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Who is liable for business debts in a limited company?

Posted on: Monday 10th February, 2020

Who is liable for business debts in a limited company?

Once a company gets to the stage where it is struggling to keep up with its liabilities as and when they fall due, options need to be considered to protect the business and its creditors from incurring further losses. If your company has a significant amount of debt, you may be wondering who is liable for paying this back should the business is unable to do so. The answer really comes down to the structure of your business – whether you operate as a limited company or a sole trader.

Limited Liability

Limited liability is one of the main benefits of trading as a limited company. Limited liability offers the director a layer of protection against his or her company. In the eyes of the law, a limited company is seen as a complete separate entity from its directors. When it comes to a company experiencing financial issues, limited liability really comes into play. Any debts accrued by the company, in the company’s name, belong entirely to the company. Therefore should an insolvent business cease trading and enter liquidation unable to fully satisfy its outstanding creditors, the debts will die with the company.

Following the liquidation, any creditors left out of pocket will not be able to go after the director personally for the outstanding monies, meaning there is no risk of the director losing their home or other personal possessions as a result.

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Personal Guarantees

The exception to this rule is if any debts were personally guaranteed. A personal guarantee (PG) is when the borrower makes an agreement with the lender that should the business be unable to pay back the money it owes, responsibility will then switch to the individual who will be required to take on this debt and pay it back from their own personal funds.

PGs are often requested on property leases, company credit cards, and large loans particularly those offered to newly incorporated businesses. If you are in any doubt as to whether you have personally guaranteed company debts you should make it a priority to check through the original paperwork and find this out. If your company is struggling financially and you have personally guaranteed a significant portion of the debts, your options may well be different to those available to you if no personal guarantees had been signed.

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Wrongful Trading

Occasionally a director can be held liable for some or all of the debts of their company following a formal insolvency procedure if it can be proven that the directors deliberately contributed to the financial failings of the company. Actions can include continuing to trade while knowingly insolvent, or making preference payments to certain creditors. This is known as wrongful trading and can result in disqualification from acting as a director in the future. It must be said that this is incredibly rare, and providing you have met your responsibilities and acted in the best interests of the company, you do not have anything to worry about in this regard.

Sole Traders

The situation for sole traders is different, however. The business activities (including financials) of sole traders are not distinguished from the individual themselves. Instead sole traders are seen as the same entity as their company, therefore should a sole trader be unable to keep up with their business expenses using the business’ funds, they will be required to use their own personal money. If this is not possible, a formal insolvency arrangement will have to be considered. Insolvency proceedings for sole traders are not the same as those available to limited companies. Whereas a limited company could be liquidated with no repercussions for the director personally, a sole trader will instead be looking at options such as bankruptcy or IVAs which will severely affect their ability to access credit, for both personal and business reasons, in the future.

If you require help or advice about any part of the insolvency or redundancy claim process, contact our specialists today. RCUK are Authorised and Regulated by the Financial Conduct Authority. Authorisation No 830522. You can check our registration here.

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