Personal Liability And Insolvency: When Can I Be Personally Liable For Company Debts?July 24, 2020
If your company is facing insolvency, as a company director you may be wondering when you could have personal liability for its debts.
Normally, one of your most important duties is to act in the best interest of your company.
However, when a company is unable to pay its debts, the director needs to act in the best interest of the creditors, meaning that the director should not act in a way that increases the company’s debt or should not favour one creditor to the detriment of another.
As a director, you could be personally liable and/or disqualified from being a director for up to 15 years if it is discovered that you failed to fulfil your duties and did not act in the best interest of the creditors.
You could be held personally liable for your company’s debts in the following instances:
- Having a director’s loan account
- Paying unlawful dividends
- Making preference payments
- Making transactions with undervalue
- Unpaid share capital
- Any kind of fraud
What is a liability?
A liability is a monetary obligation the company has; it is usually a debt owed by the company and appears under different forms (bills, invoices, interest, bank loans etc).
When choosing to incorporate a limited company, a separate legal entity is created, with a clear distinction between the company and its directors and shareholders.
This means that in most cases, the company director or the shareholders are not held personally liable for the company’s debts. If the company fails, you will lose what you invested in the company.
We will now cover each situation when a director could face personal liability for the company’s debts:
- Having a director’s loan account – as a director, if you take money from the company, other than expenses, salaries and dividends, you should record the exact amounts you owe the company and pay it back. Should the company become insolvent, the director’s loan account is considered an asset and must be returned to the company.
- Unlawful dividends – a dividend is unlawful when the company does not hold enough profits to cover the number of dividends paid, otherwise known as ‘distributable reserves’. In these circumstances, the directors ought to know that it is not in the best interest of the company to pay a dividend when there are insufficient reserves to cover the dividend.
- Making preference payments – A preference payment occurs when a company favours one creditor over others, to the detriment of the other creditors. We wrote an article on this topic here.
- Making transactions with undervalue – this happens when assets belonging to the limited company are sold or gifted for an amount lower than their value. Should the company become insolvent, these transactions could be overturned by the liquidator or administrator.
- Unpaid share capital – this means that the issued shares have not been paid. This usually happens in smaller companies. In the case of an insolvent company, the shareholders will be asked to pay their shares.
- Any kind of fraud – This situation is similar to making transactions with undervalue, both having the purpose of putting assets out of the reach of creditors. When it comes to defrauding the creditors, the liquidator will look for certain aspects of the presumed fraud, mainly for the intention to defraud creditors. In most cases, the intention could be proven by timing and circumstances of the transactions.
What are the consequences of having personal liability for your company’s debts?
If you find yourself in one of the situations detailed above, you might be expected to pay your company’s debts as if they were your personal debts.
Should the directors have no assets to be held liable for the business’s debts, they would need to explore other options, including personal bankruptcy.
If you need more guidance, get in touch with Hudson Weir today. We’re more than happy to talk you through anything related to insolvency and administration.