Directors and Shareholder Liabilities During Insolvency: What You Need to Know

Can directors and shareholders be held personally liable for the debts of a company in the event of insolvency? The short answer is yes for directors, and usually no for shareholders. This article sets out the potential personal liabilities of a director and a shareholder in the event of insolvency.

Debts of a Company

In the majority of cases, where a company has been managed responsibly, the company’s debts will remain with the company. If however the directors of the company have breached the law in their day-to-day management of the company, they can become personally liable for the company’s debts and/or become the subject of regulatory action.

What are the Potential Liabilities of a Director?

A director has legal duties and obligations to act in the best interest of the company and for a proper purpose. A director of a company is also responsible for governing the company on behalf of its shareholders. While a corporate entity’s limited liability protects a director to an extent, there are still certain duties that a director must uphold in common law and under the governing legislation in Australia, the Corporations Act. A breach of these duties has a number of legal consequences including criminal and civil sanctions and penalties, as well as disqualification from being a director.

As a director, the key areas of potential personal liability include:

• Acting as a guarantor or providing security over personal assets;
• Debts incurred when the company becomes insolvent (this is because a fundamental duty of a director is to ensure that the company does not trade when it is insolvent);
• Company losses caused by a breach of director’s duties;
• Illegal phoenix activity (this involves the intentional transfer to a new company of assets to avoid paying creditors, tax or employee entitlements).

A director of a company also has personal liability under the ATO’s Director Penalty Regime for any unpaid Pay As You Go (PAYG) withholding amounts or Superannuation Guarantee Charge (SGC) amounts that the company fails to pay. The key objective of the ATO’s Director Penalty Regime is to ensure that the directors of a company make sure that the company complies with its taxation and superannuation obligations and to ensure that directors of a company take appropriate and prompt action with respect to employee entitlements. A company must, therefore, ensure that it maintains enough assets to meet its PAYG and SGC liabilities otherwise its director/s may be personally liable.

What are the Liabilities of a Shareholder?

Shareholders own the company by owning shares in the company. If the company fails in its operation, the shares may be worth nothing, but the shareholders cannot be required to pay more or be held personally liable for actions of the company. This is of course unless the shares are partially paid, in which case they may have to pay any outstanding amounts so that the shares are fully paid.

In the event a company is wound up, shareholders would rank behind the creditors of the Company and are unlikely to receive any dividend in an insolvent liquidation unless it has a claim as a creditor. 

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If you have any questions about your potential personal liability as a director or shareholder of a company, let our corporate lawyers know on 1300 544 755.