As the director of a limited company, you have a level of protection from liability. However, in some circumstances, a director can be held personally liable for losses. This means that your assets, including your home, could be at risk. It is important to understand how personal liability arises and what you can do to minimise the threat.
Is a Company a Separate Legal Entity?
Companies are separate legal entities from their directors, able to enter into contracts and take on debts in their own name. This means that action will usually be brought against the company when it is necessary to enforce a debt or make a claim relating to a product or service.
When Do Directors Become Personally Liable?
Instances when a director may face personal liability for losses include:
- A breach of directors’ duties
- On insolvency, in particular, if there is wrongful trading
- Negligent misrepresentation
- Unfair prejudice
- Criminal wrongdoing, such as misappropriation of funds or fraud
- When the director has personally guaranteed to borrow
Breach of Directors’ Duties
Directors must comply with a wide range of duties and act in the best interests of the company at all times. If duties are breached and the company suffers a loss as a result, compensation may be sought from the director.
Examples of breaches include:
- Entering into a transaction that is not in the company’s best interests
- Fraudulent misrepresentation, or inducing a third party to enter into a contract with the company by making a false statement
- Having a conflict of interest or accepting a benefit from a third party without declaring it
- Failing to exercise independent judgment
- Fraudulent trading
- Not exercising reasonable care, skill and diligence
Personal Liability on Insolvency
If your company is facing insolvency and, as a director, you know or should have known that there is no reasonable chance of avoiding it, you and your fellow directors must stop trading. It is not always straightforward to identify the point at which trading should cease, and you may need to seek legal advice if you believe that your company is at risk of insolvency.
If there is a reasonable hope of recovery, then it may be possible to keep trading. The Insolvency Act 1986 sets out the point at which a company is insolvent as being when it is unable to pay its debts as and when they fall due. This is assessed by looking at issues such as:
- Ability to pay statutory demands
- Ability to pay a judgment debt
- Whether company liabilities exceed its assets on its balance sheet
- Whether the company is able to pay its debts when they are due
When a director continues to trade when they knew or should have known that there was no reasonable prospect of avoiding insolvency, this is wrongful trading. It is likely that action will be taken to recover losses from this point onwards from a director personally.
If your company becomes insolvent, then as a director, you will have a new range of duties, including:
- Ceasing trade
- Acting in the best interests of the company’s creditors
- Engaging an insolvency practitioner
- Meeting with and cooperating with the insolvency practitioner as required
- Preserving the company’s assets for its creditors
- Meeting with the company shareholders
- Providing a report for the company’s creditors
- Repaying any overdrawn sums in your director’s account
If these duties are breached and a loss arises as a result, the insolvency practitioner, creditors or shareholders can take action to recover the sums from the director.
Some actions may constitute fraudulent trading, which is a serious criminal offence and could result in a prison sentence as well as personal liability. Examples of fraudulent trading include selling assets at an undervalue, taking on credit while knowing that it cannot be repaid and accepting payments for orders that a director knows will not be filled.
How Can a Director Avoid Personal Liability?
Personal liability often arises inadvertently when a director continues to trade after the point at which they should have concluded that there was no reasonable prospect of avoiding insolvency. Seeking expert help when a business is facing difficulties can ensure that insolvency is identified and trading ceased if necessary.
As well as reducing the risk of personal liability, an experienced company solicitor will also be able to discuss potential ways of rescuing a business, including restructuring, negotiating with creditors and considering whether administration is necessary.
Directors need to have a good grasp of their legal duties while in office. When taking on finance, giving guarantees or entering into contracts, advice from a legal expert will ensure that you fully understand the implications and that the transaction is in the best interests of the company.
It is essential to avoid conflicts of interest, for example, selling assets to a friend or relative, and to ensure that assets are not sold at an undervalue.
Contact Our Company and Commercial Solicitors
If you need advice on the personal liability of directors or your company needs professional support, contact us today, and we will do all we can to help.
For more information on our services, see our directors' liability solicitors page.
To speak to one of our expert company and commercial solicitors, ring us at 0330 173 3980, email us at info@witansolicitors.co.uk or fill in our contact form, and we will talk through your situation with you and discuss how we can assist.
