Chris is an Insolvency Practitioner regulated by the ICAEW since 2014,.
He is experienced in contentious insolvency with excellent analytical skills and strong knowledge of both general and technical insolvency matters.
As a company director, you might wonder if your personal finances are at risk if your business fails. The good news is that, in most cases, you’re protected by the principle of limited liability.
Limited liability essentially means the company you run is considered a separate legal entity from you, the director, meaning you generally can’t be made personally bankrupt if the company becomes insolvent.
However, there are some important exceptions you need to be aware of. The limited liability protection can be waived if:
You’ve given personal guarantees for company debts
You have an overdrawn director’s loan account when the company becomes insolvent
You’re found to have engaged in wrongful or fraudulent trading
It’s crucial to understand that bankruptcy applies to you as an individual, not your company. If your limited company fails, it may go through insolvency proceedings, but this is a separate process from personal bankruptcy.
We often see directors confused about their personal liability when their company is struggling. If you’re worried about your company’s financial situation, we strongly recommend seeking professional advice as soon as possible. As insolvency practitioners, we can help you understand your position and explore your options.
What Are the Circumstances in Which a Director Could Be Made Bankrupt?
A director could face personal bankruptcy under certain conditions despite the usual protections offered by the veil of incorporation. These circumstances typically involve actions that breach the legal and financial duties expected of a director. Key scenarios include:
Personal Guarantees
As a director, personal guarantees can be your biggest risk when it comes to potential bankruptcy if your company becomes insolvent. Here’s why they’re so significant:
When you sign a personal guarantee, you’re agreeing to repay a company debt if the business can’t. This creates a direct link between company debts and your personal finances, effectively bypassing limited liability protection.
If your company becomes insolvent, the creditor can pursue you directly for the full amount.
We often see this scenario with the following:
Bank loans, especially for smaller businesses
Commercial property leases
Supply agreements with key vendors
If you’re facing this situation, don’t panic. There may be options available, such as negotiating with the creditor or exploring an Individual Voluntary Arrangement (IVA). However, these situations can escalate quickly, so we strongly advise seeking professional advice as soon as possible.
Overdrawn Director’s Loan Account
When you withdraw more money from the company than you’ve invested or are owed in salary and dividends, your DLA becomes overdrawn. In normal circumstances, this isn’t necessarily problematic if the company can afford it and you plan to repay it or offset it against future dividends.
However, if your company enters insolvency with your DLA overdrawn, the liquidator is obliged to recover this debt from you personally. This is because the overdrawn amount is effectively a company asset that needs to be realised for the benefit of creditors.
The risks to you include:
Being required to repay the full overdrawn amount immediately
Facing legal action if you can’t repay, potentially leading to bankruptcy
If you find yourself in this situation, seek professional advice promptly. There may be options to negotiate repayment terms or offset the loan against other entitlements.
Wrongful Trading
As a director, you have a legal duty to act in the best interests of creditors once you know, or should have known, that your company has no reasonable prospect of avoiding insolvency. If you continue trading beyond this point, you’re engaging in wrongful trading.
If wrongful trading is proven, the court can order you to make a personal contribution to the company’s assets. This amount isn’t capped and could potentially cover all debts incurred from the point you should have ceased trading. If this sum exceeds your personal assets, bankruptcy may result.
Key factors that could lead to wrongful trading allegations include:
Continuing to take credit when you know you can’t repay
Entering into new contracts when you’re unlikely to fulfil them
It’s worth noting that the burden of proof for wrongful trading lies with the insolvency practitioner, who must demonstrate that you knew or ought to have known about the company’s inevitable insolvency.
Fraudulent Trading
Fraudulent trading occurs when you knowingly carry on business with the intent to defraud creditors or for any fraudulent purpose. This could include:
Taking customer deposits for goods or services you know you can’t provide
Deliberately misrepresenting the company’s financial position to obtain credit
Transferring company assets to yourself or related parties at undervalue
If proven, the consequences are severe. The court can hold you personally liable for all of the company’s debts, not just those incurred during the period of fraudulent activity.
