There is a plethora of Australian legislation which sheets home personal liability to directors and officers.

Below are some reminders of traps for directors and officers for transactions that might be undertaken in the usual course of a director or officer’s normal arrangements.

Trap 1: Super re-contribution

Some advisors propose, as a strategy for limiting superannuation death benefits tax, withdrawing superannuation balances and re-contributing that amount into super as a non-concessional tax-free contribution.

Directors and officers should be aware that this is not the bullet proof plan it is promoted as. The Bankruptcy Act 1966 (Cth) provisions have broad application and such payments are at risk of being “clawed-back” where they are made outside of the person’s normal practices.

If a payment made to super, is outside of the ordinary course of conduct, and the director or officer subsequently becomes a bankrupt, payments made leading up to the date of bankruptcy (during the clawback period) are at risk to creditor claims.

A “pattern” of contributing to super may assist to rebut creditors’ claims and reduce the risk of claw-back.

Trap 2: Constructive Trusts

A constructive trust is a remedy that the Court can impose, with the primary purpose being aimed at preventing the unconscionable enjoyment of property.

The rationale for constructive trust relief is, in the absence of such relief, a person may secure or maintain an interest in property or money that would be contrary to equitable principles for that person to maintain that interest.

Constructive trust relief can be a problem for directors and officers where the Court determines that the “not at risk” recipient (i.e. spouse, dependant or related party) who obtains a benefit, should not be entitled to retain it.

Trap 3: Forgotten Guarantees

Recent New Zealand cases highlight the risk of failing to carefully consider the drafting of guarantees and ensuring that once obligations have been satisfied, any guarantees are released.

In the case of Hieber v Reddington, the Court of Appeal affirmed the position that when a guarantor dies, any guarantees do not automatically terminate unless this is specified in the guarantee.

In the case the guarantee contained limitations on certain matters but not that it would terminate on the death of the guarantor.

The Court held that, if the parties had intended for the guarantee to terminate on death, they could have inserted a provision to that effect. In the absence of such a provision, the guarantee was not discharged on Hieber's death.

In the case of RD1 Ltd v McKinnon, RD1 provided products to the debtor on credit, and McKinnon guaranteed the debtor's payment obligations to RD1.

The contract between RD1 and the debtor initially specified a credit limit of $2,000, but RD1 supplied products on credit in excess of the limit.

The debtor defaulted on payment, RD1 sought payment from McKinnon under the guarantee.

On appeal, it was held that the $2,000 credit limit was not a term of the guarantee. The guarantee expressly provided that the terms of credit may be varied, and that the guarantee would continue even though the terms changed.

The Court held that the guarantee allowed RD1 to recover from the guarantor credit in excess of the limit, and ordered McKinnon to pay the full amount owing by the debtor to RD1.

This is a cautionary reminder that express terms of a guarantee may, in some circumstances, negate the principle that substantial variations to a credit contract without the consent of the guarantor will discharge the guarantor from liability.

These cases are a reminder of the importance of understanding the terms of a guarantee and ensuring that guarantees are released.

What could directors or officers do?

  • Recognise that long term asset protection planning is the key to mitigating risk and start planning now.
  • Take steps to develop a pattern of behaviour to establish the reason you are undertaking a particular activity.
  • Understand time periods under the Bankruptcy Act.
  • If possible, don’t give personal guarantees. See if other security can be offered instead or if the terms of the guarantee can be negotiated.
  • Understand the implications of the guarantee and ensure that when the obligations have been satisfied, that the guarantee is released.