Can a Director be Made Bankrupt if a Business Fails?

Reviewed by

Christopher Andersen

Reviewed by Christopher Andersen

Chris is an Insolvency Practitioner regulated by the ICAEW since 2014,. He is experienced in contentious insolvency with excellent analytical skills and strong knowledge of both general and technical insolvency matters.

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10th April 2024

Creating a limited company offers directors a significant shield against personal financial risk, thanks to the principle of the “veil of incorporation.”

This legal concept recognizes the company as an independent entity, separate from its directors and shareholders. Essentially, it means that the company owns its assets, incurs its debts, and is liable for its actions, not the individuals behind it. As a result, if your business encounters failure, your personal assets are generally protected, limiting your financial exposure to the amount you’ve invested as share capital.

However, this shield is not impenetrable. In situations of insolvency, the “veil of incorporation” can be “lifted,” exposing directors to personal liability. This occurs under specific circumstances, such as when directors are found to have acted wrongfully or engaged in fraudulent activities that result in financial losses for the company’s creditors.

I’ll explain the specific circumstances when directors’ personal liability could even force you into bankruptcy.

What Are the Circumstances in Which a Director Could Be Made Bankrupt?

A director could face personal bankruptcy under certain conditions, despite the usual protections offered by the veil of incorporation. These circumstances typically involve actions that breach the legal and financial duties expected of a director. Key scenarios include:

1. Personal Guarantees: If you’ve provided personal guarantees for loans or other financial obligations of the company, you become directly liable for these debts if the company cannot pay them. This is a common practice where lenders seek additional security, especially from startups or businesses with limited trading history.
2. Wrongful Trading: Wrongful trading means engaging in business activities when you knew, or should have known, that avoiding insolvency was impossible. This implies continuing to incur debts when the company had no reasonable prospect of meeting those liabilities.
3. Fraudulent Trading: If you’re found to have intentionally attempted to defraud creditors or conduct business for a fraudulent purpose, you could be held personally liable for the company’s debts.
4. Breach of Duty: Directors have a duty to act in the best interest of their company. If you fail in this duty and cause financial loss to the company or its creditors, this could lead to personal liability. Examples include misappropriation of company assets or funds.
5. Tax Liabilities: Directors can be made personally liable for certain unpaid taxes of the company, especially if it’s proven that tax reporting or payment failures were due to fraudulent or negligent behaviour.
6. Disqualification: Directors disqualified for not meeting the legal obligations of their role may face personal liability for company debts if they continue to act in the capacity of a director.

It’s important to note that the threshold for lifting the veil of incorporation is high, requiring clear evidence of improper conduct. However, understanding these circumstances can help directors take proactive steps to mitigate their risk of personal bankruptcy.

The Bankruptcy Process for Directors

If, as a director, you face personal liability, often due to a personal guarantee for company debts, and find yourself unable to cover what you owe, declaring personal bankruptcy may become a necessary step. This typically occurs when the financial obligations exceed your ability to pay, highlighting the importance of understanding the liabilities attached to personal guarantees.

In such cases, an insolvency practitioner overseeing the company’s insolvency will guide you through your options, including the implications of personal bankruptcy. This process involves formally declaring bankruptcy, which then leads to an assessment of your assets and liabilities to manage repayment to creditors as fairly as possible.

The consequences of declaring bankruptcy are significant. It affects your credit rating, making it difficult to borrow money, obtain a mortgage, or even hold certain company positions. Bankruptcy remains on your credit record for six years, marking a period during which your financial freedom is considerably restricted. The role of the insolvency practitioner is crucial here, as we can provide the necessary advice and steps to navigate this challenging period, ensuring you understand both the process and its long-term impact on your personal and professional life.