Directors’ duties: A refresher on liability and personal asset risk

Scope of liability

Directors’ personal liability in Australia is stricter than just about anywhere else in the world.  The scope of that liability is now greater than ever due to the difficulty directors have in predicting with any real certainty how COVID-19 affects the future earnings and operations of the company’s business.  Yet Australian regulators have indicated they expect directors to do so – and the reality is that if directors continue to cause a company to trade, even if it is not likely to be viable in the long-term in the absence of government fiscal support, they may face substantial personal liability.

Core Directors’ duties

Directors in Australia owe the company a number of core duties, imposed both at general law and under the Corporations Act.  Directors are required to act:

• with reasonable care, skill and diligence (s180);
• in good faith in the best interests of the company (s181);
• for a proper purpose (s181);
• without any conflict of duty or interest that results in a personal advantage or detriment to the company (s182); and
• without improperly using the company’s information to gain a personal advantage or cause detriment to the company (s183).

Breach of the statutory and general law duties may result in:

• orders requiring directors to pay compensation to the company – this is uncapped and depends on the relevant loss involved for shareholders and/or creditors (s1317H);
• orders requiring directors to pay a civil penalty of up to $1.05 million (ss1317E and 1317G);
• disqualification of directors from managing companies for a period of time (s206C); and/or
• imprisonment or the imposition of a fine if directors have been reckless or intentionally dishonest in committing the breach (s184).

It is now commonplace for ASIC to pursue directors personally on the basis of a ‘stepping stone’ case theory when a company has committed a serious contravention of its ordinary obligations, whether under the Corporations Act or another piece of legislation or applicable regulatory standards.  The argument is that, in permitting the company to commit the breach, directors at least failed to act with reasonable care, skill and diligence, in good faith in the best interests of the company and for a proper purpose.

This basis for liability was affirmed most recently by the Federal Court in ASIC v Vocation Limited (in liq) [2019] FCA 807 and it significantly opens the door to greater personal liability for directors.

Duty to prevent insolvent trading

Directors have a positive duty under s588G of the Corporations Act to prevent the company trading while insolvent. If the duty is breached – and directors cannot take advantage of a defence, such as appointing a voluntary administrator to prevent the company incurring a debt, or otherwise use the safe harbour available under s588GA for directors that pursue a viable restructuring attempt under the advice of a restructuring expert – directors can be pursued for the value of the debts incurred (ss588J and 588M). Criminal liability will also arise if any debts are incurred dishonestly.

As part of the response to COVID-19, the Commonwealth Treasurer granted a 6 month exemption to directors for insolvent trading liability, which is due to end on 25 September 2020. The Treasurer is currently considering whether to extend this 6 month moratorium.

However, insolvent trading aside, directors need to seriously consider the prospect of the company being able to trade viably without the benefit of government fiscal support measures introduced since March. If there is no realistic chance of a return to profitable trade once the support measures are wound back as early as September, and directors continue to trade on in ‘blind faith’, they may risk breaching their ordinary duties of care, skill and diligence at the very least.

And, given that, in times of imminent insolvency, the ‘company’ corresponds to the interests of creditors, directors may breach their duty to act in good faith in the best interests of the company by continuing to trade in these circumstances.

In that sense, temporary immunity from insolvent trading liability offers something of a false comfort.

Disclosure obligations

Listed entities have general ‘continuous disclosure’ obligations under the Corporations Act and the ASX Listing Rules, requiring them to disclose to the market all information that a reasonable person would expect to have a material effect on the price or value of their securities (s674(2) and rules 3.1-3.1A of the Listing Rules).

The consequence of a continuous disclosure breach is civil and possibly also criminal liability for the company itself (ss1317E and 1317G), as well as personal liability for directors (ss674(2A), 1317E and 1317G).

Predicting the impact of COVID-19 on a company’s operations, and making earnings forecasts and forward-looking statements, is very difficult.

The continuous disclosure liability risk therefore becomes very significant if you sit on the board of a listed company (or another disclosing entity). For that reason, on 25 May 2020, the Treasurer used his temporary power to modify the Corporations Act to make changes to the continuous disclosure regime. Until 25 November 2020, companies and their directors are immune from liability for a continuous disclosure breach in the absence of knowledge, recklessness or negligence as to whether material information ought to have been disclosed.

However, the moratorium only prevents a civil penalty or compensation claim. ASIC can still pursue criminal proceedings and it also remains possible for companies and directors to face civil liability for misleading and deceptive conduct.

