What Happens to Company Directors During Liquidation?

The Directors of companies operating in Australia are required to run their businesses in the best interest of shareholders. So, if their company becomes insolvent, it’s their responsibility to take action, which can include entering into company liquidation to rectify the situation. Bankruptcy is a daunting idea for many Directors, and it carries a risk that the Directors will be held personally responsible for some of the debts the company has incurred.

For companies that are facing liquidation, it’s important to understand the impact the process will have on the Directors and any consequences they may experience as a result.

Suspension of Directors Powers

Companies can enter liquidation in two ways. In a Voluntary Liquidation, the Directors and shareholders of an insolvent company can vote to wind the company up and appoint a Liquidator to distribute its assets. In a Court Liquidation, if a company’s stakeholders (such as lenders) are concerned that the company is unable to pay its debts, they can apply to the Court to have a Liquidator appointed.

In either case, the first thing that happens is the decision-making powers of the Directors are suspended. Instead, the Liquidator will take responsibility for the company’s affairs and assets during the liquidation process. Once the Liquidator has taken control of the company, they will begin investigating the company’s affairs and finances. If the Liquidator determines that the Directors have acted unlawfully or breached their duty to shareholders, the Directors can be held personally liable for the company’s debts. If the Liquidator finds that the Directors met their obligations and that they acted lawfully, it’s unlikely they will be held responsible for repaying company debts.

Breaching Director Duties

Directors of Australian companies are required to act honestly and trade in the best interests of the company’s shareholders. If the Liquidator finds that a Director has failed to meet these obligations, they may be held personally liable for the company’s debts. In addition to being held liable for company debts, Directors can face civil penalties (such as fines) and even criminal charges and imprisonment.

Directors commonly breach their responsibilities in three ways:

  • Insolvent Trading. If a company is unable to pay its debts on time it is considered insolvent. Insolvent trading occurs when a company continues to operate when the Directors know that it’s insolvent, or when the Director’s could reasonably be expected to know that it’s insolvent. Insolvent trading is illegal in Australia. If the Court finds the Directors guilty of insolvent trading, they can be held personally liable for company debts.
  • Fraudulent Trading. When Directors carry on a business that is intentionally misleading or defrauding creditors, it is considered fraudulent trading. Fraudulent trading can take many forms, such as intentionally misleading creditors or accepting contracts for work that the company won’t be able to handle. Fraudulent trading is illegal and the Directors of a company may receive a fine or a prison sentence up to 10 years.
  • Directors are responsible for managing their company’s money in the best interests of shareholders. Misfeasance occurs when company funds are misused or misappropriated by Directors, such as drawing company money improperly. A Director that commits misfeasance can be required to repay any money that was misused towards the company’s debts.

Directors Personal Guarantees

Funding a growing business is a fine balancing act. Seeking funding and assets from creditors can allow Directors to expand the business and improve the returns being seen by shareholders. One way of obtaining company finance is for a Director to issue a personal guarantee against the loan. If a Director issues a personal guarantee, the creditor will be entitled to recover the money they are owed from the Director if the company becomes unable to pay the debt.

Similarly, the Director of a company may choose to secure a business loan using a personal asset such as their home. If this happens, the creditor will be entitled to recover their debts from the Director personally, even after the liquidation process has been completed.

Directors Tax Obligations

Companies operating in Australia are required to meet a range of obligations to the Australian Taxation Office (ATO). These obligations include paying company taxes, meeting Pay As You Go (PAYG) requirements and paying superannuation entitlements to employees. If a company doesn’t meet their tax obligations, the ATO can hold the Directors personally liable for repaying the money that is owed.

Because financial difficulties are one of the main reasons that a company would fail to meet its tax obligations, the ATO is still entitled to recover their money, even during voluntary liquidation or court liquidation. To do this, the ATO will issue a Directors Penalty Notice (DPN) to the Directors personally. The DPN will include the ATO’s estimate of how much money is owed and the amount the Directors are liable to repay.