Article by Dean Jones – Partner
If a company is struggling financially a hard decision may need to be made to put the company into administration or liquidation. Administration may mean that a deal can be worked out with the creditors and that the company can continue to trade. If not, the company may end up in liquidation. That is the process of winding up the affairs of the company.
One of the reasons that people run their businesses through a company, rather than under their own names, is to reduce the risk of personal financial liability. But, when a company liquidation occurs, there are some circumstances where the director can be held personally liable for the debts of the company.
Set out below are the main personal risks a director could face upon liquidation of the company.
1. Director Penalty Notices (DPNs)
- If by the due dates a company does not pay:
– Tax to the ATO on employee wages or
– Superannuation on employee wages or
the amount owing can become a penalty owing by the company directors.
- The ATO can give a director’s penalty notice to the director.
- There are different sorts of notices with different rules, but basically, if the outstanding amounts are not paid within 21 days the director becomes liable for the outstanding amount.
- The ATO can then commence legal proceedings against the director to recover the outstanding amount as a debt.
2. Directors’ drawings and loan accounts
- Quite often directors who are also shareholders of a company are paid drawings by the company.
- The amounts of these drawings are described in the company balance sheet as director’s loans.
- These loans are intended to be repaid by applying shareholder dividends from the profits of the company.
- If the company struggles financially there may be a problem for the director as there won’t be enough dividends to apply to eliminate the loan.
- If the company then enters liquidation the director can expect to receive a letter from the liquidator which demands that the director repay the loan to the company. The director is likely to be sued if the loan is not repaid.
3. Insolvent trading
- A company is insolvent if it cannot pay its debts as and when they fall due and payable
- If the company continues to trade and incur debts whilst it is insolvent, and then enters liquidation, the liquidator can sue the director personally for payment of any unpaid debts that the company incurred whilst it was trading whilst insolvent.
4. Breaches of director’s duties
- The Corporations Act sets out some duties of directors. These include:
- Exercising reasonable care and diligence;
- Acting in good faith and for a proper purpose; and
- Not using your position for personal advantage.
- If a director breaches these duties the director can be sued by the liquidator and can be liable for the amount of damage caused to the company as a result.
5. Uncommercial transactions
- Under the Corporations Act, a liquidator can also sue a company director for uncommercial transactions.
- A transaction is an uncommercial transaction if the company enters into a financial agreement, or transfer of property, that:
- Provides no benefit to the company, or
- Is to the detriment of the company.
- Most demands are made by liquidators of directors when prior to the liquidation, company assets are sold or transferred for less than fair value.
- In that case, the liquidator will claim the value of the benefit received from the recipient of the property or benefit. Motor vehicles and operating equipment are commonly involved in these claims.
6. Double payment due to preference recoveries
- Preference payments are payments made by the insolvent company to creditors within 6 months before the liquidation, which are made in preference to payments to other creditors.
- The liquidator can demand that preference creditors repay their receipts to the company.
- A problem for directors here is that if the company pays the ATO within 6 months of liquidation and the ATO has to refund that amount to the liquidator then the ATO can seek to recover from the director personally any amounts it repays the liquidator.
- Quite often the director, in an attempt to keep the company afloat, will have used personal funds to pay the ATO in the first place. This may mean the director may end up having to pay the same amount to the ATO twice. The same problem may arise due to the terms of any guarantee or indemnity which means that a director may be required to double pay there too.
7. Personal guarantees
- Many parties that enter into commercial arrangements with companies require personal guarantees from directors of the company. Common examples are:
- Leases of premises.
- Bank loans and finance, such as overdraft accounts.
- Trade credit accounts.
- As it is unusual for all creditors to be paid out on a liquidation it’s most likely the personal guarantees will be enforced against the directors to pay the company’s debts.
- Company debts are normally disproportionately large compared to a director’s personal assets and income, which puts at risk the director’s home and could result in bankruptcy.
8. Phoenix activity
- Phoenix activity is the transfer of a business and assets from an insolvent company to another company with the same directors, or an associate of the directors.
- Quite often the liquidator of the company in liquidation will allege that the transfer is not for fair value and was on uncommercial terms.
- Claims may then be made by the liquidator against the company that received the business or assets, and the director.
Who should you call for advice?
Call Eales & Mackenzie. We have significant experience advising company directors and defending company directors from the claims of liquidators referred to above. If you need advice or help defending one of these claims, please contact me at Eales & Mackenzie on 8621 1000.