Walking the directorship tightrope – Print21 feature

Being a company director may bring status, influence and remuneration, but uppermost in the mind of most directors today, are the ever-increasing obligations and responsibilities and the degree of scrutiny to which they are subjected. Of particular concern to many is the responsibility of directors in relation to solvency.

Unfortunately the printing industry has seen its fair share of casualties—often companies which have tightly managed their cash flow for some months, or even years, but have ultimately been unable to stave off inevitable insolvency. As if the demise of the business were not devastating enough, their directors have in many cases faced the unwelcome prospect of being found personally liable for debts incurred by the company.

For private companies, the greatest exposure generally arises if the company finds itself unable to satisfy its creditors as they fall due—whether they be financiers, the ATO or suppliers. In this article, we provide an overview of the legal responsi-bilities of directors in this regard, including the implications of insolvent trading and the nature of directors’ liability.
Responsibilities of directors

Appropriately, shareholders, creditors and regulatory bodies hold the directors accountable for a company’s successes, failures and any financial loss they may subsequently suffer.

Sections 180 to 184 of the Corporations Act sets out the basic expectations of a person appointed as a company director, including that they act honestly in the exercise of their powers and the discharge of their duties; that they should exercise a reasonable degree of care and diligence; and that they should not make improper use of information acquired by virtue of their position for their benefit or the detriment of the company.

Directors also have a general duty to avoid any actual or potential conflict between their own interests and those of the company, and between their duty to the company and their duties to third parties - such as other companies of which they are also directors or officers. Owner-managed businesses in particular frequently engage in multiple transactions with directors and their related parties—not only the payment of remuneration and dividends, but often the rental of premises or commissioning of various services from entities related to the directors. In practice, in the event of insolvency, such transactions are likely to come under close scrutiny, particularly if they have not been entered into on arm’s length terms.
Insolvent trading

The section which generally gives the most concern to directors is Section 588G of the Corporations Act, which imposes a duty upon directors to avoid insolvent trading.

This section stipulates that if a director incurs a debt and the company is insolvent at that time or becomes insolvent by incurring that debt and there are reasonable grounds for suspecting that this is the case, then the director may be held personally liable for the debt. “Incurring a debt” is construed widely and would include, for example, obtaining additional finance facilities, increasing a bank overdraft or drawing down further amounts on a revolving credit facility, ordering new plant and equipment or placing an order with a paper supplier.

Under this part of the Act, directors are under a positive duty to ensure that the company does not incur debts whilst it is insolvent, otherwise they can become personally liable. Criminal liability may also attach to such actions.

As such, it is essential that company directors understand the meaning of “insolvency” and are able to make a proper assessment, at any point in time, as to whether or not the company is solvent. This requires knowledge not only of the current financial position of the company, but also of its prospects and availability of ongoing financing. Put simply, a company is only solvent if it is able to pay all of its debts as and when they fall due.
No excuses for directors

Under the insolvent trading provisions, directors cannot argue a lack of involvement in the company’s affairs as a defence. The law makes no distinction between those directors actively involved in running the business and non-executive directors, whose involvement may be limited to a couple of days a month. Furthermore, there is no greater onus placed on the director with responsibility for finance, notwithstanding that he may be best placed to advise the board on the solvency position of the company. Family members who may have been appointed directors for tax, legal or other reasons, and who may have no active involvement in the company, need to be particularly aware of their responsibilities.
Taxation liabilities

The Insolvency (Tax Priorities) Act, enacted in 1993, armed the Commissioner of Taxation with powers to recover group, prescribed payments and withholding taxes directly from a director of a company which, as primary taxpayer, has not remitted these taxes by their due date for payment. This has since been amended to cover unpaid GST liabilities.

The Commissioner commences the recovery process by issuing an assessment or an estimate to the company for the unpaid taxes. If this is not satisfied, a penalty notice equal to that amount may be issued against each of the company’s directors, giving them fourteen days to satisfy the claim or take one of the following actions:

• Make an arrangement with the Commissioner to pay the liability
• Appoint an Administrator to the company, or
• Place the company into liquidation.

After fourteen days has lapsed, if none of the above actions has been taken, each director is personally liable for the penalty and the Commissioner can proceed with recovery action.
It should also be noted that, if a company settles a debt owing to the Commissioner in preference to other creditors and a liquidator is subsequently appointed, the liquidator may recover such payments from the Commissioner. If this occurs, the Commissioner is able to recover any payments set aside from the company’s directors.
Trade Practices Act

Section 52 of the Trade Practices Act makes a company director potentially liable to pay damages to creditors if he engages in misleading and deceptive conduct in the course of the execution of his duties as a director. It has been held that misleading and deceptive conduct includes the circumstances where a company incurs debts when the directors knew or ought to have known that the company could not make payment for goods supplied by a due date.
Summary
An appointment as a company director is not something to take on lightly. For an owner-managed business, the potential for directors to be held personally liable for company debts has significantly reduced the protection afforded by operating a business within a limited liability company.
Unfortunately, these provisions expose company directors to a high risk of personal liability, which has impeded decision making by creating uncertainty, affecting corporate risk-taking and investment decisions. l

Justin Audcent is a partner in HLB Mann Judd (Melbourne), which provides a range of audit, taxation, business recovery and consulting services to companies in the printing and allied industries. Ph: (03) 9606 3300.