Are Directors Personally Liable For Company Debts?
While the legal structure of a company typically limits directors’ personal liability for company debts, there are specific circumstances where it can apply. Liability occurs most commonly during insolvency, when directors are found to have acted, or failed to act, in ways that worsen the creditors’ financial position.
I’ll cover the issue of directors’ liability in detail below.
- What Are Directors’ Liabilities for Company Debts?
- Directors Loan Accounts
- Directors Personal Guarantees
- Wrongful Trading
- Preferential Payments
- Fraudulent Trading
- Transactions at an Undervalue
- Insufficient Record Keeping
- Unlawful Dividend Payments
- When Can a Director Be Liable for Company Debts?
- What Are the Consequences for a Director if They Become Liable for Company Debts?
- Am I Still Liable For Business Debts After Resigning As Company Director?
- Can Sole Traders and Partnerships be Held Liable for Company Debts?
- FAQs on UK Directors’ Personal Liability
What Are Directors’ Liabilities for Company Debts?
By default, company directors have limited liability for company debt, meaning their personal assets are protected from the company’s obligations by the nature of the limited company structure.
In fact, the principal reason to operate under a limited company structure is to benefit from this limited exposure to corporate debt.
However, there are exceptions to this rule, such as when a director signs a personal guarantee for a company loan or if their actions worsen the creditors’ position.
Here are 10 situations where a director could find themselves personally liable:
Directors Loan Accounts
During insolvency, the liquidator evaluates all amounts owed to the company, including any from a Director’s Loan Account (DLA), as this is viewed as debt owed by the director to the company.
Directors Personal Guarantees
The most common cause of personal liability for company directors is signing a personal guarantee document. This is a legally binding contract in which a director agrees to repay a company’s debt if the company cannot do so. Personal guarantees are very difficult to get out of, even if the director did not sign the guarantee freely or if they were unaware of the full implications.
Section 214 Trusted Source – Legislation – Insolvency Act 1986, Section 214 of the Insolvency Act refers to ‘Wrongful Trading’, which is the term used to describe the actions of a company director who, knowing the business was insolvent, failed to put the interests of creditors first. This breach of duty can render the director personally liable for the company’s losses incurred during the period of wrongful trading.
The reason for this is that directors are considered to be trustees of the company’s assets on behalf of the company’s creditors. When a director engages in wrongful trading, they are essentially misusing the company’s assets in a way that benefits themselves or other parties at the expense of the company’s creditors.
A preference is a payment made by an insolvent company to one creditor over another in the lead-up to insolvency. This can be done in a number of ways, such as by paying off a particular debt in full, by providing security for a debt, or by selling assets to a particular creditor at a price below market value.
Directors can be held personally liable for preferences if they knew or ought to have known that the company was insolvent at the time that the preference was given. This is because directors owe a fiduciary duty to the company and its creditors to act in their best interests. When a director gives a preference, they are breaching this duty and can be held personally liable for the amount of the preference, plus interest.
Fraudulent trading is a more serious charge than wrongful trading. It occurs when a company director knowingly and deliberately engages in trading activities with the intention to defraud the company’s creditors. Directors who engage in fraudulent trading can be held personally liable for the company’s losses incurred. This is because fraudulent trading is a tort (civil wrong), and directors owe a duty to the company and its creditors to act honestly and in good faith.
In addition to personal liability, directors who engage in fraudulent trading can also be disqualified from acting as directors for up to 15 years and may also face criminal prosecution.
Misfeasance refers to a breach of a director’s fiduciary duty to the company and its creditors, characterized by improper actions or violation of their duties. This includes issuing dividends when the company is insolvent, paying themselves unauthorized remuneration, using company assets for personal benefit, engaging in self-dealing transactions, and acting in ways prejudicial to the interests of the company or its creditors. These actions represent a departure from the responsibilities and ethical standards expected of company directors.
If the director is found to be liable for misfeasance, they may be ordered to repay the company or its creditors for the losses that they have caused.
Transactions at an Undervalue
A transaction at undervalue is a transaction where a company sells an asset for less than its market value. This can happen for a variety of reasons, such as if the company is insolvent and needs to raise cash quickly or if the director is personally benefiting from the transaction.
Directors can be held personally liable for transactions at an undervalue if the company is insolvent and the transaction causes the company to lose assets that could have been used to pay its creditors. This is because directors owe a fiduciary duty to the company and its creditors to act in their best interests. When a director sells a company asset at an undervalue, they are breaching this duty and can be held personally liable for the difference between the market value of the asset and the price that it was sold for.
When a director makes a misrepresentation to a third party, such as a bank or supplier, on behalf of the company, they are breaching their fiduciary duty to the company and its creditors to act honestly and in good faith. If the third party relies on the misrepresentation and suffers a loss as a result, the director may be held personally liable for that loss.
