Avoiding director’s liability during insolvency

Running a business in Australia comes with many responsibilities, and as a company director, one of the most significant is ensuring the company meets its legal obligations. However, when a business faces financial trouble, directors can find themselves at risk of personal liability if they fail to act appropriately. Understanding how to protect yourself legally during insolvency is critical for directors who want to navigate this challenging time responsibly and avoid potential consequences.Here’s what you need to know about avoiding director’s liability when your business is in financial distress.
Insolvency proceedings

Understanding director’s duties in Australia

Under Australian law, directors have a fiduciary duty to act in the best interests of their company. This duty includes:

  • Acting with care and diligence.
  • Avoiding conflicts of interest.
  • Acting in good faith and for a proper purpose.
  • Ensuring the company complies with relevant laws, including tax and employment obligations.

When a company is solvent, directors must prioritise the interests of shareholders. However, if insolvency is looming or the business is already insolvent, directors are required to prioritise the interests of creditors.

What is director’s liability?

Director’s liability refers to the legal responsibility directors may bear for the actions or inactions of their company. In cases of insolvency, directors can be held personally liable for debts incurred if they continue to trade while the business is insolvent. This is known as insolvent trading, and it’s a serious breach of the Corporations Act 2001 (Cth).

Penalties for insolvent trading can include significant fines, compensation orders, disqualification from managing companies, and even criminal charges in severe cases.

Steps directors can take to protect themselves

To avoid personal liability during financial trouble, directors need to act diligently and take proactive measures. Here are some key strategies to consider:

  1. Stay informed about the company’s financial position

It’s crucial to have a clear understanding of your company’s financial health. Regularly review financial statements, cash flow projections, and other key metrics. If you suspect the business is approaching insolvency, seek immediate advice from your accountant or financial advisor.

  1. Act early

One of the most common mistakes directors make is delaying action when financial issues arise. The earlier you address potential insolvency, the more options you’ll have to protect the company and yourself. Early intervention can include renegotiating terms with creditors, cutting unnecessary expenses, or seeking restructuring advice.

  1. Avoid incurring new debts

Once you suspect insolvency, refrain from incurring further debts. Continuing to trade while insolvent not only worsens the financial situation but also increases the likelihood of personal liability. Be cautious about entering into new contracts or agreements that could exacerbate the company’s financial difficulties.

  1. Document decisions and actions

Maintaining detailed records of all decisions and actions taken during financial distress is essential. These records demonstrate that you acted responsibly and in the best interests of creditors, which can be critical if your actions are ever questioned.

  1. Seek professional advice

Engage with insolvency experts or corporate advisors who can provide tailored guidance for your situation. These professionals can help you understand your obligations, assess options such as restructuring, and guide you through formal insolvency processes if necessary.

  1. Consider safe harbour protection

The safe harbour provisions under Australian law offer directors protection from personal liability for insolvent trading if they take specific steps to turn the business around. To qualify for safe harbour, you must:

  • Develop a plan to return the company to solvency.
  • Act in good faith and on proper advice.
  • Ensure the company complies with tax reporting and employee entitlement obligations.

By adhering to these steps, directors can explore recovery strategies without the immediate threat of personal liability.

  1. Engage with creditors transparently

Open communication with creditors is crucial during financial distress. Being transparent about your company’s position and negotiating payment terms can help preserve relationships and potentially avoid legal disputes.

  1. Understand and comply with legal obligations

Directors are required to ensure the company complies with tax, superannuation, and employment laws. Non-compliance in these areas can lead to personal liability under Australia’s Director Penalty Regime. Stay on top of all obligations to avoid additional penalties.

Common pitfalls to avoid

While it’s important to take proactive steps, directors should also be mindful of common pitfalls that could lead to liability:

  • Failing to seek help: Waiting too long to seek professional advice can limit your options and increase your risk of liability.
  • Neglecting to monitor finances: Ignorance of the company’s financial position is not a defence against liability.
  • Improper use of funds: Using company funds for personal purposes or favouring certain creditors can lead to serious legal consequences

When formal insolvency processes are necessary

If recovery is no longer possible, formal insolvency processes such as voluntary administration or liquidation may be the best course of action. In these cases, engaging an insolvency practitioner can help ensure the process is managed appropriately and your legal responsibilities are met.

The role of professional advisors

Navigating insolvency is complex, and the guidance of experienced advisors can make all the difference. At AVA Advisory, we specialise in supporting Australian business directors through financial challenges. Our team provides tailored advice to help you fulfil your legal obligations, protect your assets, and explore the best path forward for your business.

Facing financial trouble as a director can be daunting, but understanding your responsibilities and taking proactive steps can help you avoid personal liability. By staying informed, seeking advice early, and acting in the best interests of creditors, you can navigate insolvency with confidence and integrity.

If your business is experiencing financial distress, don’t wait to seek help. Contact AVA Advisory today for expert guidance and support to protect yourself and your company.

Get in touch with us on 1300 181 220 to schedule a confidential and obligation-free consultation or click here to lock in an online meeting via our bookings platform.

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