One of the biggest misunderstandings directors have is assuming every company debt is also their personal debt. That is not always true. But it is also not safe to assume the company structure will protect you in every situation.
As Liam Bailey, Managing Partner of O’Brien Palmer, explains, a recent bankruptcy matter highlighted just how misunderstood this area can be.
A bankrupt debtor had listed a number of people as creditors of his personal bankrupt estate. But after investigation, it became clear that some of those people were not personal creditors at all. They were creditors of companies he had been involved with.
That distinction matters. Company debts and personal debts are not automatically the same thing. But there are important situations where a director can become personally liable.
The most common risk: personal guarantees
The most common way a director becomes personally liable for company debt is by signing a personal guarantee. As Liam explains: “A personal guarantee is a contractual obligation that says that notwithstanding that a company has incurred a debt to somebody, if the company can’t pay it, then the director will.”
Many suppliers require directors to sign personal guarantees before providing goods, materials or credit. If the company later cannot pay, the director may be personally exposed.
ATO Director Penalty Notices
Another major risk comes from Director Penalty Notices, commonly known as DPNs. (Check out many of our videos and blogs on this topic to learn more – listed below.)
A standard DPN can make directors personally liable if the company does not deal with certain tax debts, or fails to appoint an administrator or liquidator within the required timeframe.
A lockdown DPN can be even more serious, particularly where lodgements are late.
Liam notes that if business activity statements are more than three months late, directors may become personally liable for debts incurred in that reporting period.
Unpaid superannuation can also create personal exposure.
Insolvent trading and breaches of duty
Directors can also become personally exposed if a liquidator later brings a claim for insolvent trading or other breaches of duty. This often arises where a company is placed into liquidation before the director becomes bankrupt.
The liquidator may then investigate whether the director allowed the company to incur debts while insolvent, or breached their duties in another way.
When a promise may not be enough
One interesting point Liam raises is that a simple verbal promise to pay someone back personally may not be enough to make that person a creditor of the director’s bankrupt estate. There usually needs to be more than just a casual promise.
This is why accurate advice matters, especially in bankruptcy or insolvency matters where creditor claims need to be carefully assessed.
Why this matters for directors
The reason why this all matters comes down to why you started the company structure in the first place. Companies are often used as business structures to help protect personal assets. But that protection only works if the company is run properly.
As Liam puts it: “A corporation, a business, a company properly run is designed to shield you from the adverse effects of business failure so that you can then start again, but only if you do it properly.”
Having your business set up as a company can provide protection, but it is not magic. Personal guarantees, tax debts, DPNs, unpaid superannuation, insolvent trading and breaches of duty can all create personal risk for directors.
Therefore you need to understand where personal exposure may sit before the problem becomes urgent.
Directors should be aware of:
- what personal guarantees they have signed
- whether tax and superannuation obligations are up to date
- whether BAS lodgements are being made on time
- whether the company is trading while insolvent
- whether there are any personal assets at risk
- whether professional advice is needed before decisions are made
If you are unsure where the risks and exposures sit in your business, speak with your accountant or seek advice early. Understanding the problem is often the first step in protecting yourself, your family and your assets. If you want professional and obligation-free expert advice, please get in touch.
LIAM BAILEY, MANAGING PARTNER
O’BRIEN PALMER
📞 (61) 2 9232 3322
📧 obp1@obp.com.au
🌐 obp.com.au
