Can directors be held liable for company debts?

When a limited company becomes insolvent, directors are not typically held personally responsible for the outstanding debts of the business. This is because the limited company legal structure protects directors from personal liability in relation to business debts through what is known as 'limited liability'.

There are certain situations, however, where directors can be ordered to provide financial compensation to creditors for the losses they have suffered. This may occur when a director is found guilty of wrongful trading, which is continuing to trade while knowingly insolvent and exposing creditors to further financial losses in the process.

“The biggest concern of directors who call us is the issue of personal liability. These concerns range from directors who are unaware of the scope of limited liability, to others who focus on specific debts such as those secured with a personal guarantee. Personal liability is one of the first things we discuss with directors, ensuring we give them the full picture and helping them understand their situation right from the start.”
- Julie Palmer, Partner, BTG Begbies Traynor

Understanding personal liability for company directors

When a company becomes insolvent and subsequently enters liquidation, the appointed insolvency practitioner is required to undertake an investigation into the actions and conduct of the company's directors in the time leading up to it becoming insolvent.

Being able to demonstrate that creditor losses have been minimised once directors knew - or ought to have known - that the company was insolvent, is a key issue when it comes to directors potentially facing personal liability for company debts.

When do director duties shift during insolvency?

When a company is solvent, your primary duty as a director is to act in the best interests of the company and its shareholders. However, when a company is insolvent, or when insolvency becomes likely, this duty shifts. When insolvent, directors must shift their interest to protecting the position of creditors.

This shift is critical because it changes what you can and cannot do with the company’s money and assets. Decisions that would be perfectly reasonable when the company is trading well, such as paying yourself a dividend, investing in growth, or taking money from the company, can become grounds for personal liability once the company is in financial difficulty.

“Many of the directors we speak to don’t realise that their legal obligations change the moment insolvency becomes a realistic prospect — not just when it actually happens. Understanding when that line is crossed is one of the most important conversations we have.”
- Julie Palmer, Partner, BTG Begbies Traynor

When might a director be held liable for company debts?

Antecedent transactions

Of particular interest to the liquidator during their investigations are antecedent transactions. These are transactions that have worsened the position of a creditor, or group of creditors.

They include:

• Preferential payments: when one creditor is paid in favour of others, it creates a ‘preference’ - the recipient may be required to repay the money.
• Transactions at an undervalue: if an asset has been sold for less than its true value, it diminishes returns for creditors and may be reversed by the liquidator.
• Fraudulent trading: trading with the intent to defraud creditors; 'intent' must be proven for a case to be made against the director.

Other types of transactions of particular interest to the insolvency practitioner are:

• Overdrawn director’s loan account: an overdrawn director’s loan account will be considered an asset of the company in liquidation, and subject to immediate repayment by the director.
• Personal guarantees: if personal guarantees have been provided, the lender may enforce the guarantee to recover their money. Failing to repay a personal guarantee will be considered a breach of its terms. Of the directors we speak to about personal liability, personal guarantees are the most frequent source of genuine exposure as many directors signed them years ago and have forgotten the terms.
• Unlawful dividend payments: dividend payments are only lawful when there are sufficient distributable profits available to support them, so drawing a dividend when the company is insolvent is likely to lead to a demand for immediate return of the payment(s) in full.

Can HMRC hold me personally liable for company tax debts?

In most cases, company tax debts such as VAT, PAYE, corporation tax, are the company’s liability, not yours personally. However, HMRC has two specific powers that can change this:

• Personal Liability Notices (PLNs) — If HMRC believes a director has intentionally or recklessly failed to ensure the company pays its PAYE, National Insurance, or Construction Industry Scheme deductions, they can issue a PLN making the director personally responsible for the outstanding amount.
• Joint and Several Liability Notices (JLNs) — Introduced in the Finance Act 2020, JLNs allow HMRC to make directors jointly and severally liable for certain tax debts, particularly where there is a pattern of repeated insolvencies (sometimes called ‘phoenixism’). Where the company no longer exists, the director becomes solely responsible for the relevant debt.

For a detailed guide to JLNs and what they mean for directors, see our article on Joint and Several Liability Notices.

What we typically see

A director of a retail business contacted us after receiving a letter from a creditor threatening to pursue them personally for a company debt of approximately £120,000. The director believed they were personally liable and was considering selling their home. After reviewing their position, we established that the debt was an unsecured company liability with no personal guarantee attached. The director had limited liability protection and was not at risk of personal claims. The company subsequently entered a Creditors’ Voluntary Liquidation, and the director’s personal assets were not affected.  This is a scenario we see regularly where directors assume the worst before understanding their actual position. In many cases, the reality is far less severe than they fear.

What are the consequences of being held responsible for company debts?

If a director is made liable for some or all of the debts of the company, they will be required to use personal funds or assets to settle the amount owed. If this cannot be done, the director may need to consider a form of personal insolvency, such as bankruptcy to deal with the matter.

As well as being held responsible for company debts, directors can also be disqualified from acting as the director of a limited company for a period of up to 15 years. A disqualification order may also bar the individual from taking on certain roles, such as trustee of a school or charity. If fraudulent activity is proven, directors face a criminal conviction and a possible prison sentence.

How to protect yourself as a director from personal liability

1. Seek advice at the first signs of financial difficulty. Don’t wait until insolvency is certain. The earlier you speak to a licensed insolvency practitioner, the more options you have and the easier it is to demonstrate that you took your duties seriously.
2. Keep clear records of all decisions. If the company’s conduct is later investigated, you’ll need to show that your decisions were reasonable and made with creditor interests in mind. Board minutes, financial records, and professional advice notes are all important.
3. Review any personal guarantees you’ve signed. Many of the directors we speak to don’t have a clear picture of what they’ve personally guaranteed. Check the terms, the amounts, and whether they’re still enforceable before a lender tries to enforce them.
4. Don’t pay yourself or preferred creditors ahead of others. Preference payments and unlawful dividends are two of the most common routes to personal liability. If the company is in difficulty, don’t withdraw money, pay off friends or family, or declare dividends without professional advice.
5. Check your directors’ loan account. If it’s overdrawn, it will be treated as an asset in liquidation and you’ll be required to repay it. For more detail, see our guide to overdrawn directors’ loan accounts.

If you’re worried about being held personally liable for your company’s debts, you’re far from alone, in fact it’s the most common concern raised by the directors we speak to. In many cases, the situation is less severe than you might think, but the only way to know for certain is to get a professional assessment of your position.  Call your nearest BTG Begbies Traynor office to arrange a free, confidential consultation. We’ll review your personal exposure, explain where you stand, and set out the options available to you.