Last month we discussed the increasing trend in corporate governance towards legal responsibility, and therefore personal liability, of directors.
We are going to follow that up with what steps you can take to reduce your exposure and protect your personal assets with three lines of defense.
Second Line of Defense: Reducing your exposure
The second line of defense is reducing your exposure to risk. Two of the most effective ways to do this is through indemnities and insurance.
Indemnities are given by companies allowing directors to offset liabilities they may personally incur on to the company. The scope and depth of an indemnity is usually negotiated between the director and the company, with the company attempting to limit it as much as possible and the director, of course, attempting to secure as broad an indemnification as possible.
It is important to note that there are some circumstances in which a company may not indemnify their directors! These include assuming the liability of any pecuniary order under the Competition and Consumer Act 2010. Cartel behaviour, for example, cannot be indemnified by the company. Similarly, the company may not indemnify a director for any criminal activity under any act.
A director is also prevented by the Corporations Act 2001 from relying on an indemnity in circumstances where they have failed to act in good faith.
Director and officer’s insurance is essential. In the first instance, it often fills any gaps in which exposure not covered by an indemnity, such as defending any proceedings taken under the Consumer Law.
The company may also require you to hold additional Side B & C coverage which will reimburse the company for liabilities incurred under an indemnity and provide coverage where a company is required to defend an action taken by shareholders.
Insurance policies always contain exclusions, and director’s insurance is no exception. Fraud or dishonesty will void the policy. Claims between insured under the same policy will be excluded, as will any prior or pending litigation. Importantly, any liabilities assumed under contract, such as personal guarantees, will also be excluded.
You should discuss your insurance requirements thoroughly with your broker and ensure that you understand what you are insured for.
Third Line of Defence: Protect your Assets
Asset protection is not about hiding assets, avoiding responsibility or giving you an opportunity to act unethically. Asset protection is about isolating personal assets for the benefit of you and your family in the event something unexpected happens.
Majority ownership – family home
One of the most popular options for small business owners and sole traders is to transfer the family home to your spouse. The advantages are that it is quick, easy and relatively cheap because it does not attract additional taxes. This strategy however is not without some risk. It is crucial that your spouse does not participate in the management of the company and does not engage in decision making regarding the company or its finances. If it can be at all inferred that the spouse participates in the management or decisions of the company, they can be deemed to be a ‘de-facto’ director and therefore liable for the debts of the company.
Superannuation is one of the most tax effective methods for growth of assets, and has statutory protection from creditors, making it one of the securest options to preserve retirement assets. An industry or corporate superannuation fund can be used as a vehicle to preserve cash.If you wish to have more control and flexibility over investment assets, then a Self-Managed Superannuation Fund (“SMSF”) is an extremely effective (and secure) way to build a superannuation portfolio. It is safeguarded against bankruptcy, litigation and the litany of things that can go wrong.
One of the most effective ways to protect assets is by holding them in a trust for the benefit of your spouse and children. In this structure, the trustee maintains absolute control as to who, when and how beneficiaries may receive a distribution. Establishing a trust is a tax event and therefore costly, but because beneficiaries do not own or have any interest in the property, it is one of the most secure and flexible asset protection vehicles available.
First Line of Defense: Understand your obligations
Insurance coverage is not bullet proof, and a trust fund will not save you from going to jail.
If you hold the position of a director or officer in any company, you MUST know and understand your obligations and have the skills necessary to duly perform your duties.
And as always, if you are ever in doubt – seek professional advice.
In our previous blog, we will explored some of the ways in which directors can be held personally liable – you can find this article here.
In the meantime if you have any questions about your obligations as a director – call or email us for a no obligation chat.
* This blog is for general guidance only. Legal advice should be sought before taking action in relation to any specific issues.