For example, if a director makes a false statement about the company’s financial position in order to secure a loan, the director may be held personally liable for the loan if the company subsequently becomes insolvent and is unable to repay the loan.
Insufficient Record Keeping
Directors have a statutory duty to keep accurate and up-to-date records of the company’s financial position. If a director fails to keep adequate records, it can make it difficult for the company to meet its obligations to its creditors and to the government.
For example, if a director fails to keep adequate records of the company’s sales and purchases, it may be difficult for the company to calculate its tax liability or to identify and address any financial problems early on. This could lead to the company becoming insolvent and the director being held personally liable for the company’s debts.
Unlawful Dividend Payments
Dividends can only be legally distributed from available profits. Paying dividends from an insolvent company, or when it endangers solvency, is unlawful. Liquidators will seek the return of such dividends. Even if the company is not yet insolvent but facing financial challenges, distributing dividends may still breach legal standards
When Can a Director Be Liable for Company Debts?
It is typically the insolvency of a company which causes problems for directors around liability. For many, there is an unawareness of the way legal responsibilities change once the company is officially insolvent, and this ignorance leads to actions and behaviours which worsen the situation for creditors.
The Insolvency Act 1986 covers just this eventuality in Section 214 which established the concept of wrongful trading. This clause outlines that failing to put creditor interests first can be considered wrongful trading if the director ‘knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation.’
When the liquidator overseeing the company closure comes to examine the financial affairs of the business in the period preceding insolvency, they are tasked with investigating the directors conduct in this regard to ascertain if they acted lawfully.
Where it can be proved that this wasn’t the case, then directors can be held personally liable for some or all of the debts in question.
What Are the Consequences for a Director if They Become Liable for Company Debts?
If directors become personally liable for company debts, they may face the following consequences:
They might have to use their personal assets, like savings or property, to pay off the debts. They also risk being disqualified from serving as a director of any UK company for up to 15 years, particularly if they fail to meet their legal duties.
Creditors could take legal action against them to recover debts, which might involve court judgments or asset seizure. This situation can harm their credit rating, making future borrowing or credit access more challenging.
In severe cases, if directors can’t repay the debts, they may face bankruptcy.
Am I Still Liable For Business Debts After Resigning As Company Director?
Whether you can still be held personally liable for business debts after resigning as a company director depends on the specific circumstances of your situation. In general, there are two main situations where you may still be liable for company debts after you have resigned:
- If you have personally guaranteed a loan or other borrowings
- If you have been found to have committed fraudulent or wrongful acts
Can Sole Traders and Partnerships be Held Liable for Company Debts?
Yes, sole traders and partners in partnerships can be held personally liable for business debts.
For sole traders, there is no legal distinction between the individual and the business. Therefore, personal assets can be used to settle business debts.
In partnerships, partners are jointly and individually liable for business debts. This means creditors can pursue any or all partners for the full amount of the debt. However, in a limited liability partnership (LLP), partners’ personal liability is limited to the amount they invested in the business or any personal guarantees they have provided.
FAQs on UK Directors’ Personal Liability
What situations lead to directors’ personal liability for business debts?
Personal liability can occur if directors have signed personal guarantees, engaged in wrongful or fraudulent trading, misused company funds, or have not adhered to the fiduciary and statutory duties required by UK company law.
How can a director be disqualified in the context of company debt?
A director can be disqualified if they fail to fulfil their legal responsibilities, leading to company insolvency. Examples include continuing to trade when insolvent, not keeping proper accounting records, or not paying taxes due. The UK Insolvency Service can investigate and pursue disqualification.
Does a director’s overdrawn loan account affect personal liability?
Yes, if a director has an overdrawn director’s loan account when a company goes into liquidation, they may be required to repay this amount, thus becoming personally liable for this portion of the company’s debt.
What steps can directors take to avoid personal liability?
Directors should maintain accurate and timely financial records, adhere to corporate governance laws, avoid personal guarantees where possible, and seek prompt professional advice if they face financial difficulties. Acting responsibly and within the law is key to protecting oneself from personal liability.
Are directors personally liable for unpaid employee wages if a company is insolvent?
Typically, directors are not personally liable for unpaid wages; these are covered by the National Insurance Fund in the UK. However, directors can be held liable if they have violated employment laws or contractual terms intentionally.
What are the consequences of personal guarantees on directors’ liability?
If a director has signed personal guarantees for loans or other financial commitments, they will be personally liable to cover these debts if the company cannot. This can lead to severe personal financial consequences, including the potential loss of personal assets.
How does personal liability affect a director’s future in business?
Personal liability can lead to disqualification from serving as a director and negatively affect one’s credit rating and reputation, which can hinder future business endeavours or opportunities to hold managerial positions in other companies.
The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.
You can learn more about our standards for producing accurate, unbiased content in our editorial policy here.
- Trusted Source – Legislation – Insolvency Act 1986, Section 214