As a director, am I liable for the debts of my company?

The general answer is no, a director is not liable for company debts. The purpose of a limited liability company is to shield its directors from personal liability.

This means that in the unfortunate situation where a company fails, the creditors of that company cannot pursue the directors personally for any debts due by the company.

That said, there are exceptions and it is important to know when those exceptions may arise. In this article we look at some of those exceptions.

Examples of where personal liability may arise include:

Where debts have been personally guaranteed by a director
Where an act of wrongful or fraudulent trading has occurred
Breach of the Creditors Duty
Liability for tax debts
Misuse of a Bounce Back Loan

Who is responsible for company debts?

Under English law, a company has a separate legal personality. But what does that mean in the real world?

It means, once incorporated, a company is a distinct legal person, separate from its founders, directors and shareholders. As a legal person, a company enjoys many of the same rights as a natural person: it can buy or sell property, enter legally binding contracts, sue and be sued and continues to exist notwithstanding any changes in the composition of its management or ownership.

What this means in terms of liability for a company’s debts is that it is responsible for its own debts and obligations. The debts are those of the company, not the individuals behind it.

This long standing legal principle originates from the case of Salomon v A Salomon & Co Ltd, where the House of Lords held that creditors of an insolvent company could not pursue Mr Salomon personally, despite Mr Salomon having almost total control over the affairs of the company.

This means that if a company cannot pay its debts, creditors can only claim against the company’s assets and not the personal assets of directors.

Directors do not attract personal liability simply because they are responsible for the management of the company’s business.

Major exceptions to the rules

As with all things, there are exceptions to the rule that a director cannot be held liable for the debts of the company.

Personal liability may arise in the following circumstances:

Personal guarantees

If a director personally guarantees a company debt, and the company defaults, then the director will have personal liability for the debt. This is not an exception to the rule that a company has separate legal personality. In these circumstances, the director will have assumed a direct contractual obligation to the creditor to pay the debt and the creditor is entitled to recover the debt from the director.

If you are interested in knowing more about personal guarantees, and the circumstances in which it may be possible to challenge your liability to pay, then please read our previous articles on this topic: Personal guarantees: an essential guide.

Wrongful trading

This is a statutory liability under section 214 of the Insolvency Act 1986 (“IA 1986”). It arises where a person who is, or was, a director of the company continues to trade in circumstances where they knew or ought to have known that there was no realistic prospect of the company avoiding insolvent liquidation or administration, and they fail to take every step to minimise losses to creditors.

Where wrongful trading is found to have occurred, it is open to the Court to make an order requiring the company directors to contribute personally to the company’s assets.

A director for these purposes not only includes a registered (or de jure) director, but also de facto directors and shadow directors.

An application for an order requiring a director to contribute can only be made once the company has entered into liquidation or administration. Ordinarily it will be the appointed liquidator or the administrator who makes that application, albeit it is possible for a liquidator or administrator to assign the right of action to a third party.

Given the potential risk for personal liability, directors who are concerned about the financial health of their company are strongly recommended to seek professional advice on their legal duties at the earliest possible opportunity.

Fraudulent trading

Fraudulent trading occurs where a person, including, but not limited to, a director, has carried on the company’s business with the intent of defrauding creditors or for any other fraudulent purpose. In such circumstances, it is open to the liquidator or administrator to seek an order that anyone who was knowingly a party to the fraud must contribute to the company’s assets: section 213 of the IA 1986.

The section does however, only extend to those who were knowingly parties to the fraudulent trading. The fact that the directors may have allowed the company to continue to run up further liabilities despite being insolvent is not sufficient. There need to be “actual dishonesty, involving … real moral blame”.

Misfeasance or breach of fiduciary duty

Section 212 of the Insolvency Act 1986 provides that if, in the course of a winding up, it becomes apparent that a current or former director has misapplied or improperly retained company monies, or committed some form of misfeasance or breach of fiduciary duty, then they can be ordered by the court to repay, restore or account for the money or property or to contribute to the company’s assets.

The Creditor Duty

In circumstances where a company is at risk of tipping into insolvency, the common law imposes an additional fiduciary duty on the directors to give proper consideration to the interests of potential creditors. This obligation is known as the Creditor Duty and requires directors to act in the interests of the company’s creditors rather than its shareholders.

The Creditor Duty applies where the directors know or ought to have known that the company is insolvent or at imminent risk of insolvency.

A breach of that duty can give rise to personal liability on the part of the directors to compensate the company for any losses incurred as a result.

Liability for tax debts

Since July 2020, HMRC has had the right, pursuant to section 100 and Schedule 13 of the Finance Act 2020, to order that directors and other persons involved in tax avoidance or evasion should be held jointly and severally liable for the company’s tax liabilities if there is a risk that the company may be deliberately put into insolvency.

Bounce Back Loans

Directors are not generally personally liable for Bounce Back Loans (“BBLs”) taken out by their company. These loans were ultimately underwritten by HM Government and therefore the banks have a means of recourse in the event of default.

The exception is where a BBL has been misused. While BBLs were available for a wide variety of uses aimed at supporting businesses during the Covid-19 pandemic, they could not be used for personal use.

Where a BBL is found to have been used for a non-business related purpose, then the directors may be required to personally repay the BBL from their own assets. In addition, the director also faces the risk of disqualification.

Conclusion

Operating a business through a limited liability company offers many advantages, including inserting a protective barrier between the company and its directors. It ensures that a director’s personal liability is limited to the amount they have invested into the company and they will not be liable for the debts of the company.

However, there are exceptions and directors need to be aware of the circumstances in which those exceptions may potential arise.

If you are a director and find yourself a party to a claim, then it is important that the claim is not ignored and you seek professional advice as early as possible. Morr & Co LLP has extensive experience of dealing with all forms of company related disputes. If you need assistance, please contact us.

How can Morr & Co help?

Personal guarantees carry significant risks and understanding their terms is crucial both before signing and when facing a claim.

If you have any concerns or questions, please do not hesitate to reach out by calling our Dispute Resolution team on 01737 854500 or email info@morrlaw.com

As a director, am I liable for the debts of my company?

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