Outcomes for Directors of a Company in Liquidation
When a company goes into liquidation, directors may face personal liability if found guilty of insolvent trading or breach of duty. This can include being required to pay company debts from personal funds, especially if they’ve acted against creditors’ interests or continued business knowing the company couldn’t meet its debts.
Liquidation can be a daunting prospect for Directors. Many view it as a personal failure, and there is some risk that Directors can be held liable for company debts. If they have breached their obligations or acted unlawfully, Directors can be responsible for debts or even face criminal charges. However, for the majority of Directors who carry out their duties honestly, liquidation doesn’t need to be a stressful experience.
For Directors facing the prospect of liquidation, it’s important to understand how the process works and what consequences they may face as a result of liquidating the company.
Liquidation and Directors
When a company enters liquidation, the decision-making powers of Directors are immediately suspended. As the liquidation proceeds, the Liquidator will determine whether the Directors may be held personally liable for company debts. If the Liquidator finds that the Director acted lawfully and met all their obligations, it is unlikely they will be held responsible for repaying the company’s debts.
During the liquidation process, the Liquidator will become responsible for managing the company’s affairs and assets. The liquidation process includes a detailed investigation of the company’s affairs and financial situation. If it’s discovered the Directors breached their duty, acted unlawfully or issued personal guarantees, they may be held personally liable for company debts. While the Directors are stripped of the power to run the company, they are required to assist Liquidators as and where necessary. For instance, Directors are often asked to supply financial records and the reasoning behind the decisions they made while operating the business.
Breaches of Director Duties
One of the main reasons Directors may be held personally liable for company debts is if the Liquidator discovers that the Directors are in breach of their duties. Australian law requires the Directors of a company to act honestly, trade in good faith and make decisions that are beneficial to the company’s shareholders. A Director who fails to meet these obligations can face penalties such as compensation proceedings, civil penalties and even criminal charges.
There are three common types of breaches of Director duties:
- Insolvent Trading. A company is insolvent when it becomes unable to pay its debts as and when they are due. Insolvent trading occurs when the Directors of a company continue to trade while knowing the company is insolvent, or if the Directors should have reasonably known that the company is insolvent.
Not only is insolvent trading a breach of Director duties, it is illegal under Australian law. If the Court decides that a company was traded while insolvent, the Directors can be held personally liable for company debts. There is no financial limit on how much a Director can be held liable for, and they may need to file for personal bankruptcy to resolve the debt.
- Fraudulent Trading. Fraudulent trading occurs when Directors are carrying on business with the intention of defrauding creditors. This can include things such as falsifying information or taking deposits for goods and services the company won’t be able to provide.
If the Court decides that a company has traded fraudulently, Directors can be held personally liable for company debts. Fraudulent trading is also illegal and Directors may receive a fine, be imprisoned for up to 10 years, or both.
- Failure to Act in Good Faith. This occurs when Directors breach their obligation to act in the best interest of the company and its shareholders. This can include things such as drawing money from the company improperly or misusing company funds. If the Court finds that a Director has failed to meet legal fiduciary duties, they may be required to repay any funds to the company’s debt.
Personal Guarantees By Directors
Aside from breaching their duties, a Director can also be held responsible for company debts if they made personal guarantees to the company’s creditors. Typically, a personal guarantee means that someone (such as a Director) is acting as a guarantor for the business’ debts. If the company becomes unable to pay its debts, the creditor can use the personal guarantee to recover their money from the Director and their personal assets.
Alternatively, some Directors may take out business loans using their own personal assets as security. For example, a Director may use their home as collateral to secure a loan made to the company. In this case, the secured creditor may be able to hold the Director personally liable for the company’s debts even after liquidation has been completed.
Director Penalty Notice
Companies are required to meet certain obligations to the Australian Taxation Office (ATO). This includes meeting Pay As You Go (PAYG) withholding and Superannuation requirements. If a company fails to meet these obligations, the ATO is allowed to recover the amounts owed from the Directors personally. To do this, the ATO will issue a Director Penalty Notice (DPN).
As financial difficulties can be one of the main causes behind a company failing to meet its tax obligations, DPNs can be issued after a company has entered into liquidation. The ATO will estimate the amount of tax owed by the company and use a DPN to hold the Directors personally liable for repaying the money.
Effects of Liquidation On a Director’s Credit Rating
While a personal bankruptcy can have major ongoing effects, the same is not always true for company liquidation. As long as the Directors have acted honestly and met their obligations to shareholders and creditors, the personal impact of liquidation will be limited:
- Credit Rating. The details of companies that enter liquidation are kept on file by credit agencies. These records include the names of people who were Directors at the time of the liquidation. However, this should have minimal impact on the Director’s credit rating, as companies are separate from personal credit records. Entering into Members Voluntary Liquidation will not affect the Directors’ credit rating.
- Further Directorship Opportunities. In most cases, the Directors of a liquidated company will not be prevented from becoming the Director of another company in the future. If a Director has been in charge of multiple companies that have been liquidated, or if they have been found in breach of their duties as a Director, they may not be able to work as the Director of another company.
Contact SV Partners to Learn About the Impact of Liquidation on Company Directors
It’s important for the Directors of a company to remain vigilant about the business’ financial position. If the company is struggling, seeking advice early on is the best way to improve the chance that the company can continue to trade. However, once the company becomes insolvent, entering into Voluntary Liquidation can offer relief from creditors and assist Directors to wind up the company in an orderly fashion.
Before making any decision, it’s important to seek professional advice. SV Partners is an experienced Liquidator, and we can ensure the process is conducted appropriately and fairly to help Directors meet their obligations. To find out more about the impact of liquidation on Directors, contact us online, or call 1800 246 801 and book a confidential consultation with our team.