Struggling with bills with your company even as it’s facing a potential insolvency is hard enough. You don’t want to be facing other problems from popping up in such situations especially the prospect of being blamed for all the debts the company makes and being made personally liable for all of them.
However, that’s one problem many directors face with their companies. Regardless of what type of company they’ve set up, liability is seemingly an inescapable thing. So, is there a chance that you as the director can be personally made liable for your company’s debts? The answer is yes but the likelihood of one depends on a number of circumstances.
When Can You Be Held Liable for Company Debts?
Liability for company debts is something that will not apply to you in all instances. That being said, however, you can inadvertently (or intentionally) make yourself liable for any debt your company makes through a number of circumstances.
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Insolvent Trading
Basically, continuing to incur debts while the company is facing insolvency is one of the primary reasons directors get themselves personally liable for the same. When a company is declared insolvent, any insolvency agent will be on the lookout for “red flags” for any indication that you are about to create an act that aims to maximize the returns for shareholders over the creditors.
However, this is not an indefensible allegation. You can be protected from claims of insolvent trading by proving that:
- You had reasonable grounds to believe that the company was still solvent.
- You never participated in any trade-related activities on behalf of the company due to supervening events such as illnesses.
- You exerted all possible efforts to keep the company from incurring debt.
Naturally, these would have to be defended in court. However, you only need to prove one of the three to prevent being made liable for debts in this instance.
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Frauds and Misrepresentation
Supposed that you applied for a loan on behalf of the business and were successful in it being approved. However, in the process, you may have misrepresented some facts about the business. Or how about when you fail to make a distinction between your personal expenses and that of the business? All of these instances constitute fraud and can make you personally liable for the debts the business incurs from such.
If these acts were not enough, any of the following practices can make things worse for your part.
- Repaying the same debts through fraudulent means.
- Selling company assets for less than what they are actually worth.
- Continuing to trade with no intention to repay debts.
- Favouring some creditors over others.
- Prioritising paying yourself over that of shareholders and creditors.
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Using Personal Property as Loan Security
This is quite common in limited liability companies and partnerships. To obtain a loan, directors of these types of businesses often put up their personal property like their homes and vehicles as a security.
Naturally, if the company defaults on the debt, the lender is entitled to repossess the asset put up as security. This is one of the instances when your being made liable for debts was something that was born from the stipulation of the contract and not due to some unintentional (or intentional) act on your part.
Similarly, you can make yourself personally liable for company debt if you use your personal credit card or home equity loans to increase the business’s capital. The reason for this is quite simple: regardless of how you used your credit or loan and for what, it does not remove the fact that the one who signed to acquire them was you, not the business. As such, using your credit for the business will still be entered as part of your personal debt.
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Personal Guarantees
How this happens is quite straightforward: A director guarantees to pay a creditor for any debt that the company incurs with that person. If the company fails to meet its obligation, those debts would be automatically be registered to the director as debt by Personal Guarantee.
Unless there is a voluntary administration, the creditor can actually enforce the guarantee on you. If you do pay the debt, you are actually entitled to replace the creditor who got paid, technically making you director and creditor to the company.
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Claims of Loss from Employees
So, the worst has come and the company has been forced to liquidate all of its assets. You might be tempted to compel your employees to sign up to an agreement that reduces the amount you have to pay for them for their termination.
However, in order for your debts to be demandable in this respect, that agreement must be made for two intentions. One is to intentionally prevent employees from recovering entitlements. The other is to intentionally and significantly reduce the amount that employees can recover through their entitlements.
Either way, making such an agreement makes you automatically liable for debts through employee entitlements. This is why it’s often a major indicator that a business is going to be insolvent when upper management starts laying off people. It’s a technically legal thing to do, mind you, but it’s not going to do much in fostering any goodwill you may want to have with people you might have to work with in the future.
Can Shareholders be Made Responsible for Debts, Too?
As with directors and executives, a shareholder might be protected from personal liability in some corporation structures. For instance, a limited liability company should have enough protection to make sure shareholders don’t have to deal with debts incurred by the company becoming their personal concern.
However, there are instances when a shareholder does become personally liable for debt. First, the shareholder must personally guarantee to a debt. Second, they should have manifested some actions that constitute as fraud with the intention of diverting money acquired through transactions for their personal enjoyment.
Dealing with Debt
So what then if you are made personally liable for debts incurred by the company. There are actually some things that you can do to manage the debt without overstretching your resources. Here are some of them:
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Know What You’re Getting Into
As a director, there is no hard and fast rule in distinguishing which loans you will be made liable for. As such, it pays to be extra careful when deciding which loans to take to increase the capital of the business.
The first thing you have to do is to be aware of your business’s truest chances of success. It can be tempting to believe that your business is going to be a sure-fire hit on paper but even the best laid businesses out there can fail. When taking out a loan, make sure that your business has the ability to remain in operation for the next 5 years first.
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Prioritise
The best way to deal with debt, after all, is to not make unnecessary ones in the first place. One of the instances when you incur personal debt from the company is if you favour paying shareholders and yourself first before attending to the obligations your company makes with creditors.
A director is a pretty influential position, in fact, and you have enough clout to tell the rest what to prioritise first. If the company’s finances are in dire straits, one way you can extend goodwill to the creditors is by communicating that you are prioritising the debts of the company over the returns that everyone in the management team can still hope to recover from the business. Also, maintaining an open line of communication between shareholders and creditors can help prevent potential issues from popping up.
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Seek Help
Perhaps the best way to deal with incurring personal debts from company transactions is to go out of your way and find someone who can help you manage both the business’s and your personal financial obligations. Keep in mind that one of the reasons you inadvertently incur company debt is when you have no distinction as to what of your expenses are businesses and what are personal in nature. An expert might be able to help you set that line and prevent liabilities from each from mixing up.
Also, a financial expert can tell from miles away if you are going to accidentally incur personal debt from the company’s dealings. They can advise you what to do in certain situations so you can protect yourself from unwanted obligations. Sure, paying for the services of a debt management expert can be expensive but the money you can personally save from avoiding incurring accidental debts from the company will be quite considerable in the long run.
Have you had incurred debts from the dealings your company made in the past? What other instances can you think of that will make directors automatically liable for company debt? Let us know in the comments section down below.
