Many directors believe that they are personally liable for their limited company's debts if the business was to fail or become insolvent - BUT this could not be more wrong! It is important to remember the company’s debt belongs to the company. However, there are some exceptions which are addressed below.
Firstly...what are liabilities?
Liabilities are sums of money or debts owed by a company. It can take the form of unpaid rent, unpaid invoices, hire purchase agreements, loans and asset finance.
'To be liable' means you/the company are responsible for the repayment of such sums.
Circumstances when a Director can be held personally liable
Many directors arrange personal guarantees with landlords and creditors in order to acquire loans and funding. However, if payments cannot be met, the director is personally liable for covering the shortfall. This would affect a personal credit rating if he/she is unable to pay and ends up going bankrupt or goes into an IVA. This could mean that you will lose your home or other personal possessions.
Overdrawn Director’s Current Account
If a company is doing well, directors can pay themselves a small salary and withdraw dividends from profits. They are charged at a low tax rate of 7.5% for dividends up to £46,351 and 32.5% above that level, the idea being that it incentives and rewards directors for making profits.
If the company starts to struggle financially and the director(s) continue to withdraw dividends, this is where problems begin. The tax rate effectively becomes higher yet many directors do not realise this, so they continue withdrawing dividends. By being taxed too little, they are essentially therefore in debt to HMRC. This pattern can spiral out of control and eventually produce a large overdrawn directors’ loan account. If the company becomes insolvent, the director will likely be ordered to pay back everything they owe to creditors, making them personally liable for the debt. However a deal can be done with the insolvency practitioner depending on the circumstances.
Partnernships and Sole Traders
The partnership structure is completely different to that of a limited company. If you trade as a partnership, the business’s debt becomes your debt and you are personally liable if the business gets into financial trouble. By having to pay off the debt from your own savings and investments, your own financial situation and credit rating will be harmed. In some cases, individuals have had to declare bankruptcy because they are unable to afford the partnership’s debts.
Similarly, when you run as a sole trader, you are seen as legally equal to your entity hence become personally liable for any unpaid debts. This tends to be why many people prefer running limited companies or limited liability partnerships, where there are 'less strings attached'.
Using Fraudulent Means to accumulate debts
This can be from obtaining finance from inaccurate information, accepting payments for goods which you know will not be delivered or failing the obligation of upkeeping accurate company accounts.
Disposing of company assets below their market value
If you are not personally liable for the debts of your company, you have much less to worry about if the company becomes insolvent. All that needs to be recovered here, is the monies owed to creditors through your business' bank account - creditors are not able to touch your own personal posessions.
When you are personally liable, you face greater worries.
What about my company’s credit rating?
If any business falls into financial difficulties, the company’s credit rating will undoubtedly suffer. If there have been County Court Judgements, debt and general cash flow problems, credit agencies will pick up on this. Of course if things improve, so will the company’s credit rating.
If you are facing any of these worries or risk becoming personally liable, speak to one of our expert advisors today who will assist you, assess your eligibility and discuss and further options needed.
Worried about poor cashflow? Covid-19?, How to pay wages on pay day? For expert advice on a range of issues download our free Ultimate Guide For Worried Directors today. Or just call us on 0800 9700539
Please note that the guide includes updates due to Covid-19 For instance there have been some changes to insolvency legislation that limits creditors actions and relaxes rules regarding wrongful trading. A new 20 day moratorium for distressed businesses has also been introduced.