Company Directors are becoming increasingly exposed to personal liability for business debts.
Company Directors are under a positive duty to ensure that the corporate entity does not incur a debt whilst it is insolvent or does not become insolvent by incurring a debt. As well execution of personal guarantees by directors has become commonplace and essential today to continue in business. This means that directors of a small to medium sized businesses may expose themselves to personal liability by guaranteeing the debts of their corporate entities. Demands on the directors will normally proceed when there is a default pursuant to a personal guarantee.
Furthermore since 1993 the Australian Taxation Office (ATO) also has had its recovery powers for corporate debts extensively increased. The ATO can penalize directors equal to the tax debt outstanding for the company pursuant to Section 588 FGA of the Corporations Act. This provision allows the ATO to be indemnified by the directors for certain taxation liabilities of a company.
In addition to liability for PAYG withholding amounts, directors are personally liable for their corporate entities unpaid superannuation guarantee charge. Furthermore a new director is not liable to a director’s penalty charge for corporate entity debts that existed when they became a director until 30 days after they become a director. Hence a new director may be liable for paying debts of the corporate entity.
There are also Common Law and Contractual duties owed by directors that are governed by Case Law as well as individual employment contracts.
Furthermore the Common Law duty of care, skill and diligence stems from the law of negligence and the relationship of proximity between the director and the corporation.
Rules of equity also impose a number of duties on directors by virtue of a fiduciary relationship between a director and a company. A liquidator is able to bring proceedings for breach by a director’s duty owed to the company.
In effect corporate structures are no longer as protective instruments they once were against commercial risk. It is more evident that directors are personally exposed in the case of insolvency.
Directors and Officers (D and O). Insurance
There may be little benefit to an insolvency practitioner or creditors in pursuing directors unless of course directors are covered by D & O insurance giving the practitioner to the funds and insurance company.
There are however a number of exclusions from D&O policies which significantly restrict the amount of ambit of such insurance. These include:
- prospectus-type liability exclusion which will often be of importance to directors of companies who propose to embark on a public offering;
- professional indemnity exclusion which excludes cover for claims alleging a breach of duty other than the professional duties owed by a director;
- insured versus insured exclusion which excludes claims brought by one person covered by the insurance against another, including by the company against a director. This is a significant exclusion because a director’s duties owed to the company itself and actions thus brought by the company are a significant potential source of liability. Many D & 0 policies contain an exception to the insured versus insured exclusion. This is to prevent the manufacturing of a claim for example by the directors of a company breaching a duty and voting to sue themselves to get damages for which the company is insured.
D & O policies normally include an exclusion to extend cover to claims brought in the name of the company at the instigation of a receiver, administrator or liquidator.
D & O Insurance in the Context of Insolvent Trading Claims?
Section 199B and 199C of the ACT provide that a company must not pay an insurance premium of the company against a liability arising out of conduct involving a wilful breach of duty. So as long as the D & 0 policy excludes such claims from its ambit a company is able to take out effective D & 0 insurance for its directors and officers.
Sections 199A prevent a company from indemnifying a director against liability incurred for a pecuniary penalty order or a compensation order under s1317H.
Protective Steps Directors should consider.
- Planning your personal asset structure is fundamental to preventing assets being disgorged by a liquidator of your company.
- Structure ownership of your personal assets not only for taxation purposes but also for your asset protection purposes. This needs to be undertaken when you are solvent. The insolvency laws only capture transactions, where it appears that they were executed when the person had or ought to have had knowledge of the insolvency of their company or themselves.
- Directors should avoid having control of the entities that their assets are held in. One may still be held to be the beneficial owner of assets when it can be proven that one had control over the structure holding the assets.
Solutions
These Solutions are by no means exhaustive but rather indicative of some of the strategies that may be employed. The application of these strategies will be dependent on the individual’s circumstances.
- Transfer property such as your residential property to a low risk party such as your spouse. Obviously your spouse cannot be a director of your company if this strategy is undertaken. Recent case law has determined that even directors who take no active role in their company’s management cannot avoid insolvent trading liability simply by pleading that they did not understand their role and responsibilities. This step is less effective given recent bankruptcy law changes and caution should be exercised.
- Transfer property into a discretionary trust allowing your family to be the beneficial owners of your property. This mechanism also protects your property in the event you die and your spouse commences a relationship with someone else. That person may not be able to claim a share in the property subject to the trust as your spouse may not be the beneficial owner of the property. Bloodline Testamentary Trusts may be useful in such situations.
- Placing contributions with a Superannuation Fund. Superannuation funds have over the long term provided one of the best returns when compared to the stock market and property.
- Separate your trading entities from your asset holding entities. A basic example would be to place your assets in a discretionary trust such as your residential property whilst operating your business as a company.
Commercial Lawyers Sydney at Pavuk Legal can assist you with your appointment as a director, including due diligence of the company, review of existing indemnities and liabilities, drafting deeds of indemnities as well as Estate Planning and Asset Protection requirements.
Pavuk Legal can assist with the above and many other legal aspects.
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