If you’re facing spiraling business debts you might be wondering if you, as director, could be personally liable to pay them.
The answer is dependent on a few different factors which we will cover in detail below. Starting with the most important…
How the Business Is Structured Matters
When a business is set up, directors must choose between becoming a sole trader, partnership, or private limited company. Here is how each structure affects liability for business debts:
If a director decides to operate as a sole trader, they and the business are legally considered the same entity. There are pros and cons to this. While all the business earnings are theirs to do with as they please, they are also personally responsible for all unpaid business debts.
So if the business runs out of money and is unable to repay creditors, the director will need to use personal funds to resolve this. If they can’t pay, creditors are able to take personal assets to recover the money owed.
There are two types of partnerships in the UK; limited partnerships and limited liability partnerships.
In a limited partnership, ‘general’ partners can be held personally liable for all of the partnership’s debts. ‘Limited’ partners are only liable for the amount they invested in the business.
In a limited liability partnership, none of the partners are personally liable for business debts. As above, they are only liable for the amount they invested.
Private Limited Companies
Private limited companies are their own legal entity. They offer the most protection to shareholders and directors because no individual is personally liable for the debts of the company. But there are exceptions to this rule.
Here’s When a Director May Find Themselves Liable for Company Debts:
You Signed a Director’s Personal Guarantee
Personal guarantees are a security measure used by financial institutions and other lenders; another way to guarantee that the money loaned will eventually be repaid.
Directors sign personal guarantees all the time. They do this to secure extra funding, rent office space, hire equipment or buy goods from suppliers on the account. But, if the business becomes insolvent and is unable to pay these debts, the director becomes personally liable for them. This means using their own assets to clear the debt.
You Failed to Act in the Best Interest of the Company’s Creditors
When a company goes into liquidation, its directors are investigated by an insolvency practitioner. Directors have a legal responsibility to act in the best interest of the company’s creditors during insolvency. This essentially means doing everything possible to ensure debts continue to be repaid.
A director must not do anything that causes debts to increase or go unpaid nor should they show favoritism towards a particular creditor.
Directors who fall foul of any of this face serious consequences, including being made personally liable for company debts.
Overdrawing From the Director’s Loan Account
A director’s loan account allows directors to extract money (that isn’t a salary or a dividend) from the business. If they never take money out of the business or put in more than they take out, the loan account balance will be at zero (or in credit). But, if they take out more than they put in the loan account becomes overdrawn and this is where issues can arise.
When a business becomes insolvent, the director’s loan accounts are considered an asset. Assets are used to pay off creditors. If the loan account is overdrawn, directors are expected to pay back the money they have borrowed. The problem becomes very complicated if the director cannot pay it back. If you find yourself in this position seek expert advice immediately.
The Consequences of Being Liable for Company Debt
Company debts can be significant and they must be paid. If a director is found liable, they must do what they can to personally repay them.
This could include selling assets, remortgaging their home, or using savings. But if none of this is an option, and the director is unable to repay debts, they can be forced into bankruptcy by their creditors. Some directors may even choose to declare themselves bankrupt in extreme circumstances.
Furthermore, if a director is made liable because they failed to act quickly and properly during insolvency, they may be barred from being a director for up to 15 years.
The issue of personal liability can seem complicated and cause great worry but the majority of limited company directors are not responsible for business debts. If you acted in the best interests of the business, repaid any loans from the company, and have not signed any personal guarantees, you can rest easy.
If you have any concerns about your personal liability, talk to an insolvency practitioner for advice.
liability concept -DepositPhotos