Setting up a trust as a business structure is common and has various benefits to businesses. Often, companies are used to act as the trustee of the trust due to the limited liability of corporations. However, section 197 of the Corporations Act 2001 (Cth) raises concerns with the liability that directors’ of trustee companies have for certain debts and obligations of the trust and raises various implications for directors of trustee companies.
Section 197 of the Corporations Act 2001 (Cth) deals with directors’ personal liability and states:
(1) A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or a part of the liability if the corporation:
(a) has not discharged, and cannot discharge, the liability or that part of it; and
(b) is not entitled to be fully indemnified against the liability out of trust assets solely because of one or more of the following:
(i) a breach of trust by the corporation;
(ii) the corporation’s acting outside the scope of its powers as trustee;
(iii) a term of the trust denying, or limiting, the corporation’s right to be indemnified against the liability.
The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection.
Note: The person will not be liable under this subsection merely because there are insufficient trust assets out of which the corporation can be indemnified.
(2) The person is not liable under subsection (1) if the person would be entitled to have been fully indemnified by 1 of the other directors against the liability had all the directors of the corporation been trustees when the liability was incurred.
How does it apply?
Assume, for example, that a trust has $20,000 in assets and the trust deed restricts the trustee’s right to be indemnified to $200,000. Where the trustee company incurs a legitimately incurred liability of $150,000, the directors will not be personally liable pursuant to section 197 of the Act, as the company is entitled to be fully indemnified from trust assets, even though the trust does not have sufficient assets to meet the liability.
On the other hand, if the trust has assets of $20,000 and the trust deed restricts the trustee’s right to be indemnified to $300,000, and the company incurs a liability of $350,000 which cannot be discharged, the directors could be personally liable given the effect of section 197 of the Act, as the company is not entitled to be fully indemnified.
Other circumstances where a director could be personally liable
Additionally, directors may be liable in circumstances where directors have:
- Caused a trustee to act outside of its powers;
- Signed a personal guarantee or indemnity in favour of a third party;
- Committed a breach of tort (i.e. negligence) resulting in personal liability;
- Allowed the corporate trustee to trade whilst insolvent;
- Incurred a personal liability as a result of a breach of a statutory obligation;
- Committed a fraud;
- Engaged in misleading or deceptive conduct;
- Loss of employee entitlement claims;
- Failed to meet PAYG taxation debts and superannuation contributions;
- Breach of their directors’ duties;
- Contravened various sections of the Competition and Consumer Act 2010 (Cth);
- Contravened various sections of the Work/Occupational Health and Safety (OH&S) Legislation;
- Contravened various sections of State, Federal or Local Environmental Protection Legislation;
- Contravened various sections of State or Federal Discrimination Legislation;
- Contravened the Federal Criminal Code (as amended on 23 February 2016 by passing into law of the Crimes Legislation Amendment (proceeds of crime and other measures act 2016) relating to the making, auditing, or concealing of accounting documents;
- Made unreasonable director-related claims.
Further, a bill was introduced to Parliament on 13 February 2019 to amend the Corporations Act 2001 (Cth) which, if passed, would introduce criminal and civil offences for directors and others who have engaged in or facilitated, illegal phoenix activity.
Under the Tax Administration Act 1953, companies are under an obligation to remit amounts owed to the Commissioner of Taxation (S 16 – 17 of Schedule 1 of the Act) or going to voluntary administration or liquidation. Directors of companies must cause the company to comply with its obligation. The directors will continue to be under their obligation until the company complies with its obligation, or an administrator is appointed, or the company begins to be wound up: section 269-15 of Schedule 1 of this Act.
There are several defences in section 269-35 of Schedule 1 of this Act that a director can use in recovery proceedings:
- Illness (or some other good reason);
- All reasonable steps were taken by the director to comply with its obligation. What are ‘reasonable steps’ is determined with regard to when and how long the person was a director and took part in the management of the company, as well as all other ‘relevant circumstances’;
- Reasonably arguable position (as taken from section 269-35 (3A) of Schedule 1 of this Act). With regard to superannuation guarantee charge, a director is not liable for a penalty, “to the extent that the penalty resulted from the company treating the Superannuation Guarantee (Administration) Act 1992 as applying to a matter or identical matters in a particular way that was reasonably arguable. If the company took reasonable care in connection with applying that Act to the matter or matters”.
New directors may also be liable even if they have not personally seen or heard of the debt or even is the debt precedes their involvement in the company. Directors will be liable if they become a director after the due day and began to be under an obligation (to cause the company to comply with its obligation) and are still under the obligation 30 days later.
For more information on the personal liability of directors, contact Rockliffs Lawyers.