Insights + Resources

July 25, 2024

The Director’s Corporate Veil: In 2024, the Emperor Still has Clothes…but it’s no Kevla Vest

Did you know that as a director, you can be personally liable for company debts many years after it has gone into administration, even if you were not even a director at the time of administration? It is almost folklore that a key attraction of incorporating a limited liability company is to allow owners and directors to be shielded from personal liability for company debts and obligations. Another piece of folklore is that any legal claims must be commenced against a person or entity within 6 years. But as a recent case reinforces, the corporate veil may in fact have properties closer to gossamer than kevlar, and can be surprisingly easily pierced.

Introduction

The metaphorical concept of the corporate veil has long been considered in many quarters to possess properties more akin to a kevlar vest for directors, shielding their personal assets from access by creditors of the business. However, recent actions by the Australian Taxation Office (ATO) serve as a stark reminder that this protection is not absolute. In a case reported by ABC News this week,[1] a former business owner and director faces a claim by the ATO demanding $437,000 in unpaid superannuation dating back to 2013.

This article investigates the corporate veil of limited liability and the circumstances in which it may be pierced.

The invention of the “Kevla Vest”- Limited Liability

Limited liability is a cornerstone of modern business practice and was first enunciated by the House of Lords in 1897.[2] It is a legal principle that serves to protect company directors from being personally liable for the company’s debts and obligations.[3] Limited liability facilitates entrepreneurism and societal progress by reducing the financial risk for individuals starting a business, promoting risk-taking, and ordinarily protecting the personal assets of its directors.

Holes in the Kevla Vest – Limitations to Limited Liability

The principle of limited liability is not absolute. An example is illegal phoenixing activity, where a new company continues the business of an existing company that has been liquidated to avoid paying debts. As we covered in New Laws make Directors Personally Liable for GST Debts, the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (Cth) imposed a number of new criminal offences and civil penalties upon directors, officers and professional advisors who engage in illegal phoenix activity in order to avoid tax and other liabilities.

In addition, directors can become personally liable where:

  • a company trades while it is not solvent (see our article on Insolvent trading and the position of Australian directors);
  • a director has personally guaranteed the company’s debts;
  • a director has been personally negligent; or
  • there is a breach of workplace health and safety obligations.

Limitation Periods

Under s 1325(4) of the Corporations Act 2001 (Cth), there is a 6-year limitation period on an applicant from the time a cause of action occurs due to corporate misconduct. However, under a myriad of rules and legislation, in effect the ATO has discretion to pursue corporate directors indefinitely through Director Penalty Notices (DPNs).  A DPN can make a director of a company personally liable for three kinds of corporate tax debts: Pay As You Go income tax, the Superannuation Guarantee Charge  and GST.

In essence, there is no time limit on the ATO pursuing DPN debts owed, and such debts remains collectable indefinitely.

Recent ATO Enforcement Action

As reported by ABC News this week,[4] a former business owner has received a DPN from the ATO demanding $437,000 in unpaid superannuation dating back to 2013.

In 2016, the business owner resigned as director and was replaced by his sister, who became the sole director. The company was then placed into voluntary administration (VA), at which time it owed more than $2 million to unsecured creditors. The business owner believed that money owed to employees would be dealt with by the administrators as part of the process, where a Deed of Company Arrangement (DOCA) was entered. The owner’s sister, sole director at the time of the VA, was declared bankrupt, and the insolvency matter was finalised in 2022.

The ATO is presumably pursuing the business owner on the basis of Division 269 of the Taxation Administration Act 1953 (Cth), under which directors are personally liable for superannuation guarantee charges (SGC) (as well as PAYG withholdings (PAYGW) and GST), which:

  • were due before the date of resignation;
  • fell due after resignation for PAYGW and net GST, if the first withholding event in the reporting period occurred before resignation; and
  • fell due after resignation for SGC liabilities, from the date the charge becomes payable.[5]

This case study serves as a stark reminder for company directors that:

  • Resigning as director does not absolve a director from personal liability.
  • The passage of time does not absolve a director from personal liability.
  • The bankruptcy of the director at the time of administration does not absolve a director from personal liability.
  • The finalisation of a VA process by a DOCA does not absolve a director from personal liability.

An Increasingly War-Torn Corporate Landscape – Exercise a High Degree of Caution

Directors must be cognisant of their duties and responsibilities now more than ever. In the last year, the rate of Australian company insolvencies has exceeded pre-pandemic and post-GFC levels.

According to ASIC’s latest insolvency data, there has been a more than one third increase in companies failing from the period of 1 July 2023 to 31 March 2024 when compared to the prior reporting period. The Australian Institute of Company Directors identifies that businesses are suffering from tight purse strings amid high interest rates, the cost-of-living crisis, a squeeze in credit availability and an increase in ATO aggression.[6]

The ATO is also taking an increasingly combative approach. ATO DPNs are at an all-time high, with records from the Tax Office showing that the number of DPNs has leapt exponentially. That is, 13,454 DPNs were issued during the first half of FY 24 alone, compared to:

  • 17,459 in the whole of FY2023; and
  • 3,160 in in the whole of FY2022.

Moreover, the Federal Government has tasked the ATO with recovering upwards of $34 billion in identified debt.[7]

Concluding Remarks

The corporate veil is not the bullet-proof kevla vest that some may believe. A combination of new legislation and more militant regulators, including the ATO and ASIC, mean more than ever directors must remain vigilant and diligent in managing company affairs.

Part of this vigilance is taking the right corporate legal advice at the right time. In particular, directors should be aware of the ATO’s increasingly aggressive stance with respect to compliance with tax and superannuation obligations.

Like countries with a travel warning, we recommend that directors and their advisors exercise a high degree of caution in the present Australian corporate landscape.

Edwards + Co Legal advises companies and directors on a range of corporate regulatory and compliance matters under Australian law. For further advise on obligations as directors of limited liability companies, please contact us confidentially below.

[1] https://www.abc.net.au/news/2024-07-16/directors-personally-liable-for-unpaid-superannuation-tax-ato/104086046

[2] Saloman v Saloman & Co Ltd [1897] AC 22

[3] Ford’s Principles of Corporate Law at [4.140]

[4] https://www.abc.net.au/news/2024-07-16/directors-personally-liable-for-unpaid-superannuation-tax-ato/104086046

[5] https://www.ato.gov.au/businesses-and-organisations/hiring-and-paying-your-workers/engaging-a-worker/in-detail/director-penalty-regime

[6] https://www.aicd.com.au/board-of-directors/duties/insolvency/corporate-insolvencies-rise-in-australia.html

[7] https://www.abc.net.au/news/2024-03-18/ato-chases-small-business-debts-insolvencies-to-hit-gfc-levels/103583512

Close Btn Created with Sketch.

RECEIVE FREE NEWS + EXCLUSIVE INSIGHTS

Straight to your inbox on legal and business developments set to disrupt and transform.