No, not normally. That was simple, wasn’t it? A bit too simple. As with most legal issues, it’s not quite that clear cut and straightforward. The general rule is that directors will not be liable for the debts of the company, but there are a few exceptions. Let’s delve into it a little deeper.
The general rule: directors are not liable for company debts
Usually, directors have no liability for any debts they incur on the company’s behalf. That’s because the company is a separate legal entity, which incurs its own debts, for which the company itself is liable.
If the company can’t pay its debts, then creditors sue the company, not the members or the directors. To enforce a successful judgment, creditors can only seize the assets which the company owns, and not the personal assets of the directors. Unfortunately for the creditors, that means that they stand to lose money if the company’s assets are insufficient to pay off the debts. But it’s good protection for the directors, whose personal assets are protected.
However, if you follow this reasoning to its extremes, that would give directors free reign to mismanage company money, neglect paying their suppliers, and drive up debts without any consequences. Of course, the law doesn’t allow for such reckless abandon.
Directors will be liable for their own misconduct
Directors can’t hide behind the corporate veil (of the company’s separate legal entity) when he or she has behaved unconscionably.
For example, if the director enters a contract for goods on behalf of the company, knowing that the company does not have sufficient funds to pay, that could be seen as fraudulent misrepresentation. In those circumstances, the director will be personally liable for the debts, which technically belong to the company. It’s a punitive measure to discourage inequitable behaviour.
Directors need to be very careful in situations where the company is struggling financially. If there’s no way that the company will avoid insolvency, then you shouldn’t continue trading as normal, including paying directors’ salaries. Continuing to trade in these circumstances could be evidence of wrongful trading.
If a director is found guilty of wrongful trading, then he or she will be asked to make a personal contribution for the loss caused by their actions. This is more of a compensatory measure.
Directors have a number of fiduciary duties, and other duties, which they owe to the company. If they breach these duties, they are liable for misfeasance and can be ordered to pay money to the company to compensate for their actions.
Guarantees will give rise to personal contributions
For completeness, it’s also possible for directors to incur personal liability if they provide a guarantee for a loan to the company. The difference here is that the director goes into this arrangement with their eyes open, knowing that their house is potentially on the line if the company defaults on the loan.
Here are some practical measures you can put in place as a director to safeguard yourself against the risk of paying company debts personally:
· Know and uphold your directors’ duties.
· Seek professional advice at the earliest sign of financial problems in the company.
· Raise financial concerns with the board and keep accurate records of board meetings.
· Cease trading as soon as you realise the company is insolvent.
· Get Directors & Officers Insurance. This insurance covers the cost of compensation claims made against directors for alleged wrongful acts.
If you’d like to speak to a legal adviser about your directorship and how to protect your position, please contact us. Get in touch for a free, no-obligation discussion.