Join our investing community

When does limited liability not protect a director?

Discussion in 'Business & Startup Investing' started by iiinvestor, 15th Feb, 2007.

  1. iiinvestor

    iiinvestor Well-Known Member

    Joined:
    1st Feb, 2007
    Posts:
    121
    Location:
    Sydney
    Hi investors

    Could someone please :) explain to me when the limited liability of a Pty Ltd does not protect a director? For example, if I was previously the director of a company and a customer initiated legal proceedings for work done in the period when I was a director, could that affect me?

    Let's assume there was no illegal activity; the customer was just not satisfied with the end result. Assume the business kept operating after I formally resigned as director and the customer is only acting now. Also assume it's not an obvious case (like a house built upside-down), it's much more subjective and could be related to the customer not specifying their requirements properly.

    As an extension to this, what if the company filed for insolvency now? Does that affect the legal action of the customer?

    I know this sounds quite specific, but I'd be eternally thankful for any information! :D

    Thank you
     
    Last edited by a moderator: 15th Feb, 2007
  2. Nigel Ward

    Nigel Ward Team InvestEd

    Joined:
    10th Jun, 2005
    Posts:
    1,172
    Hi Triple I :D

    Complex topic, but I'll post something later today.

    Cheers
    N.
     
  3. iiinvestor

    iiinvestor Well-Known Member

    Joined:
    1st Feb, 2007
    Posts:
    121
    Location:
    Sydney
    Thanks Nigel

    I just did a bit more reading and I think it's becoming a bit clearer. It seems that in the absence of unlawful actions and personal/director guarantees, only the company can be sued. I also forgot about professional indemnity insurance, I assume that would cover any payout if suing the company was successful. However, I'm sure the insurance company wouldn't want to throw money away and would investigate in detail.
     
  4. Nigel Ward

    Nigel Ward Team InvestEd

    Joined:
    10th Jun, 2005
    Posts:
    1,172
    Sorry it’s taken me so long to respond. I won’t comment on specifics, but will make some general comments on liability of directors.

    According to the AICD:
    So the potential sources of liability for directors are much wider than most people would be aware.
    Realistically though, directors are typically exposed to claims from a couple of key sources:
    1) Employees for Occ Health & Safety
    2) Depending upon the nature of your business - environmental agencies
    3) shareholders for corporations act breaches of directors’ duties. On this point note the business judgment rule discussed below.
    4) creditors/liquidators for insolvent trading as you’ve flagged. There are specific defences which are discussed below.
    5) customers where the directors are said to be involved in fair trading or trade practices style breaches (regulators often act on these as well) and sometimes for torts (i.e. civil wrongs) committed by the company in some circumstances
    6) for directors of trustee co's note s 197 (see our article Trustee Directors Liability for an explanation of the issue. I note that the proposed amendments have now been passed.) Note the defences available to the insolvent trading provisions are NOT available to directors to combat a s197 claim.


    Business judgment rule - s180(2) of the Corporations Act includes what’s known as the “business judgment rule” defence but note that it applies only to breaches of directors duties. In essence the business judgement rule implicitly recognises that all business endeavours involve risk and directors are not required to underwrite the financial success of their company’s ventures. So if they act in good faith, have no conflicts of interest, understand the issues and rationally believe a particular course of action is in the best interests of the company, they won’t lose the family home if it all goes pear-shaped.

    Insolvent trading defences. Section 588H of the Corps Act sets out some defences to insolvent trading contraventions under s588G. In a nutshell if you are a director and:
    A) had reasonable grounds to believe that when the debt was incurred that the company was solvent and would remain so even; or
    B) you were really unwell and not taking playing any part in managing the company at the time your evil fellow directors drove the company into the ground; or
    C) you took reasonable steps to prevent the company from incurring the debt,
    then you won’t get pinged for insolvent trading. Otherwise you're toast.

    Interestingly, according to the D&O insurers it is employees (or presumably quite often former employees) who most often sue private companies. I would have thought it much more common for customers to sue, but employees are more than twice as likely to sue than customers. Shareholders are the second most likely to sue a private company.

    D&O Insurance often has terms which cover former directors for claims arising during their tenure – but of course as a former director you’ve got no way to make sure the company keeps paying the premiums! Also, D&O insurance can be quite expense for small business to afford. Given the choice of either paying insurance for your equipment which you KNOW you need to make a living vs insuring yourself of the off-chance somebody might sue you personally rather than the company for something the company has done.

    So what’s the washup? Directors should protect their assets because whilst the likelihood of being sued is probably low for most people, the potential is real. See this article for a brief discussion of some of the issues Don't Panic - The Real Story on Asset Protection
    Hope that helps. Of course people should get legal advice if they have concerns.

    Cheers
    N.
     
    Last edited by a moderator: 16th Feb, 2007
  5. iiinvestor

    iiinvestor Well-Known Member

    Joined:
    1st Feb, 2007
    Posts:
    121
    Location:
    Sydney
    Thank you for your time and the information Nigel

    Like you said, it is a surprise that employees are more likely to sue than customers. As events unfold though, I am starting to see why. :mad:

    I've recently discovered that this 'not-so-hypothetical' business has filed for insolvency and the remaining directors have kindly liquidated all assets without even telling me (I'm still a shareholder). My concern now is whether they've liquidated to pay creditors or to pocket the money before creditors start chasing. The latter sounds somewhat illegal.

    Does the process of liquidation need to follow some sort of legal framework, or can directors literally liquidate by themselves and just record the sales in the books?

    Thank you
     
  6. Nigel Ward

    Nigel Ward Team InvestEd

    Joined:
    10th Jun, 2005
    Posts:
    1,172
    Triple I, you need to get some legal advice for your specific circumstances. The Corporations Act contains extensive provisions setting out the framework for winding up. But speaking generally there are a couple of different modes of winding up.

    For a winding up to be voluntary, the directors must be able to say the company is solvent and there must be a special resolution of the members approving the wind up (of which you as a shareholder should have received notice).

    Where a company is insolvent, there are a range of people who can seek an order for it to be wound up. These include directors, shareholders (such as yourself), creditors and ASIC.

    The winding up needs to be advertised. Once a liquidator is appointed they have an obligation to identify the shareholders if they consider there will be a surplus of proceeds to distribute once the assets of the company are realised.

    But as I mentioned, you really need to get some advice if you think there's value in your shares.

    Cheers
    N.
     
  7. iiinvestor

    iiinvestor Well-Known Member

    Joined:
    1st Feb, 2007
    Posts:
    121
    Location:
    Sydney
    Single N:

    You've hit the nail on the head. If I had any faith that the directors hadn't completely run the business into the ground, then I would seek advice. But alas, I'm mostly just curious at this stage. It goes without saying too, that I appreciate you sharing your knowledge.

    A quote I saw on here (or another forum) sums it up perfectly: Lemons ripen early and plums ripen late. Let's just say this one ripened before the seed was even planted (in hindsight of course).
     
  8. The Stig

    The Stig Well-Known Member

    Joined:
    3rd Dec, 2007
    Posts:
    190
    Location:
    Central Coast NSW
    Hi,

    I can't be bothered reading every ones replies but I know that a director can go to gaol or be fined for Work Cover breaches in NSW.

    This was one of the main reasons I sold my plumbing business. The tradesmen just would not do what they were told when it came to safety when I was not looking.

    So I left :D.

    Cheers
    The Stig