Can Directors be Held Personally Liable for Company Debt?
If your limited company is starting to struggle financially then it’s understandable that you’ll be concerned about how the failure of the business could affect you personally. Clearly, the loss of your business will be a difficult situation to deal with, but things could be made dramatically worse if you were made personally liable for company debts and your own funds or even your home was at risk.
One of the main reasons business owners choose to form a private limited company (LTD) or a limited liability partnership (LLP) is to limit their liability for business debts. However, there are still some occasions when the directors or officers of LTDs and LLPs can be made personally liable for company debts.
When might a director be held personally liable for company debts?
- You sign a personal guarantee
- You over pay yourself using company funds and create an overdrawn director’s loan account
- You continue to trade for the benefit of the shareholders despite knowing the business is insolvent
- You sell the assets of an insolvent company for less than their market value
- You raise funds to repay creditors via fraudulent means
- You fund the business with credit cards or personal loans
If you have not been involved in any of the above, your liability for company debts will be limited to the amount of money you personally invested in the business. If your business becomes insolvent and enters into an insolvency procedure or liquidation, your creditors will only be able to recover the money they are owed through the business’s bank accounts and the sale of its assets.
What if you operate as a sole trader or partnership?
The situation for those operating as a sole trader or partnership is very different. That’s why so many business owners take the step to become a limited company. If you run a sole trader then there is no separation between you and your business. In legal and financial terms, you are one and the same thing. That means, if the business racks up debts it can’t afford to pay, creditors can ask you personally to repay the debts and even seize your assets to reclaim the money they are owed.
Partnerships are slightly different. They can be run as limited partnerships or limited liability partnerships (LLPs) in the UK. Partners in an LLP can only be made personally liable in one of the scenarios listed above. However, in a limited partnership, there can be both ‘general’ partners and ‘limited’ partners. Only general partners can be made personally liable for the partnership’s debts.
Private limited company debts
Let’s take a look at the different scenarios when you could be made personally liable for company debts in more detail:
Signing a personal guarantee
As the director of a limited company or a limited liability partnership, there are occasions when banks, landlords and suppliers might ask you to sign a personal guarantee before they will extend you a credit line or agree to a commercial lease. That’s because they are aware directors are not ordinarily liable for company debts and they do not want to be left out of the pocket if the business were to fail.
If you sign a personal guarantee then you will become personally liable for that debt if the business is unable to pay. For that reason, personal guarantees should not be given up lightly or without a full understanding of the potential consequences if the business were to fail.
Creating an overdrawn director’s loan account
A director’s loan account is a record of transactions that occur between a company and a director outside of the usual salary, dividend or expense repayments. A director’s loan account becomes overdrawn when a director takes more money out of the company than they have put in. This in itself is not a problem as long as it is recorded properly and repaid.
An overdrawn director’s loan account becomes an issue when a business becomes insolvent and the loan has not been repaid. In that case, the overdrawn director’s loan account becomes an asset of the company that you can become personally liable to repay for the benefit of your creditors.
Continuing to trade for the benefit of shareholders while the business is insolvent
A director is expected to be aware of the company’s financial position at all times. If the business is unable to repay its debts when they fall due or its assets no longer cover its liabilities, the business is said to be insolvent. As soon as a business is insolvent, the directors have a duty to seek professional advice from an insolvency practitioner and act to limit the losses of the business’s creditors.
If the directors continue to trade for the benefit of the business’s shareholders and accrue further debts in the process, they could be accused of wrongful trading. They could then be made personally liable for all or a proportion of the company’s debts.
Selling assets for less than market value
If a company is in financial difficulty, it might be tempting to have a ‘fire sale’ and try to sell assets quickly to raise funds. However, it’s important to remember that during and in the lead up to insolvency, the creditors’ interests must take priority. That means all assets must be sold at market value.
If the business does enter a formal insolvency process, the transactions that have taken place will be scrutinised. If any assets are found to have been sold at undervalue, the court can order the transaction to be set aside. The directors can also be held personally liable and ordered to make a financial contribution to the company.
Fraud, misrepresentations and insufficient record keeping
If you lie or misrepresent the facts while applying for a business loan, accept money for goods you know won’t be delivered or fail to maintain proper separation between personal and company finances, creditors could pursue you personally for the debts you create.
Funding the business with personal loans or credit cards
If you use personal finance sources such as credit cards or home equity loans to fund your business, you will always be personally liable for those debts. In fact, it’s also likely that you’ll be personally liable for payments made on a business credit card, so make sure you read the terms and conditions carefully before you apply.
Steps you can take to avoid personal liability
As you can see, many of the problems occur when a business is either insolvent or close to insolvency. For that reason, we would advise any company director who fears their company could be nearing insolvency to act diligently and seek professional insolvency advice immediately. More specifically, to reduce the likelihood of being made personally liable for company debts, an insolvency practitioner and HMRC will want to see that you have:
- Put the interests of your creditors ahead of the position of your shareholders
- Always maintained cleared lines of communications with your creditors
- Done everything possible to manage your debts as best you can
- Taken professional advice at your earliest opportunity
Can shareholders be personally liable for the debts of a company?
Just like company directors, shareholders of limited companies enjoy limited liability status. That ensures their liability for company debts is limited to the level of their original investment. However, there are also circumstances where that protection will not apply. That includes:
- Where a shareholder or group of shareholders personally guarantee a debt
- Where a shareholder acts improperly or fraudulently, for example, by using company funds for personal expenses
Concerned about your personal liability for company debt?
If you’re worried that you could be made personally liable for your company’s debts, or you’re concerned your company has become insolvent and you’re not sure what to do, we can help. We can make sure you meet all your obligations as a company director and avoid personal liability claims while undergoing a company insolvency or rescue procedure. For free advice, please get in touch with our team today.