One of the greatest benefits of conducting business through a corporation is having “restricted liability.” This means that unless you have personally guaranteed a liability, such as to a bank or landlord, you are not accountable for the company’s debts in the event of bankruptcy.
Nonetheless, a major caveat to this notion of “limited liability” is that a director might be held personally liable by a liquidator if they enabled the company to continue trading after it became apparent that it would be liquidated.
This is because it is considered unfair to suppliers and other creditors to continue accepting credit when you know you cannot repay.
What exactly is a liability?
Liabilities are debts or financial obligations that a firm has to its creditors. A debt can take several forms, such as a loan, hire purchase agreement, or unpaid payment. One of the main advantages of forming a limited liability corporation is the shielding of personal assets from corporate debts.
But what, precisely, does it mean to be a “limited liability” company? Limited liability, as was previously mentioned, serves as a buffer between the firm and its directors. The directors are shielded from individual liability in the event of a debt default by the company.
Can the debts of a business be erased?
If a company goes through a formal insolvency process like a Creditors’ Voluntary Liquidation, its debts will be written off (CVL). Any creditors still owed money can’t demand that the company director pay it back out of their own money. The company’s debts die with the business.
When is a company director responsible for the company’s debts?
Although the corporate status of a director offers significant protection, there are several situations in which limited liability may not be applicable, making the director accountable for the firm’s debts.
These include:
- A personal guarantee signed
- Debts have been racked up through dishonest means, like taking out loans you knew you couldn’t pay back.
- Director did wrong.
- Continuing to pay dividends to shareholders even though the company is broke
- Taking money out of business or using it for something other than a business;
- Misfeasance is the name for this kind of crime.
- Selling the company’s assets for less than they are worth or for nothing.
Let’s take a closer look at some of these scenarios:
1. Individual guarantees
Banks and other lenders won’t allow unsecured borrowing unless you sign a personal guarantee. This is true even if your business is well-established and has an excellent credit rating. A personal guarantee is required before a business can negotiate a lease for commercial property or apply for financing. This is so that the bank has a backup plan in case your company goes bankrupt or cannot pay back the debt.
As already mentioned, limited liability protects a director from being held accountable for the obligations of their firm. A personal guarantee eliminates this safeguard by removing the company director’s ability to repay the obligation should the firm not be able to.
2. Overdrawn loan accounts for the director
A business owner can withdraw funds from their firm through a director’s loan account without being considered a wage, dividend, or expense (DLA). Each transaction must be recorded in writing. The account will be overdrawn if you withdraw more money than you deposit, and you will be responsible for making up the difference with your employer.
It’s not a problem if a director’s loan has been fully repaid as long as the sum is under £10,000. However, things become more difficult if the organisation is having financial issues. Directors’ overdrawn loan accounts are an asset that can be used to help save a failing company.
The directors will be required to repay the corporation for the borrowed funds to pay off creditors. Even when their company has problems like this, directors often don’t have the money to do anything about it. It is best to get expert advice as soon as possible because the rules about overdrawn directors’ loan accounts can be very complicated, especially when the company goes bankrupt.
Director responsibilities?
When a company has insufficient assets to cover its debts, it is considered insolvent. The board of directors has a legal obligation to make decisions that are in the best interests of the creditors. The company’s directors must show that they have exhausted all available options to satisfy their debts.
The Company’s directors shall not engage in any activity to increase or avoid payment of the Company’s liabilities. A preference payment would be made if the directors gave a certain supplier or debtor preferential treatment. Directors risk losing their right to serve as directors of limited companies if they have breached one of their essential duties by failing to act in the best interests of all of the firm’s creditors when the company is insolvent.
What are the repercussions if a director becomes accountable for corporate debts?
As with any other personal liability, directors will be required to pay business debts if they are found liable. Unfortunately, coping with a bankrupt business typically substantially impacts personal finances. Perhaps the director lost their only source of income when the business stopped operating, or personal savings were spent to keep the business afloat.
Unfortunately, these issues frequently coexist, regardless of the cause. If you’re unable to meet your financial commitments, you’ll need to explore your bankruptcy options just like the company did when it couldn’t pay its payments.
Depending on the total amount of your debts and the value of your assets, you could choose between a Debt Management Plan (DMP) and more formal insolvency proceedings like an Individual Voluntary Arrangement (IVA) or bankruptcy.
Contact
Please get in touch with Southside Accountants Wimbledon, if you would like help and support with your limited company.
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