One of the key benefits of operating a business as a ‘proprietary limited’ company is the protection it affords to the personal assets of those involved in the business. However, there are certain circumstances in which the directors or shareholders of the company may be personally responsible for the company’s debts or sued for the company’s actions. If you are involved in a business, you will likely want to protect yourself and your personal assets from these risks. This article sets out when directors or shareholders of a company may be personally at risk from the company’s actions.
If you are a company director, complying with directors’ duties are core to adhering to corporate governance laws.
This guide will help you understand the directors’ duties that apply to you within the Australian corporate law framework.
What is a Company?
A company is its own legal entity, separate from its owners and the people who manage it. A company has the same rights as a real person, meaning it can:
- enter into contracts;
- sue someone; and
- be sued itself.
The key people involved in a company are its directors and its shareholders. Directors manage the company’s day-to-day business and have responsibilities and duties to the company. Shareholders are the owners of the company who hold shares in the company. Shareholders can be:
- individuals; or
- other types of legal structures, such as companies or trusts.
Directors are usually responsible for the decisions a company makes and the actions it takes. However, certain decisions require shareholder approval, either under the law or per the company’s shareholders agreement. As such, you will likely have some involvement and responsibility in the path the company takes regardless of whether you are a director or a shareholder of a company.
What is the Benefit of Using a Company to Run My Business?
Running a business through a company is one of the best ways for individuals to protect themselves personally. This is because a company is its own legal entity and has ‘limited liability’. This means a company:
- is generally liable for its own actions;
- can enter into contracts and legal obligations in its own name; and
- can be sued in its own name.
What Are a Shareholder’s Risks?
Below we outline three risks shareholders face.
1. Partly-Paid Shares
Shareholders are usually only liable to a company for any unpaid amounts on their shares. In order to own shares, shareholders have to pay the full price of their shares. Usually, shares are ‘fully paid’, meaning the shareholder paid the full price of the shares upfront. However, shares can also be ‘partly paid’, which means the shareholder still owes some money in respect of those shares.
If this is the case, a shareholder is responsible for paying the company for the unpaid amounts. The company can demand repayment at its discretion. This means that if the company goes into liquidation, shareholders who hold partly paid shares will need to pay the unpaid amount on their shares.
2. Guarantees and Secured Assets
A shareholder may also be responsible for the debts of a company if they provide:
- a personal guarantee over a company debt; or
- security over a company debt.
Under a personal guarantee, you promise to pay a debt the company has taken on if the company cannot do so itself. Providing security over a company debt means that an individual grants a creditor an interest in some or all of their valuable assets. This means that if a company cannot repay a debt, the creditor can take possession of those assets and sell them to try and repay the debt.
3. Breaching the Law
In some circumstances, the law can hold shareholders personally liable for company debts even if they do not provide a personal guarantee. Generally, this occurs when a shareholder has engaged in fraudulent or other illegal activity that has caused the company to incur debts.
What Are a Company Director’s Risks?
Below we outline three risks shareholders face.
1. Directors’ Duties
Company directors are responsible for managing the company and owe certain duties to the company. Examples of directors’ duties include the duties to:
- act in good faith, in the best interests of the company and for a proper purpose;
- exercise care and diligence when managing the company;
- ensure that a company is not trading while it is insolvent;
- disclose any significant personal interests they have that relate to the company’s affairs; and
- not use their position for personal gain at the expense of the company.
If a director fails to fulfil their directors’ duties, they may be personally responsible for doing so. Potential consequences for directors include:
- having to pay financial penalties;
- having to pay off company debts personally;
- jail time; and
- disqualification from managing a company.
2. Guarantees and Secured Assets
It is common for directors, particularly of small or newly established companies, to have to provide personal guarantees for company debts. For example, if the company takes out a business loan, the lender may ask for a director to provide a ‘director’s guarantee’ to guarantee the company’s repayment of the loan.
Directors are typically seen as the most appropriate people to take on these risks. This is because they:
- have the best understanding of the company’s financial position; and
- must manage the company in the best interests of the company and its shareholders.
If a director guarantees a loan on behalf of a company, and the company cannot repay that loan out of its own cash and assets, the director’s personal cash and assets will be at risk. This is because they will have to repay the company’s loan personally.
Most commonly, a company will provide security for a loan over its own assets. However, in the rare case that a director agrees to secure a loan, that director will have to risk losing their own assets to satisfy repayment of the loan if the company fails to meet its repayment obligations.
3. Breaching the Law
A director will be personally liable for some of the company’s unlawful breaches. Typically, these breaches involve criminal activity, such as:
- fraud;
- money laundering;
- illegal phoenixing (where a company cannot pay its debts); and
- further acts of dishonesty.
Directors can also be personally liable for breaching the following:
- Australian Consumer Law;
- state and territory-based work health and safety (WHS) obligations;
- federal, state and territory environmental protection law;
- Australian Taxation Office (ATO) offences; and,
- superannuation obligations.
What Can I Do to Mitigate These Risks?
Running a business is inherently risky. However, the proactive management of personal and business assets can empower shareholders and directors to:
- mitigate personal liability risks; and
- safeguard themselves and their families from having their assets fall into the hands of creditors or regulators.
1. Personal Asset Structuring
You should consider how becoming a director or shareholder can impact your personal assets when starting a business or entering a new venture. You should work with financial and legal advisors who can give you personalised advice on protecting your family home and other essential assets in case something goes wrong with the business.
2. Stay Informed and Engaged
As a director, it is essential to understand your company’s financial position and risks. This will help you:
- make informed decisions; and
- avoid situations that could breach your duties as a director or expose you to personal liability.
In other words, you should stay involved in the management and decision-making processes of the company to minimise company risks.
3. Address Issues Promptly
If you notice any concerns or problems within the company, such as financial difficulties or debts, you should not ignore them. This is because delaying the resolution of these issues can increase the risk of personal liability later on. Therefore, you should seek help from legal and financial advisors or insolvency experts who can guide you through these challenges.
4. Seek Independent Legal Advice
If you are worried about creditors or regulators personally suing you, it is wise to consult an independent legal advisor. While your company’s advisors can help you in your role as a director, personal liability matters require specialised expertise. An independent legal advisor can:
- assess your situation;
- understand the company’s position; and
- provide guidance on how to minimise your personal risks.
Key Takeaways
Operating a business through a company means that the individuals who are involved in the company are protected from personal risks. However, certain situations exist where directors and shareholders can be personally responsible for company risks. Directors and shareholders can be at risk if they:
- provide personal guarantees;
- provide security on behalf of a company when it is taking on debt; or
- breach any applicable laws.
You should note that directors face more significant personal risks because they have legal obligations regarding the management of a company. These obligations can lead to quite severe personal liability if they are not met.
If you have any questions regarding personal liability for company risks, our experienced commercial lawyers can assist you 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.
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