How limited companies protect their directors’ personal finances
A question we’re often asked by worried directors concerns their personal financial liability in the event of an insolvency or a liquidation.
They are rightly concerned with their own exposure and potential for personal financial ruin. They might well worryingly ask “if my limited company goes under, could I lose everything?”
It’s a valid concern and not necessarily an overblown one depending on individual circumstances.
We’ll explore when and how directors could be held personally responsible for their company’s debts and what steps they can take to protect themselves.
Veil of incorporation
The most important thing to understand about limited companies is that, unlike sole traders or partnerships, they are separate legal entities from their owners.
This separation is the key to a director’s independence and protection if the business fails.
The business is responsible for its own debts, not the owners or directors so if they fall into arrears and cannot be paid, they will stop at the limited company. If it is closed in a creditors’ voluntary liquidation process then its outstanding debts are written off and die with the company – they don’t follow the directors.
However, the “veil” of incorporation isn’t bulletproof and there some instances – if a director were proven to have acted fraudulently, recklessly or negligently, then the veil could be lifted and a director could be held personally liable for company debts.
When a business goes into an insolvency process, administration or liquidation, a liquidator is appointed.
Their job is to investigate the directors’ actions to understand why the company failed and whether there was any wrongdoing or any further grounds of investigation are warranted.
Investigatable actions
Among the kinds of actions that a liquidator would take an interest in would be:-
- Fraudulent or reckless behaviour – lying to or deceiving creditors or taking on additional debt when a director knows (or should know) that the company couldn’t reasonably repay it could make them personally liable for this and any other debt accrued under these conditions
- Preferential payments – This is if a director favours one creditor over others or pays them before others especially if they’re a family member or someone who holds a personal guarantee for a loan. Making preferential payments could see a director being held personally financially liable for them from other creditors if outstanding debts remain
- Transactions under value – This is where company assets and stock are sold at unrealistically low prices to the director personally, another company they control or to their relatives or other connected parties. By doing this, they are depriving the company and creditors of funds they should rightfully have.
All of these actions can be investigated up to two years after a company has gone into insolvency or even closed.
When can a director face personal liability?
The three most common scenarios when a director will could face having to use their personal finances to repay creditors of their insolvent business are as follows:-
- Fraud – if the liquidator finds evidence of fraudulent activity committed by the director or negligence (not knowing about fraudulent activity at the business that they should reasonably be expected to have been aware of) then they could expect to become liable
- Overdrawn director’s loan accounts – In this instance the director will essentially owe money to the company. They may have borrowed the money or taken dividends when there weren’t enough profits to justify them doing so. If the company goes into liquidation then they would be liable to repay the money from their own funds.
- Personal guarantees – this is one of the most common ways a director could open themselves up to personal financial jeopardy. Several banks and other lending institutions require directors to provide personal guarantees in order for them to lend. In the event that the business does go into liquidation then the onus on repayment will then fall on them personally.
Chris Horner, insolvency director with BusinessRescueExpert, said: “While it’s true that directors’ disqualifications have increased in the past couple of years, there’s specific and predictable reasons for that.
“The Insolvency Service are investigating more directors who are thought to have abused Bounce Back Loans and other Covid support measures offered by lenders and backed by the government in 2020 and 2021.
“Directors of companies that have gone into administration or liquidation that have fulfilled their directors’ duties and done their best to steer them in the right direction will realistically have little to worry about from an investigation.
“The liquidator will be looking for obviously illegal behaviour but understands that business failure and restructuring is a natural part of the business cycle and wants to piece together a story of what happened rather than look for culprits or blame when in reality there are neither.”
If you’re the owner or director of a business that is facing difficulties then please get in touch with us today to arrange a free initial consultation with one of our expert advisors.
They will be able to let you know what your options are depending on your unique circumstances, possibly including more than you might think you have if you make contact early enough in the process.
Hopefully we’ll speak to you soon.