Directors of limited companies are, in principle, protected from business debts by the limited company structure. One of the main reasons of setting up a LTD company, as opposed to remaining a sole trader, is to preserve a clear separation between personal and corporate finances, and take advantage of the protection that comes along with that.
There are a number of exceptions to that, which do make directors personally liable, which this article will clarify.
Signing a Personal Guarantee?
The personal guarantee document is a legal means of breaching the corporate veil. Put simply, this means that a lender such as a bank asks for a legally binding agreement which offers a personal asset as security for a business loan.
Personal Guarantees can be signed by an individual, severally (meaning multiple people sign up on a proportionate basis) or jointly and severally. This latter term means that although multiple parties sign, all are held responsible for up to the full guarantee amount.
We recommend all directors consider taking out personal guarantee insurance, an expense which can be covered by the company, as a protective mechanism in the case of insolvency.
When Directors Prioritise Shareholders Over Creditors
Since personal guarantees are most often called in during insolvency situations, it’s worth understanding the law around this.
At the point of insolvency, a directors responsibility shifts from shareholders to creditors, a fact which surprisingly few directors realise.
Failure to adhere to this crucial aspect of the law means that the director runs the risk of a civil offence known as wrongful trading, which can mean fines, penalties and in the most serious cases jail time.
Transactions at Undervalue and Preferences
Another common mistake by directors at the point of insolvency is to try to move money out of the limited company by selling them at a less than market value.
Since one of the duties of an insolvency practitioner is to investigate the actions of directors in the period preceding insolvency, this kind of behaviour is inevitable uncovered and may result in the directors being held personally liable for the corporate debts.
Overdrawn Directors Loans
When directors withdraw money from the limited company it should be done so via the appropriate methods, such as wages, expenses, benefits or dividends.
Directors loans are also permissible but, should the company become insolvent, these should be paid back, or the director themselves becomes a company debtor.
The liquidator has considerable power to pressure this is paid by, including forcing you into bankruptcy if necessary.