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Trading Places - Does It Really Work When a Company is Insolvent?

Bruce Gleeson
Bruce Gleeson

A talking point that I find is often raised by a director when their company is in financial difficulty and liquidation may be imminent is whether they should change directors. Let me be clear in explaining that the reason the current director is contemplating putting in their spouse or finding someone else as a director (both of whom may know very little about the business or importantly the financial position of the company) is about self preservation.

Whilst it is not an unreasonable question to be posed, it is one that I find typically carries with it a lot of mis-information around the supposed benefits. Indeed, the 80’s movie (if you’re that old!) called “Trading Places” springs to mind when I hear this talking point.

The reasons for the current director seeking such change in my experience are generally centred on the following concerns:
1. It will make it less difficult for them to get finance in the future;
2. They won’t be personally liable for ATO debts such as PAYG [Pay-As-You-Go] and SGC [Superannuation Guarantee Charge];
3. They won’t be personally liable for insolvent trading; and
4. The placement of the company into  liquidation won’t count as a “strike” against them for the purposes of a Section 206F director banning order.

If only it was that easy! The balance of this article will debunk all of the above commonly held views. Also relevant is that some directors believe that by backdating the effective date of the replacement that this will further enhance their position. Regrettably this also very rarely is the case. So let’s get into some debunking.

1. It will make obtaining finance less difficult for me in the future
The bottom line is that most finance applications have declarations/acknowledgement along the lines of “have you or the other co applicant, ever been a shareholder or an officer of any company of which a manager, receiver, and/or liquidator has been appointed”.
We can see that there is no timeframe around the above question and thus even if they had resigned as a director shortly before the company was placed into liquidation (for example) the individual would still have to answer Yes. I note many credit providers conduct a variety of checks and a simple ASIC director name search will show such details. So in this sense there appears little utility in considering such a change, particularly in an environment where Banks and Financial Institutions continue to more heavily scrutinise applications for business and investment property loans.

2. I won’t be personally liable for ATO debts such as PAYG and SGC incurred by the company
Again this is unlikely to be the case and depending on the specifics of the matter, it could result in both individuals being liable. The ATO’s ability to seek recovery against a director and his/her assets for PAYG and SGC was further enhanced in 2012 where now if these taxes remain unreported and unpaid for more than three (3) months after the due date, the director at that time and successive directors who have been appointed for more than thirty (30) days will be automatically personally liable. Such liability occurs under what is known as the “lockdown provisions”. There are other ways in which the ATO can also seek recovery of these taxes which may potentially enable them to be quarantined in an administration or liquidation scenario, however this is on the basis that pre-emptive action is taken by the company’s director/s at that time. So in short this wouldn’t seem to provide an overly successful outcome either. The area of the ATO and director penalty notices continues to be a complex area and one where specialist advice is required – don’t simply rely on the internet.

3. I won’t be personally liable for insolvent trading as a former director
Section 588G of the Corporations Act is framed in terms of who the directors were at the time that the company incurred a debt and whether as a result of incurring such debt the company became insolvent or was already insolvent. As such, even if any individual has subsequently removed themselves as a director, if a liquidator forms the view that the company was insolvent at the time a debt was incurred during their tenure as a director then they are still on the hook. So such belief that this possible liability will always be avoided is also incorrect and misguided.

4. Director banning – Section 206F of the Corporations Act
This Section states:
“ASIC may disqualify a person from managing corporations for up to 5 years if:
(a) Within 7 years immediately before ASIC gives a notice under paragraph (b)(i):
(i) the person has been an officer of 2 or more corporations; and
(ii) while the person was an officer; or within 12 months after the person ceased to be an officer of those corporations, each of the corporations was wound up and a liquidator lodged a report under subsection 533 (1)… about the corporation’s inability to pay its debts…
(b) ASIC is satisfied that the disqualification is justified”.

So even under this scenario unless you had resigned more than twelve (12) months before the date of liquidation, each such instance will still be counted as a strike.

This area is a little more complex than what some individuals believe. The personal risk to directors can be legitimately mitigated if certain actions are taken at critical times. Clearly the sooner such action is taken, the better for all stakeholders involved. Directors quite naturally are going to be curious about what measures can be taken to preserve their position – but it is important they get access to the right advice.
Jones Partners is here to assist in this area.

Published on by BiziNet

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