Are Directors Ever Responsible For Company Debts?

In the UK we have two types of limited company – Private Limited Company (denoted by LTD after its name) and Public Limited Company (denoted by PLC).  We also have Limited Liability Partnerships (LLPs).  You may also have heard the term Limited Liability Company (LLC), but this is a US business structure and does not exist in the UK.  The vast majority of companies in the UK SME sector (Small and Medium Enterprises) are Private Limited Companies.

As a director of a limited company – either public or private – your liability for the debts of the company are normally limited to  the face value of your shareholding unless you have signed personal guarantees to render yourself personally liable for a particular debt of the company – for example, an overdraft facility with the company’s bank.

What Is ‘Limited Liability’?

The term ‘limited liability’ does not just relate to trading debts accrued by a company, it also applies if your business is sued.  As directors, or partners in the case of an LLP, your personal assets are protected.  However, depending on the circumstances, a director or partner could potentially face personal litigation, which can be brought outside the protection of the corporate structure.

The responsibilities of a director are set out in the Companies Act 2006 and, potentially, any breach of these requirements and responsibilities could give rise to personal litigation or criminal prosecution. It is therefore imperative that you discharge your duties as a company director in diligent fashion, always being mindful of your duty of care to the Company and your legal obligations under the Companies Act 2006.

So When Is A Director Personally Liable For A Company’s Debts?

Providing a director can be seen as having always acted in the best interests of the company and within the letter and spirit of the law as laid out in the Companies Act 2006, he or she should never be liable for any more than the face value of the shares they hold in the company.  The exception to this rule is where the director has voluntarily signed to personally guarantee a specific debt – for example, a bank loan, finance agreement, overdraft facility or supplier agreement.

Where personal guarantees have been given by more than one director, they may well be given under ‘joint and several liability’.  This means that if there is only one director who has realisable assets, he or she could find that the creditor (for example the company bankers) will seek repayment of the full amount of the debt rather than merely a proportionate amount.

Wherever possible a director should refrain from giving personal guarantees, but it must also be recognised that failing to provide a personal guarantee will, in many instances, result in failing to secure the funding that the company requires.

A director can also be deemed as being personally liable for a company’s debts if it can be shown that the director’s actions have led to the company trading fraudulently or whilst insolvent.  There are also many other potential scenarios whereby a director could be held personally liable under legal actions brought for matters ranging from misrepresentation to tort (civil liability for a wrong doing) and breach of duty.

Equity Stake or Loan?

This is a dilemma that most  directors of private limited companies will face at some point if they want to expand and grow their business.  Unless you are very fortunate, and are able to grow your business purely through reinvestment of profits, it will probably need capital investment at some stage in order to expand.  Whether that investment is by way of a loan (probably subject to personal guarantees) or by way of an equity stake (which will probably dilute your holding in the company) is a decision not to be taken lightly.

If you are looking to ensure that you are never in a position where you could become liable for the company’s debts then the equity stake is probably your only option, as you would otherwise be personally guaranteeing the loan, unless the company owned significant assets that on their own would provide suitable security for the loan.  Even so, banks and other specialist lenders are notorious for taking a ‘belt and braces’ approach which will require the company directors to not only provide specific assets as security, but will ask for an all encompassing debenture and fixed and floating charge over all the company’s assets as well as personal guarantees from the directors.

On the other hand, if you are confident of your ability to successfully grow your business, and have contingency plans in place in the event of unforeseen circumstances (like a pandemic!), then you are justified in questioning why you should give up a significant stake in your company when you have worked so hard to get it to this stage – only for someone else to take a large slice of the resultant future profits.  But then again, a 50% holding in a profitable company is better than owning 100% of a company that is making a loss and has the potential of personal financial ruin if everything goes pear-shaped!

Think About How Much You Can Afford To Lose!

Running a business is not too dissimilar to gambling.  It can become addictive; you can lose a lot of money, you can win a lot of money or you can spend a lot of time and effort just struggling to break even!  The key is to ensure that you never risk more than you can afford to lose – whether that is in gambling, in life or in business.  Always err on the side of caution and don’t be afraid to seek professional assistance.  Too many people see asking for help as a weakness – it’s not, it’s commonsense!

A Business Consultant can take an objective view and help you to make an informed decision based upon facts rather than emotions.  These facts will include advising of the likelihood of you being held personally responsible for the company’s debts and liabilities and will also address ways to mitigate this.  Forewarned is forearmed, as they say, and it is no good becoming wise after the event.

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