Managing your director obligations

What this means

As a director, you have a duty to exercise powers and duties with the care and diligence that a reasonable person in the same circumstances would exercise.

The duty of care and diligence is contained in section 180 of the Corporations Act.

It means taking reasonable steps to stay informed about the company’s activities and financial position and using that information to make decisions. This includes:

• actively reviewing available financial and business information relevant to the decision
• asking questions where something is unclear, and
• taking appropriate steps where issues or risks arise.

You must also understand obligations that apply to your company outside of the Corporations Act (e.g., taxation, employment, work health and safety) and take reasonable steps to ensure your company complies with those obligations.

Practical tips for meeting this obligation

• Stay informed about how your company is operating. You cannot delegate responsibility for understanding the company's affairs, even where accountants, bookkeepers or advisers provide assistance.
• Review financial and business information regularly and understand what it shows.
• Ask questions when information is incomplete, inconsistent or unclear.
• Take reasonable steps to understand the financial impact on the company of decisions involving company funds (for example, dividend payments and director loan payments).
• Take appropriate and timely steps where you identify issues or warning signs.
• Base decisions on information available to you, rather than assumptions alone.
• Seek professional advice (from an accountant or lawyer) where needed but remember you remain responsible for your final decisions.

Case study: When a positive bank balance hides financial trouble

Background

Jennifer is the sole director of a small company and has been withdrawing money from the business through a director loan account to cover personal expenses.

The company is experiencing cash flow pressure, including overdue supplier invoices, late tax payments and increasing reliance on customer deposits to pay existing bills. Despite these warning signs, Jennifer continues to make withdrawals without fully understanding the company's financial position or considering the impact on its ability to meet its obligations.

Why this is a problem

Each withdrawal reduces the cash available to pay creditors and worsens the company’s financial position. Because the withdrawals are recorded as a ‘loan to the director,’ the financial statements may still show a positive balance, even if the company cannot pay its debts as they fall due. This can create a misleading picture of the company's financial position and may prevent Jennifer from recognising the extent of the company's financial difficulties.

Consequences

If the company is unable to pay its debts, a liquidator may be appointed. In this case, the liquidator may take action against Jennifer to seek repayment of the director loans and for breach of her director duties. ASIC may also seek to take civil or criminal action against the company or seek to ban Jennifer from acting as a director for any other company for a period of time.

Key lesson for directors

As a director, you are expected to act with the degree of care and diligence that a reasonable person would exercise in the same circumstances. That means staying informed about the company’s financial position and understanding when it may be under financial pressure.

Where issues or warning signs arise, you must take timely and appropriate action, including considering whether to seek advice and what steps may be available to address the company’s position.

If you do not take these steps, you may be at risk of breaching your duty of care and diligence.

Ongoing oversight and informed decision making are critical to meeting your obligations as a director.

What this means

As a director, you must act in good faith and in the best interests of the company.

The duty to act in good faith and for a proper purpose is contained in section 181 of the Corporations Act.

This means using your judgement to make decisions based on what is best for the company, having regard to its financial position, obligations and risks. Not on what is best for you personally or for family, friends or other associates.

Even if you are the only director and shareholder, the company is a separate legal entity with its own interests. You are expected to make decisions in the interests of the company as a whole, which may include considering the impact on creditors and employees. This is particularly the case when the company is under financial pressure.

Practical tips for meeting this obligation

• Make decisions based on what is best for the company, not just what is easiest or best for you personally or for your associates.
• Consider how your decisions will affect the company’s ability to meet its obligations, including obligations to creditors and employees.
• Be careful about taking money out of the business (such as dividends or director loans), particularly if cash is tight and the decision might impact the company’s ability to pay creditors/employees.
• Take extra care with any transactions involving you, your family, or people connected to you. You must be able to justify these related party transactions as being in the company’s best interests.
• Write down the reasons for key decisions that you make – even just a short note – to show why they are in the best interests of the company.

Case study: Failing to put the company's interests first

Background

A small company leases office space from the director’s spouse. The rent charged is significantly higher than the market rate for similar properties.

As business conditions deteriorate due to a local economic downturn, the company begins to fall behind on tax payments and debts owed to suppliers. Despite this, the company renews the lease and continues paying the above-market rent, worsening cash flow pressures.

Why this is a problem

The above-market rent reduces the funds available to pay creditors and increases financial pressure on the company. The lease benefits a person closely connected to the director, creating a risk that the decision is seen as favouring personal interests rather than the company's interests.

