As insolvency practitioners and advisors, directors often ask us two questions: “Am I liable? And for what?”

Before answering this common concern, it is worth noting that a company under its directors’ stewardship is often referred to as a “safe” business structure. This is because company assets and liabilities are separated from personal assets and liabilities, and there is limited liability for those who create the company.

That liability is limited to the value of their investment, usually in the form of whatever paid-up capital they paid and any unpaid amounts on those shares. The company’s separation from the individual owners is called the corporate veil.

But, and we all know there are always buts, there are circumstances that see the corporate veil lifted, and personal financial risk can fall to the directors. Examples of how directors may become personally liable and a brief explanation are:

Unpaid company taxes and Employee superannuation

The Australian Taxation Office (ATO) can issue a Director Penalty Notice (DPN) requiring the director to take certain actions within a specified timeframe. These DPNs are of two distinct types, and these have been addressed in previous articles. Failure to comply will result in the director/s becoming personally liable. The taxes include:”

• Pay as you go (PAYG),
• Goods and services tax (GST),
• Superannuation Guarantee Charges (SGC),
• Luxury car tax (LCT), and
• Wine equalisation tax (WET)

Insolvent trading

While a claim for insolvent trading only exists once a company becomes insolvent, it is nevertheless a significant claim created under the Corporations Act. We have heard many times that “I don’t need to worry, as liquidators rarely sue for such claims.” However, what is not being considered in that argument is the number of claims that are settled (not requiring litigation) but still have a significant financial impact on the directors.

Anti-phoenixing

A new law was introduced a few years ago to assist liquidators in pursuing claims to transfer assets under value. This typically arises when the company receives a notice from the ATO or an unfavourable judgement against it, and poor advice or no advice is received telling the directors to start a new company and transfer the assets over for less than market value. In such circumstances, the transactions are undone once a liquidator is appointed and the directors are prosecuted.

Breach of director duties

Directors’ duties are set out under the Corporations Act. Generally, a director must act in good faith and not for an improper purpose. They must also manage conflicts of interest and prevent insolvent trading. The consequences are not just civil but may also be criminal.

Personal guarantees to suppliers of goods, services and assets.

In the small business environment, suppliers frequently demand personal guarantees and indemnities from directors in addition to recording personal property security interests. As suppliers develop their terms of trade and security documents, it is not uncommon to see charging clauses under the personal guarantee section that gives them the right to charge real property in the name of guarantors, including the family home.

These clauses effectively strip away the corporate veil and benefit of using a corporate structure.

Director and shareholder loan accounts.

We frequently see accountants make recommendations to their clients who want to avoid paying pay-as-you-go taxes on what is effectively remuneration for their services or tax on dividends.  The practice is not illegal and may create tax advantages. However, it also creates an unpleasant surprise when the company is not performing as it might.

The real problem comes to roost when a company is liquidated or wishes to benefit from the small business restructure (SBR) regime. These debts must be factored into the contribution payment in an SBR or repaid in a Liquidation, which can often result in the directors becoming bankrupt or selling significant personal assets to pay the liquidator.