Am I liable for company debts?
Companies in need of help have been in the news again recently, with reports from some leaked documents, that the Royal Bank of Scotland’s rescue service was actually dealing the death blow to some businesses it was supposed to be helping. This is one among a host of reasons why you should try and deal with an independent company rescue service if your company is facing difficulties. Independents have no conflict of interest when they are advising you.
As a director of a company that has hit hard times, you will be understandably anxious about your liabilities, and about any guarantees that you’ve given, as well as worrying whether bankruptcy is a foregone conclusion. Read on for information and advice that will help you to decide what to do next.
How am I affected personally?
If the company is insolvent, then you need to start looking at the options. Foremost among these is voluntary liquidation, in which the Directors themselves start the process of closing down the company, due to insolvency. The company’s creditors get a formal notification and meet to discuss the situation. Meanwhile a liquidator is appointed and begins the process of winding up the company. The liquidator takes on the responsibilities that a director would usually have.
It’s a little appreciated fact that this doesn’t mean the business is finished. As a director, you may well be able to continue the business as a sole trader, while the limited company is being wound up. In fact, if there are personal liabilities arising from the company, a director may be well advised to do this, so that they can meet any demands for payment that are made to them personally.
Let’s look at how a company insolvency can personally affect you as a Director, and what steps you can take to protect yourself.
In normal circumstances, neither shareholders nor company directors are responsible for a limited company’s debts. However, many directors find in the course of business, that banks, landlords and even suppliers, ask them for a personal guarantee as part of a loan agreement, or a lease contract. Any guarantee of this kind exists outside of the “limited liability” aspect of the company, even though the lease or loan was granted to the company rather than to you individually.
Personal guarantees can’t be undone once they’re given; however, they’re not necessarily set in stone. The other party asked for a guarantee to be sure of getting their money. If they insist on the guarantee and you can’t pay, you may (but it’s not inevitable) have to declare yourself bankrupt. And the creditor will get nothing. Most business creditors are realistic enough to know that some money is better than none, and may therefore agree either to reduce the amount, or to reschedule the payments, so that you have more possibility of paying them.
Check the paperwork on the personal guarantee
You must check the small print. There are two reasons for this. First, some personal guarantees have an insurance with them, to protect you should the business fail. You may well not have been aware of this at the time, so it’s worth checking.
Secondly, personal guarantees have to be drawn up very precisely to be legally valid. If yours was drawn up by someone other than a bank or large company, it’s worth getting someone to check the precise wording because it is possible that the document itself is invalid.
It’s essential to talk to a professional advisor as soon as possible, because they are able to advise on all the options available, and help you assess which is best for you.
Don’t favour the creditor who has your personal guarantee
The person or company who is owed money may issue a Statutory Demand. This is an official demand for the money owed. You have 21 days to pay, and if you don’t, the creditor can begin proceedings to make you bankrupt; but only if the debt is over £5000. The creditor could also go down the county court judgement route, which can end up in the high court, as a warrant allowing the bailiffs to repossess assets you own. They may take a charge against your home, so that they are paid first if the home is sold.
This may make you panic (it’s probably intended to) and try to pay off this creditor first. But be careful. The fact that the creditor is holding a personal guarantee doesn’t mean that you’re allowed to pay them first. It’s part of your duty as a director to treat all of your creditors equally. In fact, if you show a “preference” and repay one creditor above the others, you could make yourself personally liable for other company debts so this is definitely not a good idea.
This is just one example of the intricacies of the law surrounding company insolvency, and another good illustration as to why you should contact a skilled practitioner early on. They know all these technicalities, and when they give advice, they take all of these details into account.
Personal Liability Notice
When the company is trading normally, National Insurance (NI) is paid on behalf of anyone on the payroll who is receiving a salary. In small companies, this could just be one director. When the company is insolvent, HMRC, the government’s tax collector, becomes one of your creditors if the company has not paid all the tax and national insurance that is due.
If HMRC feels that you have run up a whacking great tax and NI deficit and are now liquidating the company with a view to opening another one and escaping these liabilities, it is likely to take aggressive action. This can include issuing a Personal Liability Notice. They are likely to do this if they feel that fraud or neglect have been involved. Obviously while fraud is a matter of fact, neglect may be a matter of the Revenue’s judgement, so they are potentially able to cast their net fairly widely here.
This notice means that any director is personally liable for not only their personal NI contributions, but all of the NI that should have been paid by the company. As with the preferential payments that we looked at under personal guarantees, one of the things the Revenue will look at is whether the company was paying other creditors while it was failing to pay its NI bill.
Once the notice has been issued, there is an appeal process and any director is strongly advised to contact a company assistance expert to help make the best case to the Finance and Tax Tribunal, the body that will hear your appeal. Once the notice is issued, interest will start to be charged until the outstanding NI is paid. If it isn’t paid, then HMRC sets off down its usual debt recovery path.
Most people issued with a Personal Liability Notice will already have received a series of communications from HMRC stating what must be paid and threatening action if it isn’t paid. If you receive a notice from HMRC saying that they are starting a Personal Liability Notice investigation, you need to get expert advice as quickly as possible. Expert advisors can help you make your case to HMRC and the Revenue has sometimes been known to rescind the notice when mitigating circumstances or corrections of fact are made known. But early action is essential.
