A limited liability company is an independent legal entity. This means that, if someone sues the company, they are suing the entity and not its directors or shareholders. As a result, a director or shareholder’s financial liability is limited to a fixed sum. This sum is usually the value of their investment in the company. However, there are some circumstances in which a director is personally responsible for a company’s debts and liabilities. Therefore, they may have to use their personal assets and finances to pay the debts the company owes.
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 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:
- 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.
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 affairs of the company 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 in respect of a guarantee.
Trading While the Company is Insolvent
You may be personally responsible for losses which your company incurs as a result of 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 held 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.
An example of a company director being personally liable for insolvent trading is in the case ASIC v Edwards. Here, 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 that there were reasonable grounds for MRL’s director to suspect that the company was insolvent during the period in which CJC carried out the works. Ultimately, this meant that CJC was disadvantaged, because MRL 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.
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 management of the company at the time the company incurred the debt due to illness or another legitimate reason.
Engaging in Phoenix Activity
The term ‘phoenix activity’ refers to fraudulent activity which involves a director transferring company assets to another entity. They then put the old company into administration or liquidation to avoid paying creditors or employees.
If you have engaged 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.
Liability Under Statutory Regimes
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.
Unlike shareholders, directors may be personally liable for their company’s debts. Therefore, you should understand your duties as a director under the Corporations Act and liabilities that arise under other legislation. You should also act honestly and properly in your company’s affairs and seek legal and financial advice where necessary. If you have any questions, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
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