A Director's Guide to Liability for Company Debts

Justeen Dormer
Apr 2
5 min read

Insolvency

As a company director, you hold a position of significant responsibility. While a company is a separate legal entity, the protection this structure offers is not absolute. In certain circumstances, you can be held personally liable for company debts, a situation that can have severe financial consequences. Understanding these areas of potential director liability is crucial for navigating financial difficulties and protecting your personal assets.

At Dormer Stanhope, we provide expert legal advice for directors facing these complex challenges. This guide outlines the key areas where personal liability can arise and explains your duties under Australian corporate law.

A Director's Guide to Liability for Company Debts

Can Directors Be Held Liable for Company Debts?

Yes, directors can be personally liable for a company's debts. The primary areas of potential director liability include:

Insolvent Trading: Incurring debts when the company is insolvent.
Unreasonable Director-Related Transactions: Transactions that unfairly benefit a director or their associates.
Loss of Employee Entitlements: Actions taken to avoid paying employee entitlements during liquidation.
Taxation Debts: Unpaid PAYG withholding, net GST, and superannuation contributions.
Personal Guarantees: Agreements where you have personally guaranteed the company’s debts.

Understanding the distinctions between these liabilities is essential. They differ based on who can make a claim, whether the company must be in liquidation, and how the liability is established.

Who is Considered a Director?

Under the Corporations Act 2001, the definition of a director is broad. It includes not only formally appointed directors but also "de facto" and "shadow" directors; individuals who act as directors or whose instructions are followed by the board, even without a formal title. This means you do not need to be officially appointed to face director liability.

Insolvent Trading Claims

A director has a fundamental duty to prevent their company from trading while insolvent. Insolvent trading occurs when a company incurs a new debt at a time when it is unable to pay its existing debts as they fall due. If a director knew, or should have reasonably known, about the company's insolvency, they can be held personally liable for those debts.

How is a Director Made Liable?

A liquidator appointed to a company can pursue a director for compensation related to insolvent trading. To succeed, the liquidator must prove the elements of the claim in court. An enforceable liability only arises after a court makes an order against the director.

What are the Defences Against Insolvent Trading?

Section 588H of the Corporations Act provides several defences for directors. You may avoid liability if you can establish that:

You had reasonable grounds to expect, and did expect, that the company was solvent.
You did not participate in the company's management at the relevant time due to illness or another valid reason.
You took all reasonable steps to prevent the company from incurring the debt. This can include attempting to appoint a voluntary administrator.

Appointing an administrator or liquidator can help mitigate exposure to an insolvent trading claim, but it does not eliminate liability for debts incurred before the appointment. Liquidators have six years from the start of the liquidation to commence legal action.

Unreasonable Director-Related Transactions

A liquidator can investigate transactions that appear to favour a director or their associates. A director-related transaction can include payments, transfers of company property, or the issuing of securities.

These transactions become problematic if they are deemed "unreasonable." A transaction is considered unreasonable if a reasonable person, in the company's circumstances, would not have entered into it. The assessment considers the benefits and detriments to the company versus the benefits received by the director or other parties.

Who is a "Close Associate"?

The term "close associate" is defined broadly and includes a director's relatives, such as a spouse, parent, child, or sibling. Transactions involving these individuals can also come under scrutiny.

If a court finds a transaction to be an unreasonable director-related transaction, the director can be ordered to compensate the company for the loss it suffered. This applies to transactions that occurred within four years before the winding-up process began.

Loss of Employee Entitlement Claims

Directors have a duty to protect employee entitlements. You can be held liable if you enter into an agreement or transaction with the intention of preventing or significantly reducing the recovery of employee entitlements, such as wages, leave, and superannuation, in a liquidation.

Under section 596AB of the Corporations Act, a person must not engage in such conduct. A director who contravenes this provision can be pursued by a liquidator or, in some cases, directly by employees for the financial loss they suffer as a result. The amount recoverable is typically equal to the loss caused by the transaction, limited to the unpaid priority employee entitlements.

Director Liability for Taxation Debts

The Australian Taxation Office (ATO) has significant powers to hold directors personally liable for a company's unpaid Pay As You Go (PAYG) withholding, net Goods and Services Tax (GST), and Superannuation Guarantee Charge (SGC) amounts. This is managed through the Director Penalty Notice (DPN) regime.

When a company fails to remit these amounts by the due date, directors automatically become personally liable for a penalty equal to the unpaid sum. The ATO can then issue a DPN to recover this penalty.

Furthermore, directors can become liable to the ATO if a liquidator successfully recovers payments from the ATO as an "unfair preference." In this scenario, if the ATO is forced to return money to the liquidator, the directors become personally liable to indemnify the ATO for that amount.

Personal Guarantees

A personal guarantee is a separate contractual agreement between a director (as a guarantor) and a creditor, such as a supplier or a bank. In this agreement, the director promises to pay the company's debts if the company fails to do so.

Crucially, insolvency administrations like liquidation or voluntary administration do not invalidate a personal guarantee. While a creditor cannot enforce a guarantee during a voluntary administration, they can act on it immediately once that period ends. The company does not need to be in liquidation for a creditor to exercise their rights under a personal guarantee.

If you, as a guarantor, pay a creditor in full, you may gain the right of "subrogation." This allows you to "stand in the shoes" of the creditor and pursue the company for the amount you paid.

How to Protect Yourself and Your Business

Navigating the complexities of corporate law and director liability can be overwhelming, especially when your business is facing financial distress. The key is to act promptly and seek expert legal advice. Ignoring warning signs or delaying action can significantly increase your personal risk.

If you are concerned about potential director liability for company debts, have received a Director Penalty Notice, or are facing an insolvent trading claim, our team at Dormer Stanhope Lawyers can help. We provide clear, authoritative guidance to help you understand your obligations and explore your options.

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