Who is liable for the debts of a limited company?

Am I liable if my company cannot pay its debts? 

Limited companies that cannot pay their debts are said to be insolvent. Insolvent businesses can sometimes be saved through informal and formal payment plans that give the company more time to pay. However, there is often no way back for companies with more severe debts or without a realistic route back to profitability. 

Companies that are not financially viable usually enter Liquidation and are closed down. But that begs the question: who is liable for its debts when the company cannot pay them? Do they pass to the company's directors or shareholders, or are those who are owed money by the company (known as its creditors) left out of pocket? 

Who is liable for a limited company’s debts?  

It’s more difficult to run a limited company than a sole trader. Not only do you have to go through the incorporation process to set the company up, but you also have more complex accounting and tax compliance obligations. 

However, limited companies have several advantages over sole traders. One of the most important is the limited liability this structure brings. In a limited company, the finances of the directors and the company are legally separate, so ordinarily, the directors are not personally liable for the company’s debts.

If a limited company cannot pay its debts and enters Liquidation, all the directors and shareholders stand to lose is their initial investment in the business. That contrasts with a sole trader, who is legally liable for every penny their business owes. 

That said, there are a few circumstances when a director or shareholder can become personally liable for the debts of a limited company that you should be aware of. 

Can directors be personally liable for company debts?

Problems can arise for company directors when their business becomes insolvent. If the company enters a formal insolvency procedure such as Administration or Liquidation, the administrator or liquidator must investigate the directors’ conduct leading up to the insolvency and submit a report to the Insolvency Service.

The directors will usually be free from personal liability issues if they have run the business in line with their legal duties and put the interests of the creditors first when it was insolvent. In the case of Liquidation, the liquidator will sell the company’s assets to repay the creditors as much as possible, and any debts the company cannot pay will be written off. However, it’s not always so straightforward.  

When can directors become liable for company debts?

There are several scenarios when the director of an insolvent company can become liable for some or all of its debts. 

Personal guarantees

If, as a director, shareholder or any other officer of the company, you provide a personal guarantee for the business’s borrowing, you can be made liable to pay the debt if the business cannot. If the business defaults on the repayments or the company enters liquidation, the finance provider can call in the guarantee and pursue you for the outstanding sum. 

Overdrawn directors’ loan accounts

As a director or shareholder, if you take money out of the company that’s not a dividend or salary, your director’s loan account becomes overdrawn, and that’s money you must repay. 

If the company becomes insolvent with an overdrawn director’s loan account, the liquidator will request that you repay the money to the company for the benefit of its creditors. The liquidator can pursue you through the courts to retrieve the sum.

Trading an insolvent company

Directors who trade their company when it’s insolvent can become liable for its debts. When a company becomes insolvent, the directors must contact a licensed Insolvency Practitioner immediately. It may be possible for the company to continue trading, but only an Insolvency Practitioner can make that decision. 

Preferential payments

The directors of insolvent companies must protect the interests of their creditors as a whole. That means they cannot pay certain creditors ahead of others, particularly when those creditors are connected parties such as business partners or family members. The liquidator will attempt to reverse the transactions, but if that’s not possible, they can make you personally liable for those payments. 

Transactions at an undervalue

When a company enters Liquidation, the liquidator will sell its assets to raise money to repay its creditors. If the liquidator finds company assets have been sold for less than their true value in the lead up to the Liquidation, they can reverse the transaction or make the directors personally liable for the shortfall. 

Fraudulent trading

Directors can also become liable for company debt if they have traded with the intent to defraud their creditors. For example, if a director or shareholder takes credit on behalf of the company without the means or intent to pay it back, it can fall on them to repay it. 

Unlawful dividend payments

A company can only pay dividends if it has sufficient profits. If you pay dividends the business cannot afford and it subsequently becomes insolvent, you can become personally liable to repay the sum to the company for the benefit of its creditors. 

What happens if you become personally liable for company debt?

When a company enters Liquidation or Administration, the Insolvency Practitioner will investigate the director’s conduct and the reasons for the insolvency. They will prepare a report for the Insolvency Service outlining any conduct that could give rise to personal liability issues. The Insolvency Service will then review the findings and determine whether to take further action. 

The liquidator can take legal action to recover the amount and the court can order you to pay compensation. If you cannot pay, your personal assets can be at risk and you may have to consider a form of personal insolvency, such as an IVA or bankruptcy. 

Are you struggling with unmanageable debts?

If your company is struggling financially and you’re worried it may be insolvent, you should contact a licensed Insolvency Practitioner immediately. 

At UK Liquidators, we will explore options to save your company and advise you on the most appropriate course of action. If your company is no longer viable, we can liquidate the business on your behalf while working to protect your position throughout. Please get in touch for a free consultation or arrange a meeting at your nearest office.