- Debts incurred by the company when it was insolvent
- The company is not withholding employees’ pay as you go tax
- Failure to pay employee superannuation guarantee charges
- Losses the company suffers as a result of your breach of duty as a director
- You will be personally liable for any debt you provided a guarantee for as a director
How does the government enforce compliance?- Director Identification Numbers
A Director Identification Number or Director ID or DIN as it may be known is a 15-digit unique identification number that all directors— future and existing, must hold.
Implementing Director Identification Numbers will potentially prevent directors from operating under fake and fraudulent names.
You see, it’s not very uncommon for directors to use their middle names or completely false names on company records to prevent them from being legally connected to their companies.
Crazy, isn’t it? We think so too, but it’s true. Recently, there’s been a rise in ‘Dummy Director’s’ where companies rip off creditors and avoid paying huge bills to the tax office by operating with a false identity.
Can they come after my house?
The answer is generally no if you’re a director of a limited liability company. Under limited liability, your house can’t be taken away to repay any money.
However, the liabilities of directors may still arise. If you breach your duties as a director you can still be personally liable and be at risk of losing your house if:
- You provided a personal guarantee that you are committed to repaying the loan
- You offered your home or other personal assets as a form of security to a bank
- You have unpaid PAYG taxes and unpaid superannuation
- Insolvent trading
Can a company’s shareholders be made liable for company debts?
Shareholders enjoy limited liability, just like company directors. However, they may be personally liable if:
- A shareholder has personally guaranteed a debt
- A shareholder has have acted improperly or fraudulently (this holds for any individual, not just shareholders), for example, using company money for personal use.
How long can I be liable as a company director?- Liabilities of directors
The liabilities of directors will continue until ASIC deregisters the company. Your obligations as a director may continue even after your company has ceased trading and deregistered.
Do liabilities of directors still apply even after resignation/ Can I still be liable if I’ve resigned as a director?
Yes, you may still be liable even after you’ve resigned as a director. This is because your fiduciary duties and duty of care as a director still survive even after you resign.
As such, it’s a positive idea to be proactive and act in your company’s best interest of the company even after you leave.
What is liability under a guarantee?
Personal guarantees or security act as a fallback when your company can’t pay its debts. If you provide a guarantee to your company’s creditor, you will become personally liable if the loan isn’t repaid.
For example, your company may take out a loan from a bank, and as director, you offer your house as security. If the company is struggling and doesn’t meet its repayments, you may lose your house.
What do I need to know about director penalty notices?
A Director Penalty Notice is a mechanism for the ATO to pierce the corporate veil. It allows the ATO to pursue you personally if your company does not meet its PAYG and SGC obligations.
Are directors personally liable for wages?
Directors can be personally liable for underpaying employee wages and other entitlements. The Fair Work Act imposes accessorial liability on directors if they’re involved in breaching the act.
Accessorial liability means that the director:
- Assisted, recommended or caused the contravention
- Influencing the infringement- for example, making promises or threats
- The director was a party or inspired others to be part of the contravention
Do liabilities of directors and duties only apply to directors?
Of course, company directors will owe directors duties. But, are directors the only individuals that must abide by directors’ duties in Australia?
Surprisingly — no. Any individuals who are company officers will owe directors duties.
Are there any circumstances where directors are relieved from the consequences of breaching their duties?
There are many possible methods of relief offered to directors for breaching their director’s duties. The most common forms of relief are:
- 1. Ratification by members — A director would be relieved of a breach because they had been granted consent from the board of directors and members in a general meeting before their conduct which would otherwise be a breach of obligation
- 2. Relief by the court — Section 1318 of the Corporations Act 2001 (Cth) gives the court power to grant a director relief if they acted honestly.
- 3. Indemnification insurance — A director can only be indemnified through insurance if they did not act dishonestly (section 199A(2) of the Corporations Act 2001 (Cth)
What’s next?
Every now and then, our law undergoes a bit of development, and as a director, it may affect your responsibilities and liabilities.
Whether the law relates to your legal duties as a company director or company in general, it’s essential to be aware of instances where you may be personally liable for your company’s debts if you don’t meet the required expectations.
If you want to make sure you’re personally covered in cases your company experiences some trouble, we can help you through the process to ensure you don’t miss a step. Hire a lawyer today to get started.
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