Are directors liable for company debts? Know your risk
“Are directors liable for company debts”? is a common question asked by business owners who are insolvent or facing insolvency. Behind it is a lot of understandable anxiety.
Introduction
When you’ve built a business, the thought that its financial problems could become your personal responsibility can be incredibly stressful. It can leave you worrying about your home, your family and your future.
The good news is, if your company is insolvent and unable to pay its debts when due, in most cases you won’t be held personally liable.
However, while this is the general rule, there are certain circumstances where you can be. Understanding what these are is critical to knowing what you’re potentially facing and what you can do to protect yourself.
Unsure where your business stands? Try our free Assess Your Options tool.
Salomon principle and limits to protection
A big misconception around the question “Are directors liable for company debts?” is that company insolvency and personal bankruptcy are the same thing. They’re not. Your business’s financial difficulties and your own personal financial situation are generally separate issues.
The reason most directors are protected is because of a fundamental principle of Australian law known as the Salomon principle. This common law rule (recognised under the Corporations Act 2001) establishes that:
A company is a separate legal entity with its own identity beyond its owners and directors.
A company’s debts and obligations generally belong to the company – not the people behind it.
Owners and directors are protected by limited liability. They aren’t automatically responsible for paying their company’s debts if it fails.
That’s the default position on director personal liability. The exceptions include:
insolvent trading,
personal guarantees,
director loan accounts,
director penalty notices (DPNs),
breaches of director duties, and
illegal phoenix activity.
These exceptions cover situations where a director has taken certain actions, accepted personal obligations, or failed to meet their legal responsibilities.
Six pathways to director personal liability
Before we look at each exception (or pathway to liability) in detail, here’s a handy table outlining the situations where you could be at risk.
Pathway to liability | Who is at risk | Learn more |
|---|---|---|
Insolvent trading (s588G) | All directors of insolvent companies | |
Personal guarantees | Directors who have signed personal guarantees on loans, leases, or credit | |
Director loan accounts | Directors with outstanding loan balances owed to the company | |
Director Penalty Notices (DPNs) | Directors of companies with unpaid PAYG, SGC or GST | Director Penalty Notice (DPN): A Quick Guide For Company Directors |
Breach of director duties (s180–184) | Directors who have failed to act in good faith or with due care | See section below |
Phoenixing / illegal phoenix activity | Directors involved in transferring assets to avoid creditors | See section below |
ATO debt got out of hand?
Insolvent trading (s588G)
Small Business Restructuring represents a significant shift in how Australia helps struggling businesses recover. SBR was designed to help viable companies survive and thrive, unlike traditional insolvency solutions that often lead to business closure or administration.
Created in response to the economic challenges of COVID-19, this solution recognises that many good businesses can face temporary setbacks without being fundamentally broken.
The process allows you to (we do it on your behalf) negotiate with creditors while keeping your company doors open. Think of it as a business hospital rather than a business morgue – it's about recovery, not closure.
Most importantly, owners stay in control of their small businesses throughout the process, unlike other insolvency solutions where they hand over control to an administrator.
Read more: Small Business Restructuring vs Liquidation: Which path is right for your company?
Personal guarantees
If you’ve ever signed a personal guarantee on a business loan, commercial or equipment lease or supplier credit, you may be personally liable for your company’s debt – so always understand what you’re agreeing to.
A personal guarantee is a binding legal agreement between you and the creditor that allows them to go after you personally if your company fails to meet payments.
The guarantee is separate from your business debts, so it usually continues to apply even if your company enters liquidation.
Director loan accounts
Taking money out of your company as a loan (rather than salary or dividends) can create personal exposure if your company becomes insolvent.
Any outstanding loan balance is a company asset. This means if your company enters liquidation, the liquidator may request you repay the outstanding amount to help pay creditors.
Depending on how the loan was structured, you may also face Division 7A tax implications. In some cases, the amount may be treated as a taxable dividend if the loan doesn’t meet the required conditions.
Director penalty notices (DPNs)
Company tax debts with the Australian Taxation Office (ATO) are a common insolvency issue.
Unfortunately, if your company has unpaid:
Pay-As-You-Go (PAYG) withholding,
Super Guarantee Charge (SGC) and/or
Goods and Services Tax (GST)...
…the ATO can issue you a director penalty notice (DPN), which can make you personally liable for these debts.
If you’ve reported your obligations but haven’t paid what’s owed, you may get a non-lockdown DPN, giving you 21 days to act and avoid personal liability. If you haven’t reported or paid, you may get a lockdown DPN and lose the option to avoid liability.
Read our full article: Director Penalty Notices
Breach of director duties
As a director, under Sections 180-184 of the Corporations Act, you have certain duties and obligations to meet. These include acting with care, in good faith and for a proper purpose, while not misusing your position or company information.
If you fail to meet these duties, you’re breaching the law. This can result in civil penalties, compensation orders and other consequences.
For serious breaches of duties, the Australian Securities & Investments Commission (ASIC) can disqualify you from managing a company.
Act sooner, and you'll have more options available.
Illegal phoenix activity
If your company is in distress, restructuring or setting up a new business is an option, but it must be done with care. Using this process to leave creditor debts unpaid while transferring assets or operations to a new entity can put you in illegal phoenix territory.
Both the Corporations Act and the ATO include anti-phoenix provisions that can expose directors involved in this type of activity to personal liability. ASIC takes illegal phoenixing very seriously, with potential criminal penalties and director banning orders.
Director liability versus personal bankruptcy
Worried about bankruptcy? It shouldn’t be a primary concern.
In Australia, there’s a difference between company and personal bankruptcy. Director liability can arise in certain circumstances when a company experiences financial distress, and ASIC can disqualify directors with serious misconduct histories. However, bankruptcy only applies to individuals, so liquidation doesn’t automatically mean bankruptcy.
Personal bankruptcy can happen following liquidation, but only where you become personally liable for debt or claim, such as:
A personal guarantee
An unpaid DPN
An insolvent trading claim
If you have one of these liabilities and you don’t pay, the creditor or ATO can apply to the court for a bankruptcy order, or you can file a debtor’s petition. That formal order is what makes you bankrupt.
Your personal credit rating isn’t automatically affected by a liquidation. It’s only impacted if you have personal debts that go into default, or if you’re declared bankrupt.
How to protect yourself as a director
Protecting yourself from director liability if your business is facing insolvency comes down to two things: considering your exposure risks and acting quickly. While avoidance can feel like a natural response, personal liability risks often increase the longer you delay.
Consider your exposure: Have you signed personal guarantees? Do you have any outstanding director loan accounts? Is your PAYG/SGC up to date? Reviewing your personal exposure early – including guarantees, tax obligations and potential insolvent trading risks – helps you understand where you may be vulnerable and what steps you need to take.
Engage a qualified advisor: Is it possible to turn your business around? A specialist will give you an honest take and talk you through your options: restructuring with a Safe Harbour or more formal options such as voluntary administration (VA) or a CVL. Each has different implications for liability, so choosing the right one matters.
Having appropriate management liability insurance, including Directors & Officers cover, can provide another layer of protection if you’re facing certain claims. However, it doesn’t replace the need to meet your director obligations.
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Act today to avoid liability
If company debts have got you concerned about personal liability, that awareness is a positive first step. You know there’s an issue, or think there might be one, and you’re taking action to understand the risks and your options.
The next step is seeking guidance. Speaking with an advisor isn’t admitting failure or committing to anything. It’s about gaining clarity – whatever your circumstances – and making informed decisions about what happens next. Acting decisively now can mean more options later.
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