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Can directors be held liable for company debt?

25 Apr 2024

Written by Begbies Traynor

When running a business there are two main ways you can choose to operate; either as a self-employed sole trader, or to incorporate as a limited company.

Sole traders vs Limited company

As a sole trader, there is no legal distinction between yourself as an individual and your business affairs; therefore, any debt run up by the business will essentially be the debt of the individual. A limited company, however, is classed as its own legal entity rather than an extension of its individual directors. If a limited company, therefore, takes out a loan or other type of borrowing, it is the responsibility of the company to make the required monthly repayments to service the terms of the finance agreement.

But what happens if a limited company becomes insolvent and can no longer make the repayments on the money it owes?

What is limited liability?

In the event of insolvency, a feature of limited company incorporation known as ‘limited liability’, becomes extremely important. Limited liability means a director’s liability for company debt is limited to the value of their shares; in essence, this protects directors from becoming responsible for the debts of their limited company in the event of insolvency.

When a company is insolvent, it is likely to be the case that it will have to enter into formal insolvency proceedings in order to resolve the situation. If this involves liquidation, any debts which cannot be repaid as part of the liquidation process will die with the company and essentially be written off.

There are, however, a couple of notable exceptions to this rule which all company directors should be aware of.

Understanding personal guarantees

The most common reason a director becomes personally liable for company debts following insolvency is when a personal guarantee has been given.

Personal guarantees are often required by lenders as a condition of borrowing, particularly when the company in question is a start-up or has a limited trading history. Those companies which have defaulted on loans or other types of company borrowing in the past may also be more likely to be asked to provide a personal guarantee in order to secure any further loans.

A personal guarantee essentially makes the guarantor responsible for repaying the money borrowed should the company not be in a position to do so. When a company becomes insolvent and enters into a liquidation process, the personal guarantee crystalises and the individual who provided the guarantee will then find themselves liable to repay the outstanding balance using their own funds.

Depending on the amounts involved, repaying the balance on the personally guaranteed company loan may simply not be possible, particularly for a director who is recovering from the financial fallout of their business becoming insolvent.

In this instance directors have two main options. They can look to negotiate with the lender to come to a mutually-agreeable repayment plan for the outstanding amount owed, or alternatively, they may need to consider personal insolvency options such as an IVA or bankruptcy. The appointed licensed insolvency practitioner will be able to discuss the possible options and help to identify the most appropriate solution for directors in this position.

Personal liability due to wrongful trading

Another reason why a director may face personal liability for company debts is due to wrongful trading. When a company becomes insolvent, its directors have a number of legal duties and responsibilities, one of which is to priorities the interests of creditors and minimize any further losses.

In reality this means seeking expert insolvency advice as soon as it becomes clear the company is insolvent. Continuing to trade while the company is knowingly insolvent is a breach of a director’s duties, and can be seen as an instance of wrongful trading.

If found guilty of wrongful trading, directors can be held personally liable for the losses suffered by creditors from the moment they knew, or ought to have known, that the company was indeed insolvent.

So, while limited liability does provide a valuable element of protection to directors when it comes to personal liability, caution should still be taken when giving personal guarantees or continuing to trade while knowingly insolvent. Both actions could see you faced with a significant personal bill should the company need to be liquidated.