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Insolvency

Insolvency: Legal Obligations for Australian Directors

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When financial distress looms, company directors face heightened legal obligations to safeguard stakeholders’ interests.

In Australia, the Corporations Act 2001 (Cth) outlines director obligations and imposes significant consequences for non-compliance. Generally, directors must:

  • Act with reasonable care and diligence
  • Exercise powers and duties in the company’s best interests
  • Not improperly use position, powers or information for personal advantage or gain of someone else.

During insolvency and financial distress in general, the director’s duties extend to consider the interests of creditors. When a company is in this position, a director is legally obligated to prevent insolvent trading and creditor-defeating dispositions.

If you are a company director and suspect it will not be able to pay its debts, seek professional advice as soon as possible. A registered liquidator or other suitably qualified adviser can review solvency and outline options.

If you receive a section 222AOE or ‘director penalty notice’ from the Commissioner of Taxation for your company’s unpaid tax, you should immediately seek professional advice. Failure to act within 14 days may result in the recovery of outstanding tax being taken against you.

Directors lose control of their company when it enters voluntary administration or liquidation. Please find out more about different insolvency appointments in our previous blog.

Duty to Prevent Insolvent Trading

One of the directors’ paramount duties is outlined in Section 588G of the Corporations Act 2001 (Cth). Directors are legally obliged to take reasonable steps to prevent insolvent trading. Failure to uphold this duty can result in severe consequences, including civil penalties and criminal charges.

If directors allow insolvent trading, they may become personally liable for the repayment of debts accumulated after the company’s insolvency. This can lead to the loss of personal property and, in extreme cases, bankruptcy.

For example, you may be asked by a bank to use the mortgage over your house to secure the company’s loan. If the company does not repay the loan, the bank may enforce its right to take possession or sell your home. This is a standard commercial practice.

A director must take necessary steps to prevent insolvent trading, such as stopping all trading activities and ceasing to incur new debts.

Consequences of Insolvent Trading

Insolvent trading is a severe offence in Australia. Potential penalties include fines and, in extreme cases, up to ten years of imprisonment. Directors who continue trading while insolvent may face damages, liabilities, and potential disqualification from managing companies.

The Australian Securities and Investments Commission (ASIC) is the regulatory body that will take legal action against directors.

The ASIC imposes general duties on directors, emphasising the need to exercise powers and responsibilities with care, diligence, and good faith in the company’s best interests. Breaches of these duties, mainly if driven by dishonesty or recklessness, can lead to criminal offences with penalties of up to $444,000 in fines and imprisonment for up to 15 years.

Creditor-Defeating Dispositions and Other Risks

Directors must be vigilant regarding creditor-defeating dispositions, such as selling company property for less than its market value. This effectively hinders creditors in winding-up proceedings as less money is available to pay outstanding debts.

This may expose directors to allegations of illegal Phoenix activity. This is where a new entity is formed, and assets are transferred to the new company for little or no cost. Therefore, when the existing company undergoes liquidation, there are no assets to repay debt.

The duty to prevent such dispositions arises when the company is insolvent or insolvent due to these transactions.

Regulatory Guide 217 Duty to prevent insolvent trading: Guide for directors offers valuable guidance to understand and comply with their duties under Section 588G of the Corporations Act.

Financial Records and Other Obligations

To navigate these complexities, directors must maintain adequate financial records to reflect the company’s financial position and performance accurately. Failure to do so may lead to presumptions of insolvency, triggering civil penalties of up to $200,000.

Directors also bear responsibilities during voluntary administration or liquidation, including assisting external administrators or receivers by providing necessary information and reports.

Directors are legally responsible for advising them of the location of the company’s property and delivering the property to the external administrator or receiver.

Director Penalties and Disqualifications

Directors may face personal liability under the Australian Taxation Office’s Director Penalty Regime, particularly regarding outstanding tax obligations and employee-related responsibilities. They must ensure the company meets its Pay As You Go (PAYG) withholding and Superannuation Guarantee Charge (SGC) obligations.

Moreover, directors involved in multiple company liquidations within the last seven years may face disqualification for up to five years. In severe cases, ASIC can seek disqualification for up to 20 years if the management contributed to the failures.

If you fail to perform your duties as a director, you may:

  • be investigated, charged and convicted of a serious criminal offence
  • have contravened a civil penalty provision, and the court may order you to pay a fine
  • be personally liable to compensate the company or others for any loss or damage they suffer
  • be disqualified from managing a company.

Director fines and penalties change regularly and can be found on the ASIC website.

Ensure You Are Fulfilling Your Director Duties

Directors must navigate the intricacies of insolvency with utmost diligence. Failing to fulfil legal obligations can result in severe consequences, including criminal charges, civil penalties, and potential disqualifications.

Seeking professional advice, particularly from insolvency lawyers, is imperative for directors facing financial distress.

By understanding and adhering to their legal duties, directors can safeguard their companies and protect the interests of all stakeholders.

Clout Advisory is a leading insolvency accountant and specialist restructuring advisor with decades of experience working with SMEs in several industries.

Contact Clout Advisory at coffs@cloutadvisory.com.au or call (02) 6650 5888.

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