Director’s Personal Liability Issues in Corporate Insolvency
When a company becomes insolvent, directors potentially face a daunting set of future personal liabilities. The corporate veil becomes rather thin. This scenario means directors must assess any possible company insolvency and personal liability risks at an early stage and quickly implement plans to deal with both issues. The legislation is skewed towards forcing directors to behave in this way.
We set out some of the personal risk scenarios which a corporate insolvency can trigger for directors.
ASIC now acts on tip offs and its own information to visit and investigate potentially insolvent companies via the National Insolvent Trading Program. Specialist insolvency secondees from accounting firms assist ASIC in this program. Those visits can trigger the need for a voluntary administration (“VA”) appointment by the board of the company being investigated.
The ATO can jolt directors into action by issuing them with a 222AOE or 222APE Notice in respect of unpaid tax. Unless the directors act to cure the company’s tax default in 14 days they will become personally liable for the company’s tax debt. Appointing a VA within that short time is often the only choice left to save the director.
If a director waits until the last dollar has been spent before trying to professionally rehabilitate the company, this VA choice may practically be unavailable. This is because many potential administrators seek an indemnity for costs and/ or upfront money on account of their fee estimate, given the uncertainties of getting paid out of asset recoveries. This fee can range from $15,000 upwards in our experience, but is variable depending upon the tasks involved. The statutory requirements for the VA process, mean the directors may then be personally funding the administrator to investigate and report to creditors on their past conduct and on any potential claims available against them. If possible claims exist, then directors will be keen to implement a Deed of Company Arrangement (“DOCA”) to avoid some of them. Hopefully a white knight exists if the directors own funds have run out.
If a bank or non-bank lender holds a fixed and floating charge over the company’s assets, then the administrator’s fear of not being paid can become more acute, as they may be left with no assets if a DOCA is not achieved, with only insolvent trading or voidable transactions to pursue. A mortgagee lender to the company will often choose not to be bound by a DOCA (as they are entitled to do) and may look to any director’s third party home mortgage equity, or guarantee if the bank holds those securities, to meet any charge shortfall.
Sometimes a director cannot afford a VA and a provisional liquidation application may be necessary. This application will rarely defeat a section 222AOE Notice, as a final liquidation must be achieved within the 14 days to do so. In a worst case scenario, the director may just let a receiver be appointed, or the company to be wound up by a creditor. Whilst it is still possible to propose a VA after such appointments, this becomes a decision of the insolvency practitioner and not the board.
The failure of a company to meet its taxation obligations does not always trigger immediate legal action by the ATO. Negotiated tax repayment plans can sometimes occur in circumstances where a director reveals the company’s parlous financial position to the ATO. Unwittingly a director may be taking on their greatest personal risk by that step. That is because if the company is liquidated shortly thereafter, the liquidator may sue the DCT to recover an alleged voidable unfair preference for those tax plan installments. The DCT will invariably join the director to those proceedings, seeking a personal indemnity for that same claim and a costs order, as it is entitled to do under the Corporations Act. This right is the trade off given to the Commissioner in return for her losing a priority creditor position in liquidations.
Claims under personal guarantees are not released by a DOCA. Whilst the VA stays any guarantee enforcement action, a director often needs to find the funds to meet the inevitable guarantee claims following the usual less than 100 cents in the dollar return in the DOCA, which they may also have had to fund. A Part X arrangement under the Bankruptcy Act with the director’s creditors may be required. Co-guarantors may also face later adjustment claims amongst each other, so each bears a fair contribution to the whole debt guaranteed.
A receiver or liquidator will look at whether the director has breached their duties to the company and caused it any loss which might be recoverable. A Deed Administrator will do likewise if such potential claims fall within the DOCA assets and are not secured by a charge. They all can readily access third party funding to fund public examinations and any potential meritorious claims, based upon a success fee being paid out of any recoveries.
Directors may be publically examined in court, to investigate potential claims against directors and by that means a director’s personal assets or insurance coverage may be examined, to see the likelihood of any recoveries against them. The court transcript is also admissible as evidence in any later proceedings against them. A directors must answer relevant questions in the examination, even if they self incriminate the director (but this is subject to some safeguards).
ASIC also has a fund available for assetless liquidations, or those with few assets, to fund liquidators to investigate and report on breaches of the Corporations Act. ASIC are particularly looking at Phoenix claims – the transfer of a business and/ or assets at low values to a related company when the company is insolvent.
ASIC has power to seek disqualifications of directors of failed companies from their future involvement in managing companies.
ASIC and the ATO have very deep pockets in litigation. Directors may not if they are uninsured, or the insurer refuses cover due to the nature of the allegations against a director. Insurers have deep pockets if the director has to sue them to seek indemnity, if coverage is denied. Directors should carefully read the exclusion provisions in their D&O policies.
Insolvent trading can lead to the liquidator, or in some cases a creditor, seeking compensation orders against directors. The privilege against self incrimination will generally only provide limited assistance in these cases – not the more carte blanche protection allowed in disqualification applications and penalty claims.
ASIC might seek a civil penalty or compensation for any insolvent trading, even after a DOCA has been implemented – note the Waterwheel - John Elliott case.
Directors can also face being joined into any suits based upon a breach of the Trade Practices Act, as a knowing participant in such a breach, if a company defendant is insolvent.
Directors facing the above risks, need to consider whether they should seek personal independent advice from an experienced legal advisor, so that their own position can be considered separately from the company’s. An advice from the one advisor, covering the company and the director’s positions is not recommended. Any legal professional privilege of the company for legal advice it obtains, will usually become information accessible by the insolvency appointee. Personal advice mixed with the advice to the company as the client may not attract a separate privilege. That privileged information is not available to the appointee where independent personal legal advice is given to the director.
For further information please contact James Hamilton on 9018 6403 or E-mail: jhamilton@rbhm.com.au
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