Updated: 6th January 2021
Setting up a limited company offers protection from personal liability as a director in most instances, and should your business fail, your liability will be limited to the amount of money you put into the company.
There are circumstances in which the threat of director bankruptcy becomes a real possibility, however, when your company enters insolvency. The protection you receive as a company director can be removed – a process commonly known as ‘lifting the veil of incorporation.’
If your creditors suffer a material financial loss and you are found to have acted wrongfully as a director, or fraudulent activity is proven, the courts may decide to make you personally liable for some or all of the company’s debts.
Cash flow problems are usually the first sign that your company is struggling, and it is at this early stage that you should seek professional advice. It is often the case that directors attempt to trade their way out of difficulty in this situation, which is understandable, but this can create a huge problem.
It is a legal obligation to cease trading as soon as you suspect your company is insolvent, or is likely to become insolvent in the near future. Failing to do so could result in disqualification as a director, personal liability, and potential bankruptcy.
If you fail to place the interests of creditors first, it could lead to the liquidator pursuing you for any additional company debt taken on from the date of insolvency – potentially before this date if fraudulent activity is uncovered.
Essentially, this means you must stop trading, make sure the company takes on no further debt, and does not accept new orders or deposits from customers. You should also seek professional assistance if you haven’t already done so.
When the liquidator begins their investigations, you need to demonstrate that you have done everything in your power to maximise the financial returns for creditors, and that no ‘questionable’ transactions have taken place.
These could include:
Many lenders insist that directors provide a personal guarantee before they will allow a company to borrow. This significantly reduces the lender’s risk, but puts directors in serious danger of bankruptcy should the company fail, as they become personally liable for repayment of the loan.
If you are unable to repay, the lender can force you into bankruptcy, putting at risk your home and other personal assets. Your situation is further compromised because your ability to earn a living is taken away due to the insolvency, unless you have other streams of income.
It is common practice for directors to withdraw money from their company on a temporary basis, which is fine when business is profitable. If your company enters insolvency, however, and your director’s loan account is overdrawn, the liquidator will pursue you for repayment in order to increase returns for creditors.
This can result in a difficult financial situation if you do not have the funds to repay. As with the personal guarantees mentioned above, it leaves you exposed to the threat of bankruptcy as you must pay back the money you have extracted from the company.
As a sole trader you are at greater overall risk of bankruptcy if your business fails, because unlike a limited company, it is not a separate entity in law. Creditors can pursue you through the courts for money on a personal level, putting your home and other assets at great risk.
As a result you may be forced into bankruptcy, or have to declare yourself bankrupt as protection against other creditors. Although this process does allow you to start afresh once the bankruptcy period is over (usually 12 months), your access to finance in the future will be severely limited.
Although being director of a limited company reduces the risk of personal bankruptcy when compared with sole traders, it is clear that the threat can emerge very quickly once any business starts to fail.
Real Business Rescue can help if you are a company director or sole trader worried about personal bankruptcy. There may be alternative options, such as an Individual Voluntary Arrangement (IVA), and we may be able to negotiate an affordable agreement with your creditors. Call one of the team to arrange a same-day appointment in complete confidence to establish your situation. With 100 offices stretching from Inverness down to Exeter, Real Business Rescue can offer unparalleled director advice across the UK.
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