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When Is a Director Held Personally Liable for Company Debts?

Posted by Todd Davison on May 31, 2022 2:17:58 PM

While company status often offers protection to a business director, there are certain circumstances when directors may be held personally liable.

Image of businessman holding alarmclock against illustration background. Collage

This can result in you bearing responsibility for company debts should the business become insolvent.

In most cases, these scenarios are easy to avoid if you are properly prepared.

In this article, we will explore the reasons why a director may find themselves personally liable for company risk and debt, and the actions you should take to avoid this, reducing the chances that you will lose your assets or have to pay for your company’s insolvency.

Signing a personal guarantee

A company director is not personally responsible for repaying their business’ debts unless they put down a personal guarantee. Using a personal guarantee is a great way to secure necessary loans for your business, but it is, of course, risky.

A lender may ask you to place personal assets down before they approve a business loan, so your assets can be used as collateral if your company defaults on the loan.

This means that if your company finds itself in debt, you would be personally liable and you would lose your assets, which will be taken as payment for the unpaid loan.

One way you can avoid this is to take out personal guarantee insurance. With PGI you’re able to insure your assets against any potential insolvency. At Purbeck Insurance, our policy offers cover up to 80% for your personal guarantee, protecting your assets.

If my director’s loan account is overdrawn, will I be liable for business debt?

A director’s loan account, or DLA, allows directors to withdraw money from the business, that does not count towards a salary, dividend, or expense. The aim of a DLA is to work as a short-term solution for unexpected bills and should be treated as an emergency reserve rather than an account to make regular payments from.

However, whatever amount is withdrawn from a DLA is then owed back to the company.

You can withdraw up to £10,000 from your DLA, however, an issue can arise if the company becomes insolvent. Liquidators will then view the money owed as an asset, and the director responsible for making the withdrawal will then have to make the payment personally.

The best way to avoid this, is to use a DLA sparingly as it is intended, and only when absolutely necessary, as well as keeping track of the amount that has been withdrawn.

Can director misconduct cause liability for business debt?

Directors may be made liable when the company debts have accumulated through fraudulent means, these are referred to as wrongful trading.

Wrongful Trading

Wrongful trading is a term used to describe situations where a director’s actions fail to act in the creditor’s best interests when the business becomes insolvent. A director may not mean to do this purposefully. It can happen due to a misunderstanding or lack of awareness of correct procedures to follow.

If a company becomes insolvent and goes into liquidation, a director is personally responsible for taking actions to protect creditor interests. This also includes overseeing anyone else who has responsibilities within the company, such as shareholders or employees.

It is also worth knowing that even if there are multiple directors, it is not possible for one to take over and manage business issues entirely. Each director must make sure that they are taking responsible actions in consideration to the company creditors.

Actions that can be considered as wrongful trading and may land you in trouble include:

1. Dividend payments

Continuing to pay shareholders dividends while the company is insolvent is considered wrongful trading, as dividends can only be paid when there is enough funding to support the entirety of the business.

For example, if the company is made insolvent and there is an existing problem of paying employee wages, a shareholder cannot accept their company dividend as payment.

2. Making undervalued transactions

Another instance where a director may be accused of wrongful trading is when an undervalued transaction takes place. This is where a company asset is sold below its true value. The reason for making an unvalued transaction varies, but mainly it’s made in an attempt to secure a sale and recuperate funds.

If the value of an asset is diminished this is seen as affecting the creditor's returns, and a liquidator may see to it that the transaction is reversed.

3. Preferential payments to creditors

This occurs when particular creditors are chosen to be paid above others in the company.

Taking the interests of one creditor over the rest, instead of acting in the interest of all creditors equally, goes against a director’s legal duties. In this circumstance, a liquidator will state that the money has to be repaid by the creditor in order to make fairer payments.

What are the legal consequences for liable personal directors?

The legal repercussions of directors who are found to be wrongfully trading are extensive. Here are some potential consequences for directors who are held accountable:

-> Evidence of fraudulent action can result in criminal prosecution.

-> Formal disqualification from holding directorships or other roles for up to 15 years.

-> Personal liability for company debt, resulting in loss of assets and potential bankruptcy. You may also face court action by a liquidator, in which you will be liable to pay for their legal costs too.

What can directors do to protect themselves from personal liability?

All of this may seem like a legal minefield, but there are ways that you can protect yourself from becoming personally liable.

Here are the 4 ways we recommend to help you avoid personally paying for any business debt:

  1. 1. Stay well-informed of the law and maintain this vigilance as you make decisions for your business.
  3. 2. Acquire specialist legal advice, especially if you’re unsure of how your actions may affect the company, that way you can avoid taking actions that are considered ‘wrongful trading’.
  5. 3. Keep accurate records of your decision making. If you are suspected of wrongful trading, liquidators are legally required to scrutinise your actions. If you maintain records, they can be used as evidence to prove you approached certain situations correctly and that you are not personally liable.
  7. 4. Take out a personal guarantee insurance policy. This ensures that if you have used your personal assets to secure a business loan, they will be covered up to 80% if your company defaults on the loan payments.
  9. Personal guarantee insurance from Purbeck Insurance

When looking to protect your assets, you want the peace of mind that you’ve got the best, most comprehensive insurance available.

At Purbeck, we are specialists in supporting directors up and down the country, ensuring that when you secure a business loan against your assets, that you can rest assured that you are protected.

Should you have any questions, don’t hesitate to get in touch with our friendly personal guarantee insurance specialists.

Ready to apply? You can find our online application page here.

Topics: #pgi, #personalguarantee, #personalguaranteeinsurance, #commercial finance, #bankruptcy

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