In 2021, 4,235 Australian companies became insolvent and entered liquidation, accounting for 22.5% of the construction industry. All too often, liquidation disadvantages the director. If your company is facing a financial struggle, you must seek professional advice about the consequences of liquidation. Improper preparation might lead to bankruptcy of the directors.
Read on to learn all you need to know about how company liquidation affects the director to ensure you make the right decision.
What are the Disadvantages of Company Liquidation?
Liquidation is a formal insolvency procedure to end the company. They will liquidate all the company’s assets to repay debts and creditors. When finishing your company, you will lose all brand recognition. Therefore, you waste all marketing efforts and costs — meaning it is a very costly procedure and a decision you should not take lightly.
After liquidation, the liquidator must investigate the directors’ actions while the company was trading. If they prove that the company’s directors did not act in the best interests of the creditors, they may face severe consequences.
Five Responsibilities of Directors During Liquidation
Before considering liquidation, you should fully understand all the company director’s responsibilities. Failure to observe your responsibilities could result in personal bankruptcy.
1. Personal Guarantees
A personal guarantee is the director’s commitment to pay any debt should the company liquidate itself. With a personal guarantee, all creditors can rightfully demand payment directly from the director. Knowing which creditors actually hold a personal guarantee is hard without clear paperwork. Therefore, you must keep accurate records of personal guarantees.
Once the company is liquidated, the creditors will pursue the company director to pay outstanding debts. Typically, creditors with personal guarantees include lenders, landlords, and major suppliers.
2. Creditors and Banks
Generally speaking, banks and lenders will always have a personal guarantee and additional security, such as rights to the property, should you fail to pay the company mortgage.
If the company cannot repay debts to the bank (whether a mortgage or other outstanding payments), the bank can use the personal guarantee and mortgage security to retrieve the funds.
Therefore, if a director cannot or does not repay the bank, they might force the sale of real estate, retain all proceeds, and risk homelessness if they hold the mortgage over the director’s home.
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3. Insolvent Trading
When a company liquidates, they appoint a liquidator. The liquidator investigates when the company entered insolvency and determines unpaid debt during insolvency—this is what the director must personally pay.
4. Director Penalty Notices (DPNs)
When the ATO issues a director penalty notice (DPN), it enables them to seek unpaid tax payments from the company director. These include:
- Pay As You Go (PAYG).
- Superannuation Guarantee Charge (SGC) liabilities
- Goods and services tax (GST).
There are two types of DPNs: the traditional Director Penalty Notice and a Lockdown DPN. The former gives the director three weeks to avoid personal liability. However, a Lockdown DPN automatically makes the director personally liable if they do not lodge company tax returns within three months.
Once issued, the director cannot avoid personal liability. If you’re issued a DPN, you should seek immediate professional advice about what you should do.
5. Banned Director
Suppose your company goes insolvent and enters liquidation. In that case, the Australian Securities and Investments Commission (ASIC) has the power to ban individuals from becoming company directors for up to five years.
Breaching Your Director’s Duties
Liquidators must investigate insolvent companies after liquidation. This includes reviewing the company’s actions and potentially investigating wrongdoing, such as breaching their civil obligations or committing a criminal offense. If the liquidator reveals any breaches, they will report you to ASIC, who may prosecute you as a director.
Directors face many potential exposure and personal liability risks should their company become liquidated. Some of the threats that face a director could have severe consequences, including homelessness or prosecution. Directors legally must act in the best interests of creditors.
If your company is entering insolvency, it’s best to seek advice before liquidation. Ensure you speak to a trusted advisor and carefully consider all your options.