February 13

Directors’ Personal Liabilities

There are many good reasons to trade as a company, including a flat income tax rate and more flexible ownership, investment and control structures.  However, easily the most compelling reason for incorporation is the ‘shield’ the company provides to separate the owners (usually asset holding individuals) from the risk bearing trading activities.
It therefore surprises us when we see directors of ‘Pty Ltd’ businesses unnecessarily exposing themselves to personal liability.  On the ‘flip side’, we regularly hear experienced business owners overlooking the difference between a company obligation and the obligations of those behind it.

The most common method for getting around the corporate shield is the personal guarantee.  Individuals, including directors, should always try to avoid signing these documents because it exposes the guarantor to the company’s trading liabilities, which is among the best reasons for using a company to trade in the first place.  Having said that, in practice it will often be impossible to obtain bank or trade credit without giving a guarantee.
As a creditor, you should always obtain a personal guarantee unless you are doing business with a large and reputable company (like Ansett, One.Tel, HIH Insurance?).  Directors are often reluctant to give one.  Ask them: “If you are not confident enough in your company’s ability to honour its obligations to be personally liable for them then why should I provide goods or services on credit to it?
There are a myriad of arguments that may be raised to avoid liability under a poorly worded (or incorrectly completed) guarantee.  Ellem Warren Lawyers have assisted many directors to escape liability under guarantees because of confused cross-referencing, terms incorrectly defined or the use of inconsistent company names or ACNs.  We recommend guarantee documents be prepared, and regularly reviewed, by an experienced lawyer.
Tax obligations 

Directors are exposed to the company’s tax liabilities in some (not all) instances, including as follows:

  • The directors are exposed if the company fails to remit PAYG withholding tax or superannuation and does not report or pay it within 3 months of the due date for lodgement.  It is no longer enough to wait in safety for the issuing of a director penalty notice.  Defences are potentially available but only in very limited circumstances.
  • Directors will be exposed if the company enters into, and breaches, a repayment agreement made with the ATO under s.222ALA of the Income Tax Assessment Act 1936.

The ATO is easily the most frequent creditor in company liquidations, and is often the largest, and the last 18 months have been one of the most active periods of ATO enforcement that we have ever seen.
Insolvent trading

Directors have a duty to prevent a company from insolvent trading.  Insolvent trading occurs when a company incurs a debt that it cannot (and does not) pay, at a time when the director knew or should have known that the company was insolvent.  The director may become liable to pay compensation equal to the amount of these unpaid debts.
Directors may be able to successfully defend an insolvent trading claim if they can establish one of the following: (a) they had reasonable grounds to expect (and actually expected) that the company was solvent; (b) they did not participate in management because of illness or some other good reason; or (c) they took all reasonable steps to prevent the company from incurring the debt. These defences are more difficult to make out than they may appear.  The courts expect all directors to very closely supervise company operations.
The above examples are, in my experience, the most common causes for directors becoming personally liable for company debts but this article is not intended to be exhaustive.  If you are a director, and ever become concerned about solvency issues, do yourself a favour and promptly consult with a solicitor with suitable expertise.

February 13

Asset Protection – PPSA Review

Most Australians insure their home, contents and vehicle, with good reason, but for most people in business, there are greater risks that are often left exposed:

  • The ability to earn an income – there is unlikely to be a more valuable asset in a person’s life than their ability to work and yet, life, trauma and income protection insurances are often neglected;
  • Marriage break-down – it will never happen to me … but statistically, the odds are poor and if it happens, fire, flood and theft are the least of your concerns;
  • Insolvency – unfortunately, this can happen to even the most prudent business person: a GFC, overseas labour or imports, new competitors, new taxes, a big client going into liquidation, etc.; and if it does happen it affects more than a single asset or a split of marital assets.  It is 100%, less the bare essentials (a basic wage, car, furniture and trade tools).

This firm does not sell insurance; nor do we try to provide tax or accounting advice; we do not provide family law services; however, we know good people who do these things, and they can all be important elements in an asset protection plan.  We provide the overall strategy: designing and creating structures (corporations, family trusts, unit trusts, etc.) to create asset havens; risk identification and mitigation (e.g. planning against director personal liabilities); asset security advice (mortgages, charges, security registration); and guidance in times of financial crisis (insolvency advisory).
Asset-holding entity / Trading entity
The purpose of this short article is to provide an update and warning about a very popular, and usually effective, asset protection strategy: separating the asset-holding entity from the risk-taking trading entity, while giving the trading entity access to the valuable and essential assets (e.g. vehicles, plant and machinery or intellectual property in a franchise or software company) informally, or through a lease, licence or bailment arrangement.
This has been a favourite (and effective) accountants’ strategy for decades.  If the trading entity suffers misfortune, and becomes insolvent, the most valuable and essential assets are preserved in the asset-holding entity.  It is much easier to start again; lawful “phoenix” activity.
Personal Property Securities Register – PPS Leases

