Is It Possible For Directors To Be Held Liable For Company Debts In A Limited Company?

A limited company is insolvent when its assets are less than its liabilities orthe business is unable to repay its debts due to a shortage of cash. 

Being insolvent can arise at a far earlier point in time than closure, liquidation or bankruptcy.

In setting up a business there are two main approaches in which you can choose to operate, incorporating and forming a limited company or alternatively taking on work as a sole trader. Limited companies have their own individual legal entities, so if a company should come under financial difficulties, this can be a great benefit for the directors involved A limited company safeguards a director’s own personal assets unlike being a sole trader.

However, this may not always be the case and a director can be liable for debts in a limited company.

What constitutes a liability?

For a business, a liability refers to an amount of money or other debt owed. These can be unpaid invoices, hire purchase agreements or loans. Limited companies have a layer of protection between the directors and the company itself meaning that the directors cannot be held automatically personally accountable for any liabilities the company may have.

Can company liabilities be written off?

When a Company enters a formal insolvency procedure such as a creditors voluntary liquidation or CVL its liabilities will be written off.

When is a director liable for company debts?

In most cases limited liability protects a director, although there are a few circumstances in which a director is responsible for paying company debts.

These include:

·      Signing a personal guarantee

·      Overdrawn director loan accounts

·      Paying shareholder dividends while the company is in insolvency

·      Debts accumulated via fraudulent activities

·      Director misconduct

·      Offloading company assets undervalued or at no value

·      Withdrawing and/or using company funds for non-business purposes, this is also known as misfeasance

·      Incurring debts at a time when it was known they would not be paid.

Unless you have a well-established business, it is quite likely for banks and other lenders to ask for you to sign a personal guarantee before agreeing to unsecured lending, it is becoming increasingly common for new start-up companies to be unable to find any source of funding or even be unable to find a lease for a commercial property without providing a personal guarantee to the lender. This is to provide the lender(s) with extra safety precautions should the company become insolvent, essentially removing the protections that a limited company provides its directors. Making them personally liable for paying those debts if the company is unable to do so.

A director’s loan account or DLA allows a company director to take money out of a business account without it coming out as a salary, dividend or expense. These transactions must all be thoroughly recorded, should more money be taken out in this manner than is put in then this account is considered overdrawn. Normally having an overdrawn DLA is fine as long as that amount remains under ￡10,000, however this becomes a problem when the company is insolvent. When a business becomes insolvent any director loan accounts are seen as assets of the company meaning the director must pay back the money loaned via the account so it can be used to repay creditors. More often than not the directors are not in a position to repay these loan accounts when their company becomes insolvent, this can be an extremely complicated situation and it is recommended to find professional guidance immediately.

What are a director’s duties in insolvency?

·      Directors have a statutory duty to act in the best interests of a company’s creditors when their company becomes insolvent.

·      Directors must prove that they have done all they can to ensure repayments of all creditors using company resources.

·      Directors cannot knowingly cause an increase in company debts or deliberately cause debts to go unpaid.

·      Directors cannot Show any favouritism for certain creditors or suppliers, also known as preference payments.

When a director fails to meet their duties of acting in the best interest of the company’s creditors while the company is insolvent they are liable for disqualification of acting as a director in the future as well as facing servere personal liabilities.

Company debts and shareholder liabilities.

Often, in smaller companies the directors are the only shareholders of the company. This is not always the case as, for example a director could resign from their position but still hold a portion of the shares in the company. In the case of an insolvency, shareholders have no liabilities other than any which they have agreed to contribute in the Articles of Association or the value of any unpaid share capital.If a shareholder has signed a personal guarantee (whether in the capacity as director or merely in their capacity as a shareholder), they will have to pay the PG claims. Where no such guarantee has been signed, they are only liable up to the value of their own shares.

What happens when a director is held liable?

When directors are held liable for company debts, they are expected to pay them like any other personal debt. Commonly personal finances are used by directors to try and keep their business afloat and when they subsequently become insolvent, being liable for company debts can be very damaging to the director’s personal finances, especially if the business was the only source of the director’s income. If a director should find themselves in a position where they are unable to pay for company debts they are liable for, there are several solutions that exist. These solutions range from debt management plans to individual voluntary agreements or bankruptcy and would be recommended based on the level of debts owed and their own personal assets.

How can director redundancy help?

Directors are often classed as an employee of their own company; meaning that should the company become insolvent they are entitled to receive a director redundancy. The director redundancy works in the same way as it would for regular employees. So long as the company has paid a regular salary to the director and the company has been incorporated for at least two years, it is highly likely the director would qualify for redundancy pay once liquidated.

The amount able to be claimed depends on several factors such as length of service, age, and salary of the director. The pay-out is often used to settle personal liabilities and to help pay for the liquidation of the company and even leave with some extra for the director personally.

Seeking help.

If you are concerned about financial difficulties your business might be experiencing and are worried about the possibilities of being help liable for company debts, contact our specialists at Lucas Ross who will work with you to understand your position and help arrive at the best outcome for you and your business.

Call us today on 03301289489 or Email us at [email protected]