Directors need to get the right advice.
In 2016, I originally wrote this article regarding the often
under-disclosed impacts of liquidation on directors. Now, eight
years later, I find it pertinent to revisit this topic. The core
advice remains unchanged: directors must seek comprehensive and
professional advice tailored to their specific situations and that
of their company. This is essential for making informed decisions
about potential steps forward. Directors must uphold their duties
responsibly while also considering the personal repercussions of
their decisions.
Regrettably, it’s all too common for directors to be
misguided by advisors who lack the necessary expertise or who may
have ulterior motives, prioritising their own financial gain over
the wellbeing of their clients. Such advisors might simplistically
suggest that liquidation will solve all problems—a misleading
and often incorrect assertion. Directors need to be cautious and
ensure they are receiving guidance from knowledgeable and ethical
professionals to navigate the complex process of liquidation
effectively.
This article will touch on the following and the impact of each
on directors:
- Personal guarantees
- Charging clauses – often found in personal
guarantees - Directors loan accounts
- Director penalty notices (DPNs)
- Insolvent trading
- Queensland Building and Construction Commission (QBCC)
licensing - QBCC Deed of Covenant
- Section 588FGA liability
- Section 588FDA actions
Personal guarantees
Although it may appear straightforward, the implications of a
personal guarantee are frequently overlooked by directors. To
clarify, a personal guarantee is a commitment made by a director to
be responsible for the company’s debts. This commitment is
often included in a credit application signed by a director with a
creditor. If a director has signed a personal guarantee, that
director will then become liable for any debts unpaid by the
company. This can amount to a large amount in the event of a
liquidation.
In the event of a company’s liquidation, creditors with
personal guarantees in place are particularly proactive in
proactive in pursuing payment from the director.
One common challenge directors face is a lack of awareness about
which of their creditors hold these personal guarantees. It is our
suggestion that directors should maintain a register of creditors
who hold personal guarantees. It is also our recommendation that
the director seek to put a ‘cap’ on any personal guarantees
that they sign rather than leaving it as unlimited.
Charging clauses – often found in personal
guarantees
Many personal guarantees include a “charging” clause,
a critical component that gives a creditor the ability to secure a
claim against any real property owned by the director, or any other
signatory to the personal guarantee. This clause effectively gives
the creditor the status of a “secured creditor”,
providing them with security over any real property owned by the
director.
In practical terms, this means that if the personal guarantee is
called up and not paid, the creditor has the right to lodge a
caveat against the director’s real property. Should it become
necessary, the creditor can then commence legal proceedings to
enforce this caveat. Such actions could lead to the appointment of
a statutory trustee, who would be authorised to sell the property.
The proceeds from this sale would first be used to settle debts
with any creditors who hold a mortgage over the property. Then, any
creditors with caveats with any remaining funds will then be paid
to the owners of the property.
Given the potential impact, charging clauses are a formidable
tool in the hands of creditors and something directors much fully
understand and carefully manage. It is our advice that any director
should seek proper legal advice before signing any personal
guarantees to ensure that they understand whether there is a
charging clause included. It may be that the director is better off
finding a different supplier that doesn’t have a personal
guarantee with a charging clause.
Directors loan accounts
There has been a notable rise in the use of director loan
accounts. This has been for two reasons:
- Directors choose to draw minimal salaries or none at all,
opting instead to withdraw funds from the company through a
director’s loan account. The benefit being that there is no
PAYG (Pay as you go) or superannuation paid under this
approach. - During the COVID period, the directors withdrew significant
sums for personal use, whether it be to renovate the house,
purchase a caravan, boat etc.
Regardless as to why, this approach carries significant risk in
the event of liquidation. One of the first actions a liquidator
will undertake is to identify and demand payment of any director
loan accounts. These loan accounts are often of a significant
amount which places a heavy financial burden on the director to
settle the debts.
It is our recommendation that directors should not pay their
salaries through a loan account, but rather through a proper
payroll salary, which includes paying the PAYG and superannuation.
While it will cost a little more to do this, it ensures minimal
risk should the company be wound up. The superannuation is a
benefit received by the director in any case.
Secondly, it is our view that any director should not take money
out of the company for personal expenses by way of a loan account.
If the company has surplus funds, these should be paid out in the
normal process of a dividend declaration to shareholders.
Director penalty notices (DPNs)
Worrells has released a substantial amount of information in
respect of DPNs, so I do not propose to dive into this into too
much detail.
A DPN enables the ATO to directly recover unpaid company PAYG,
Superannuation and GST from directors. It’s crucial for
directors to be aware of the risks associated with DPNs,
particularly if they have outstanding tax lodgments. Directors may
find themselves automatically liable for a significant portion of
these unpaid taxes and superannuation.
Receiving a DPN is a serious matter that requires immediate
action. Directors should seek professional advice as soon as they
are notified of a DPN. Ignoring a DPN will only exacerbate the
situation, leading to potentially more severe financial
consequences. Proactive engagement is essential to managing and
resolving these obligations effectively.
Further information on DPNs can be found
here.
