Directors of Limited Companies are generally protected from being personally liable for company debts – but there are scenarios where they can become responsible.
The legal structure of a Limited Company gives directors Limited Liability, but it’s not absolute. For example, suppose a company is in difficulty or insolvent. In that case, directors could become personally liable if they don’t act – or take action which is not in the interests of creditors.
When Are Directors Liable For Debt in a Limited Company?
There are multiple situations where directors may be held liable for debts of a Limited Company, but they generally all revolve around protecting the interests of the people and organisations owed money by the company – its creditors.
The point at which directors are at risk of being liable for debts is usually when a Limited Company becomes insolvent – when it can no longer pay its bills or settle its debts.
When this happens, directors have a legal duty to protect the interests of creditors. If they don’t do this, they could become personally liable for the debts to creditors.
This scenario is often referred to as ‘wrongful trading.’ But wrongful trading isn’t always intentional – often, it can be simply because directors are unaware of procedures that must be followed or don’t know how to follow them correctly.
If a Liquidator or Insolvency Practitioner becomes involved in liquidating the insolvent company, the directors’ actions will be examined in detail, so it is well worth being aware of your responsibilities.
One of the most common mistakes is carrying on trading even though you are insolvent. Directors must stop trading as soon as the company has been identified as insolvent. If the company continues trading, worsening its financial condition, there could be dire consequences.
If a director takes action like this – or omits taking action (whether they are aware or not) – that worsens a creditor’s situation, then they could be held personally liable. These actions or inactions are known as antecedent transactions.
This responsibility also extends to ensure other company officers do not fall into the trap of committing antecedent transactions.
Here are some examples of antecedent transactions that could result in a director being identified as personally liable for company debt:
- Abusing Directors’ Loan accounts
- Undervaluing Transactions
- Illegal Dividend Payments
- Supplying personal guarantees
- Fraud and misrepresentation
- Poor bookkeeping
1. Abusing Directors’ Loan accounts
If a director chooses to pay themselves from the company bank account when the company is insolvent, then it could create personal liability. An overdrawn Directors’ Loan account may need to be repaid by the individual.
2. Undervaluing Transactions
If directors choose to sell company assets below their market value, they may have to reverse those sales as it could be seen as not being in the best interests of creditors if not enough money has been raised to repay debts.
This can happen when directors attempt to sell assets to a new version of the company, known as a ‘phoenix company.’
3. Illegal Dividend Payments
Dividends are a common, tax-efficient way of paying directors at a lower rate of tax than a salary. But dividends must be paid from profits. An insolvent company doesn’t have any profits by its very nature, so it cannot pay dividends. So if dividends have been paid, they have been paid unlawfully.
4. Supplying personal guarantees
Whether banks or other suppliers, lenders will often require a personal guarantee from a director for a loan. If a Limited Company cannot repay that loan, then the director who guaranteed it could be liable for the debt.
5. Fraud and misrepresentation
If a director applies for a loan or credit but essentially lies to get the funding, they will likely become personally liable for the debt.
6. Poor bookkeeping
Limited Companies are separate entities from directors and business owners. While this has many advantages – such as being able to pay dividends – directors cannot treat the company bank account as their personal bank account. Transactions must be properly recorded, or directors could become liable for company debt.
What happens when a director is held personally liable for Limited Company debts?
If a director has been held personally liable for company debts because they have not acted in the interests of creditors, they will need to repay that debt themselves.
However, if the director cannot repay the debt, then a liquidator – or court – may require their assets to be sold, and there would be a risk of personal bankruptcy.
There is also the threat of disqualification from being a director of a Limited Company for up to 15 years.
Finally, if the liquidator’s investigation reveals serious fraud, it could result in a criminal investigation.
Conclusion
One of the critical advantages for directors when choosing to run a Limited Company is the Limited Liability that comes with it. Briefly put, Limited Liability means directors are protected when the company has debts – they are not held personally liable for its debts.
But this is not true in all cases, and directors should be wary when a Limited Company becomes insolvent and work in the interest of creditors. Acting promptly in this situation is critical – showing liquidators that you are acting in the best interests of creditors is likely to earn considerable favour.
If directors choose not to take the required action or act in a fashion that worsens the creditors’ interests, they may be held persistently liable for the debt.
Directors may not be aware of their responsibilities when a company becomes insolvent, and the first port of call should be to obtain professional advice. Future Strategy has helped countless customers who have their Limited Companies in trouble and can advise the best action to take.
