At a Glance
- Directors owe statutory and fiduciary duties to the company
- Duties apply in good times and become stricter during financial distress
- Breaches can lead to civil penalties, compensation orders and personal liability
- Insolvency significantly expands director risk exposure
- Reliance on informal arrangements or assumptions is a common cause of liability
Core Duties of Company Directors
Under the Corporations Act 2001 (Cth) and general law, directors owe several key duties, including:
- Duty of care and diligence
Directors must exercise the degree of care and diligence that a reasonable person would exercise in the same position, taking into account the company’s circumstances. - Duty to act in good faith and for a proper purpose
Decisions must be made in the best interests of the company, not to advance personal interests or those of related parties. - Duty not to misuse position or information
Directors must not improperly use their position or confidential information to gain an advantage or cause detriment to the company. - Duty to prevent insolvent trading
Directors must prevent the company from incurring debts while insolvent or where insolvency is likely.
These obligations apply regardless of whether the director is executive, non executive, or part time. Passive involvement is not a defence.
The Duty of Care in Practice
The duty of care does not require perfection, but it does require active engagement. In ASIC v Healey (Centro case), the court confirmed that directors cannot blindly rely on management or advisers. They must read and understand financial statements and question matters that do not make commercial sense.
This is particularly relevant for owner managed companies, where informal decision making and reliance on trusted staff are common. Courts consistently emphasise that familiarity does not replace oversight.
Insolvency and the Shift in Risk
Once a company approaches insolvency, the focus of directors’ duties effectively shifts. While the duty is still owed to the company, creditor interests become increasingly relevant.
In ASIC v Plymin, the court identified practical indicators of insolvency, including:
- ongoing cash flow shortages;
- inability to pay debts as and when they fall due;
- reliance on extended creditor terms or temporary funding; and
- repeated deferral of statutory liabilities.
Continuing to trade in these circumstances can expose directors to insolvent trading claims, compensation orders and, in serious cases, disqualification.
Personal Liability, When the Corporate Veil Falls Away
A common misconception is that incorporation fully shields directors from personal exposure. While companies are separate legal entities, director duties operate as a direct personal obligation.
Personal liability may arise through:
- insolvent trading compensation claims;
- civil penalty proceedings by ASIC;
- claims for breach of fiduciary duties;
- recovery actions involving related party transactions; and
- accessorial liability where directors are knowingly involved in contraventions.
In Daniels v Anderson, the court reinforced that directors are expected to understand the company’s financial position and cannot avoid responsibility by delegating entirely.
Practical Case Example
A privately owned construction company experiences prolonged cash flow pressure due to delayed project payments. The director continues signing new contracts, relying on expected future income, while tax liabilities and supplier invoices accumulate.
When the company later enters liquidation, the liquidator alleges insolvent trading for debts incurred during this period. Despite the director’s genuine belief that the business would recover, the court focuses on objective indicators of insolvency. The director is ordered to personally compensate creditors.
This fact pattern is common and highlights how optimism does not displace legal standards.
Common Mistakes We See
From a practical perspective, director liability rarely arises from intentional misconduct. More often, it stems from:
- failing to monitor cash flow in real time;
- assuming short term funding issues are temporary;
- prioritising related party repayments;
- delaying professional advice; and
- continuing business as usual despite warning signs.
The law applies objective tests. Once risk thresholds are crossed, good intentions provide limited protection.
Are There Defences Available?
Yes, but they are limited and evidence driven. Potential defences include:
- reliance on safe harbour provisions for restructuring;
- taking reasonable steps to prevent insolvent trading;
- relying on competent professional advice; and
- establishing that debts were incurred when the company was solvent.
Early documentation and advice are critical to preserving these defences.
Key Takeaways
- Director duties are continuous and personal
- Financial distress significantly increases exposure
- Insolvency is assessed objectively, not subjectively
- Early intervention materially reduces risk
Frequently Asked Questions
Can directors be personally sued for company debts?
Yes, particularly in insolvent trading and compensation claims.
Does resignation avoid liability?
No. Liability can arise from conduct while the person was a director.
How We Can Help
We regularly assist directors and business owners with:
- duty compliance and governance advice;
- insolvency risk assessments;
- safe harbour strategies;
- responding to ASIC investigations; and
- defending insolvent trading and compensation claims.
Our approach is commercial, pragmatic and focused on protecting both the business and the individuals behind it.
