Can Directors Be Held Personally Liable For Business Debts?
If you’re a limited company director with financial difficulty, you might be concerned that you could be personally liable for your business debts, especially if the business becomes insolvent.
One of the main reasons people form a private limited company or an LLP is to limit liability: in general, the law is there to protect you.
But there are certain circumstances where you can be held personally liable, meaning the limited liability inherent in the corporate structure is bypassed.
Potential liabilities for UK directors can include not just being held financially responsible but, in some cases, criminal liability if your actions are deemed fraudulent.
In this piece, we will explore the various ways in which directors can become liable for company debts and the consequences that can follow.
- What Are Directors’ Liabilities for Company Debts?
- When Are Directors Responsible for Company Debts?
- Directors Personal Guarantees
- Wrongful Trading
- Fraudulent Trading
- Transactions at an Undervalue
- Fraud, Misrepresentations and Insufficient Record Keeping
- Can Sole Traders and Partnerships be Held Liable for Company Debts?
- How to Reduce the Risk of Personal Liability if Your Company is Insolvent: Our Key Insights
What Are Directors’ Liabilities for Company Debts?
The law treats directors as ‘fiduciaries’, meaning their legal duty is to manage the company on behalf of others. This means shareholders while the company is solvent and, once insolvent: creditors.
Liability typically occurs when the directors have failed to adhere to this basic principle and placed other interests first.
Common examples of instances in which directors could face liability include:
- Making decisions that result in the company incurring debts, it cannot pay
- Failing to manage the company’s finances responsibly
- Engaging in activities that are illegal or unethical
- Failing to maintain accurate financial records
- Engaging in transactions that result in the company becoming insolvent.
When Are Directors Responsible for Company Debts?
In most cases, the directors of an insolvent limited company do not find themselves liable since the limited liability protection maintains a clear separation between personal and business debts.
However, there are certain circumstances in which this ‘corporate veil’ can be broken. Insolvency practitioners have a legal responsibility to act in the best interests of creditors when winding up a company and will thoroughly investigate the director’s behaviour as part of the process.
Situations, when a director may find themselves personally liable, are as follows:
Directors Personal Guarantees
The most common cause of personal liability comes from when a director has signed a ‘personal guarantee’ document with a bank or lender, putting up a personal asset as security for finance. These documents are specifically designed to pierce the corporate veil and are very difficult to get out of.
Beyond personal guarantee documents, the key piece of legislation outlining potential liabilities is the Insolvency Act 1986.
Here are the key sections within that pertaining to liability:
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.
Wrongful trading is not something conducted out of connivance or wilful desire to defraud. Rather, it is about ignorance of due procedure and a failure to understand the rules.
For example, a director who understands that the company is insolvent might pay himself out of the last money in the account simply because he needs to pay his mortgage on time. That action qualifies as wrongful trading because it’s putting his own interests before those of company creditors.
Section 213 of the Insolvency ActTrusted Source – Legislation – Section 213 of the Insolvency Act refers to the more serious charge of ‘Fraudulent Trading’, which means that any actions taken by the director were done ‘knowingly.’ Fraudulent trading may result in civil and/or criminal liability.
Defrauding creditors may result in personal liability to contribute to the assets of the business and/or criminal prosecution..
Section 212 of the Insolvency ActTrusted Source – Legislation – Section 212 of the Insolvency Act covers ‘misfeasance’, which, in plain English, is the improper activity or a breach of fiduciary duty. Essentially this covers activities surrounding the use of money, such as when dividends are issued inappropriately or unauthorised remuneration to directors.
Transactions at an Undervalue
Section 238 of the Insolvency ActTrusted Source – Legislation – Section 238 of the Insolvency Act covers the situation where an officer of the company sells an asset at less than market value in a way that results in less return for creditors.
For example, if a company is insolvent and a director sells a company property to a family member for a less-than-market rate, it could result in personal liability for the amount missing.
Section 239 of the Insolvency ActTrusted Source – Legislation – Section 239 of the Insolvency Act refers to the situation of one creditor receiving preferential treatment over others.
For example, if a director pays one supplier and not others, based on a long and trusted relationship, after becoming aware of the company’s insolvency, he/she could find themselves personally liable as, overall, the creditors find themselves worse off.
Section 239 of the Insolvency Act refers to the situation of one creditor receiving preference over another.
For example, should the director pay one supplier – on the basis of long and trusted relationship – post become aware of the company’s insolvency, he/she could find themselves personally liable as, overall, the creditors find themselves worse off.
Fraud, Misrepresentations and Insufficient Record Keeping
If you lied or misrepresented any of the facts while applying for a credit or loan agreement on behalf of your business, you could be held personally liable for the debt.
You are also obliged to preserve and maintain accurate company accounts. If you fail, you could be personally liable for some of the company’s debts.
Can Sole Traders and Partnerships be Held Liable for Company Debts?
Sole traders can be held liable as the law sees no distinction between their personal and business finances. There is no requirement for a separate bank account, and no limited liability protection ensues.
In the case of partnerships, all partners are usually jointly and severally liable for the business’s debts. This means that each partner is individually responsible for paying the business’s debts, and creditors can pursue any partners for payment.
The exception to this is where a limited liability partnership has been formed: these limit the partner’s liability to the extent of the investment they have made in the company.
How to Reduce the Risk of Personal Liability if Your Company is Insolvent: Our Key Insights
When a company becomes officially insolvent, the appointed insolvency practitioner will look at the director’s conduct in the period leading up to insolvency.
If you suspect your company is insolvent or close to it, we suggest you behave with the utmost diligence and contact us as soon as possible for advice. It’s also worth checking to see whether there is an overdrawn directors’ loan account, as this can be quite serious.
Generally, on liquidation,. the insolvency practitioner will want to see evidence that you :
- placed creditors’ interests first once you understood the company’s financial position
- kept clear lines of communication with both creditors and shareholders
- took prompt and decisive action
- maintained clear and accurate records
You can read a full article here on Wrongful Trading.
Get Free Advice Now on Personal Liability
If you’re worried about being made personally liable for your business’ debts, contact us today. We can help you meet your obligations as a company director and avoid any personal liability for your debts while undergoing a company insolvency, company liquidation or company rescue procedure.
If a director is held personally liable for the debts of a company, they may be required to use their personal assets to pay the debts. This can result in significant financial consequences, including personal savings or property loss. Where wrongful or fraudulent trading is discovered, the director may also face legal action and penalties, such as fines, disqualification from acting as a director or even imprisonment.
If directors are concerned about their personal liability for business debts, they should seek professional advice immediately from an accountant, financial advisor or insolvency practitioner. They should not pay anyone, including themselves, and keep careful records of any actions taken.
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
- Trusted Source – Legislation – Section 213 of the Insolvency Act
- Trusted Source – Legislation – Section 212 of the Insolvency Act
- Trusted Source – Legislation – Section 238 of the Insolvency Act
- Trusted Source – Legislation – Section 239 of the Insolvency Act