DIRECTORS – WHERE ARE YOU EXPOSED?
Well, what are year 2020 was. Thankfully, things are getting back to some form of normality for both health and business purposes across the country. The majority of the Government stimulus has now come to an end and as such businesses now need to start standing on their own without any additional support.
The stimulus has certainly provided many businesses with significant cash flow during the pandemic and in fact many businesses are actually doing better than before the pandemic. However, there are still many businesses that are barely treading water during the pandemic. Now that government support has largely come to an end, these businesses need to consider what actions need to be taken for the long-term future of their business. Critically this includes directors of companies now having to take ownership of the financial position of their company and being aware of the potential exposure on them personally.
Our 2016 article ‘Liquidation – The ugly side for directors' set out some things directors need to consider before winding up their company, and now we're going to provide some commentary about the potential exposure in these unique post-covid times. These are all issues that the directors need to consider when trading their businesses, particularly when profits are down.
- ATO – Director Penalty Notices (DPNs) – The ATO is about to come knocking
- Personal Guarantees – make sure you negotiate
- Voidable transactions – Did the directors spend the stimulus irresponsibly?
- Insolvent Trading – The safe harbour is over
- Get the right advice – Don't google!
ATO – Director Penalty Notices (DPN) – The ATO is about to come knocking
I don't propose to dive deeply into the DPN regime given that we have a good, detailed factsheet on the regime. In summary;
• A DPN allows the ATO to seek payment of unpaid company tax debt from a director personally in certain circumstances.
• There are two types of DPN's
1. Lockdown DPNs – A director is automatically personally liable for the company tax debt where the lodgements are outstanding for a period of 3 months (1 month for SGC) or more. The only way this can be resolved is with the DPN being paid in full.
2. Non Lockdown DPNs – Where the lodgements are up to date but the ATO issues a DPN upon the directors providing them with a period of 21 days to act. The options available include paying the debt or appointing voluntary administrator or liquidator. If that action is taken within the prescribed time period, personal liability is avoided.
• DPNs can be issued for unpaid GST (post April 2020), PAYG, superannuation, luxury car tax and wine equalisation tax.
The important message here is to ensure all lodgements are on time to avoid the lockdown DPN. That way, if the ATO issues a DPN the director will have up to 21 days to take action to avoid the personal liability crystalising.
To date the ATO has not been issuing DPN in the Covid environment, however it is our understanding that this is going to change from April 2021 onwards whereby the ATO will start taking action to collect unpaid tax debts, which will include the issuing of DPNs.
Personal Guarantees – Make sure you negotiate
Many of our readers would be very familiar with personal guarantees. It is where a director signs a document personally guaranteeing a debt incurred by the company. If the company is unable to pay the debt, the creditor then has the right to demand payment from the director personally. It is always our suggestion that a good asset protection strategy that directors avoid signing any personal guarantees where possible.
During the Covid period many businesses needed to seek some form of relief from their landlords and financiers. This would likely have been in the form of rent reductions matching revenue reductions and loan repayment deferral periods. In many cases the reduced rent and loan waiver period has come to an end. It is likely that the deferred debt during the COVID period has now been added to the future obligations which may make affordability an issue. It is important that the company attempts to negotiate a position with those parties with affordable options in relation to paying the future liability of the debt. It is vital that the directors understand that if the company is unable to pay any of these personally guaranteed debts they will be personally exposed.
If it is a situation where an informal negotiation process hasn't been successful it may be time to consider taking some formal action through a restructure of the business to make the business more profitable for the long term to ensure the more critical debts like landlords and finance debts can be paid. This restructure can be done through a Small Business Restructure or a Deed of Company Arrangement.
All too often we see a position in a liquidation where there is a loan owing by the directors to the company. Upon investigation and discussion, it is often the case this is as a result of the directors paying their wages through a loan account rather than through the payroll system. Their justification is that they didn't want to pay the PAYG. Unfortunately, the personal exposure for the directors is much worse than paying the PAYG. In a liquidation scenario, the liquidator will demand that the loan account be repaid which means that the director must repay all of their income that was dealt with in that manner, and sometimes this can span over a number of years.
The key takeaway on such a scenario is to ensure that all director and related family wages are properly paid and documented through the payroll system. The small cost of PAYG will fair outweigh the potential personal liability in a liquidation scenario.
Voidable transactions – Did the directors spend the stimulus irresponsibly?
The government handed out a large amount of cash during 2020 through different stimulus packages, with the larger ones being job-keeper and cash boost.
This has left many businesses cashed up and we have identified that generally companies dealt with the cash in the following ways:
1. Paid down debt – Good option!
2. Kept the cash as working capital given the uncertainty of the business landscape – Good option!
3. Took the money out and spent it frivolously – typically a new 4WD/Toy or renovation to their home – Maybe not a good option.
We have heard numerous stories in relation to option 3 above. Now of course, we are all in business to make an income and enjoy the fruits of our hard work. There is nothing wrong with enjoying the money, as long as the business has sufficient working capital to survive and it doesn't have outstanding debt. Our concern is that directors may have taken the money out (either through a loan account, drawings or a shareholder dividend) at a time when there was unpaid debt. In such a circumstance, if a director has taken the money out for a personal benefit rather than paying company debt and the company ends up in liquidation, there is every possibility that a liquidator may have a right to make a claim against the director for those funds taken out.
It is always important that the director acts in the best interests of the company, which includes paying due and payable debt before using the money for personal benefit.
Insolvent Trading – The safe harbour is over
Part of the Government's temporary law reform of 2020 included a moratorium for the period between March 2020 and 31 December 2020 on any insolvent trading claim. That is, no director in Australia could be held liable for insolvent trading for debts incurred during that period. Effectively, this provided a temporary safe harbour position for all directors.
Critically the temporary law reform came to an end on 31 December 2020. That being the case, the directors can now be held personally liable by a liquidator for any debt incurred from 1 January 2021 onwards that was not paid.
If a company is trading on insolvently, it is critical that the director seek proper advice as to what their options are. It might be that a Small Business Restructure or a Deed of Company Arrangement could save the business and avoid a liquidation scenario, thereby avoiding any personal liability for insolvent trading.
Get the right advice – Don't google!
As outlined above, there are many issues that directors need to consider in their role including what potential exposure may exist. It is important that they keep talking to their trusted advisors through any challenging times to be sure that they are getting quality and accurate advice.
We have noticed a very worrying trend over the last few years where directors are going online to find a solution for the company's financial distress. You wouldn't go online to self-diagnose if you had a medical condition. The same approach applies to the financial position of a company. Speak to a restructuring and insolvency expert.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.