One of the key benefits of operating your business as a limited liability company is that the company is a separate legal entity to the individuals that make it up. This means that, unlike operating as a sole trader or a partnership, you as a director are not liable for the company’s losses or debts. This also means that usually only the company can be sued (not you personally) for the company’s operations. This is sometimes referred to as the ‘corporate veil’.
However, there are some circumstances where you as a director could be held personally responsible for company’s losses or debts. In those cases, you may be required to meet those obligations using your own personal assets (known as ‘piercing the corporate veil’). This article outlines where you as a company director may be held personally responsible.
Breach of director’s duties
You may be held personally responsible for any losses your company suffers or debt it incurs caused by a breach of your duties as a director. In addition, for breaching your director’s duties you may:
- Fined up to $200,000, or sentenced to up to 5 years imprisonment (or both)
- Ordered to personally compensate any loss or damages suffered by the company, and
- Temporarily or permanently barred from managing the company (and other companies)
It is also important to note that you may be considered a director even if you are not registered as one.
One of your most important duties as a director is to ensure that your company does not trade while insolvent (when the company has debts it is unable to pay). If your company continues to trade while insolvent, you could be found in breach of this duty, and be held personally responsible for any losses, new debts the company takes out while insolvent, or any debts that caused the company to become insolvent.
However, to be responsible for insolvent trading you must have known, or suspected, that the company was insolvent, or that taking on new debt would make the company insolvent. So how do you know whether your company is trading while insolvent? Here are some common signs:
- The company is struggling to make repayments on existing loans
- There are problems with paying creditors (for example, your suppliers or landlord) on time
- Low cash flow or profits are being generated by the business
- Creditors refusing to extend more credit
- Legal action is threatened, or taken, against the company
More generally, you should assess whether current and future expected cash flows will be sufficient to meet any existing or proposed new obligations, and otherwise whether the company could sell (or ‘liquidate’) any assets to meet those obligations. If not, you may be trading while insolvent.
Tax obligations and employee entitlements
The ATO’s director penalty regime means that you may be held personally responsible for tax obligations of the company. For example, if the company does not pay its goods and services tax (GST), you may be required to pay it from your own assets.
Further, if your company has any employees, you could be held personally responsible for pay as you go (PAYG) withholding and superannuation guarantee charge (SGC) obligations.
Personal Guarantees and Property Security
It is common practice for a bank or other lender to request a guarantee or security for extending a loan to your business. Because this makes the loan ‘safer’ for the lender, a guarantee or security will often enable your company to borrow more, or access cheaper interest rates. However, offering a personal guarantee or security over property may expose you personally to the company’s debts.
- For a personal guarantee, you may become personally liable to repay the company’s debts if the company itself does not pay.
- For property security, your lender may ask you to register a mortgage or lodge a caveat over your property. If a business loan is secured by a mortgage over your property, you run the risk of the lender possessing and selling your property if the company defaults on the loan. If a business loan is secured by a caveat over your property, you will be unable to register any dealings on your property (e.g. you cannot sell the property), until the loan is repaid and the caveat is lifted.
‘Phoenixing’ is where an existing company winds up its operations, but a new company is created to continue the same business. Phoenix activity is used to avoid paying the liabilities of the existing business, such as debts, taxes and employee entitlements. Usually phoenix activity is illegal, and may expose you to personal liability as a director.
To sum up
Although generally as a director you are not liable for the losses and debts of your company, there are some circumstances that expose you personally. In order to avoid personal exposure as a director, you should strive to fulfil your duties as a director, and ensure that the company meets all of its tax and employee entitlement obligations.