When deciding whether to operate as a sole trader or a company is it important to understand the liabilities of each. There are key differences between the personal liability of a director and a sole trader that affect how debts are repaid.
What is a Director?
According to the Corporations Act 2001 (Cth) a director of a company is responsible for managing the affairs of the business.
Liability of a Director
A company exists separately from its directors and shareholders. A director will have limited liability meaning they are generally not personally responsible for the debts the company incurs. The company’s assets are owned by the company and not the directors. As a result, the company can sell the assets to pay off the debts.
However, it is important to note that there are instances where a director may be liable. They include when a director:
- signs a personal guarantee that they will pay the repay the debt if the company cannot;
- breaches their duties;
- engages in an illegal phoenix activity; or
- trades while the company is insolvent.
For more information on when a director can be liable see the article ‘When is a Company Director Personally Liable?’
What is a Sole Trader?
A sole trader is a common business structure for small businesses and is easy to set up. The sole proprietor is legally responsible for all facets of the business.
Liability of a Sole Trader
Unlike a director of a company, the sole trader and the business are considered to be a single entity. As a result, a sole trader has unlimited liability. This means if the business cannot meet its debt obligations, the creditor may be able to recover the debt by seizing their personal assets (e.g. their home or car).
Additionally, the loans sole traders obtain from banks or other lenders are usually secured against their personal assets. Thus, if a sole trader fails to repay the loan to the lender then their personal assets can be used as a payment.
Directors and sole traders have different personal liabilities and it is important to understand the distinction. A director is usually not personally liable for debts whereas a sole trader is.
For more information on the liabilities of directors and sole traders please contact 1300 337 997 or fill out the form on this page.