With so many companies closing, it is important to assess what the implications are for directors. Directors do not necessarily escape all liabilities just because their company has entered administration. Some could be held personally responsible for money owed and there are legal implications to consider.
Directors are generally held personally liable where fraud has occurred, but it is important to look into the legal implications even when a failed company has been run in accordance with the law.
Entering administration and unpaid debts
There are usually unpaid debts after a company enters administration. An administrator is placed in charge of the company as an interim director to make sure the process happens quickly and as many debts as possible are paid off. The administrator will also make sure the director(s) acted legally throughout the running of the company, and which issues led to its financial problems.
Relevant legislation includes the Insolvency Act 1986, the Company Directors’ Disqualification Act 1986 and the Companies Act 2006.
Wrongful trading and director liabilities
Under the Insolvency Act 1986, if a company is unlikely to be able to pay off its debts, it should stop trading immediately. Otherwise the director(s) will be held personally liable for debt accrued from further trading beyond this point. The safest option here would be to get advice from an accountant.
Giving a personal guarantee to creditors
Some directors have fallen into the trap of giving personal guarantees, or borrowing money through their personal accounts. They are held personally liable for those debts, even though they were for business use. It is important that all loans, lines of credit and any financial agreement is done in the company name, and there is no personal link for directors, shareholders and members of the company.
If the director owns any shares in the company, the value of shares will be used to cover the cost of any debt accrued.
Personal liability for unpaid taxes
HMRC will attempt to claim back as much money as possible. If it believes there has been fraud or an attempt to ‘fiddle’ accounts, HMRC will hold the director personally responsible and issue a personal liability notice. HMRC uses the Social Security Administration Act 1992 to claim the money from a director, instead of the company, when it determines there was an attempt at defrauding the government.
When there are VAT liabilities, action taken will depend on whether a director has had previous issues with paying VAT due to company insolvency. A VAT security notice will be issued by HMRC when there is evidence that the director has left a previous company without paying the VAT due.
What is ‘fraud’?
Fraud is more than just changing a few figures on the accounts or not declaring the full profit or loss. When a director knows that the business is suffering financially, and insolvency looks to be the only option, s/he may decide to take assets out to protect his or her own income or that of anyone else who invested in that business. Some directors choose to sell assets at a lower-than-value rate. Any of these actions could be deemed fraudulent.
When assets are sold at a lower rate than their actual value, courts can intervene. This in turn can lead to the person buying the assets suing for damages. Transactions that are completely legitimate may also become questionable during insolvency, so it is important to speak to a professional before doing anything.
Directors are usually kept separate from their company in cases of administration and bankruptcy, but there are times when there is a personal liability. It is important to consider the way that the business was run, as the administrator will look into that, and to case law, to determine whether there is a personal liability.
Alex Ingham writes many business related articles for Real Business Rescue.