This week, amendments to the Corporations Act 2001 (Cth) (‘the Act’) were passed to eliminate personal civil liability of company directors in certain circumstances.
It’s well known that the Act imposes various duties on directors and non-compliance with those obligations can lead to both civil liability and criminal penalties. Consequently, it’s important for directors to understand the changes to the Act.
The current insolvent trading position
Ordinarily, directors are not personally liable for a debt incurred in the name of their company – this is commonly referred to as the ‘corporate veil’. Section 588G(2) of the Act, however, provides an exception to that general rule in that the ‘corporate veil’ is pierced and directors become personally liable for a company debt if:
- they are a director when the company incurs the debt;
- the company is insolvent at the time the debt is incurred or becomes insolvent as a result of incurring the debt; and
- there were reasonable objective grounds to suspect the company was insolvent at that time.
The amendments create a ‘safe harbour’ for directors. In other words, even if the three elements of section 588G(2) are met, directors will avoid personal liability if they, after suspecting the company was insolvent, took action reasonably likely to lead to a better outcome for the company and its creditors than if the company was liquidated.
The amendments provide a non-exhaustive list of factors to aid courts in the evaluation of whether the director’s action was “reasonably likely to lead to a better outcome.” These factors include:
- whether the director has taken steps to prevent any form of misconduct within the company which could impact the company’s ability to pay its debts
- whether the director has taken steps to keep financial records
- whether the director has informed themselves of the company’s overall financial position
- whether the director has implemented, or has begun to develop, a plan to restructure the company to improve its financial position
If the director is able to provide evidence of the above four factors, the onus of proof shifts to the individual alleging insolvent trading (usually the company’s liquidator) to prove that the ‘safe harbour’ defence does not apply.
The ‘safe harbour’ defence will commence the day after the Governor-General assents to the amending bill. The impact of the ‘safe harbour’ amendments will be independently reviewed in two years.
Things to remember
- The ‘safe harbour’ defence does not apply to all debts
- Directors are unable to rely on the ‘safe harbour’ defence if the company has not been meeting its employee entitlements or tax reporting obligations
If you suspect that the company of which you are a director may be trading insolvently and you’re concerned about your potential personal liability, please don’t hesitate to contact Clifford Gouldson Lawyers’ Litigation + Dispute Resolution Team.