In 2016, we saw media giant Gawker go under, and its director Nick Denton apply for bankruptcy protection. While this occurred under a US law which differs to the laws that apply here, it is nonetheless an example of what can happen to many company directors in Australia. If your business does not operate in the right way, you can end up personally liable for company debts.
Let's look at the claims that commonly arise – and what directors need to know to avoid them.
Ways you can be personally liable for company debt
A company is a standalone entity, with its own property, rights, assets, legal status and liabilities. However, directors can be personally liablefor its debts in the following situations:
- If the company incurs new debts while it is unable to pay existing debts (insolvent trading)
- If you do not honour your PAYG tax or superannuation payment obligations
- If you have granted personal guarantees to a bank, financiers, landlord or creditors (putting your own funds or assets, like the family home, on the line)
- If the director or a related party has loan accounts on the business' balance sheet
- If there are claims for uncommercial transactions or preferences, including phoenix activity
- If you breach your duties as a director, entering situations (like loans with related parties) that benefit you but not the company
— Laura Kusisto (@LauraKusisto) October 21, 2016
Incurring personal liability does not necessarily mean you are acting in bad faith – there are many situations where a director cannot avoid becoming responsible for the company debts, such as obtaining finance. However, the consequences can be severe.
The consequences of failing to act in your company's interests
As the Australian Securities and Investments Commission (ASIC) points out, directors have a duty to always act in the best interests of their company. In addition to personal liability, ASIC adds that serious legal ramifications can occur.
You can be fined $200,000 or jailed for five years, be barred from managing companies in the future, gain a criminal record and be required to pay extra compensation. This is why the right pre-insolvency advice is so important – to assist company directors in making sure they minimise risk.
How to avoid or deal with personal liability
There are many solutions for dealing with personal liability. For example, directors that pay themselves wages from company accounts can be increasing their liability. But by using an accountant to help account for these as salary and paying the appropriate PAYG tax, you can minimise the risk of this being recouped in liquidation.
Essentially, you need to be aware of your company's weaknesses and your exposure to potential personal liabilities at all times. The insolvency accountants at Cactus Consulting can provide you with valuable advice before these issues arise, helping you structure both the business and your personal assets in a manner that both reduces potential personal liability and helps the business steer clear of corporate insolvency.
Directors shouldn't end up in the situation that Nick Denton found himself in. With the right pre-insolvency advice and foresight, you won't.