One of the key benefits of incorporating a ‘limited company’ is known as the ‘corporate veil’, a term defining the clear legal difference between the business and its directors/shareholders.
Within a legal context, this means that the company is a separate entity from its directors/shareholders, and all the debts incurred by the company are in theory the company’s liabilities and not the legal liabilities of the directors/shareholders.
However, while limited liability status provides valuable protection to directors, there are certain circumstances where the company status is disregarded and the ‘corporate veil is lifted’, leaving the person behind the veil, (in other words the director/shareholder), responsible for paying the company’s debts.
In this article we’re going to explore what situations could make a director personally liable for a corporate debt.
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Directors can be held personally responsible for company debt by a liquidator if they permitted the business to continue to trade after it became clear to them that it was insolvent.
This is because it’s considered unfair to suppliers and other creditors to carry on taking credit when directors are fully aware that the company won’t be able to repay these debts. Equally, if the director paid anyone ‘preferentially’ (for example a family member of particular supplier) this can also be problematic as it is to the detriment of other creditors.
Wrongful trading doesn’t mean the directors were knowingly defrauding creditors, but merely that their ignorance of due procedure resulted in the same end.
Part of the responsibilities of being a company director at to understand your legal responsibilities, including what to do in insolvency. Once an insolvency practitioner is called in, he/she has a legal mandate to investigate directorial conduct in the period preceding insolvency. It is therefore the IP (insolvency practitioner) who establishes whether there are grounds for a wrongful trading charge.
When Do Directors Become Personally Liable for the Company’s Debts?
Directors become personally liable to contribute to the company’s assets and to help meet the deficit to unsecured creditors when they decide to continue to trade and in doing so worsen the company’s finances, rather than opting to put the company into liquidation straightaway.
Put simply, the corporate veil can be lifted or pierced and all protections afforded by the veil are removed. Consequently, directors may face claims for ‘wrongful trading’ made against them personally and possibly even become disqualified for their actions.
With insolvency looming, directors should take note of the following:
· The director’s culpability is based on the information that was known or should have been known at the relevant time, and the court will consider each director’s conduct in this light.
· Person liability for company debts can also apply to non-executive directors. Even when a director only attends board meetings as he or she still has a role to play in the decisions about the company and will be judged accordingly.
· Resignation is not a solution once the issues have emerged and should only be considered if a director’s views are being ignored.
Situations which can trigger personal liability include the following:
- Overdrawn directors loan account
- When a personal guarantee document has been signed
- Evidence of fraudulent trading
- Directorial misfeasance or misconduct
- When company assets have been sold for an incorrect value
How can Directors of a Limited Company Avoid Personal Liability?
These useful tips can help to protect directors as the Court tries to underpin why decisions were taken to continue trading, as well as demonstrating that all decisions were carefully thought through.
· Directors should make careful dated notes and take minutes of all decisions and actions taken to protect the company’s creditors.
· They must have up-to-date management accounts and financial information, as well as a daily cash flow model and budgets for profit and loss.
· Directors must know the financial position of the company even when it’s not their specialism or area of interest
· They should have regular minuted board meetings to discuss the company’s position, review cash flow and take decisions to act
· Director should negotiate a Time to Pay or TTP arrangement with HMRC, a payment plan to repay tax arrears.
Personal Guarantees in Insolvency
In the event of the company becoming insolvent, lenders, banks and finance companies will pursue directors personally for company debt repayments. Directors may have decided to provide a personal guarantee in support of a loan or a line of credit for a number of reasons for the day-to-day running of the business. For instance, for a business loan or trade supply deal. Where these guarantees are given, directors are quite literally signing an agreement to say that if the business is unable to pay the money back in the future, they will.
For further guidance on personal liability for company debts, as well as more information on the impact of personal guarantees, please call 08000 24 24 51 or email email@example.com for free and confidential advice from one of our professional advisers.
Can Personal Assets of Directors be Seized From a Ltd Company?
Should your company be visited by corporate bailiffs, they are not allowed to take personal goods from the premises, in most scenarios.
The only situation where this might become a possibility is where a director has used a particular asset (or assets) as collateral for a loan. Under the terms of this finance, the creditor would then carry a legal charge of that asset, meaning it became their property in case of insolvency.
In this situation, baillifs, acting on behalf of a creditor with a legal charge, would have the right to seize those assets mentioned in the personal guarantee, but no others.
What about Shareholders Liability for Debts?
While it is common in smaller companies for directors to be the only shareholders, it is also common for ex-directors to remain shareholders. They key point with business insolvency is that shareholders can be held liable, if certain criteria apply, but only up to the value of their shareholding. Of course, any personal guarantee which may have been signed changes this, as per the intention of those documents.
Whar Consequences Should Drectors Expect if they’re Found Liable?
Once the court concludes that a director is responsible for some or all of a corporate debt, he/she has no choice but to pay it. It is by no means uncommon for directors to be forced into personal bankruptcy in these scenarios, since the closure of a business usually means cashflow is already hampered. There are, of course, debt management plans and Individual Voluntary Arrangements which are ways of avoiding this.