If in your position as director you allow your company to operate while insolvent and unable to pay debts, you could be liable to serious penalties.
The Australian Securities and Investments Commission (ASIC) outlines key considerations for directors whose companies are in financial difficulty or are insolvent.
Am I a director?
Under the Corporations Act 2001 you could be classified as a director even if you don’t formally hold that role, if you act in that role or directly influence the actions of the company’s director/s.
For example, if you have appointed a family member to the role of director but you are really the one calling the shots, you could be deemed the director.
What are my duties as director?
Your primary duties are to serve the company’s shareholders and comply with all relevant laws, but if your company is insolvent your duties expand to include creditors (including employees with outstanding entitlements).
As per the Corporations Act, you have the general duty to:
- Exercise your powers and duties with care, in good faith, and in the company’s best interests.
- Be accurately informed of the company’s financial position.
- Ensure the company doesn’t trade if it is insolvent.
- Not improperly use your position to gain personal advantage.
- Not cause harm to the company.
If you breach these duties in a dishonest or reckless way, the breach can be a criminal offence punishable by up to 15 years’ imprisonment.
Duty to prevent creditor-defeating dispositions
You have a duty to prevent your company from entering into a transaction that is a creditor-defeating disposition. This is a disposition of property:
- For less than the market value of the property or the best price reasonably obtainable, and
- That prevents, hinders or significantly delays the property from becoming available to benefit creditors in a winding up.
Illegal phoenix activity may include creditor-defeating dispositions.
Where recklessness is involved, this is an offence under the Corporations Act. A court can order compensation be paid to creditors equal to the loss or damage suffered.
Duty to not trade while insolvent
While this requirement is listed under general duties, ASIC draws attention to this as a key duty of directors.
Regulatory Guide 217 Duty to prevent insolvent trading: Guide for directors sets out guidance to help directors understand and comply with their duty under section 588G of the Corporations Act.
Duty to keep books and records
Not keeping adequate financial records is a contravention of the Corporations Act.
A creditor, ASIC or a liquidator can take legal action against you for insolvent trading. If you haven’t correctly recorded and explained the company’s financial performance, it may be assumed that it was insolvent throughout the period.
Consequences of insolvent trading
Consequences for insolvent trading include:
- Civil penalties: up to $200,000
- Compensation proceedings: A compensation order can be made in addition to civil penalties. There is no limit to compensation payments, which could cause a director to become bankrupt and disqualified from managing companies.
- Criminal charges: which can lead to a fine of up to 2,000 penalty units or imprisonment for up to five years, or both.
It is worth noting that while the maximum prison sentence for insolvent trading is five years, breaching additional duties such as recklessly causing harm to the company to obtain a personal advantage could increase the maximum prison sentence up to 15 years.
What can I do to protect myself?
If your company is in financial difficulty, you should get professional accounting and/or legal advice as early as possible.
Available options for insolvent companies or those at risk of insolvency include liquidation and voluntary administration. Keep in mind that under these arrangements you will lose control of the company.
You will also be required to assist external administrators in carrying out their functions. Failure to cooperate may lead to a public examination of a director, under oath.
If you fail to take the appropriate steps, you may receive a director penalty notice from the ATO for your company’s unpaid tax, whereby you could become personally liable for the repayment.
Be wary of pre-insolvency advisers who contact you out of the blue. While some are legitimate, others may suggest that you take illegal actions such as phoenixing activity.
Directors who allow their companies to trade while insolvent may be liable to severe penalties, including imprisonment and large fines. It’s important to be aware of your duties as a director and take the necessary steps to protect yourself. If your company is in financial difficulty, you should get professional advice as soon as possible.