However, in January 2012, the Personal Property Securities Register came online and changed the rules.  This popular strategy to separate asset ownership from the trading entity may fail if not on the Register.  Business owners with these structures should promptly seek advice.
The law introducing this register, the Personal Property Securities Act 2009 (PPSA), creates a legal concept new to Australia called the “PPS Lease”.  As you might expect, the “PPS Lease” concept includes a lease, however, it also often includes a licence, bailment, hire-purchase, consignment or retention of title arrangement.  Basically, the new concept covers most occasions when the asset (tangible or intangible) is in the possession of another.
If the trading entity has possession of the assets for more than 12 months (or 90 days for assets that may or must have a serial number, e.g. vehicles), and the true ownership is not registered as a security interest on the Register, then receivers or liquidators and some other registered secured creditors (e.g. financiers to the trading entity with broad-based security – fixed and floating charges in the pre-PPSA terminology) can often ignore the true legal ownership, and seize and sell the assets.
Register the true ownership as a PPS Lease or else, possession can become “10/10ths” of the law.

February 12

Accidents Happen – Work Health and Safety

Every person in business ought to know – and we are sure that most do – the basics about work health and safety (WH&S) laws in Australia, including that:

  • Each State and Territory has laws:
    • imposing responsibility, liability and exposure to prosecution (civil and criminal; corporate and personal) on employers, contractors, workers and others connected to the risk of work injury;
    • imposing an obligation on all who engage workers to insure against work injury, usually as part of a “no fault” statutory insurance scheme;
  • Most of the WH&S laws impose a general obligation to “ensure safety” and then put “meat” around this “bare bones” obligation with detailed regulations and codes of practice;
  • Failure to “ensure safety” exposes the business, and directors and management personally, to very severe consequences, including massive fines, prison in extreme cases, and adverse publicity.

There are (literally) many thousands of pages of WH&S legislation, regulations and codes of practice across the country.  The various jurisdictions have broadly similar laws but there are also (occasionally) significant differences.  Then, in certain industries, there are thousands more pages of targeted WH&S laws; for example, in the transport industry, there is separate chain of responsibility legislation, dangerous goods regulation and fatigue management laws.  Similarly, the construction and mining industries have to deal with additional laws, for example, requiring site-specific safety management plans on mine sites.
How does someone running a national company in Australia comply with all the various WH&S regimes in place across our eight States and Territories?  Answer: in truth, they probably don’t.  National employers could perhaps be forgiven – but, of course, they won’t be – for throwing their hands in the air in frustration at the complexity of it.
This complexity was improved significantly at the beginning of 2012 when nationally harmonised WH&S laws came into effect.  However, even now, there are more than 1,406 pages in the WH&S legislation, regulations and codes.  These numbers do not include industry specific regulations.
So, can WH&S compliance be summarised in 2-page article?  No, but there is space here to point readers in the right direction … This firm has assisted many clients with pre- and post- incident advice and we have identified two consistent themes, particularly when post-incident advice in this area, as follows:
(1) a safety culture; and

(2) the benefit of hindsight.
In regard to safety culture, one of our practitioners recently handled a case where a claw hammer was being used to pull a nail from wood.  Tragically, in this case, the nail flicked into the young worker’s eye and he lost vision in it, permanently. He was in his early 20s at the time.
All personnel on site had been issued with PPE, including safety goggles, and all had received induction training in which the use of goggles had been mandated.  However, the evidence gathered during the post-incident investigation showed that people on-site rarely wore the goggles.  It could be demonstrated that the site supervisor (forgive a horrible pun) had been turning a blind eye to poor safety practices.
Similarly, in a warehousing case that one of our practitioners was involved in several years ago, sheet metal was stored in racks to roof-height.  A worker injured himself when he fell from the racks holding a piece of sheet metal.  The injured worker had climbed approximately one metre up the racks to pull down the sheet for a customer.  He lost balance, fell, and the sheet fell on him and severed part of his hand.
The company had a forklift on-site and a system for the safe removal of the metal sheets.  If the forklift and system had been used clearly the incident would not have occurred.  Of course, the incident did occur, and the evidence gathered by the prosecuting authority showed that on-site staff regularly reached high above their heads and/or climbed racks to pull down the metal sheets, rather than use the system that had been prescribed.  The evidence showed that the on-site supervisor regularly permitted workers to take “short cuts”, including climbing the racks and not using the available Kevlar safety gloves.
Both the employer company as well as the on-site (employee) supervisor were prosecuted and convicted of WH&S contraventions.  We know from talking to the supervisor years after the event that he still suffers from feelings of guilt, including nightmares.
In regard to hindsight, in most cases, post-incident, when the regulator is investigating and prosecuting it is relatively easy to think of things that could have prevented the incident; often inexpensive things.
Take Comcare v Linfox [2010] FCA 793 as an example. In this case, a fork truck driver was carrying a 32-ton container approximately 8 metres in the air when it collided with a stationary stack of containers, causing the truck to flip forward onto its roof, and trapping the driver in the cabin.  The driver severely damaged both his legs and left forearm.
In this case, the fork truck was old and not fitted with a speed-limiting device or speedometer.  Also, it had no device for measuring the weight of objects carried, or tilt-warning devices.  It was found that congestion and speed were the major causes of the incident.  Both were obvious hazards, which had been identified in earlier safety reviews performed by Linfox, and are common to incidents involving forklifts and fork trucks that happen all too frequently.  Wider marked carriageways and a speed-limiting device, which could have been retro-fitted, would have prevented the incident.  Neither would have been particularly expensive.  Linfox consented to orders imposing penalties and costs of $175,000.
Finally, a case where the facts speak for themselves: Inspector Vierow v Rail Infrastructure Corporation.  In this case: maintenance work was being performed on a live railway line close to an adjacent live line; trains using the line could travel at speeds of up to 75kph; the work system did not require train drivers to be advised that work was being performed on the line and did not require the workers to be informed of the times that trains may be present in the work area; there was no requirement for a person to be allocated the task of a lookout; the working area was not required to be clearly marked to give passing trains advance warning of the workers; and there was no system of direct contact with the nearest signal box so as to be informed that a train was approaching.
A worker was hit by a train and killed.  Clearly, just a little fore-thought could have saved his life.

