Westcourt

When the Corporate Veil is Broken: Asset Protection Gone Wrong

Asset Protection

Most directors of small and medium-sized companies across Perth know about asset protection from a company.  Operating a business through a company for its asset protection advantages is one of the main reasons that business accountants across Perth recommend companies. 

What is a company?  

A company, as legally defined by the Corporations Act 2001 (Cth), represents a legally recognised entity that exists independently of the individuals who serve as its directors and shareholders. This unique characteristic confers upon the company a distinct legal status, allowing it to do a wide range of activities and functions. 

A company can do the following: 

  • A company can contract with other entities. These contracts can cover a range of business contracts, supply agreements, employment contracts, and partnership arrangements. 
  • A company can start legal proceedings when its interests are adversely affected. So a company can suing other entities for breaches of contract. 
  • Conversely, a company is also subject to legal action from others. This means that the company can be sued and be subject to penalties and legal proceedings separate from the personal assets and liabilities of its directors and shareholders. 

So a company’s legal recognition as a separate entity provides an essential shield for its directors and shareholders, insulating their assets and finances. This separation of legal identities underscores the fundamental principle that a company, although often operated and managed by individuals, is an independent and legally distinct entity with its own rights and responsibilities. 

This legal distinction plays a pivotal role in allowing individuals to engage in business ventures with a level of risk mitigation and legal protection. 

Which government agencies monitor companies? 

The Australian Investment and Securities Commission (ASIC) serves as the government agency with the responsibility of overseeing and regulating companies. It protects the interests of investors, maintains the integrity of financial markets, and ensures corporate compliance with statutory regulations. Here’s an in-depth expansion of ASIC’s role: 

  • Regulatory Oversight: ASIC acts is tasked with ensuring that companies operate according to the Corporations Act 2001 (Cth). 
  • Enforcement Authority: ASIC enforces the provisions outlined in the Corporations Act. This includes not only civil items for corporate secretarial work but also criminal penalties for any infractions or breaches of the Act. 
  • Protection of Investor Interests: ASIC safeguards the interests of investors, shareholders, and consumers. It watches financial products, services, and corporate practices to ensure transparency, fair dealing, and the protection of consumers. 
  • Market Integrity: ASIC is responsible for maintaining the integrity and stability of financial markets in Australia. This involves monitoring market manipulation, insider trading, and other misconduct. 
  • Licensing and Registration: ASIC is the licensing authority for various financial service providers, including companies involved in securities trading, financial advice, and credit services. 
  • Educational Initiatives: ASIC engages in educational efforts to enhance financial literacy and awareness among the public.  
  • Compliance Monitoring: ASIC monitors compliance with corporate governance standards, disclosure requirements, and reporting obligations. It also supervises the conduct of company directors and officers to ensure they meet their statutory duties. 

In summary, ASIC serves as the primary regulatory and enforcement authority in Australia, responsible for maintaining the integrity and legality of financial markets, protecting investor interests, and ensuring that companies and financial institutions comply with statutory regulations, particularly the Corporations Act.  

What is asset protection? 

Asset protection is safeguarding a family’s assets from potential threats and vulnerabilities. This strategy revolves around structuring a family’s tax structures to minimise exposure to risks and liabilities. 

  • Preserving Wealth: Asset protection is fundamentally about wealth preservation. Asset protection strategies are designed to safeguard this wealth from being eroded or unjustly seized by unforeseen financial challenges or legal actions. 
  • Mitigating Legal Threats: Companies operate in an intricate legal landscape where potential legal threats lurk around every corner. Asset protection strategies are employed to minimize the impact of these legal threats by segregating assets and making them less susceptible to litigation-related losses. 
  • Risk Diversification: Diversification is distributing assets across a range of tax structures.  
  • Maintaining Business Continuity: Asset protection contributes to business continuity. When a company’s assets are well-protected, the daily operations can continue without distraction. 
  • Asset Transparency: Proper asset protection requires clarity and good record-keeping proving ownership.  
  • Personal Asset Protection: Asset protection also extends to safeguarding family wealth.  
  • Planning for the Future: Asset protection isn’t just about the present; it’s about planning. The family’s next generation can be a risk for the family wealth just as much as an outside creditor. 

How can a company’s asset protection benefits fail? 

In most cases, directors are shielded from personal liability for the company’s actions because of the company’s separate legal status. However, there is a growing trend where ASIC and creditors of financially strained companies with limited assets seek personal recourse from directors who may have violated their obligations under the Act. 

Directors can be held personally responsible for the company’s losses. Some of these situations include: 

  • Insolvent Trading: The Act forbids a company from trading while insolvent. Directors may be held accountable if they allow the company to continue trading despite being aware of its insolvency. 

To address irresponsible or reckless trading, the Act outlines that directors who permit insolvent trading may be liable for the company’s debts. However, some defences may apply, such as if directors had reasonable grounds to believe the company was solvent when the debt was incurred, they were not involved in management due to illness or a legitimate reason, or they took steps to prevent the company from incurring the debt. 

The threat of personal liability for insolvent trading may lead directors with temporary cash flow issues to opt for early administration, even if the company has a good chance of survival. To balance the encouragement of entrepreneurship and community protection, additional safeguards for directors, known as “safe harbor provisions,” have been introduced. 

Under these provisions, directors can avoid liability for debts incurred while insolvent if they take steps likely to result in a better outcome for the company than immediate administration or liquidation. 

The factors could include proper understanding of the company’s financial reports, preparation of a financial solvency statement, seeking advice from a Perth business accountant, and taking steps that could reasonably increase solvency.  So items like a 3 way integrated cashflow forecast prepared by a Perth business accountant can be essential to show that you are not trading while insolvent. 

Directors generally can’t rely on safe harbour provisions if the company fails to meet obligations for employee entitlements, maintain accurate financial records, or comply with taxation laws. 

  • Personal Guarantees: A personal guarantee is a separate agreement between a director and a creditor where the director agrees to pay the company’s debt if itts obligations. This may involve providing security over personal assets. 

If a personal guarantee has been granted simply resigning as a director will not revoke the guarantee.  

  • Breaching Directors’ Duties: Directors have specific duties under the Act, and if they breach any duties, resulting in losses for the company, they can be personally liable, facing civil and criminal penalties, including compensating the company. 
  • Taxation Debts and Superannuation Contributions: Directors are personally responsible for ensuring that the company complies with Pay As You Go (PAYG) withholding and Superannuation Guarantee Charge (SGC) obligations. Failure to meet these obligations can lead to personal liability and penalties. 
  • Phoenix Activity: This occurs when directors put a company into administration or liquidation to evade creditor payments but continue business under a new company name. Directors engaged in phoenix activity can face civil and criminal penalties, including imprisonment. 

In conclusion, being a company director comes with significant responsibilities and potential personal liability. To manage this risk, directors should understand their duties, legal obligations, and situations that could lead to personal liability, actively participate in the company’s operations, and seek professional advice on the company’s finances and cash flow forecasting. This knowledge and proactive involvement can help directors navigate their roles successfully while minimising personal liability.   

At Westcourt our only focus is on helping business families succeed.  Our asset protection advice, both locally and worldwide through GGI, covers financial solvency, business risk and tax management. And because we are not connected to insurance products, investments or pressured to cross sell to other divisions we are well positioned to provide great asset protection advice while working closely with your other advisors.  So why not call us today?

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