Moreover, fraudulent trading is a criminal offence. You could face fines, director disqualification for up to 15 years, and even imprisonment. These penalties are in addition to any civil liability, compounding the risk of personal bankruptcy.
The burden of proof for fraudulent trading is higher than for wrongful trading, requiring evidence of actual dishonesty.
Misfeasance
As a director, you can face a misfeasance claim if you’ve misapplied, retained, or become accountable for any money or property of the company. This might include:
Paying excessive salaries to yourself or other directors
Making improper loans to yourself, other directors, or connected parties
Using company assets for personal benefit without proper authorisation
Selling company assets at an undervalue to yourself or related parties
If a liquidator succeeds in a misfeasance claim against you, the court can order you to repay the misapplied funds or compensate the company personally for losses.
Unlike wrongful trading, there’s no need to prove that you knew the company was insolvent at the time.
To defend against misfeasance claims, keep detailed records of all transactions and ensure all decisions are properly authorised and in the company’s best interests. If you’re concerned about past actions, seek professional advice promptly to understand your position and options.
Tax Liabilities
As a director, certain tax liabilities can put you at risk of personal bankruptcy if your company becomes insolvent. Here’s what you need to be aware of:
PAYE and National Insurance Contributions (NICs) are a particular risk. If your company fails to pay these, HMRC can issue a Personal Liability Notice (PLN) to you as a director. This makes you personally responsible for the unpaid amount, which can be substantial.
VAT is another area of concern. In cases of deliberate non-payment or evasion, HMRC can pursue directors personally. This is more likely if there’s evidence of funds being diverted for personal use instead of paying VAT.
If your company has taken out a Bounce Back Loan or other COVID-19 support and you’re found to have misused these funds, you could be held personally liable for repayment.
HMRC has extensive powers to recover unpaid taxes, including:
Petitioning for your bankruptcy
Securing charges over your personal property
Initiating court proceedings against you
It’s crucial to ensure all tax affairs are in order, even when your company is struggling financially. If you’re facing difficulties, engage with HMRC early. They may be willing to arrange payment plans, potentially avoiding personal liability and bankruptcy.
Remember, HMRC is often the largest creditor in insolvencies and takes a robust approach to recovery.
Failure to Cooperate with the Insolvency Process
Under the Insolvency Act 1986, you have a legal obligation to cooperate with the official receiver or liquidator. This includes providing information about the company’s affairs and surrendering company property and records.
Failure to cooperate is a criminal offence. While it doesn’t immediately place you in contempt of court, you may be prosecuted. Penalties can include:
Fines for failing to comply with the official receiver’s requests (s235(5))
Daily default fines for continued non-compliance
Fines for failing to submit a statement of affairs (s131(7)), with additional daily fines for ongoing failure
These fines can accumulate rapidly, potentially leading to significant personal financial strain.
Moreover, non-cooperation can be considered in director disqualification proceedings. If disqualified, your ability to earn a living through directorships or company management will be severely restricted, potentially for up to 15 years.
Why Sole Traders Face a Higher Bankruptcy Risk Than Directors
As a sole trader, you face a significantly higher risk of personal bankruptcy if your business fails than limited company directors. Here’s why:
Unlike a limited company, your business isn’t a separate legal entity, meaning you and your business are one and the same in the eyes of the law. As a result:
Your personal assets, including your home, are at risk if the business fails
Creditors can pursue you directly for any unpaid business debts
For example, if your business owes £50,000 to suppliers and you can’t pay, they can take legal action against you personally. This could lead to a bankruptcy petition if you’re unable to settle the debt.
If you’re a sole trader facing financial difficulties, it’s crucial to seek advice early. There may be alternatives to bankruptcy, such as Individual Voluntary Arrangements (IVAs) or informal agreements with creditors.
