Are directors personally liable for the debts of an insolvent company?

A company is a separate legal entity and has its own properties, duties and rights.  The company can own and sell property and other assets, sue and be sued and enter into contracts in its corporate name.  This means that the company’s debts are its own, however there are several instances where a director may become personally liable for the debts of the company.

Personal liability

Directors’ duties continue even after the company is no longer trading or registered and a director may be personally liable in the following situations:

1. Debts incurred by company while trading insolvent

One of the most important director’s duties is to ensure that the company does not continue to trade while insolvent.  If a company is insolvent it means it is unable to pay all its debts when and as they fall due.  This is explained further below..

If you continue to operate and incur debts whilst trading insolvent, then not only may you find yourself personally liable for these debts, but you may also find yourself facing civil and criminal sanctions for breaching your director’s duties contained in the Corporations Act 2001.

2. Director acts as a guarantor or security has been provided over the director’s personal assets

Often you may be requested by creditors to act as a guarantor or provide security over your personal assets to guarantee your company’s loan.  It is common practice for a bank to request a mortgage over your house to secure your company’s payment of a loan.  If the company does not repay the loan then you become personally liable to the creditor for your company’s debt or you may lose your personal assets as a result of the security you have provided.  Always ensure that you seek independent legal and financial advice prior to providing a guarantee or security for your company.

3. Debts incurred by the company acting as trustee

If your company is acting as a trustee and breaches the terms of the trust then you may face personal liability as a director.

4. Losses to the company caused by a director’s breach of their duties

If by breaching one or more of your director’s duties you have caused your company to suffer a loss then you will be liable for that loss and likely face further civil and/or criminal sanctions.

5. Phoenix activity (illegal)

Phoenix activity is illegal and is simply transferring the assets from one company to a new company for the purpose of avoiding the payment of debts.  This is a serious offence and breaches the civil and criminal provisions of the Corporations Act 2001.  Aside from the warning signs of insolvency (see below), soon after the first company is liquidated or goes into administration a new company appears with similar management or directors of the old company and similar assets.

6. Tax Office debts

You may find yourself personally liable to the Australian Taxation Office, and if your company has employees then you may also be personally liable for PAYG payments and superannuation entitlements.

A director who has breached their director’s duties (civil and criminal penalty) may face a maximum penalty of $200,000 and/or up to five years imprisonment (criminal).  Aside for being personally liable for losses and damages caused to others and/or the company, the director may also be prohibited from managing another company.

Indicators of insolvency

There are two things to ask yourself if you believe your company may be trading while insolvent or at risk of becoming insolvent.

1. The Company’s cash flow

Is your company’s projected current and future cash flow sufficient to pay current and future debts of the company as and when they fall due?

2. The Assets and Liabilities of the Company

What is your company’s current financial position in terms of the assets and liabilities balance sheet?  Can the company sell (liquidate) assets to cover the debts as and when they fall due?

Other Warning Signs

– low profits or cash flow

– problems paying creditors on time

– creditors refusing to extend your company further credit

– difficulties making loan repayments on time

– legal action threatened by creditors over debts

If the answers to the above questions are no, or you become aware of the warning signs, then it is likely that your company is trading while insolvent or at risk of becoming insolvent and you should seek immediate financial and legal advice in order to protect your personal assets and avoid the risk of personal liability.

More helpful articles and resources

1. Defending or avoiding unfair preference payment claims

2. General information about insolvency law

Adam Ahmed & Co have extensive experience defending directors from liquidators.  This article is reproduced from Adam Ahmed & Co.

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