Who Is Liable for Debts in a Limited Company?
Limited companies fall under limited liability, meaning that any debts are the company’s responsibility alone, and not that of its directors or shareholders.
However, this is not a universal rule – there are instances where loans can become the responsibility of the company’s directors in the event of its closure.
In this guide, we’ll be looking at when a company director can become responsible for company debts and what options there are to help avoid this.
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When Can a Director Be Made Personally Liable for Company Debts?
Overdrawn Director's Loan Account
When a company enters into insolvency, the liquidator will have to collect any debts owed to the company so that they can be used to repay its creditors. When directors have an overdrawn loan account, they owe money to the company – this too will need to be collected.
Although the liquidator sometimes writes off some debts, amounts over £10,000 must be pursued.
The rules regarding directors’ loan accounts are complex, so they require specialist advice.
Personal Guarantees
For many new companies without a proven credit record, personal guarantees are a requirement set out by lenders in order to obtain financing.
A personal guarantee is a promise from directors that they will personally repay any outstanding amounts on the loan should the business fail. This circumvents the protections offered by limited liability.
Misfeasance
When a director fails to uphold their fiduciary duties to creditors – whether knowingly or unknowingly – they can be charged with misfeasance, a civil offence under the Insolvency Act 1986.
Actions that can qualify as misfeasance include:
- Making preferential payments (typically to a creditor you have a personal guarantee with)
- Selling company assets below market value
- Failing to declare company assets
- Taking an unreasonable salary
If found liable for misfeasance, directors can be made personally liable for company debts. Other penalties include court fines and disqualification from future directorship.
Wrongful Trading
When a company is insolvent, a director’s duties change. Instead of promoting the interest of company shareholders, they must protect the position of company creditors. This requires directors to stop the company from trading, as this risks further compromising the position of creditors.
When a company continues to operate while insolvent, it is known as wrongful trading. Wrongful trading is a civil offence under the Insolvency Act 1986. Wrongful trading charges do not need to prove the director knew that the company was trading while insolvent. Instead, they simply need to prove that the director ought to have known that the business was insolvent.
If found liable, you can be made personally liable for company debts. You may also be disqualified from future directorship or hit with large court fines.
Fraudulent Trading
Fraudulent trading is a criminal offence under the Insolvency Act 1986. Any deliberate attempt by directors to defraud the company’s creditors from retrieving their funds – such as taking out loans with no intention to repay – can serve as grounds for this offence.
If found guilty, becoming personally liable for company debts may be the least of your worries. Fraudulent trading charges can result in directors facing a prison sentence of up to 10 years.
Can Company Shareholders Be Made Liable for Company Debts?
Generally speaking, no. Company shareholders will not be made responsible for company debts in the event of an insolvent liquidation – although they shouldn’t expect to see any returns either.
Company shareholders can be made personally liable, however, if they are involved in the day-to-day running of the business and:
- The company was trading while insolvent
- Assets have been sold below market value
- They have taken out loans from the business
Shareholders will also have to pay for any unpaid shares, as these will be considered debts to the company and its creditors.
How Can I Protect Myself?
If you think your company is insolvent, it’s best to seek the help of an insolvency practitioner right away.
Entering into a Creditors’ Voluntary Liquidation will allow you to uphold your duty to creditors, avoiding the charges that carry the potential for personal liability.
If you have a personal guarantee that has already been triggered, our advisers may be able to assist you with an Individual Voluntary Arrangement. This will help to make repayment of the guarantee more manageable, stretching out repayments while protecting your assets.
In some cases, it may be advisable to take up a business recovery option – such as a Company Voluntary Arrangement or administration – in order to keep the company trading, allowing directors to use their salaries to offset the debt.
Our team will assess your situation and guide you towards the best solution for you. Get in touch today to book a free consultation.
