Can I be held liable for my company’s debts?

This is a question that directors often ponder deeply when their company is insolvent either before or after the onset of formal proceedings. And although the benefit of trading as a limited company provides limited liability status for directors because the company is a separate legal entity, there are instances where a director can be held liable for a company’s debts.

The safety net of limited liability only protects a director to a certain extent. The court can deem one or more directors liable for a company’s debts that arose before formal insolvency. The legal action, normally instigated by the liquidator, arises when it is felt that the director has undertaken any inappropriate action that has worsened the position of the company’s creditors. Such action includes :

Continuing to receive dividends as a shareholder despite the company being insolvent.
Using fraudulent methods to raise the funds needed to repay creditors i.e. obtaining financing using misleading or inaccurate information, or collecting payment for goods or services that could not be delivered.
Withdrawing and/or using company funds for non-business activity : referred to as misfeasance.
Entering into a personal guarantee and then breaching its terms.
Disposing of the company’s assets at undervalue or for no value.
Receiving an exorbitant salary and/or benefits from the company without regard to other shareholder groups.
Creating a large overdrawn director’s loan account.

Once a company has become insolvent because its debts are greater than its assets, the director has a statutory duty to act in the best interests of the company’s creditors as a whole. A director must be able to demonstrate that he has done everything possible under his control in order to ensure repayment of all creditors using the company’s resources.

A director should not take any action that would cause the company’s debts to increase without a practical plan to settle them, or leave them unpaid. Also, a director should not show any favouritism towards a particular creditor. If a director fails to meet his fundamental duties of acting in the interest of all the company’s creditors by allowing the company to trade whilst insolvent, he may well face personal liability and disqualification from acting as a director of a limited company in the future. One aspect is wrongful trading.

What is wrongful trading?

Every director has a duty to be aware of the company’s financial position at all times. If a director continues to allow the business to trade when he thinks, or know, that the company is insolvent, he may be accused of wrongful trading. Examples of wrongful trading include :

Extending lines of credit with suppliers with no obvious means of settling liabilities.
Drawing an excessive salary that the business is clearly unable to support.
Allowing the company to assume additional debt without a realistic plan to repay it.
Not paying PAYE, NIC, BAT or other taxes on time.

The ramifications of wrongful trading include financial penalties and disqualification as a director. If the liquidator can gather sufficient proof, a director can be held personally liable for company debts from the date he was, or should have been if acting responsibly, aware of the inability to repay liabilities.