A director is expected to make decisions based on what is best for the company. Where a transaction involves a family member or other close associate, directors should be able to demonstrate that the arrangement is commercially justifiable and no less favourable to the company than a comparable arm's-length arrangement.

Consequences

If the company experiences financial difficulty, it may enter the small business restructuring process. Related party transactions that appear to favour the interests of the director or their associates may make it more difficult to obtain creditor support for a restructuring proposal.

If the company is unable to pay its debts, a liquidator may be appointed. In this case, the liquidator may investigate the related party lease and payments made under the arrangement and consider whether to take action against the director for breach of their director duties. ASIC may also seek to take civil or criminal action against the director or seek to ban the director from acting as a director of any other company for a period of time.

Key lesson for directors:

When making decisions as a director, you must act in the best interests of the company and not allow personal relationships or interests to influence your judgment.

Where a decision involves a family member, associate or other connected party, you should be able to demonstrate that the arrangement is fair, commercially justifiable and in the company's best interests. Taking steps such as obtaining independent advice or conducting market comparisons can help show that the decision was made for the benefit of the company rather than to provide a personal benefit to someone connected to you.

What this means

As a director, you must not use your position or any information you obtain through your role as director to benefit yourself or others or cause harm to the company.

The duty to not misuse your position or information is contained in sections 182 and 183 of the Corporations Act.

In practice, this requires you to use your position and access to information only for the benefit of the company, and to exercise judgment where personal or competing interests may arise.

This duty covers information about the company’s finances, customers, pricing, contracts, or business opportunities. Even if you are the sole director and shareholder, it's important to remember the company is still a separate legal entity, and you must not use your role or access to information to advantage yourself (or an associate) at the company’s expense.

Practical tips for meeting this obligation

• Use your role only to advance the company’s legitimate business interests.
• Keep company information confidential and use it only to make decisions for the company.
• Do not steer customers, contracts, or opportunities away from the company – for example, to a new business you control or to relatives or associates.
• Keep clear boundaries between the company and personal interests.
• Think carefully about how your decisions affect the company’s ability to meet its obligations, including paying creditors.
• If you’re unsure whether something crosses the line, get advice from a trusted professional such as your lawyer or accountant.

Case study: Diverting a company opportunity

Background

John is the sole director of a small company that provides services to a small number of regular clients. A longstanding client approaches the company seeking delivery of a large and profitable project.

Instead of arranging for the work to be performed by the company, John establishes a new company that he controls and arranges for the project to be undertaken through that entity. He uses the client relationship developed through his existing company to secure the work and also uses equipment belonging to the existing company to deliver the project.

Why this is a problem

The opportunity arose through John's role as director of the existing company and through relationships developed by that company. By diverting the project to another company he controls, John redirects revenue and profit away from the existing business. John is also using information gained through his role as director – including knowledge of the client relationships and business opportunity – for the benefit of another entity. In addition, he uses company property for the benefit of the new business without providing a corresponding benefit to the original company.

These actions are likely to breach his duties under sections 182 and 183 of the Corporations Act, as they involve misuse of position and misuse of information.

Consequences

Diverting a business opportunity away from the company may reduce the revenue available to support its operations and meet its obligations. Where the company is already experiencing financial difficulty, this may worsen its financial position and reduce the funds available to creditors.

If the company is unable to pay its debts, a liquidator may be appointed. In this case, the liquidator may investigate the diverted project, the profits earned by the other business and the use of the original company's equipment. The liquidator may seek to recover compensation or other amounts for the benefit of creditors. The liquidator may also consider whether to take action against the director for breach of their director duties.

ASIC may also seek to take civil or criminal action against the director or seek to ban the director from acting as a director of any other company for a period of time.

Key lesson for directors

Directors must not use their role, information, or company property to benefit themselves or another business at the expense of the company. Opportunities that arise through the company belong to the company. Diverting work or revenue away from the company – especially when it is already under financial pressure – can significantly harm creditors and expose the director to serious consequences, including legal action.

What this means

As a director, you must make sure your company keeps accurate, complete and up‑to‑date financial records.

The duty to keep proper financial records is contained in section 286 of the Corporations Act.

These records must clearly show the company’s income, expenses, bills, debts, and overall current financial position, and would enable true and fair financial statements to be prepared and audited.

Even if you use an accountant or bookkeeper, you are still responsible for ensuring the records comply with legal requirements and accurately reflect the company’s financial position. Proper financial records are critical to understanding whether the company can meet its obligations as they fall due and to supporting timely and informed decision-making.

The company’s records should:

• clearly record all money coming in and going out
• show the company’s bills, debts, and true financial position - not just bank balances or high-level figures that can mask underlying debts, and
• make it possible to prepare accurate financial reports if needed.

