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A limited liability company is an independent legal entity. Therefore, if someone sues the company, they are suing the entity and not its directors or shareholders. However, there are some circumstances in which a director is personally responsible for its company debts and liabilities. In that case, they may need to use their personal assets and finances to pay the debts the company owes. 

Importantly, be aware of the measures in place by the Australian Government and the Australian Securities and Investment Commission (ASIC) that holds directors responsible for their actions. This article details the circumstances in which you, as a director, may be personally liable for a company’s debts. It also outlines how you can manage the risk of liability to avoid being personally responsible.

Liability as a Company Director

Before consenting to act as a director, it is essential to understand how long you owe obligations to the company. Once a company is registered, the rights and liabilities of each director will continue. They will continue until, and in some circumstances after, the company has finished trading or has been deregistered. Therefore, keep this in mind in light of any debts incurred by your company when acting as a director. 

Liability Under a Guarantee

As a director, you can be personally liable if you have signed a director’s guarantee. This is also the case if you have provided security over your personal assets for a:

  • loan;
  • credit facility; or
  • other agreement in the interest of your company.

A director’s guarantee operates in the same way any other personal guarantee does. You personally agree to pay a company debt if the company defaults on its obligation to do so.

Additionally, a guarantee against a director cannot be enforced without leave of the court during a period of voluntary administration. The purpose of voluntary administration is to investigate the company’s affairs and decide what strategy is in the best interests of the company’s creditors. If a guarantee was allowed to be immediately enforced during this process, the purpose of voluntary administration would not be achieved.

However, the voluntary administration process does not halt proceedings already on foot. Nor does it stop a creditor from enforcing a judgment that the court has already handed down.

Trading While the Company is Insolvent

You may be personally responsible for losses that your company incurs due to a breach of your directors’ duties in the Corporations Act 2001 (Cth). For instance, if you have caused or permitted the company to incur debts after it has become insolvent. Specifically, this is a breach of the duty not to trade while the company is insolvent. Breaches of the directors’ duties can lead to civil and criminal penalties under the Corporations Act.

To be liable for insolvent trading, there must be reasonable grounds for you, as a director, to suspect the company is insolvent or would become insolvent as a result of incurring the debt.

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Case Study

An example of a company director being personally liable for insolvent trading is ASIC v Edwards. Murray River Pty Ltd (MRL) entered into an agreement for building works with Colin Joss & Co Pty Ltd (CJC). MRL was insolvent when CJC performed the building works for MRL.

The court found reasonable grounds for MRL’s director to suspect that the company was insolvent during the period in which CJC carried out the works. Ultimately, MRL disadvantaged CJC as they did not have the money to pay for CJC’s work. Therefore, the director was disqualified from managing corporations for 10 years for breaching his duty under the Corporations Act

Defences

There are defences to insolvent trading. These include:

  • whether you had reasonable grounds to expect the company was solvent at the time the company incurred the debt and would continue to be solvent;
  • whether you took reasonable steps to prevent the company from incurring the debt; and
  • if you did not participate in the company’s management at the time the company incurred the debt due to illness or another legitimate reason.

Illegal Conduct

Engaging in Phoenix Activity

The term ‘phoenix activity’ refers to fraudulent activity which involves a director transferring company assets to another entity. Following this, a director puts the old company into administration or liquidation to avoid paying creditors or employees.

If you engage in phoenix activity, you can be personally liable for a breach of the director’s duties. You may then be disqualified from managing corporations in the future. 

Enforcing Compliance

The introduction of the Director Identification Number (DIN) aims to combat illegal phoenixing activity. The Australian Government is taking additional steps to ensure that all Australian company directors are responsible for their actions. The introduction of the new tracking system under the DIN regime will mean that each director receives a unique DIN which they will keep permanently. Therefore, if you act as a director of multiple companies, it will be easy to identify you across those companies. 

The expectation is for the DIN regime to be in full operation by 2022. 

Liability Under Statutory Regimes

A statutory regime includes written laws that formally detail your legal obligations and consequences for non-compliance. Specifically, there are some statutory regimes under which a director can be personally liable for a debt. This can be either directly or as an accessory to an infringement of statute.

For example, as a director, you have personal liability for unpaid ‘Pay As You Go’ (PAYG) tax or Superannuation Guarantee Charge (SGC) amounts the company has not paid under the Australian Tax Office’s Director Penalty Regime.

Key Takeaways

As a director, you can be personally liable for your company’s debts when things go wrong. It is important to remember that your liability may be ongoing and that you must always fulfil your duties as company director. Likewise, you must remain financially diligent and avoid trading while insolvent. Importantly, never engage in illegal conduct.

If you need help with your corporate governance obligations, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions

How long can you be liable as a company director?

Once a company is registered, the rights and liabilities of each director will continue. They will continue until, and in some circumstances after, the company has finished trading or has been deregistered.

What does ‘phoenix activity’ mean?

‘Phoenix activity’ refers to fraudulent activity which involves a director transferring company assets to another entity. Following this, a director puts the old company into administration or liquidation to avoid paying creditors or employees.

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