Director Liabilities for Company Debts: What have you really signed up to?

As the director of a single company, or multiple companies, responsible for managing or controlling day-to-day operations, you can be held liable for company debts. Not all debts, but enough to make you pause to consider the weight and responsibilities of directorships!

How can you be held liable?

The potential liability for a company’s debts arises either statutorily or contractually:

1. Statutory Liability.

Liability arising from statute holds you automatically liable for certain debts, even if you haven’t specifically accepted that liability or debt.   The liability arises merely through accepting the directorship. 

In addition, under section 9 of the Corporations Act a person can be a director from appointment or through conduct which makes the person effectively a director, defacto director or shadow director. Therefore, a person does not even have to be formally appointed as a company director to be liable, for example, for claims in liquidation.

Directors are also statutorily liable for certain other debts. That is directors are personally liable if a company fails to remit PAYG withholding, tax or superannuation contributions by the due date. The ATO has powers under the Income Taxation Assessment Act 1997 to issue a director with demands for payment through the director penalty notice regime. 

2. Contractual Liability.

Contractual director debts are liabilities that a director has accepted in their personal capacity, perhaps as a means of assisting the company to acquire a product or service. The most common of these examples are supplier personal guarantees or mortgage guarantees that you have signed for.

What type of debts can you be held liable for?

The main differences between directors’ areas of liability are:

• How the liability arises
• Who has the right to make a claim,
• Whether or not a company is in liquidation, and
• The available defences.

When a company has been placed in liquidation, directors can be held liable for a number of debts, including the following:

Preferential Payments

Under section 588FGA of the Corporations Act, directors are liable for payments originally made by a company to the ATO, then set-aside as a preferential and refunded to the liquidator. That is, if a liquidator forces the ATO to return money, the directors then become liable to the ATO for that amount, as well as any costs.  Liability extends to anyone who was the director at the time of the original payment of the ATO, not simply at the time the company was wound up.

Debts Arising During Insolvent Trading 

Insolvent trading occurs when a company incurs a debt that it cannot and does not pay, at a time when the director knew, or should have known, that the company was insolvent.

Directors have a duty to prevent insolvent trading under section 588G of the Corporations Act and a director becomes liable to pay an amount of compensation equal to the amount of the debt.  For more information about insolvent trading see “Insolvency in today’s uncertain times” by Jessica Diep at https://maclarens.com.au/news/1045/insolvency-in-todays-uncertain-times

In some instances, a claim can be made against a director for compensation for any losses resulting from insolvent trading.  

For example, a liquidator can make a demand upon a director to compensate the liquidator for the amount of the insolvent trading claim if the liquidator can prove the elements of the claim.  The amount claimable is equal to that of the debt incurred when the company was insolvent, as long as the debt remains unpaid at the time of liquidation.  The liability will not be enforceable however until such time as the court makes an order against the director.

Section 588H of the Corporations Act sets out some available defences, which include that the director took all reasonable steps to prevent the company from incurring the debt. When deciding whether a director took “all reasonable steps“, the court considers any action the person took with a view to appointing an administrator of the company, when that action was taken, and the result of that action.

The appointment of a voluntary administrator, or a liquidator will mitigate the director’s exposure to an insolvent trading claim, but it may not eliminate a claim for debts incurred prior to the appointment.

Unreasonable Director Related Transactions

A claim can be made for compensation for losses resulting from unreasonable director-related transactions. The amount claimable is equal to that of the debt incurred when the company was insolvent, as long as the debt remained unpaid at the time of liquidation.

Directors will be liable to compensate a company for loss if they cause the company to enter a director-related transaction that would have resulted in an unreasonable benefit.

Director-related transactions include;

• Payments of money made by a company.
• Conveyances, transfers, or other dispositions of company property.
• Securities issued by the company.
• Incurred obligations to make such transactions.

A transaction is unreasonable if a reasonable person in the same circumstance as the company would not have entered into the transaction after having considered:

• any benefits that the company may have obtained;
• any detriment the company may have suffered;
• any benefits that other parties to the transaction may have obtained;
• any other relevant matters.

To be directly related, a transaction must involve either a company director, close associate of a company director, or a nominee acting on behalf of, or for the benefit of, a director or their close associate.

The liquidator may claim the amount of loss suffered by the company because of the director entering into the transaction.  A director, or close associate, may be liable for more than the mere loss if any extra consideration is deemed reasonable, when compared with the benefit received from the transaction. That is, if an asset was sold for under value to a director, the director would have to pay the extra consideration deemed reasonable for that asset.

Employee Entitlement Claims

Liquidators and employees have a right to claim against a director if a company entered a transaction that reduced the amount of assets available to pay priority employee entitlements in a liquidation. These transactions are known as agreements or transactions to avoid employee entitlements.

Section 596 AB of the Corporations Act states that “A person must not enter into a relevant agreement, or a transaction, with the intention of, or with intentions that include the intention of;

1. Preventing the recovery of the entitlements of employees of the company; or
2. Significantly reducing the amount of the entitlements of employees that can be recovered.

Directors contravene the Corporations Act if they intentionally cause a company to enter into one of these agreements or transactions. A contravention of section 596AB activates section 596AC and gives the liquidator the right to make a recovery claim.

The issue of director liability can be complex.  If you require any assistance or further information about directors’ liabilities and when personal liability can be avoided, contact Maclarens Lawyers for specific advice about your circumstances.