Company debts are not always director debts.
"Is a director automatically liable for their company’s debts?" seems a strange question, doesn’t it?! Nevertheless, despite accountants, lawyers and other advisors knowing that the answer is no, it is fairly common for us to meet with directors who truly believe that every company debt is also their personal debt. Some of them have even sold assets such as the family home, putting the proceeds into the business, assuming creditors were going to get it anyway. If they had spoken to an insolvency specialist prior to the sale, they may have found a better solution.
Creditors and governments are always thinking up new ways to pierce the corporate veil. If I started listing those ways out in detail, you’d be bored before you got to the end of this article. So, I thought I’d tell you what we tell your clients, which is a simple summary of the major circumstances in which a director can be liable for company debts.
1. Personal guarantees
Basically, this is something you sign (commonly called a personal guarantee and sometimes referred to as a director’s guarantee) saying that you agree that if the company defaults on its obligation to pay the debt, then you will personally pay the debt.
In relation to trading companies, it comes up most often when the company is applying for a credit account with a supplier. Sometimes in those circumstances the supplier will include this at the back of the guarantee for the director to sign. Of course, we also see it when the company applies for finance or leases a premises.
Our second top tip in this area (the first being of course to get legal advice before signing) is to keep a register of the personal guarantees the director signs. Nobody does, which is slightly problematic when seeking advice from us. Without knowing the amount of their personal exposure, the director isn’t sure whether they need to talk about the insolvency options for them personally as well as for the company.
A number of years ago, I met with a director who believed he had given no personal guarantees. He placed his company into liquidation and thought that was the end of it. A short time later, he received a demand from a creditor of the company who produced a guarantee signed by him. We spoke again, and I counselled him on checking with all the company’s creditors as to whether he signed guarantees. He didn’t, borrowed money from family, and paid the creditor truly believing there was no other guarantees. Well, a short time later, another creditor with a guarantee appeared, which he again paid using family money. By the time the third guarantee creditor appeared, he took my advice seriously and discovered there were yet other guarantee creditors and he had no choice but to file for bankruptcy. Whilst the bankruptcy may have been inevitable, he could have saved tens of thousands of dollars by not borrowing from the family to pay the creditors.
2. Director penalty regime
The director penalty regime is essentially the Australian Taxation Office’s director guarantee. Just like you don’t have to sign up to pay tax, you don’t have to sign up to be liable under the regime!
The regime is rather straightforward but has been made complicated over the years due to different taxes being added at different dates. I could chat about the regime for far longer than you would care to read, so instead I will refer you to this article which goes into it in more detail.
Our top tip is to lodge your returns (BAS and SGC) when they are due, even if you don’t pay the tax. There are options for the director to get out of personal liability if the company lodges that don’t exist if you don’t lodge.
3. Breach of director’s duty
The Corporations Act codifies a number of duties. I generally say to directors that if you do something wrong by the company (like nicking $1 million of the company’s money and trying to hide it in the Bahamas) then chances are there is a duty the director has breached. I’ve never found $1 million in the Bahamas so it’s a bad example, but hopefully you get the point that doing wrong by the company may result in an external administrator suing the director personally for the amount of loss the company suffered.
Our top tip for directors is to seek advice before entering into material transactions, particularly if the director has concerns about the solvency of their company.
At Worrells, with 34 Principals across our 29 locations, we help individuals and businesses dealing with financial stress. Your local Worrells Principal is here to help. Contact us for a complimentary and confidential discussion.