A limited liability company is an attractive business structure for business owners and directors as the company is a separate legal entity from its shareholders and directors. This structure provides shareholders and directors with protection over their personal assets. Generally, the company’s debts are the company’s. This means if the company is sued, the directors or shareholders are not being sued in their personal capacities. However, there are some occasions where directors and shareholders can be held personally liable for the debts of the company. This article will explain the limits to the limited personal liability that a company provides.
Directors
General Liability of Directors
Directors of a private company limited by shares are generally not liable for their company’s debts. The rest of this section deals with directors of private companies limited by shares.
As a director, one of your most important directors’ duties is to prevent insolvent trading. If you breach your duty to prevent insolvent trading, you may be legally responsible for the company’s debts during this period of insolvent trading.
If you do not take a course of action reasonably likely to lead to a better outcome for the company, you may be personally liable for the company’s debts during the period of insolvent trading. Consequences of breaching directors’ duties can include:
- civil penalties of up to the greater of 5,000 penalty units or three times the benefit obtained or detriment avoided;
- paying compensation for amounts lost by creditors;
- criminal charges which can lead to a fine of up to 2,000 penalty units or imprisonment of up to five years, or both.
Tax and Super Obligations
Directors of a company are responsible for ensuring the company complies with its tax and super obligations. This includes reporting these obligations and ensuring timely payment. If your company does not pay certain liabilities by the due date, the Australian Taxation Office (ATO) is able to go after the director in their personal capacity for these outstanding obligations. This applies to current and former directors.
Director Guarantees
Another process that may give rise to personal liability as a director is where the company takes out a loan with a bank, trade creditor or anyone else providing finance or credit to the company. It is common for the lender to ask for a “director guarantee,” meaning you are personally guaranteeing the company’s loan.
For example, the lender may ask you as a director to give a mortgage over your house to secure the company’s repayment of a loan. If the company does not repay the loan it owes, the bank may enforce its right to recover the loan by taking possession or selling your home.
Illegal Phoenixing
This situation refers to one where a new company, for little or no value, continues the business of an existing company that has been liquidated or otherwise abandoned to avoid paying outstanding debts. These debts include taxes, sums owed to creditors and employee entitlements.
This happens because a company is a separate legal entity. If the company has employees, those employees have signed contracts with Company A and therefore can sue Company A. If Company A is abandoned because it owes debts to various parties, and Company B is created, runs the exact same business as Company A and where Company B has not paid at least market value to acquire the business, this is illegal phoenixing activity.
Engaging in illegal phoenixing can involve a breach of your directors’ duties. This includes failing to prevent creditor-defeating dispositions, fraudulent concealment or removal of assets and fraud by directors. Penalties include large fines and up to 15 years’ imprisonment for company directors.
Defences to Insolvent Trading
As a director, you may be exempt from failing to prevent insolvent trading if you can show that:
- you had reasonable grounds to believe the company was solvent and would remain solvent;
- you relied upon information supplied by a reliable and competent person regarding the company’s solvency;
- during the time that the debt was incurred you were not involved in the business management due to illness or another good reason; or
- you took all reasonable steps to prevent the debt from being incurred. Reasonable steps include developing a course of action to turn the company around towards a better outcome.
What You Need to Do as a Director
To place yourself in the best position to avoid trading while insolvent, a director should constantly monitor the company’s financial position for any indication that it may be insolvent. Ensure you keep informed on an ongoing basis. If you are relying solely on financial statements at the end of each financial year, this will likely not be considered sufficient.
You should immediately act on the first signs of financial difficulties that present themselves. If you believe that your company is heading toward insolvency, you should:
- not incur further debts; and
- seek professional advice from a qualified insolvency practitioner.
Liabilities of Shareholders
Private Company Limited by Shares
Shareholders, as the owners of the company, enjoy certain rights in the company, including the right to:
- receive dividends;
- receive company reports;
- attend shareholder meetings; and
- vote on key issues.
Shareholders are generally not liable (or legally responsible) for company debts. As a shareholder, you are only legally responsible for any amount unpaid on your shares. You will need to pay this amount if the company asks you to do so, which may happen during insolvency. Therefore, you have limited liability, capped to the amount unpaid on your shares. Shares are usually issued fully paid, so in most cases, you will not have any additional liability.
For example, where you have agreed to pay $100 in consideration for receiving 100 ordinary shares, and you have paid the consideration to the company, your liability as a shareholder is zero.
Where the company takes out a loan with a bank, trade creditor or anyone else providing finance or credit, the lender may ask for a “shareholder guarantee.” As such, you, as a shareholder, are personally guaranteeing the company’s loan.
Public Company Limited by Guarantee
A public company limited by guarantee is a common company structure used for not-for-profit and charitable organisations in Australia that reinvest any profit towards the organisation’s charitable purposes.
Companies limited by guarantee provide that the liability of members is limited to the amount they agree to contribute if the company is wound up. This amount is typically set out in the company’s constitution. It is worth noting that companies limited by guarantee cannot pay dividends which makes it a popular structure for not-for-profit organisations.
This guide will help you to understand your corporate governance responsibilities, including the decision-making processes.
Key Takeaways
A company is a popular business structure because it offers limited liability to directors and shareholders. As the company’s debts are the company’s, if the company is sued, directors’ or shareholders’ personal assets are safe from creditors. There are, however, limits to limited liability. For instance, directors or shareholders might give personal guarantees for the company. Additionally, if directors breach their director duties, they may be personally liable.
If you have any questions about limited liability or the company structure, 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.
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