When is a company director liable for company debts?
When is a company director liable for company debts? Limited company directors are protected by limited liability, which attracts many business owners to run their businesses through this operating structure. Limited liability protects company directors from being held personally liable for business debts, except under exceptional circumstances.
Under what grounds can a limited company director be held personally responsible for the debts of a company? Common factors that override limited liability include a personal guarantee agreement, director misfeasance or an overdrawn director’s loan.
What happens if a business is insolvent?
If a business becomes insolvent, the company director must cease trading to prevent company creditors’ financial position from worsening further. Company assets and any remaining funds must not be distributed without advice from a licensed insolvency practitioner as insolvency law sets out a hierarchy of creditors for repayments in formal insolvency procedures, such as company liquidation.
If a company enters liquidation due to financial difficulty, company assets will be realised to raise cash for creditors, and any remaining debts will likely be written off. During the insolvency procedure, the insolvency practitioner will investigate the lead-up to the collapse of the business and the director’s conduct.
This could result in severe repercussions for the company director, including personal liability
If the director fails to act in the best interests of company creditors and acts wrongfully, they could be held personally liable for the business’s debts. Director wrongdoing includes:
- Failing to uphold director duties
- Accessing finance through fraudulent means
- Director misfeasance
- Continuing to take payments knowing the business cannot afford it
- Selling company assets at a price lower than their market value
Suppose a business becomes insolvent and an insolvency service investigation finds that the company director breached company law. In that case, this could result in severe repercussions for the company director, including personal liability.
In addition to director wrongdoing, lenders commonly use personal guarantees, which can result in personal liability for a business loan.
Personal guarantees are common as they provide extra protection to the lender and can improve access to finance for the business
A personal guarantee is often required by a lender when taking out a business loan as it provides extra security if the business defaults. A personal guarantee agreement requires the company director to personally repay the loan if the business fails to do so under any circumstances.
If the business becomes insolvent and the company director has signed a personal guarantee agreement, the loan will not be written off as the duty will lie with the company director to cover the outstanding amount personally.
Personal guarantees when taking out business finance are common as they provide extra protection to the lender and can improve access to finance for the business.
Any money owed to the company by the director is classed as an asset
Overdrawn director’s loan account
A company director can take money from the business other than through salary, dividends, or expenses, through what’s known as a director’s loan account. Each time money is extracted from the business; a record must be kept.
Any money owed to the company by the director is classed as an asset, so if the business becomes insolvent, the director must personally repay the money owed to the business to repay creditors.
A licensed insolvency practitioner is best placed to advise on personal liability for business debts and business restructuring.
Keith Tully is a partner at Real Business Rescue, a company insolvency and restructuring firm supporting company directors in financial distress. From cash flow problems, and Covid-19 pressures to personal liability for business debts, Keith is experienced in all aspects of company rescue.