Practical Tips For Avoiding Directors Personal Liability

With each passage of time, accepting a position as a non-executive director of an organisation in Australia becomes increasingly more perilous.

 

The regulatory regime has become more onerous on companies, but doesn’t stop there, with burden and risk shifting more and more onto directors personally. Australia has one of the most burdensome and personally risky regulatory environments for company directors, and it is likely to get even rougher ahead.

In fact, it is arguable that the constant raising of expectations, the relentless growth of ever more regulation, and the heightened risk of personal financial loss and reputation damage now provide directors a great incentive to abandon their director careers altogether.  Fortunately for Australian society, directors and prospective directors continue contribute to the management and oversight of organisations notwithstanding the considerable personal risk to themselves.

Of great concern is that many directors, or aspiring ones, are not aware of the extent to which they may be personally liable for debts of a company, or otherwise penalised by regulatory authorities by way of significant fines or even imprisonment for breaches of corporate regulations.

Also of concern is that many directors are not aware of the extent of the regulatory regime that applies to their business. Most are aware of the Corporations Act and some of the various tax legislation, but directors must consider what other regulation applies to their organisation, such as the Competition and Consumer Act, Therapeutic Goods Act, Health Insurance Act and the Insurance Contracts Act just to name a few.

There are some 700 different laws at federal, state and territory level that impose personal liability on company directors and officers for their company’s actions.

So what are the most common areas of potential personal liability for directors exposed as a result of a breach of the law by the company:

1. Insolvent trading: Insolvent trading occurs when a company incurs a debt that it cannot and does not pay, at a time when a director knew, or should have known, that the company was not solvent. If a company ends up in liquidation, a director can be, and often will be, held personally accountable for debts incurred by the company after the company became insolvent (tip: insolvency is often been found to occur well before it was recognised by the directors).
2. Workplace safety: Where there is a death or significant injury to a person in the company’s workplace and the director is found to have failed to meet their obligations under the Work Health Safety Act.
3. Directors Penalty Notices (DPNs): Where the organisation has failed to report and pay its PAYG and/or SGC obligations and a DPN is issued and not actioned within 14 days. Of special note is that if the company has not lodged the applicable returns within three months of falling due, there is no way to avoid personal liability for these amounts, which can be significant, other than for the company to pay them (not always possible if the company is in financial distress).
4. Certain unreasonable and uncommercial transactions: If a company is in liquidation, then certain transactions conducted before the liquidation that are deemed ‘unreasonable’ (particularly where benefit accrues to a director or an associate, or where the effect is to reduce the amount of assets available to pay employee entitlements) can be recovered from the director.
5. Director’s guarantees:  A personal arrangement between the director and the creditor, bank finance and premises leases often have personal guarantees provided. Note that this form of personal liability risk is self-inflicted.
6. Director’s loans: Loans provided to directors are recoverable by a liquidator in the event of insolvency (tip: repayment of a loan made to the company by the director may also be recoverable in certain circumstances).

In respect of DPN’s, prospective directors thinking of joining a board should note especially that if the company you join as a director has unpaid PAYG or unpaid SGC and hasn’t lodged the returns within three months of their falling due, you will become automatically personally liable for those debts even if the failure to lodge and pay occurred prior to your appointment!   Do due diligence!

Directors are also increasingly being personally drawn into lawsuits taken against the company, particularly by disgruntled shareholders, in many cases following a recent corporate transaction.

A company that enters a period of financial stress is more likely to give rise to a director’s dilemma as to fighting for the company’s survival verses risking their personal assets (and potentially years of litigation).

Are there any defences for directors doing their best in what is often a challenging environment?   In some cases the answer is simply no.

There is no defence for insolvent trading for instance. Directors have been found by the courts to be acting honestly and yet still found liable for a company’s debts incurred while insolvent.  Nor is there any defence (other than proving absence due to illness) against failing to lodge applicable returns and pay PAYG and SGC liabilities to the ATO within three months of falling due.

In other cases the answer is – less and less.

Courts are increasingly ready to find directors guilty of breaches of duty or of law, and to hand out fines and penalties, even when the director believed they were acting honestly and diligently.  The ‘business judgement’ rule introduced into the Corporations Act in 2000 that was originally anticipated to provide a reasonable ‘safe harbour’ for honest and diligent directors has had little testing in the courts leaving the concept of sound business judgement ill-defined and directors little wiser. In any event, regulators appear to be whittling it down, albeit by stealth.

So what can company directors and aspiring or prospective directors do?

Practical tips include:

1. Prior to joining an organisation as a director, do a thorough due diligence. If you are not sure of what matters you should be evaluating, or what information to seek, engage a professional firm with relevant expertise such as Intellix;
2. If you are already in a directorship position with an organisation, consider having a risk assessment done;
3. Understand if and when you will be held personally liable for the debts or actions of your company;
4. Ensure the organisation has in place a robust Director’s and Officer’s Insurance policy, and also require that the relevant company indemnify you for any loss suffered by you as a result of acting for the company;
5. Continue with professional development and director education and familiarise yourself with matters of regulatory compliance and risk;
6. Engage regularly with your professional advisors;
7. Ensure you are actively involved in the oversight of the business, and don’t just leave it to other directors or management (non-participation is not a defence);
8. If you become aware of a breach or potential breach of regulations, if you suspect that your company may be insolvent, and/or if you receive a DPN from the ATO, act on it immediately;
9. And otherwise, act diligently and ethically in the interests of all stakeholders (not just shareholders exclusively).

 

And as a priority, ensure that:

• Your workplace is safe and that you understand your obligations under the Work Health Safety Act;
• The business is not and does not trade while insolvent (if you even suspect it is or might be heading in that direction seek immediate professional advice)
• You make immediate inquiries to ascertain if there are any unpaid and unreported Pay As You Go (PAYG) withholding or Superannuation Guarantee Charge (SGC) amounts.