It is very common for businesses in Australia to operate through private companies, also known as ‘proprietary limited’ companies. One of the key benefits of using a company structure is that operating a business through a company limits the risks that individuals who are involved in the business face personally. However, there are certain circumstances in which the directors or shareholders of the company may be personally responsible for the company’s debts or could even be sued for the company’s actions. 

A company will take on many risks throughout its life cycle. Common risks include:

  • taking on debts through borrowing money; and
  • taking on obligations to perform certain services or pay certain amounts of money. 

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 actions of the company.

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, there are also certain decisions which require shareholder approval, either under the law or according to 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.

For example, if your company enters into an arrangement to supply certain products to a customer and then fails to do so, the company will be seen to have breached the contract if that customer sues you. This means that your company will need to pay the customer, rather than you personally.

I Am the Shareholder of a Company. What Are My Risks?

Partly-Paid Shares

Shareholders are usually only liable to a company for any amounts which are unpaid 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 amounts which are unpaid. 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.

Guarantees and Secured Assets

A shareholder may also be responsible for the debts of a company if they provide:

Both providing a personal guarantee and providing security are ways for a creditor to help ensure a debt is repaid by the company. Under a personal guarantee, an individual promises 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 is unable to repay a debt, the creditor can take possession of those assets and sell them in order to try and repay the debt. 

Although it is much more common for a director of a company to provide a personal guarantee, in the rare case that a shareholder provides a personal guarantee or security, that shareholder will be personally responsible for the company’s debt if the company does not or cannot repay it.

I Am the Director of a Company. What Are My Risks?

Directors’ Duties

Directors of a company are responsible for managing the company and owe certain duties to the company. A director must act in the best interests of the company and shareholders and comply with the duties imposed on them under the law. 

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 which 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 personally pay off company debts;
  • jail time; and
  • disqualification from managing a company.

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:

  • are responsible for managing the company day-to-day (and so 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 is unable to 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 personally repay the company’s loan.

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 his or her own assets to satisfy repayment of the loan if the company fails to meet its repayment obligations.

Key Takeaways

Generally, operating a business through a company means that the individuals who are involved in the company are protected from personal risks. However, there are certain situations in which directors and shareholders can be personally responsible for the actions of a company. Directors and shareholders can be at risk if they:

  • provide personal guarantees; or 
  • provide security on behalf of a company when it is taking on debt. 

Directors face greater personal risks because they have obligations in law regarding their management of a company. These obligations can lead to quite severe personal liability if they are not met. If you have any questions regarding company structures and which risks you face personally as a director or shareholder of a company, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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