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Posted by Revive Financial on Oct 23, 2023 1:51:00 PM

Restructuring can help you deal with your company's debts and turn your business around when you're in financial distress. However, if you continue to trade when your situation is critical, you could be placing yourself at risk of director liability and its consequences.

It's a tricky dilemma. Do you push forward with a restructure, even when you may still be liable, as a company director, for your company's debts? Maybe you should admit defeat and bring in the liquidators? Or perhaps you should keep trading and hope you can make it through?

Unfortunately, the law isn't yet perfect. Personal liability complicates what can be an otherwise straightforward restructure. Sometimes, due to the level of personal liability, there can be no company debt reduction, completely undermining restructuring efforts.

Stay Safe with a Company Structure?

Statistically speaking, businesses will fail. However, we need entrepreneurs to keep opening new businesses and innovating to continue developing the economy. So, how do we encourage people to take risks without risking everything? This is where becoming a company makes sense.

As well as there being tax and other benefits when you're a company, the primary reason for choosing this business structure is that it's a separate legal entity to its directors. This means it keeps your personal assets safe if the company fails.

But, in reality, there are some instances where you're not protected and can become personally liable, impacting restructuring.

What Is Director Liability?

Director liability means taking legal responsibility for your company's debts.

It can extend to potential financial or legal consequences for directors whose actions or decisions are to the company's detriment. But, in our experience, this is the minority.

You generally know if you're doing the wrong thing when it comes to general directors' duties. However, most people do or try to do the right thing.

What Can Directors Be Liable For?

So, when can directors become personally liable?

The four main areas of director liability we see are:

  1. You've been paid director drawings instead of wages, and so owe your company a large loan.
  2. You signed personal guarantees to obtain a supplier account, a premises lease, or loans and finance.
  3. You were issued a Director Penalty Notice (DPN), which was either a 21-day notice that was dated more than 21 days ago or a lockdown notice.
  4. Your company continued trading while insolvent.

There are other potential liabilities directors can face due to company insolvency, but these four are the most pressing.

How These Complicate Your Situation

With any of these personal liabilities in the mix, a company restructure or even liquidation may not be effective in reducing your company's debts.

On top of paying a return to creditors and restructuring costs, you'll have to pay or negotiate settlements of personal liabilities.

For example, your company might owe the ATO a $300,000 BAS debt, and you're liable for $250,000 of that debt under a DPN that expired.

In this scenario, even though you might be able to reduce your company's ATO debt to $60,000 (being a 20% return commonly proposed under a Small Business Restructure), you'll need to pay the balance of the $190,000 DPN.

Worse still, if the ATO applies the restructure payments to debts not included in the DPN, you may end up paying more than the full amount of the DPN. If you can't afford to pay that amount, you face losing your home or personal bankruptcy. If this occurs, it may also lead to the closure and liquidation of your business.

Is-Your-Business-In-Financial-Distress

How to Avoid the Director Liability/Restructuring Predicament

The waters for being liable for your company debts are certainly murky and, as you can see, best avoided. Here are our tips for keeping liability at bay:

Avoid an expired Director Penalty Notice

The number one issue currently is expired Director Penalty Notice s (DPN). To avoid this very regrettable situation:

  • lodge your BAS on time,
  • pay your super and
  • ensure you keep your ASIC-registered personal address up to date.

If the ATO issues a Director Penalty Notice to you, lodging your BAS and superannuation guarantee charge (SGC) returns by the due dates limits the ATO to issuing a 21-day DPN, not a lockdown DPN that carries automatic liability.

A 21-day DPN is spicy, but at least you have 21 days to appoint a restructuring practitioner, voluntary administrator or liquidator to your company to avoid personal liability. A payment plan is not an option to avoid liability.

Keeping your ASIC address details up to date is important. You don't want to become personally liable for your company's ATO debt simply because the DPN went to your old address. Not getting it is not a defence.

Plus, check your mail, open it and get the right help as soon as possible. Bookkeepers and accountants aren't always across what needs to happen, so go straight to a restructuring and insolvency professional if your existing advisor network is uncertain about your options.

Check your balance sheet for a director loan

Check your company balance sheet to see if there's an asset balance for a director loan or ask your accountant. Accountants often set this up to defer paying tax on director remuneration and might be referred to as a Division 7A loan.

However, it's something that's often poorly understood by directors, who are surprised when a lawyer or insolvency professional tells them they might have to repay the amount to their company. 'But that's my wages' is a very common response, though it's most often futile.

The idea is that taking drawings, which increase the loan account, is essentially taking an advance on your company profits, which should net off at year-end. The problem is, if your company isn't making enough profit or none at all, you’re accruing a debt but not accounting for your work in the business.

If you're uncertain, talk to your accountant about whether taking drawings is an appropriate structure for you or if it's actually creating a big loan account problem that could cost you your house.

Check for insolvency (even if you'd rather not)

If your company can't pay its debts when they fall due, it might be insolvent. This includes ATO debts.

We appreciate the 'your' word is triggering. No one wants to admit it might apply to them. But it's important because if your company is trading while insolvent, you're incurring debts you can't pay—regardless of your best intentions to hopefully pay them.

While you have a duty not to keep trading in this situation, you can be held personally liable for these debts.

Safe harbour is a protection for insolvent trading, but generally more relevant to bigger companies who aren't facing personal liability under the other examples discussed.

However, the Safe Harbour provision (Section 588GA) offers directors some protection from personal liability for company debts. This protection applies if you're taking certain steps to develop a restructuring plan that's likely to lead to a better outcome for your company and creditors than immediate liquidation.

It's essentially designed to strike a balance between accountability and encouraging directors to take proactive steps to rescue their company.

Avoid giving personal guarantees

Finally, don't give personal guarantees.

This is easier said than done. But it's worth asking or not signing when applying for trade credit or negotiating to take on a premises lease.

The worst area for this is when your company runs short of cash. Stress rises and you reach for the easy money, such as credit cards and short-term and high-interest loans, often obtained online.

If your company is already in financial difficulty, using these sources of funds to pay debts is doing two things:

  1. Delaying you from dealing with the real causes of financial difficulty
  2. Transferring company debts to a personally guaranteed debt

Neither is a good idea.

Act Smart and Seek Support

The murky waters of company directors’ liabilities can significantly complicate the process of business restructuring.

While restructuring is a valuable tool to address financial distress, it's essential you're aware of the potential personal liabilities you may face, as they can undermine the effectiveness of your efforts.

By taking the right actions, including avoiding expired DPNs and checking for director loans, and seeking professional support, you can help ensure you retain the opportunity to reduce your company's debts through a restructure and take back control.

Worried about the liabilities of directors in relation to restructuring? Get in touch with our team of debt solution specialists today on 1800 534 534 for professional, non-judgmental support and advice.

Topics: Tax Debt, Business Debt, business restructuring, small business restructuring, Recent Articles, Business Advice, Director Liability, Business Turnaround, liabilities of directors, restructuring, director duties, safe harbour

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