As a director of a struggling business, it’s natural to feel confused when deciding the right approach to deal with the problems your company faces.
Voluntary liquidation might initially seem the best option (or the only option) but there are personal risks for directors that you first need to be fully aware of.
If you’re the director of a small or medium business, you’ve probably also personally invested in the company, further complicating the decision.
The need to act in the company’s best interests and not trade while insolvent may conflict with the potential personal liability you face – to the point of your family home being on the line.
Companies are intended to protect directors from personal liability. But there are various instances where this protection is not available.
Following is an overview of the main personal risks you need to be aware of as a director considering voluntary liquidation.
Voluntary liquidation: a brief overview of your risks
Deciding to appoint a liquidator is a serious decision that is essentially irreversible. To avoid any surprises, you need to be aware of the potential impact of this decision.
Often the advice that directors receive only deals with their company and not the possible consequences for them personally.
It’s also important to note that whether claims by creditors or a liquidator are pursued against you personally often depends on whether you have any assets available to satisfy these claims.
As a director considering liquidation, the key personal risks you need to understand are:
- Director drawings loan accounts
- ATO Director Penalty Notices (DPNs)
- Personal guarantees for company debts
- Insolvent trading
- Breaches of director’s duties
- Uncommercial transaction and preference claims
- Liability for ATO preference recoveries
- QBCC licence loss for building companies
These are further explained below.
Director drawings loan accounts
These are found on the balance sheet as an asset or negative liability. They often arise in respect of directors’ drawings, which is how accountants may advise directors to be paid by their company, because less tax is usually payable.
With this method of being paid, accounting entries use profit to zero out loan accounts with end of year dividends. But, for struggling businesses, the profits are not sufficient to do this. So directors may in effect have to repay their wages to a liquidator. To avoid this potentially baffling situation, read about how to deal with it here.
ATO Director Penalty Notices (DPNs)
DPNs can be issued by the ATO, making directors personally liable for unpaid PAYG (on wages) and superannuation guarantee charge (SGC) debts. These debts arise from BAS, IAS and quarterly SGC returns.
Two types of DPN exist:
- A 21-day DPN: Where BAS, IAS and SGC returns are lodged within three months of their due dates, personal liability can be avoided by placing the company in liquidation or voluntary administration within 21 days of the date of the notice.
- Lockdown DPN: If BAS, IAS and SGC returns are lodged more than three months after due dates, directors are automatically liable for these debts. Accordingly, the ATO can issue a lockdown DPN even if a company is in liquidation.
Personal guarantees for company debts
Directors often sign a personal guarantee when:
- Opening a trade credit account;
- Securing banking and finance facilities; or
- Entering into a premises lease.
As liquidation often results in little or no return to creditors, you can end up being personally liable as a director for certain company debts that you’ve guaranteed.
Company debts can be disproportionately large compared to a director’s personal assets. This may lead to the loss of the family home and bankruptcy.
But there are options for directors to avoid bankruptcy, including seeking to settle guarantee claims.
Insolvent trading claims will be for the amount of outstanding debts incurred by the company since it became insolvent. A company is insolvent if it can’t pay its debts when they fall due.
As well as being brought against a director, an insolvent trading claim can be brought against a holding company. Many SMEs are already insolvent by the time they seek professional help, so it’s important to act quickly if you suspect insolvency.
Warning signs include your superannuation or ATO debts accruing; failure to pay suppliers on time; or a personal situation, such as a marital separation, impacting your business.
It’s important to also note that recent legislation has introduced new ‘safe harbour’ protections. These are intended to protect directors from trading when genuinely trying to turnaround their business.
Uncommercial transaction and preference claims
These types of transactions can give rise to claims against a creditor or other person or company involved in such transactions. These voidable transaction claims include preference claims and uncommercial transaction claims.
Preference claims can arise against a creditor when they are repaid in the six months before liquidation, or four years for related parties. Examples include making large payments to the ATO or another creditor, or repaying director or related-party loan accounts.
Uncommercial transaction claims arise when it’s not reasonable for the company to enter into the transaction and it provides no benefit or is detrimental to the company. For example, when company assets are sold or transferred for less than fair value, such as in illegal phoenix activity.
Breaches of director’s duties
As well as preventing insolvent trading, you owe various general duties to your company and its creditors to:
- Exercise reasonable care and diligence;
- Act in good faith and for a proper purpose; and
- Not use your position to gain advantage for yourself.
If you breach these duties, you can be liable for the amount of the damage caused to your company. Beware of practices such as illegal phoenix activity, selling assets for less than fair value, or paying funds to related companies.
Liability for ATO preference recoveries
This is important for directors considering paying a large ATO debt, where the company may go into liquidation within six months.
Payments to the ATO within six months of liquidation may be recovered by a liquidator as a preference claim. Section 588FGA of the Corporations Act allows the ATO to recover PAYG recovered in the preference claim from the director personally.
Theoretically, a director using personal funds to pay the company’s ATO debt may later have to pay that debt again, if it is recovered by a liquidator as a preference.
QBCC licence loss for building companies
Individuals who hold a Queensland building licence may become an excluded individual for three years if they:
- Are a director, secretary or ‘influential person’ of a building company in the year before it is placed in liquidation or administration; or
- Become bankrupt or enter into a Part IX or Part X Agreement.
Accordingly, upon liquidation, a company and its directors will lose their QBCC licence. For companies, it means they cannot carry out building work; and excluded individuals cannot hold a senior position in a QBCC-licenced company.
Next steps for directors of struggling companies…
As you can see, many factors come into play for directors of companies showing insolvency warning signs.
There are alternatives to voluntary liquidation and all the risks it poses for directors. But you need to act quickly!
Because you have a duty not to trade your company while insolvent and options such as safe harbour can quickly disappear, speed is of the essence.
Relieve some of the pressure and stress: speak to your accountant, lawyer, or seek professional insolvency help by contacting us here.