As a director of a limited company, you’re protected from that company’s debts affecting you personally. This is because, as the company’s director, its limited liability protection separates that company’s finances from your personal finances.
This protection covers most situations, but there can be instances where limited liability protection can be bypassed, making you personally liable for the company’s debts. In your time as a director, you should take steps to make sure you run the company in a way that benefits its best interests. This can help avoid scenarios where you could be held liable for its debts. Even if you do find yourself personally liable, you can still take steps to minimise its impact.
Personal liability and company insolvency
While directors’ limited liability protection protects you from personal liability in most cases, the circumstances where that protection could be bypassed can include, but are not limited to:
- Any personal guarantees
Personal guarantees can help secure funding, especially during the business’ initial start-up stages. If you’re unable to repay the loaned amount, these guarantees become enforceable (or crystallise), bypassing the limited liability protection and making you personally liable. - If the company has traded whilst insolvent
If you continue trading while knowing that your business can’t meet the new or existing liabilities, then it could be trading whilst insolvent. This worsens your standing with creditors and can lead to you being accused of wrongful trading, trading whilst insolvent, or fraudulent trading. - The company has an overdrawn Directors’ Loan Account
When a company is solvent, as a director, you can borrow money from it and repay it through a Directors’ Loan Account. Failure to repay this can lead to your Directors’ Loan Account becoming overdrawn. While this isn’t necessarily a problem when the company is solvent, if it enters a formal insolvency process, that overdrawn account is considered a company asset, and if you don’t repay it, you could be held personally liable for that amount.
While the above applies to directors of limited companies, they don’t apply to sole traders. Sole traders and their businesses are one and the same, legally speaking.
In those situations, or if your limited liability protection is bypassed, you could face the following consequences:
- Bankruptcy
When the business’ debt becomes your own, it may, understandably, be harder to repay without the company’s funds. This could end in you having to file for bankruptcy.
- Bans from acting as a director
If you acted outside of the company’s best interests, including that of its creditors, in your time as a director, and you’re found to have committed wrongful trading, trading whilst insolvent, or fraudulent trading, you could face a director’s ban of up to 15 years. - Criminal charges
In addition to director bans, if you broke the law in your time as a director, especially if that involved defrauding customers and creditors, you may face criminal charges for these actions.
Preventing personal liability if your company becomes insolvent
The best way to prevent personal liability in insolvency is to act in your company’s best interests as its director. While this won’t automatically prevent your company from becoming insolvent, it can put you in a better standing if that happens.
If your business ever becomes insolvent, regardless of how you acted leading up to and during the period of insolvency, you will still have to contact a licensed and regulated insolvency practitioner (IP). These professionals can assess your business’ situation and advise you of the best route forward depending on your business’ circumstances:
- Company Voluntary Arrangements (CVAs)
Wherein the company repays its debts in affordable instalments via a formal repayment arrangement. While you can’t enter a CVA as a sole trader, you could apply for an Individual Voluntary Arrangement (IVA).
- Company Administration
The insolvency practitioner looks into the company’s internal affairs and tries to restructure it to a profitable state, or to make it more appealing to potential buyers. - Creditors Voluntary Liquidations (CVLs)
The insolvency practitioner closes the company, ending its operations, realising its assets, and preventing further creditor action. Once complete, any remaining unsecured debts are written off and, if you’ve acted in the company’s best interests, you can walk away and start afresh.
To summarise
Limited company directors’ personal finances are protected from that company’s thanks to limited liability protection. If your company is insolvent, this can prevent the insolvency from affecting you personally. This protection can be bypassed if you act outside of the company’s and its creditors’ best interests, leaving you at risk of personal liability for the company’s debts. Unfortunately, sole traders don’t have this benefit as they and their company are the same legal entity.
If your business does become insolvent, you should speak to a licensed insolvency practitioner for advice tailored to your situation, and to reduce the risk of longer-lasting consequences.
