Although you’d hope it would never come to pass, many limited companies end up becoming insolvent due to incurring amounts of debt that are greater than the sum of their assets. Can their directors be held personally liable for the situation, though?
In legal terms, they can’t be held liable, but creditors and suppliers might well look to make them personally responsible for paying any debts owed. It isn’t always a simple matter to resolve.
What is a limited company?
It’s important to define exactly what a limited company is. Unlike a sole trader or a partnership, a limited company, which has shares either traded privately or publicly on the London Stock Exchange, has its own legal status. The owners of a business do not necessarily run the business on a day-to-day basis – instead, directors are responsible for ensuring that the company is responsibly run.
- Company limited by shares – company directors aren’t personally responsible for debts that can’t be paid if the business becomes insolvent as long as they haven’t broken the law in their running of the business.
- Company limited by guarantee – does not usually have a share capital or shareholders, but instead has members who act as guarantors. The guarantors give an undertaking to give a nominal amount (typically very small) if the company faces winding up.
When might a director be liable for a limited company’s debts?
In terms of the director actually having to pay the company’s debts, this should only be a possibility if the debts incurred are greater than the company’s assets and if the director is proven not to have acted responsibly before, during and after the insolvency process. Shareholders receive any surplus money from the sale of the assets.
A director is liable for a company’s debts if he or she continues to allow the company to trade after it has become clear that insolvency is imminent. This is irresponsible and classed as “wrongful trading.” The information which was or should have been known by that person in that position at that time determines a director’s culpability. This means, as an example, that an experienced director operating in the background has a greater responsibility than less experienced directors who may have played a more significant role.
Some of the ways in which a director might be found to have not acted in the company’s interests include:
- Lying to creditors
- Paying shareholder dividends while the company is insolvent
- Using fraudulent methods to raise the funds needed to repay creditors (e.g. collecting payment while knowing goods or services could not be rendered or obtaining more credit knowing that you can’t realistically pay it back)
- Breaching the terms of a newly-agreed personal guarantee
- Selling the company’s assets below their market value
If a director is found guilty of failing to act in the interest of all the company’s creditors, he or she is likely to face more severe personal liabilities, including disqualification from acting as a director of a limited company for up to 15 years.
If making applications to a bank or other financial lender (which is usually the case) for credit, that lender tends to need a personal guarantee from one or all the company’s directors. If the company cannot repay all or part of its debt to the lender, the director(s) is personally held responsible.
Additionally, suppliers can claim for personal repayments when a company goes into liquidation. They will include this as part of their terms and conditions on contracts and other official paperwork so directors are aware paying off any amount the company owes the supplier is their responsibility.