So again, the interim continuous disclosure liability moratorium is something of a ‘false comfort’ to directors. It is important for all directors to pay close attention to the measurable impact of COVID-19 on the company’s operations and future earnings, and to ensure all market disclosures are made at the first available opportunity. Any material profit downgrades also need to be disclosed as the implications of the pandemic continue to rapidly change. The AICD issued joint guidance with CPA Australia and the Chartered Accountants of Australia and New Zealand in July designed to assist directors in complying with their disclosure obligations notwithstanding the uncertainty caused by the pandemic.

Director penalty notices

Since June 1993, the ATO has had the power under Division 269 of the Taxation Administration Act to issue director penalty notices (DPNs) to company directors which, if not actioned, cause directors to become personally liable to pay a penalty equivalent to the amount of certain unpaid taxes.

While the DPN provisions have always applied to amounts withheld from employee wages but not remitted to the ATO (PAYG amounts), they were later expanded to include unpaid superannuation guarantee charge (SGC) amounts and, with effect from 1 April 2020 – as part of the anti-phoenixing legislation under the Treasury Laws Amendment (Combatting Illegal Phoenixing) Act 2020 – unpaid GST contributions, including luxury car tax (LCT) and wine equalisation tax (WET).

Under the DPN regime, the ATO can issue a DPN to each individual director where those amounts have not been remitted to the ATO. For unpaid amounts that were reported within 3 months of the due date (i.e. they have been disclosed as part of the company’s Business Activity Statement filings) – known as non-lockdown DPNs – a director receiving a DPN will have 21 days to:

• pay the unremitted amounts;
• appoint a voluntary administrator; or
• appoint a liquidator to wind up the company

For unpaid amounts that were not reported within 3 months of the due date (meaning that they have not been listed on the company’s Business Activity Statement filings) – known as lockdown DPNs – a director receiving a DPN will only have 21 days to pay the unremitted amounts in full. This means that lability cannot be avoided by appointing a voluntary administrator or placing the company in liquidation.

Importantly, new directors of a company need to be aware that under the DPN regime, after they have been a director for 30 days, they become personally liable for unremitted tax amounts that were due prior to their date of appointment.

Personal asset risk

In practice, a family or discretionary trust is commonly resorted to by directors as a form of asset protection in connection with a new board appointment.  This involves a director establishing a private trust – generally appointing a family member as the trustee – and transferring personal assets, such as the family home, cash payments and various items of personal property, to the trustee, with the director becoming a beneficiary of the trust.

It is a common misconception that this automatically means the assets held by the trustee are quarantined from any claims if the director later incurs personal liability and becomes bankrupt.  It is certainly the case that the trustee owns the personal assets that a director transfers to the trust, rather than the director personally.  However, there are a number of provisions in the Bankruptcy Act 1966 (Cth) that may enable a bankruptcy trustee to ‘claw back’ the assets.

First, if the now bankrupt director did not receive an equivalent benefit from transferring assets to the trust prior to his or her bankruptcy, the bankruptcy trustee may be able to have the transfer set aside as an undervalued transaction under s120 of the Bankruptcy Act.   Essentially, a transfer within 5 years of bankruptcy can be attacked where the transfer was not for full market value consideration.  However, there is an exception so that a transfer cannot be clawed back if, in the context of a related party transfer in a family/discretionary trust scenario, it took place more than 4 years before the commencement of bankruptcy and the transferor was solvent at the time of the transfer. 

Apart from undervalued transactions, where the main purpose of the transfer is to hinder or delay recovery by creditors, it can be clawed back without a time limit, and there is no solvency defence, under s121 of the Bankruptcy Act. 

Apart from the specific clawback provisions in the Bankruptcy Act, it is also possible that, if the director, as a beneficiary of the trust, maintains effective control over the trustee’s power to make trust distributions – for example, if the director is also the trustee of the trust, or retains the power to revoke the appointment of, and replace, the trustee – a court may find that the trust property remains, in substance and reality, the property of the director.

Key takeaways

Directors need to adopt a meticulous and careful approach to board oversight, risk management and compliance in the current environment.  Even though the ongoing impact of the pandemic remains uncertain, directors are expected to continue to bring expert forensic judgment to what broader macro developments will mean for a specific company, and to proactively plan for how the company will be able to continue to trade in the long-term.  If there is no prospect of viable operations without government fiscal support, formal insolvency proceedings need to be investigated. 

While there are certain asset protection measures commonly resorted to by directors to protect their position in accepting new board appointments, there are various legal provisions that mean pre-appointment transfers will not be immune from being clawed back if a director incurs personal liability and enters bankruptcy.