Am I Personally Liable as a Director?
In last month’s newsletter, we highlighted the issue of directors and the potential risks of trading while insolvent, and more seriously, trading recklessly. This month we briefly highlight some of the more common liability issues directors may face when a company is in financial distress or liquidated.
The overarching benefit of conducting business through a company, is the protection that limited liability affords directors and shareholders. As advisers in business transformations, restructuring and insolvency, we regularly encounter circumstances where either knowingly or not, director’s actions (or inactions) negate this limited liability protection leaving them personally exposed.
Beware the fine print – Personal Guarantees
In most cases, the days of doing business on a hand shake (particularly with larger companies) are gone. In its place, account application or credit application agreements, some of them quite detailed, will normally include a personal guarantee by a director of a company. As they say, the devil is in the detail, and even the most innocuous agreements can have teeth. Care must be taken, before signing up to terms, that directors fully understand what they are agreeing too. While this may seem common sense, when the company can’t pay (often due to insolvency) the directors are often surprised at just how much of the company’s liabilities they have personally agreed to guarantee.
Liability for taxes withheld
Ordinarily the tax liability of a company remains with the company in an insolvency situation. The Inland Revenue Department is a preferential creditor for taxes such as PAYE, GST and other withholding taxes. However, directors need to remember that tax deductions and withholding taxes they have held back from payments to third parties (the most common example being PAYE from payments to employees) must be accounted for and remitted to the IRD. Where there has been a deliberate failure to account for the taxes deducted and held, then a director may be guilty of an offence under the Income Tax Act and potentially liable to pay the tax themselves, including any possible fines and penalties.
It is often cited advice, but nonetheless good advice, that if you are having problems accounting to the IRD for taxes, and in particular PAYE or other withholding taxes, professional advice early on is recommended to manage and mitigate this problem. In our experience a lot of grief can be avoided for directors if they tackle these issues early on before liabilities compound, interest and penalties are imposed and potential offences attributable to the directors personally arise under the Income Tax Act.
Keeping good records
Keeping good company records is an important part of conducting business. What Directors often don’t realise is that if they fail to keep proper records and their company is placed into liquidation they can face significant personal liability.
Essentially, the Companies Act provides that where a company is in liquidation and is unable to pay all its debts and has failed to keep proper accounting records, then the directors and former directors can be held personally responsible, without limitation of liability, for all or any part of the debts and other liabilities of the company.
This liability will arise when a court considers that the failure to comply with relevant obligations to keep proper accounting records has contributed to the company’s inability to pay all its debts, or has resulted in a substantial uncertainty as the assets and liabilities of the company, or has substantially impeded the orderly liquidation of the company.
Examples liquidators often encounter where directors could be exposed include where the accounts receivable records of a company are not up to scratch making it difficult or, in some cases, impossible for liquidators to collect those debts for the benefit of creditors.
There are a multitude of obligations a company director faces. All too often, the personal consequences for directors of neglecting or failing to understand these responsibilities only comes to light when the going gets tough and creditors come looking for their money.