Directors’ duties in times of financial distress: what you need to know

When a company faces financial difficulty, directors are under heightened scrutiny. The decisions you make can determine whether the business survives, whether creditors are protected, and whether you face personal or even criminal liability.

If you are a director of a financially distressed company, here are the key duties and risks to keep front of mind.

Your duty of care and diligence

You must exercise your powers and discharge your duties with the care and diligence that a reasonable person would if they were in your position and facing the company’s circumstances.

The business judgment rule provides protection where decisions to act (or not act) are made if you:

• act in good faith and for a proper purpose
• do not have a material personal interest in the decision
• rationally believe the decision is in the company’s best interests

Acting in good faith and for a proper purpose

You must act in good faith in the best interests of the company. When the company is insolvent or nearing insolvency, those interests extend to creditors.

An insolvent company is one that cannot pay its debts as and when they fall due - a cash flow test, not a balance sheet test.

Proper use of position and information

As a director, you must not misuse your position or information obtained as a director to:

• gain an advantage for yourself or others, or
• cause detriment to the company.

These duties can become criminal offences if dishonesty or recklessness is involved.

Insolvent trading liability

You must not cause a company to incur a debt if you suspect (or should suspect) that the company is insolvent or will become insolvent by doing so. Breaching this duty can result in personal liability and, in some cases, criminal penalties.

A safe harbour exemption may apply where directors:

• pay employee entitlements and meet tax lodgement obligations
• engage competent, qualified advisers to develop a course of action likely to achieve a better outcome than immediate insolvency
• only incur debts connected with that course of action or the ordinary course of business
• monitor and reassess the action, including considering the appointment of a liquidator or administrator if viability ceases
• document all steps taken

Risky transactions to avoid

Be careful of transactions during or approaching insolvency that may later be challenged as:

• uncommercial transactions
• unreasonable director-related transactions, or
• creditor-defeating dispositions.

Transferring assets while leaving liabilities behind can constitute a criminal offence and may be clawed back by a liquidator.

ATO Director Penalty Notices (DPNs)

The ATO can impose personal liability for unpaid PAYG, GST and superannuation via DPNs:

• Non-lockdown DPNs (lodgements made but debts unpaid): liability may be avoided if within 21 days the debt is paid, an administrator or restructuring practitioner is appointed, or winding up commences.
• Lockdown DPNs (no lodgements made and debts unpaid): no relief is available — debts must be fully paid.

Practical steps to keep your options open

• Monitor the company’s cash flow and ability to meet debts as they fall due
• Ensure all tax lodgements are made on time, even if payment is delayed
• Keep employee entitlements up to date
• Document decisions and actions aimed at achieving a better outcome than insolvency
• Seek early advice from specialist insolvency and restructuring lawyers and accountants

Key takeaway

Directors navigating financial distress must be proactive, diligent and transparent. Early, informed action maximises the chance of business turnaround and minimises the risk of personal liability.