Overdrawn Director’s Loan Account
In normal circumstances, the Director’s loan is a useful aspect of running a limited company. There are three main ways to draw money from a company: 1) salary paid to you by the company 2) dividends paid to you by the company and 3) repayment of expenses that you have paid out on behalf of the company.
The Director’s loan stands apart from these arrangements, because when you decide to take a loan from the company, you effectively create something called the Director’s Loan account. It’s somewhat akin to your bank account, except in this instance the company is acting as your banker and is granting you a loan. This is perfectly acceptable, and can be a useful way for Directors to plan their personal tax affairs, provided that the company is not in financial difficulty and the rules are followed.
However, as with a bank account, it is possible to overdraw your director’s loan account. This happens when you take money out of the company that it can’t afford to lend you. You now owe the company money. For example, the company has a poor trading year and is not making enough money to pay a dividend because it has no profits.
If you now draw cash from the company, but not as salary, you create an overdrawn director’s loan account, and you are no longer protected by the limited liability of the company: this becomes a personal liability. You have to repay the company however much you have borrowed.
This situation can happen even at otherwise healthy companies, where the unexpected collapse of a major customer who owes the company money can mean the company suddenly plunges into a loss and dividends cannot be paid. However, this is also an example of a sudden business reversal that can happen to company that has an otherwise sound business that is viable going forward.
In an insolvency, the liquidator can demand payment from the director personally, and can push for bankruptcy if the director can’t pay. We’ll look at this next, but in terms of the director’s loan, there are still some options. You may be able to offset the loan against any previous loans that you made to the company. Or it may be possible to underpay yourself over a period; for example, you declare a salary of say, £3000, but only pay yourself £2000. This means that you are gradually reducing the loan, but of course you do have to pay tax and NI on the full amount of salary you declare you are taking.
There are other options and an expert can advise as to how you can restructure the company, possibly in a Company Voluntary Arrangement (CVA) to deal with this particular director’s liability.
Will I have to go bankrupt?
Not necessarily, but if you do it may not be the end of the world.
Many company directors fear bankruptcy as the worst possible outcome. But in many company insolvency cases, even when you have considerable personal liabilities, you can avoid bankruptcy. There are three key factors:
- act early;
- use expert company rescue advice;
- don’t assume your business is finished just because your company is.
The earlier you act, the more options you and your advisor will have. If you delay and allow others, such as creditors or HMRC to take the lead, your options will narrow and you will have less room for manoeuvre and negotiation.
Not only will an expert advisor know more about company law and regulation, and have more experience in dealing with the Revenue and others, but they will approach your problems in a much calmer and more objective way. Most people dealing with a company insolvency are stressed, anxious and fearful about the future. An advisor knows this, and can help you through the process to achieve the best outcome. For you it’s the end of the world, but for them, although they will be sympathetic, it’s a set of challenges they are used to dealing with while they do battle on your behalf.
There are various methods of avoiding personal bankruptcy, including Individual Voluntary Arrangements (IVAs). But it may not come to that; there are also all kinds of ways of restructuring your personal liabilities to the company, or easing the terms.
Bankruptcy needn‘t mean the end of the business
If none of this is possible, and bankruptcy is the only option, it isn’t necessarily the end of the road. Sometimes very successful businesses hit the rocks because the people running the company are just too busy to spend much time thinking about the future or managing the books.
If you have not been disqualified as a director, you may be free to start another company, this time with the benefit of more experience. Many of our high-tech success stories are run by people who learned from early business failures and went on to build very successful businesses second time around.
Bankrupts no longer have to go to court, which takes one painful step out of the process. These days, the process takes place online. Some people don’t lose all of their assets, and although a payment order can be made for up to three years, many bankrupts do not have to make payments if their income is too low. Nearly all your debts will be written off, and you can be discharged from bankruptcy after a year.
There are of course, major downsides. You’ll find it hard to get credit, so if your business needs to trade on credit, that may be a problem going forward. Some professions do not allow people who are, or have been, bankrupt to work within them. Bankruptcy is also probably not suitable for people who owe small amounts, or who expect that they may be able to pay off their debts soon. You also need to live with the fact that your bankruptcy will be a publicly known fact, and come to terms with how this may affect you or your relatives. And your house may be repossessed.
At this stage, you need advice from someone who can assess your personal circumstances as well as those of the company.
Like every other activity, bankruptcy also has a cost so, ironically, you will need to decide whether or not you can afford to become bankrupt.
However, there are alternatives, such as a Debt Relief Order (DRO) if you owe less than £20,000 (although you can’t own a house if you have a DRO and there are some other restrictions).
So whether bankruptcy is a suitable option for a company director is very much dependent on the scale of their personal liability, and their personal circumstances in terms of home ownership, pension fund, family relationships and so on.
The main thing to bear in mind is that there are people who can help, and that there is light at the end of the tunnel. What may seem overwhelming right now, can be managed with the right help. Use a professional company rescue firm, and you’ll be surprised that what seems like the darkest hour, is actually the start of a new day.