Insolvent trading
Liquidators have the power to pursue directors for insolvent
trading claims. For an in-depth guide on how these claims are
processed, visit this link. Essentially, a
liquidator’s role involves conducting thorough investigations
to identify the precise moment a company became insolvent. The
liquidator then quantifies the total amount of debt that the
company accumulated after this date of insolvency. This amount
represents the financial liability that liquidators can demand from
the directors for insolvent trading.
This process underscores the importance of careful financial
management and timely action to prevent or address insolvency.
Queensland Building and Construction Commission (QBCC)
licensing
In Queensland, directors of companies that hold a QBCC license
face significant consequences if their company enters voluntary
administration or liquidation. The QBCC views such events as
“insolvent events” and as a result any director, or even
former director within the last 12 months who held a QBCC license
at the time of the company’s insolvency is labeled as an
“excluded individual”. This designation comes with a
three-year prohibition on holding a QBCC license.
The consequences then escalate if the director is involved with
a second company that also goes into administration or liquidation.
In such cases, the director faces a lifetime ban from holding a
QBCC license.
These measures are intended to uphold the integrity of the
building industry, but they also significantly impact the
director’s professional figure, severely restricting their
ability to earn an income in the construction industry.
It is also important to note that any appointment of a small
business practitioner does not result in an automatic insolvent
event. That being the case, if a company is subject to an SBR, the
director and the company can continue to trade and hold their
license. At Worrells we have undertaken many SBR where the company
and director have retained their QBCC licenses.
QBCC Deed of Covenant
Directors of companies that hold a QBCC license are often
required to sign a “deed of covenant”. This agreement is
meant to ensure that a company meets the QBCC’s stringent
financial requirements. By signing this deed, directors commit to
covering any financial shortfalls.
In the event that a company enters liquidation, the deed of
covenant grants the liquidator the ability to make a demand on the
director for the amount as defined in the deed of covenant.
Furthermore, if the demand remains unsatisfied, the liquidator can
then take more drastic action by lodging a caveat over any real
property owned by the director. This then provides the liquidator
with the power to receive a priority from any sale proceeds should
the property be sold, or even provide them with the power to take
action to sell the property. Earlier in this article I provided
details on how caveats can be used by creditors.
The use of a deed of covenant underscores the serious financial
responsibilities and potential risks that directors undertake when
managing a company that holds a QBCC license. Directors need to
ensure that they are seeking proper advice both legally and
financially if considering signing a deed of covenant.
Section 588FGA liability for ATO preferences
One critical aspect often overlooked by directors and their
advisors during the process of a winding up of a company is the
liability associated with ‘preferential payments’ made to
the ATO. When a company is in liquidation and the liquidator
identifies that preferential payments were made to the ATO, they
are obligated to take steps to recover these funds.
Under Section 588FGA of the Corporations Act 2001, if a
liquidator successfully secures a court order to reclaim such
payments, the responsibility for the PAYG component of these
payments shifts to the directors. This means that if a liquidator
recovers any preferential payments from the ATO, the ATO is then
entitled to pursue the directors personally for the PAYG portion of
these recovered funds.
This liability is a significant risk for directors during the
liquidation process, emphasizing the importance of seeking proper
advice at all relevant times.
Section 588FDA actions
Section 588FDA of the Corporations Act 2001 empowers
liquidators to take action against directors for what are deemed
“unreasonable director-related transactions”. This
provision is designed to scrutinise financial dealings that may not
align with the best interests of a company in distress.
To assess whether a transaction qualifies as unreasonable,
liquidators must confirm several criteria:
- Transaction initiation – The transaction must involve the
company making a payment, transferring property, issuing
securities, or incurred an obligations to do any of these
things. - Recipient of the transaction – The beneficiary of the
transaction must be a director, a person closely associated with a
director, or someone acting on behalf of the director or their
close associate - Reasonableness of the transaction – The transaction
should be such that a reasonable person, given the company’s
financial position, would not have agreed to it considering both
the benefits and drawbacks to the company.
These criteria give liquidators a broad mandate to investigate
any transactions that may disproportionately benefit directors of
their close associates at the expense of the company, often
including family members.
Liquidators closely monitor these transactions, ready to take
corrective action if they find any that do not meet the required
standards of fairness and reasonableness.
It is our recommendation that directors to not partake in such
transactions, as these will be found. Often it is the case that any
such transactions that involve family members – in which case the
liquidator will take legal action against that family member.
Conclusion
The potential pitfalls for directors of companies facing
liquidation are numerous and can have profound negative impacts.
It’s crucial for directors to consult with reputable and
knowledgeable advisors to navigate these treacherous waters.
Misleading advice, such as the notion that liquidation will
magically erase all problems, is not only unethical but also
patently false. Directors must be discerning in their choice of
advisors to ensure that they are receiving honest and effective
guidance to mitigate the significant risks associated with
liquidation. If the unqualified advice is to undertake a
transaction that seems “too good to be true” – it likely
is. Take the time and get the right advice.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
#Liquidationthe #ugly #side #directors #InsolvencyBankruptcy
