by Gillian Sayburn ACCA member and Insolvency Director at Begbies Traynor (Central) LLP
The concept of limited liability for limited companies (including LLPs) is, in the event of the failure of a SME business, often a false belief. An awareness of the areas where an SME director may be personally liable could help to minimise or avoid such liabilities should their business fail.
There are three main areas where directors can find themselves personally liable: liability under a personal guarantee; liability under contracts; and liability as a result of their failure to carry out their duties as a director which may then be challenged by an Insolvency Practitioner (IP) under Insolvency Act 1986 offences.
Personal guarantees are often given in respect of bank borrowing, company credit cards, property leases, hire purchase, lease and finance agreements. Should the business fail, a creditor with a personal guarantee will call on this personal guarantee. Where there are two or more guarantors, then the guarantee will usually be ‘joint and several’ whereby the creditor can pursue any director for the full amount. Guarantees may be either limited or unlimited in monetary terms.
Personal contracts and personal liability often occur where a company was formerly a sole trader or partnership and following incorporation, the proprietor did not legally and effectively transfer contracts he had entered into personally into the name of the limited company. The director will remain personally liable. Alternatively, the creditor may consider that they have contracted with the director personally rather than with the company.
Should a company be placed into a formal insolvency process then the Insolvency Act contains various provisions which are designed to provide relief for creditors when directors have failed to fulfil their duties as a director. A claim may be brought under one section or several sections of the Act which we will now briefly comment upon.
Misfeasance (s212 Insolvency Act 1986)
The court may make an order against anyone who “…. has misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of duty of any fiduciary or other duty in relation to the company”.
Increasingly in insolvencies, we are finding directors with overdrawn directors’ loan accounts. Leaving the legality of loan accounts aside (dealt with under the Companies Act 2006), the IP will seek to recover these funds from the director. Unauthorised loans may in some circumstances be recoverable from all directors on a ‘joint and several’ basis
Another area that is often discussed is the payment of dividends rather than remuneration to save PAYE and NI usually where the director and shareholder is the same person. The company may have made dividend payments at regular stages throughout the year at a time when the company did not have sufficient distributable reserves to make the dividend payment. The IP will seek to recover such ‘illegal’ dividends from the shareholder. The director may also be liable, as he has authorised the payment – again, it is a ‘joint and several’ issue.
Wrongful Trading (s214 Insolvency Act 1986)
When a director allows a company to continue to trade and incur liabilities when he “knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation” then the director can be liable for wrongful trading.
An example would be the company taking on a new supplier and incurring credit when the director was aware the company would not be able to pay. In this case, he could become personally liable for the additional debt incurred by the company beyond the point, viewed with hindsight, when “he knew or ought to have concluded….”. Again a ‘joint and several’ issue if there are two or more directors.
Transactions at an Undervalue (s238 Insolvency Act 1986)
A director allows the company to enter into a transaction at an undervalue where the company makes a gift for no value or enters into a transaction where the value received is significantly less in money than the value given.
An example would be where a director may sell a vehicle or piece of equipment to himself and in return he injects some cash into the business, but less than the value of the asset. In this case the IP would look to the director to pay the difference or return the assets.
Preference (s239 Insolvency Act 1986)
This is where the company does anything that puts one creditor in a better position than it would have been.
An example is where a director knowing that the company is close to failure repays to himself his directors loan or repays monies owed to friends and family or settles a debt where the director has given a personal guarantee, thereby putting him in a better position than other creditors.
This list is not exhaustive but gives an indication of areas where, should a business fail, the directors may face personal liability.
Should a director believe his company is at risk of failure then, in order to minimise his personal liability, he should seek appropriate and relevant advice sooner rather than later and act on it.
Such early independent and professional advice will help the company meet its legal requirements and provide evidence that the directors are aware of their duties. Directors should hold regular board meetings and maintain a record or minutes of the meeting. These minutes should show the directors are aware of the financial position of the company and detail the steps they are taking to ensure the creditor position does not worsen. The company should maintain up to date management accounts and circulate to all directors and retain evidence that they have been used for example when considering taking on new creditors or disposing of assets, agreeing dividends or loans.