Can a Director Be Personally Liable for a Company’s Debts?
This is a common concern for small business owners and directors. The short answer is: usually no – but in some situations, yes.
We will provide a short overview of this area of law.
The General Rule: No Personal Liability
Under Australian law, a company is treated as a separate legal entity; i.e., its own legal “person.” This principle comes from the case of Salomon v A Salomon & Co Ltd [1896] UKHL 1. This means the company can own property, sign contracts, and be responsible for its own debts. It also means that the people who own or manage the company – its shareholders and directors – are not personally responsible for paying off the company’s debts.
This idea is called limited liability. It’s one of the main reasons people set up companies in the first place. If the company fails, investors and directors generally don’t lose more than what they’ve put into the company.
But There Are Important Exceptions
There are a few key situations where directors can personally be on the hook for company debts:
Insolvent Trading
Directors have a legal duty to stop the company from taking on more debt if it can’t pay what it already owes. If a director allows the company to trade while it’s insolvent (or likely to become insolvent because of a new debt), they can be personally responsible for that debt.
In other words, if you know (or should know) the company is broke, and you keep spending money or signing contracts, you could be taken to court for it.
Personal Guarantees
Sometimes directors personally guarantee a loan or lease on behalf of the company. If the company can’t pay, the lender can go after the director’s personal assets—like their house or savings. These guarantees are legally binding, so it’s important to read them carefully before signing.
Acting as Trustee
If a company is running a trust (which is common in some family businesses or investment structures), directors might be personally liable for debts the company incurs as trustee—especially if something goes wrong, like:
- The company breaches the terms of the trust,
- It acts beyond the powers given to it by the trust,
- Or the trust says the company can’t be reimbursed for certain expenses.
In these cases, the law allows creditors to go after the director personally, not just the company.
Phoenixing and Other Misconduct
If a director engages in illegal conduct, such as phoenixing (closing a company to avoid paying debts, then starting a new one to carry on the same business), they may face personal liability, penalties, or even disqualification from managing companies.
Piercing the Corporate Veil
In rare and exceptional cases, courts may pierce the corporate veil—meaning they disregard the company’s separate legal personality and hold individuals behind it (usually directors or controllers) personally responsible.
This typically happens where directors have misused the company for improper purposes. For example:
Fraud or Improper Conduct: Courts may pierce the veil where the company is used as a sham or facade to perpetrate fraud or evade legal obligations. For example, in cases like Jones v Lipman, the court found that the company was a sham created to avoid specific performance of a contract.
Evasion of Legal Obligations: If a company is deliberately interposed to evade existing legal or contractual duties, courts may pierce the veil.
Agency Relationships: A company may be treated as the agent of its controllers if it is found to have no independent commercial existence and operates solely for the benefit of its controllers. This is not strictly piercing the veil but imputing liability through agency principles.
Group Enterprises: In rare cases, courts may treat a group of companies as a single entity, particularly where the subsidiary is a mere tool of the parent company. However, Australian courts generally maintain the separate legal personality of each company in a group unless there is evidence of misuse of the corporate structure.
Unfairness or Interests of Justice: Courts may pierce the veil where it is necessary to prevent injustice or unfairness, such as when the corporate structure is used to shield individuals from liability inappropriately. This is often invoked in cases involving insolvent trading or creditor-defeating dispositions under the Corporations Act 2001 (Cth).
These situations are uncommon, but they show that directors can lose their limited liability protections if they misuse the corporate structure.
Final Thoughts
While the general rule is that directors are protected from personal liability, that protection isn’t absolute. If a director acts irresponsibly, breaks the law, or personally guarantees the company’s obligations, they can be held personally responsible.
If you’re a director or thinking about becoming one, it’s smart to understand these risks—and to seek legal or financial advice when necessary.
please get in touch with Warlows Legal today using the contact information below for more assistance.
