Directors’ Duties for Small Company Owners in Australia

Plenty of small business owners run their business through a company. Setting one up can feel like paperwork and little else. Once you are a director, though, the law expects certain things of you. Those duties apply whether the company has one employee or fifty.

The duties sit mainly in the Corporations Act, and the Australian Securities and Investments Commission (ASIC) enforces them. Some are general duties that apply every day. Others become pressing when money gets tight. This article covers both in plain terms.

Who counts as a director

You do not need a formal title to be treated as a director. The Legal Services Commission of South Australia notes that anyone involved in a company’s affairs may be treated as one, even if never formally appointed. A director must be over 18. They must not be an undischarged bankrupt or under a personal insolvency agreement, and must not be otherwise disqualified.

A company must always have at least one director. Every director also needs a director identification number, and a person can hold only one. The commission’s factsheet on company directors sets out these rules with the relevant sections. It is a useful plain English starting point.

The general duties every director owes

The general duties are in sections 180 to 183 of the Act. Section 180 requires directors to act with care and diligence. Sections 181 to 183 require them to act in good faith and for a proper purpose. They also stop directors using their position or company information to gain an advantage or to harm the company.

Care and diligence

ASIC says care and diligence includes staying properly informed about the company’s financial position. Leaving the numbers entirely to a bookkeeper or a business partner does not sit well with that duty. Ask for regular figures and read them. If you do not understand them, keep asking until you do.

The law also recognises that business involves risk. The business judgment rule can protect a director who makes a decision in good faith and for a proper purpose. The director must have no material personal interest and must inform themselves to an appropriate extent. They must also rationally believe the decision is in the company’s best interests.

Good faith and proper use of position

Acting in good faith means acting in the company’s best interests and for a proper purpose. In a small company, the owner and the business can feel like the same thing. In law they are not. The company has its own money and its own creditors.

Using your role to gain an advantage for yourself or others can breach these duties. So can using information you learned as a director for your own gain. ASIC lists both as improper uses. Keep any dealings between the company and people close to you on clear, written terms.

Duties when money is tight

ASIC says a company is insolvent when it cannot pay its debts as they fall due. Directors must not let the company trade while insolvent, a duty found in section 588G. Before taking on a new debt, directors must consider whether there are reasonable grounds to suspect insolvency. ASIC explains this in its guide to insolvency for directors.

ASIC also says that when a company is insolvent or at real risk of it, duties extend to creditors. That includes employees who are owed entitlements. Directors are expected to know the financial position all the time, rather than just when signing annual statements. That is a high bar for a busy owner, so build it into your routine.

Warning signs to watch

ASIC lists a set of warning signs that a company may be in trouble. The list is a prompt, not a test. Several of these signs together are a reason to stop and get advice.

• Ongoing losses and poor cashflow.
• Liabilities that are greater than assets.
• Suppliers moving the company onto cash on delivery terms.
• Demands, judgments or warrants against the company.
• Overdue tax and superannuation.
• Relying on one big contract to save the company.

Overdue tax deserves special mention. The Commissioner of Taxation can issue a director penalty notice for some unpaid company debts. ASIC says failing to act within 14 or 21 days, depending on the notice, may lead to personal recovery action. Get professional advice the moment one arrives.

What happens if duties are breached

The consequences can be personal. ASIC says a liquidator, a creditor or ASIC itself can sue a director for compensation over insolvent trading. That compensation is potentially unlimited and may lead to personal bankruptcy. Bankruptcy in turn disqualifies a person from managing a company.

Civil penalties also apply. For individuals, ASIC puts the maximum for insolvent trading at the greater of 5,000 penalty units or three times the benefit obtained or detriment avoided. Where dishonesty is involved, criminal charges can follow. ASIC says penalties then include fines of up to 2,000 penalty units, up to five years in prison or both.

Safe harbour

There is some protection for directors who act early. ASIC describes a safe harbour from civil liability for insolvent trading. It can apply where, after suspecting insolvency, directors develop a course of action reasonably likely to lead to a better outcome than immediate administration or liquidation. The debt must be connected to that course of action or incurred in the ordinary course of business.

Records and good habits

ASIC says companies must keep adequate records that explain their transactions, financial position and performance. Where records are inadequate, the company is generally presumed to have been insolvent during that period. Poor bookkeeping can therefore work against a director later. Good records are one of the simplest protections available.

Directors often sign other documents that carry personal risk. Lenders and landlords may ask for personal guarantees on top of the company’s own promises. Those sit outside the company structure and can follow you personally. Know exactly what you have signed.

Your duties also touch your staff. Employees owed entitlements are among the creditors ASIC mentions. Knowing your rights as an employer and your obligations helps you keep wages and super in order. Overdue superannuation is one of the warning signs on ASIC’s list.

If you are buying a business through a company, these duties start from the day you become a director. Ask for the financial records before you commit. If things go badly later, raise the question of whether to permanently close your business with an adviser early. ASIC says not to wait for things to improve.

Directors’ duties come mainly from federal law, so they apply across Australia. Other laws that touch your business, such as leasing and some licensing rules, differ by state and territory. All of these laws change over time, so check current ASIC guidance before you act.

Frequently asked questions

Can I be treated as a director without being appointed?

Yes, in some cases. The Legal Services Commission of South Australia notes that anyone involved in a company’s affairs may be treated as a director. Formal appointment is not the only test.

What does insolvent mean for a company?

ASIC says a company is insolvent when it cannot pay its debts as they fall due. Directors must not let the company trade while insolvent. Before taking on new debt, they must consider whether there are grounds to suspect insolvency.

Can a director be personally liable for company debts?

In some situations, yes. ASIC says directors can be sued personally for compensation over insolvent trading. Director penalty notices from the tax office can also lead to personal recovery action.

When should a director get advice?

As early as possible. ASIC says not to wait for things to improve. It lists registered liquidators and specialist insolvency accountants or lawyers as options. Financial advice services can also help.

This article is general information only and is not legal advice. Laws and processes differ by state and territory and change over time. For advice about your own situation, speak with a qualified lawyer.