Can a Former Director Be Liable for Company Debts?
In simple terms, liability in this context means ‘fault’ or ‘blame’. In practical terms, directors should be concerned about whether they might be pursued, found at fault, or deemed ‘liable’ for the debts of companies.
The starting point is that a limited company is a legal body that’s solely responsible for the debts owed by that company. This means that companies are responsible for their own debts, and directors aren’t personally liable.
There can, however, be notable exceptions, and directors must be especially cautious to avoid or know in advance the circumstances in which they can personally be pursued. This typically arises in the event of company insolvency, such as liquidation. Creditors who are owed monies will then want to consider how that has happened, and insolvency practitioners will be appointed who owe duties to the creditors to investigate and consider potential claims. These claims can even be aimed against directors personally.
For the above reasons, directors need to be cautious and aware of the risks, including to themselves.
There may be circumstances in which a director can be held personally liable to pay monies to a company. These include, most obviously, where a director owes funds to the company directly. Those monies must be repaid if the company enters into insolvency.
In small companies and businesses, it’s not unusual to have directors who are also owners, as businesses can be owned and run by the same individual. Historically, it’s been more tax-efficient to receive remuneration as dividends during a financial year rather than a salary. Dividends are only technically distributed from profits, and profits are only confirmed following the end of a financial accounting period.
To ensure directors/owners/shareholders receive a regular income, it’s also common that the owners/shareholders will receive drawings as monies on account during the financial year before the company profits are known or calculated. These are monies the company pays the owner on account of anticipated future profits. These sums are reflected against a directors’ loan account with the company.
For the majority of the financial accounting period, a directors’ loan account will be overdrawn for the year. Then, at the end of the financial accounting period, when dividends are declared, the loan from the company to the director/shareholder will be repaid on paper by/from the dividends declared. In this way, the director/shareholder regularly receives funds to live on, and the director’s loan account is repaid. This works well for profitable businesses.
Difficulties can occur, however, where funds are received on account of anticipated dividends, but the company isn’t profitable. The loans and monies the director has received are then repayable to the company. If the company becomes insolvent, any overdrawn director loan accounts and/or dividends declared inappropriately (e.g., where there were insufficient profits) can be reclaimed personally from the director/owner.
The Companies Act of 2006 and Insolvency Act 1986 set out circumstances where directors can be personally pursued. There can be other circumstances where directors are liable for company debts personally, but these carry a high degree of complexity and are very fact-dependent.
For example, where a director has allowed wrongful trading, there can be a personal liability to creditors impacted by the relevant conduct. S.214 Insolvency Act 1986 sets out that where the directors knew, or ought to have known, there was no reasonable prospect of avoiding an insolvent liquidation, there will be personal risk to them.
If directors take every step to minimize loss to creditors whilst continuing trading, the Insolvency Act provides a defense, but it’s designed to be difficult to rely on.
Directors can also be personally liable where there’s a claim against them for misfeasance. Misfeasance is a serious claim that can be pursued against company directors. It relates to circumstances in which the company is insolvent and where the directors have breached their fiduciary duties to the company and to third parties.
Misfeasance claims might be pursued directly against a director in insolvency for several reasons. These can include selling assets for less than they are/were worth, making preferences to certain creditors rather than treating all equally, concealing or removing assets, removing monies including via salary, or failing to actively address complex or negative financial situations in a Company/business.
It’s not uncommon for company directors to give personal guarantees in the course of the company business. Directors will remain personally liable in those circumstances, including after they resign. Resignation and insolvency do not terminate personal guarantees. In that case, they will remain liable until the money gets paid back in full due to personal guarantees being legally enforceable, and such guarantees have no fixed period or statute of limitations to avoid liability.
When considering all the above, directors must show they acted honestly and that any breach of duty was done unknowingly or with attempts to protect all interested parties, including all creditors.
Helix Law is a firm of specialist litigation solicitors. We work nationally and are regularly instructed to assist directors, creditors, debtors, and insolvency practitioners in the recovery of monies and funds.
