Summary
- Limited liability generally protects UK company directors from personal responsibility for company debts, but this protection falls away in specific circumstances including personal guarantees, wrongful trading, fraudulent trading, breach of director duties under the Companies Act 2006, authorising unlawful dividends, trading whilst disqualified, and preference payments or transactions at undervalue.
- Wrongful trading under the Insolvency Act 1986 arises where a director continued trading after knowing, or ought to have known, that insolvent liquidation was unavoidable; directors can minimise exposure by seeking professional advice, ceasing to incur new debts, and placing the company into administration or liquidation promptly.
- Fraudulent trading is more serious than wrongful trading, requiring proof of dishonest intent, and can result in an unlimited personal contribution to the company’s assets as well as criminal liability including imprisonment.
- This article is a plain-English guide to personal liability for company directors in the UK, prepared by LegalVision, a commercial law firm.
- LegalVision specialises in advising clients on corporate governance, director duties, and insolvency matters.
Tips for Businesses
Monitor your company’s financial position regularly and seek professional advice as soon as financial difficulties emerge – acting early is the most effective way to avoid wrongful trading liability. Keep accurate financial records at all times, as liquidators will scrutinise director conduct when a company enters insolvency. Review any personal guarantees you have signed and understand the extent of your exposure under each. Never authorise dividend payments without confirming the company has sufficient distributable profits.
One of the main benefits of running a business through a limited company is limited liability. A company is a separate legal entity, which means it is responsible for its own debts, not its directors or shareholders. However, this protection has limits. In some situations, directors can be held personally responsible for company debts. This article outlines the circumstances in which company directors can be held personally liable for company debts, despite protection by limited liability.
The General Rule: Limited Liability
In most cases, if your company cannot pay its debts, creditors can only claim against the company. Your personal assets, such as your home, savings and other property, are usually protected. This is one of the main benefits of running a business through a limited company instead of as a sole trader.
A company is responsible for its own debts. If it cannot pay what it owes, it may become insolvent and be wound up. In most cases, shareholders only risk losing any unpaid amount on their shares. Directors are separate from the company and are usually not personally responsible for a company’s debts.
When Personal Liability Arises
Despite general protection by a limited liability company, there are specific situations where the corporate veil can be pierced, leaving directors personally exposed.
1. Personal Guarantees
The most common way directors become personally liable is through personal guarantees. When a company borrows money or enters into certain contracts, lenders and landlords often require directors to sign personal guarantees. This is a contractual agreement where you promise to repay the debt if the company cannot.
2. Wrongful Trading
Under the Insolvency Act 1986, directors can be held personally liable if they continue trading after they knew, or should have known, that the company had no realistic chance of avoiding insolvent liquidation.
To avoid wrongful trading liability, you should take every step to minimise potential loss to creditors once insolvency becomes inevitable. This might include:
- seeking professional advice;
- ceasing to incur new debts; or
- placing the company into administration or liquidation.
3. Fraudulent Trading
The Insolvency Act 1986 also deals with fraudulent trading, which is more serious than wrongful trading. Fraudulent trading happens when a company continues to operate with the intention of deceiving creditors or for another dishonest or fraudulent purpose.
Fraudulent trading is harder to prove than wrongful trading because it requires evidence that the directors acted dishonestly. However, the penalties are much more serious. A director found guilty can be ordered to make an unlimited contribution to the company’s assets and may also face criminal charges, including a prison sentence.
4. Misfeasance and Breach of Duty
Directors owe various duties to their company under the Companies Act 2006, including:
- duties to act within their powers;
- promote the company’s success;
- exercise independent judgement; and
- exercise reasonable care, skill, and diligence.
If you breach these duties and cause loss to the company, you can be held personally liable.
When a company enters insolvency, liquidators often investigate directors’ conduct and may bring misfeasance claims to recover losses for creditors.
5. Unlawful Dividends
Directors who authorise dividend payments when the company lacks sufficient distributable profits can be required to repay those dividends. This is particularly relevant when a company later becomes insolvent, as such payments may have depleted assets that should have been available to creditors.
6. Trading While Disqualified
If you act as a director while subject to a disqualification order, you become personally liable for the company’s debts incurred during that period. Director disqualification can arise from various forms of misconduct, and the consequences of breaching a disqualification order are severe.
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6. Preference Payments and Transactions at Undervalue
In the period leading up to insolvency, certain transactions can be challenged by liquidators. If a director benefits from a preference payment or transaction at an undervalue, they may be required to return the benefit to the company’s estate.
Protecting Yourself
The best protection against personal liability is good governance. You should keep:
- accurate financial records;
- monitor the company’s financial position regularly;
- seek professional advice when difficulties arise; and
- act in the company’s best interests at all times.
This guide will help you to understand your corporate governance responsibilities as a director, including the decision-making processes
Key Takeaways
The corporate veil generally protects directors from personal liability for company debts, but this protection falls away in specific circumstances including personal guarantees, wrongful or fraudulent trading, and breach of director duties. When insolvency looms, the critical question is whether you took every reasonable step to minimise creditor losses.
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Frequently Asked Questions
Can I be personally liable for company debts if I resign as a director?
Resigning as a director does not automatically release you from personal liability for debts incurred whilst you were in office. If you signed personal guarantees, these remain enforceable unless the creditor agrees to release you. Similarly, if wrongful or fraudulent trading occurred during your tenure, you can still be pursued after resignation.
What happens if my company cannot pay its debts and I have not signed any personal guarantees?
If you have not signed personal guarantees and have acted properly as a director, your personal assets should be protected by limited liability. However, a liquidator will still investigate your conduct to ensure you have not engaged in wrongful trading, fraudulent trading, or breached your director’s duties. Provided you have acted responsibly and within the law, creditors cannot pursue you personally simply because the company is insolvent.
Can directors be disqualified for wrongful trading?
Yes. Courts can disqualify directors for wrongful trading and other misconduct. Disqualification periods can range from two to fifteen years, and acting as a director during disqualification makes you personally liable for all debts incurred in that period.
What is the difference between a director and a shadow director?
A shadow director is someone whose instructions the board habitually follows, even without a formal appointment. Shadow directors can face the same personal liability as appointed directors, including wrongful trading and misfeasance claims, under Australian corporations law.
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