When you start a business, and obtain advice as to the most appropriate structure to operate the business, the advice received is often to set up a Company, sometimes as the trustee of a trust.
One of the main reasons you may operate a business through a Company structure is that it provides limited liability for debts incurred by the Company; that is, a Director or officer of a Company is not automatically personally liable for debts incurred by the Company. This is particularly important in situations where a Company is in financial difficulty and is unable to pay the debts it owes.
This may sound easy and like a foolproof plan to alleviate risk for an office holder of a Company, however there are a number of risks (both financial and non-financial) that Company Directors may be exposed to, despite their efforts to avoid the personal impact of the insolvency of their Company. Some of those include:
Personal Guarantees
In many situations, a Supplier, Creditor, Financier or Lessor dealing with a Company will, as part of their terms and conditions, require a Director or other third party (such as the Director’s Spouse) to sign a personal guarantee, making them personally liable for any unpaid debts incurred by the Company.
Building & Construction
QBCC – Home Warranty Insurance Claims
If the Company operates in Queensland and is required to be licenced by the Queensland Building and Construction Commission (QBCC), the Director of a Company is personally liable to rectify any defective work or otherwise to pay for the costs incurred by the QBCC to rectify the defective work for residential building works under the QBCC Home Warranty Insurance Scheme.
QBCC – Deed of Covenant
Depending on the financial position of the Company, the QBCC may require a Company to provide a personal guarantee and security over personal property of a Director (or other Person) up to a limited amount (Guaranteed Amount) to cover some of the debts of the Company in the event it is placed into Liquidation (called a Deed of Covenant). The Deed of Covenant gives the Liquidator of a Company the right to pursue recovery of the Guaranteed Amount from the Director (or other Person who provided the guarantee), which can include normal debt recovery proceedings (including pursuing the Director into bankruptcy) or to enforce security over personal property (where security is provided).
Taxation Debts
Director Penalty Regime
Where a Company fails to pay superannuation and Pay As You Go (PAYG) withheld amounts from employees’ wages, the Deputy Commissioner of Taxation (ATO), and does not comply with lodgement requirements, the Director can be personally liable for the debt owed by the Company. Further information on the Director Penalty Regime can be found in our recent March 2019 Quarterly Newsletter.
Unfair Preferences
If a Company is placed into Liquidation, the Liquidator has a duty to review transactions that occurred in the six (6) months prior to Liquidation and may recover funds paid by the Company if they are deemed to be an unfair preference (as defined in the Corporations Act 2001). If the Liquidator recovers an unfair preference against the ATO, under section 588FGA of the Corporations Act 2001, a Director may be personally liable for any amounts recovered by the Liquidator.
Insolvent Trading
Under the Corporations Act 2001, a Director of a Company has a duty to prevent a Company from incurring debt whilst it is insolvent (that is, unable to pay its due and payable debts). The Liquidator of a Company (or a Creditor in certain circumstances) is able to pursue recovery from a Director personally for any debts incurred after the ‘date of insolvency’ that remain unpaid.
Breach of Director’s Duties
A Director of a Company must also comply with certain other duties imposed by the Corporations Act 2001, which largely relate to acting in the interest of the Company. In the case where a Director does not do so; that is, they abuse their power as a Director or act in their own interest, they may be pursued for any loss incurred to the Company as a result of their actions.
Director Loans / Debts owed to a Company
It sounds simple, but it is often overlooked in small to medium business. If you owe money to the Company, either for works performed by the Company, loans given to you by the Company or drawings (as opposed to receiving a wage), you are required to pay that money back.
It is important to remember that a Company and a Director’s personal affairs are separate. Accordingly, if the Company is placed into Liquidation, the Liquidator has the ability to seek recovery of the debt owed to the Company.
Loss of Licence / Qualification
The insolvency of a Company or Bankruptcy of an individual can also impose restrictions and in some cases, the cancellation or termination of certain licences or the ability to conduct business or work in a particular industry, for example, the building industry. This can as a consequence impact a Director’s ability to work and earn an income following a Liquidation.
The above are by no means an exhaustive list, rather focus on Director risks and liabilities upon insolvency. Due to the above factors, particularly in the case of a small to medium businesses, the Lquidation of a Company that operates a business often leads to significant financial pressures on the Director and family members. The issues outlined above are often complicated and may not apply to you depending on your circumstances. It is therefore important to seek appropriate specialist advice.
If your clients are experiencing financial difficult or would like to discuss the options and the impact of the above matters further, you can contact SV Partners for an obligation free discussion.
Article written by Jason Cronan, Director and Daniel Luckman, Manager, SV Partners Sunshine Coast
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