Practical tips for meeting your obligation

• Keep your records up to date – record sales, expenses, invoices, and payments as you go.
• Use simple accounting software or another reliable system to track income and expenses.
• Check financial reports regularly, such as cash flow, profit and loss, and bank balances.
• Ask questions where information does not make sense or appears incomplete, and follow up until you understand the company’s position.
• Keep receipts, invoices, and other key documents organised, easy to find, and stored safely for at least seven years.
• Get help from an accountant or bookkeeper when needed – but remember that the ultimate legal obligation rests with you as director.
• Store records safely, whether on your computer, in the cloud, or in organised files.
• Don't leave paperwork until the end of financial year to sort out.

What this means

As a director, if there are reasonable grounds to suspect your company may be unable to pay its debts as they fall due, you must not allow it to incur further debts. In practice, this requires an ongoing understanding of the company’s financial position and taking appropriate steps where warning signs of financial difficulty arise.

The duty to prevent insolvent trading is contained in section 588G of the Corporations Act.

You breach the law if you:

• knew, or should have known, the company was insolvent; and
• allowed the company to incur further debts or liabilities while insolvent.

You may be protected from insolvent trading liability if you take early, proactive steps to develop a genuine plan to improve the company’s financial position. This is known as the ‘safe harbour protection’ (section 588GA of the Corporations Act). However, safe harbour only applies if you continue to meet your core duties as a director, which include keeping proper records and ensuring employee entitlements and tax reporting are up to date. You must seek advice if you are facing insolvency and considering safe harbour protection.

Practical tips for meeting your obligation

• Understand the warning signs of insolvency.
• Review cash flow and bank balances regularly so you know whether the company can pay its bills when they become due and payable.
• Do not allow the company to incur new debts where there are reasonable grounds to suspect it cannot pay existing debts.
• You are expected to take timely action where warning signs appear, rather than delaying decisions or relying on expected future income.
• Act quickly if the company is struggling. Pause new spending, seek advice, and focus on paying urgent bills.
• Speak with an accountant, registered liquidator or lawyer early if you notice ongoing cash flow problems.

Warning signs of insolvency

Indicators that may suggest a company is unable to pay its debts include:

• overdue tax or super
• unpaid suppliers
• maxed-out credit facilities
• inability to pay debts on time
• relying on director loans to survive
• regularly juggling which bills to pay first
• dishonoured payments or overdrawn bank accounts.
• suppliers demanding payment before delivery or reducing credit terms
• receiving letters of demand or threats of legal action
• relying on new customer deposits to pay old debts, and
• not being able to afford materials, stock or labour to complete jobs.

These indicators should be carefully assessed as part of understanding the company’s financial position and determining whether action is required.

Case study: Continuing to incur debts despite warning signs

Background

Liam is the sole director of a small construction company. The business is experiencing cash flow difficulties due to several late-paying customers and rising material costs. Despite this, Liam continues to accept new jobs and he purchases materials on credit, assuming that future payments will provide liquidity in time to pay creditors.

Warning signs are becoming apparent, including unpaid suppliers, overdue tax obligations and frequent overdrafts. Despite this, Liam continues accepting new jobs and purchasing materials on credit. He does not adequately review the company's financial position, seek advice, or assess whether the company can continue to pay its debts as they fall due.

Why this is a problem

Where there are reasonable grounds to suspect a company may be unable to pay its debts as they fall due, directors must take steps to understand the company's financial position and carefully assess whether it is appropriate for the company to incur further debts.

By continuing to take on new liabilities without properly addressing the warning signs or understanding the company's financial position, Liam increases the risk that the company will incur debts it cannot repay.

Recognising the mounting warning signs, a reasonable director would have reviewed the company's financial position, sought appropriate advice, and considered available options to address the company's financial difficulties.

Consequences

If the company is unable to pay its debts as they fall due, a liquidator may be appointed. In this case, the liquidator may investigate when the company became insolvent and whether debts incurred for materials, subcontractors or other business expenses were incurred after that time. The liquidator may seek compensation from Liam personally for losses suffered by creditors.

ASIC may also seek to take civil action against Liam or seek to ban him from acting as a director of any other company for a period of time.

Key lesson for directors

Directors must act quickly when they notice signs of financial difficulty such as overdue suppliers, tax debts, or reliance on credit to stay afloat. Continuing to trade while insolvent exposes directors to significant personal and legal risk. Seeking early advice and developing a genuine turnaround plan is essential to avoid breaching insolvent trading laws and to preserve access to safe harbour protection.