What are your personal liabilities as a director of a company?
The law recognises a business as an independent entity, separate from its directors and shareholders. The law safeguards the personal interests of business owners and directors through the concept of the corporate veil. Under the corporate veil, a director is generally not personally liable for the company’s debts or legal issues. However, in certain circumstances, it is possible for creditors to hold directors personally responsible for business debts.
Prior to accepting a role as director, you should understand your duties and responsibilities. Be sure to review the company constitution, shareholder agreements, accounting processes, and other relevant business documents governing the management and operation of the business. As a director, under the Corporations Act you will have several duties in managing the business of a company, which include most importantly: to act in good faith; to act in the best interests of the company; to avoid conflicts between the interests of the company and your interests; to act honestly; and exercise care and diligence.
Personal Liability
As a director of a company, you may be held personally liable for: Personal Guarantees; Insolvent Trading; Illegal Conduct (including Phoenix Activity); and Statutory Violations.
Personal Guarantees
You can be personally liable for any company debt you provide a personal guarantee for as a director. Signing a director’s guarantee means that you agree to be personally liable for your company’s debts. You may be requested to provide a guarantee supporting your company’s obligations in potential future situations. Examples include property leases, sale of good contracts, or simply a bank loan. A director’s guarantee may be utilised to improve a company’s credit rating and provide assurances to debtors. Personal guarantees act as a fallback when your company can’t pay its debts. If you provide a guarantee to the company’s creditor, you will become personally liable if the loan isn’t repaid. For example, in the event, the company takes out a loan from a bank, and as director, you offer your house as security. If the company then doesn’t meet its repayments, you could potentially lose your house. A director’s guarantee also means that you could be personally liable when your company becomes bankrupt.
Insolvent Trading
You can also be held personally liable for company debts incurred by the company when it was insolvent. The Corporations Act 2001 (Cth) section 588G requires directors to ensure their company does not operate while they’re insolvent. This means if you have reasonable grounds to suspect that your company will become insolvent and continue to trade, this is a breach of your duties as a director. If your company continues to incur debt when it can’t pay back its outstanding amounts, you will be failing your duties as a director.
Illegal Conduct
If directors use the corporate structure to avoid legal obligations or evade debts, the court may hold them personally responsible. You could also be personally liable for the company liabilities, allowing creditors to claim debts from company directors or parent companies if the company is used for fraudulent purposes.
Directors may also be liable for phoenix activity. Phoenix activity occurs when the company director of a struggling company purposely places themselves into liquidation, with the purpose to avoid paying its debts. The director then continues the same business and transfers company assets to another entity, under a completely new company name. Phoenix activity is illegal, and you will be liable if you engage in this activity as a director.
Statutory Violations
As director you must seek to abide by all statutory laws that govern the company. Failure of any of your duties under the Corporations Act listed above, may result in criminal or civil penalties, being held personally liable to compensate the company or others for any loss or damage suffered; and may prohibit further management of a company. You can also be held personally liable for other violations of statutory law including Australian Consumer Law, and the Tax Administration Act 1953. This includes being held personally liable if the company is not withholding pay as you go tax or failure to pay employee superannuation guarantee charges.
There are ways to limit your liability and further protect yourself as a director, including D&O Insurance and Deeds of Indemnity. Contact our team at The Small Business Lawyer for a Free Consultation to find out how we can help you with taking the next steps in your role as a director.
