The long-held belief that a limited liability company will remove all business liabilities from its owners and directors is, in today’s world, a fallacy.
The limited liability concept goes back into the mists of mediaeval history when monastic communities and trade guilds were given a form of protection, which was then extended by the Limited Liability Act of 1855. Since then, the idea of absolute protection within a company has steadily diminished.
All too often, unpaid creditors and lenders can now reach beyond the company with which they originally transacted to seek redress personally from individuals connected with it. There are several ways in which this can happen, which we discuss below.
Personal Guarantees
SMEs, especially relatively newly established ones, often lack the assets to support the commitments they need from lenders, and landlords in particular. They may also lack a sufficiently robust trading and profitability track record. Understandably, stakeholders being asked to go on risk will look for commitments from owners and directors in the form of personal guarantees, sometimes supported by a charge over their residential properties or other tangible personal assets. If a business starts to run into financial trouble, concerned suppliers and service providers may also look for some form of personal guarantee.
If the business fails and unsatisfied debts can’t be settled out of asset realisations within the company, the liability will migrate to the guarantors. We examine the implications of this scenario in this piece.
Directors’ loans
Many directors take regular monthly drawings from their companies, which are then totalled up and cleared by being allocated between a small salary processed through the payroll and a dividend declared when the end of the year accounts are prepared.
There is nothing wrong with this, unless and until the business is forced into a formal insolvency process such as Liquidation or Administration. If losses have eliminated or reduced distributable reserves, then no legal dividend can be declared, leaving the directors liable to be asked by the Liquidator or Administrator to repay any drawings not covered by their salaries. More details on directors’ loans can be found here.
Wrongful trading, compensation orders and other personal penalties
Quite apart from guarantees and uncleared loans, directors are also accountable for the way they run their businesses. Some behaviour can result in them being held personally responsible for some or all of a company’s debts in the event of insolvency. Examples are wrongful trading, fraudulent trading and misfeasance.
If directors’ behaviour is sufficiently poor, there is a risk of them being disqualified from acting as directors for a period of up to 15 years. This can trigger the making of Compensation Orders against them to force them to contribute to the losses suffered by their company’s creditors. Our detailed blog on this can be found here.
Personal liability for unpaid HMRC debt
HMRC took draconian new powers under the Finance Act 2020 to serve Joint Liability Notices on directors and some connected parties under certain circumstances, requiring them to make good unpaid tax liabilities. Further details are outlined in this piece.
What to do when business debts turn personal
Fortunately, there are ways to deal with the burden when business liabilities suddenly become personal ones. It could be that there will be some surplus income in future years to pay down the debts; perhaps a family member or a third party is willing to help with settling them. Alternatively, there may be sufficient personal assets, but ones that will take time to turn into cash.
In these circumstances, directors may be able to negotiate a deal with the business creditors to accept a percentage of the liabilities or wait for repayment. There are other formal and informal arrangements that can be negotiated and made, but timing and a willingness to communicate and compromise will be paramount.
Taking expert professional advice
One thing is certain: if you are concerned about these risks and you believe that your business might fail, you should take independent expert advice on your situation at the earliest possible opportunity. This will keep as many options open to you as possible, including rescuing your business. The longer you wait, the narrower the range of possibilities there will be and the less likely a positive outcome will be found.
How we can help
We have extensive experience assisting business owners and directors, and we will always work with you to find the best solution for you and your business.
One of our Partners would be more than happy to have a non-obligatory confidential chat with you. We can be contacted at rescue@opusllp.com or call us on 020 3326 6454 and we will arrange for a call with one of our Partners.