Are Directors Responsible For Company Debts?

Are Directors Personally Liable 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 main reason for operating under a limited company structure is to benefit from this limited exposure to corporate debt.

However, there are exceptions to this rule. Directors who sign a personal guarantee for a company loan or whose actions worsen the creditors’ position may find themselves personally liable.

Here are 10 situations where a director could find themselves personally liable:

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.

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.

Wrongful Trading

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.

This is because 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 to benefit themselves or other parties at the expense of the company’s creditors.

Preferential Payments

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

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 held personally liable for the company’s losses incurred, disqualified from acting as directors for up to 15 years and may also face criminal prosecution.

Misfeasance

Misfeasance refers to a breach of a director’s fiduciary duty to the company and its creditors, characterised by improper actions or violation of their duties. This includes issuing dividends when the company is insolvent, paying themselves unauthorised 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.

Transactions at an Undervalue

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.

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.

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

The Companies Act 2006 mandates that company directors maintain precise and thorough financial records. Simply delegating this duty is not enough to avoid liability.

In cases of insolvent liquidation or administration, the lack of proper records can be viewed as mismanagement or misconduct by directors, raising the risk of personal liability claims.

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 begins the process of making directors liable for business debts. For many, there is an unawareness of how legal responsibilities change once the company is officially insolvent, and this ignorance leads to actions and behaviours which worsen the situation for creditors and end up making the director liable.

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 director’s 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 responsible for some or all of the debts in question.

>>Read our full article on the directors conduct report

What are the Consequences for a Director if They Become Liable for Company Debts?

The primary consequence for a director held personally liable for company debts is loss of assets if a personal guarantee has been signed, or personal bankruptcy if they cannot pay the money owed. 

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 sue 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, directors may face bankruptcy if they can’t repay the debts.

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 Directors’ Responsibilities for Company Debts