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.
One of the most pressing questions we hear from directors is whether they can be held personally responsible for business debts[1]Trusted Source – GOV.UK – Director information hub: Debts and insolvent companies, especially when a company is insolvent.
Are Directors Personally Liable for Company Debts?
By default, directors are protected from personal exposure to company debt due to the clear legal separation between personal and corporate finances inherent in the limited company structure.
In fact, one of the main reasons for operating as a limited company is to benefit from this ‘limited liability’: companies are considered distinct legal entities from those that run them.
However, there are exceptions to this rule, particularly when directors have behaved fraudulently, or in a way that impacts creditors.
Assuming the director has acted properly and in accordance with their legal duties, they’re protected. However, when their actions, or failure to understand their legal responsibilities, impact others, they may be asked to compensate creditors financially
Directors should always seek professional advice as soon as they suspect their company might be insolvent, document all actions taken, and always seek to minimise losses for creditors.
When Might a Director be Held Liable for Company Debts?
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.
Wrongful Trading
‘Wrongful Trading’ 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.
Making Preferential Payments to Certain 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.
Engaging in Fraud
Fraudulent trading, defined under Section 213 of the Insolvency Act 1986, 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 disqualified from acting as directors for up to 15 years and may also face criminal prosecution.
Selling Company Assets Below Market Value
A transaction at undervalue is when a company sells an asset for less than its market value. This can happen for various reasons, such as if the company is insolvent and needs to raise cash quickly or if the director is personally benefiting from the transaction.
When a director sells a company asset at an undervalue, they are breaching their statutory 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.
Making False Statements or Misrepresentations
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.
Distributing Unlawful Dividends
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 is facing financial challenges, distributing dividends may still breach legal standards.
Overdrawn Directors Loan Accounts
During insolvency, the liquidator considers everything owed to the company, including debts from a Director’s Loan Account (DLA). According to the Insolvency Act 1986, directors’ loans are treated as recoverable assets; hence, the directors are required to repay these amounts back to the company as part of the insolvency resolution process.
What are the Consequences for a Director Being Held Responsible for Company Debts?
When a director is held personally liable, they can be asked to pay back what is owed from personal assets. This could mean bankruptcy if they don’t have the funds available.
Directors can also be disqualified from serving as a director of any UK company for up to 15 years, under the Company Directors Disqualification Act 1986[2]Trusted Source – GOV.UK – Company Directors Disqualification Act 1986. A disqualification order also prevents being a trustee of a company’s pension scheme, a school or a charity.
Where fraudulent behaviour is discovered, the director may face criminal prosecution, leading to potential fines and imprisonment.
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.
Worried about Personal Liability?
If you’re concerned about personal liability as a director, it’s crucial to seek professional advice immediately from a qualified lawyer or insolvency practitioner. At Company Debt, we specialise in providing practical, jargon-free guidance through same-day meetings, phone calls, or live chat during business hours.
To prepare for your consultation:
Gather all relevant financial documents to streamline the discovery process.
Protecting Yourself:
If you suspect your company might be insolvent, it’s essential to document every action you take, ensuring that you understand your responsibility to maximise returns for creditors. Hold regular board meetings and maintain a clear paper trail that shows all key business decisions impacting creditors.
FAQs on Directors’ Responsibilities for Company Debts
Can a Director be Held Liable for Debts After the Company is Liquidated?
Yes, directors can be held personally liable for certain debts after liquidation if their actions contributed to the company’s insolvency or if they breached legal duties.
Are Directors Liable for Unlawful Dividend Payments?
Directors who authorise dividends without sufficient profits can be held personally liable to repay those amounts, especially if such payments contribute to the company’s insolvency.
Can a Director’s Personal Assets be Seized to Pay Company Debts?
If a director is held personally liable through guarantees or wrongful conduct, their personal assets may be at risk to satisfy company debts.
What Steps Can Directors Take to Mitigate Personal Liability?
Directors should seek professional advice, cease trading if insolvency is inevitable, ensure accurate financial reporting, and avoid preferential payments to mitigate personal liability.
References
The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.
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