So, how does the employer create a safety culture and gain the benefit of hindsight pre-incident?  Answer: spend some time and money on the following:

  • Obtain professional advice and act on the recommendations provided;
  • Conduct formal safety training of workers, particularly all those on safety committees;
  • Conduct regular meetings with workers at which “war stories” are told of crushed limbs, cracked skulls and disfigurement;
  • Conduct regular safety audits, involving trained and experienced workers, to identify risks;
  • Inform workers of risks and reward them for thinking of cost-effective methods to eliminate or reduce the risks;
  • Ensure that safety is taken seriously, e.g. by implementing spot-checks and remuneration-based consequences;
  • Finally, document everything. Unless it is in writing, when an accident happens, you will not have the evidence needed to help you effectively.
February 12

Restraints of Trade

Restraints of trade are one of the areas of the law where everyday notions of “fairness” seem to have a lot more to do with the outcome than careful interpretations of complex rules, exceptions to rules, and case precedents.

First, there must be an agreed restraint in writing otherwise ‘no restraint’ is the default position.

There is a legal and public policy principle that a person should be able to perform their trade or profession to earn a living.  However, a person may agree (i.e. contract) to be restrained and, of course, it happens all the time in employment agreements, contractor agreements and sale of business agreements.  Then the restraint will be enforceable despite the public policy principle provided the restraint is no more restrictive than is reasonable and necessary to protect the legitimate business interests of the person with the benefit of the restraint, having regard to the circumstances of the parties.

Second, to be enforceable, a restraint clause must find the right balance between protecting a person’s ability to earn a living and protecting another person’s ability to conduct business without unfair competition from someone with an “inside” advantage.  A restraint is void if it is even a little too restrictive so often cascading clauses are used (multiple interpretations).  If the most restrictive interpretation is void then the next one might be okay, and so on until there is an enforceable interpretation.  The cascading clause also takes advantage of the fact that the person with the benefit of the restraint (with usually “deeper pockets”) can threaten action and the restrained person must usually succumb to a more restrictive interpretation or risk litigation he/she can ill-afford.

This “Goldilocks” assessment: trying to find a restraint point not too restrictive, but just restrictive enough to protect legitimate business interests, depends so much on the circumstances of each case that until and unless the lawyer becomes as familiar with the factual background as the client, the client is often better able to predict the outcome.

For this reason, it is more useful to look at opposing extremes and let an individual “go with their gut” than to look at tipping-point examples.

At one end of the continuum is a sale of business contract where a buyer pays $1million for the goodwill of a business in a niche market where the good reputation established by the seller in the brand name is a deciding factor in the continuing profitability of the business.  In this example, the court will be a lot more willing to protect the interests of the buyer that has paid $1million to the seller with the expectation that the business should generate profits based on reputation.  In this example, a nation-wide contractual restraint for a number of years is potentially enforceable.  At the other end of the continuum, a person flipping burgers in a fast food chain on minimum wages is unlikely to have a restraint enforced against them, no matter how well worded it is.

The most common case – an employee or contractor in a profession given direct access to clients of a business, with opportunity to develop rapport with those clients, with no lump-sum premium paid for a restraint and a remuneration package at or about market value – sit somewhere in between, but closer to the burger flipper than the business seller.  In this circumstance, a generic restraint (prohibiting work in a field of expertise within a geographic area for a period of time) is likely to be enforceable only for a limited time and/or distance.

On the other hand, a client specific restraint (prohibiting contact with clients the person encountered during the engagement) is likely to be enforced for a year or more because it is more closely connected to protecting the goodwill of the business aiming to enforce it.

In assessing restraints, confidentiality clauses and clauses assigning the benefit of intellectual property rights should also be considered.  These can have a similarly restrictive effect without risk of being void on public policy grounds.