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There is no certainty in life beyond death and taxes. The question here is what can a director typically be personally liable for in the event of a company going into liquidation.

Simple answer to the question is that the director can be personally liable for a wide range of things in the event that their limited company goes into insolvent liquidation

Limited Liability For Company Directors

The often wrongly held belief is that a limited company has limited liability, is often confused with the fact that limited liability only means that the shareholders are liable to pay a company in relation to any unpaid shares.

That has nothing to do with the matter of director liability in the event of a company going into insolvent liquidation. It is certainly the case that the basic principle is that because a limited company is a separate legal person from the directors that run it, that in the normal course of events if the company is liable to pay a supplier for goods and services the directors will usually not be personally liable and only the company will be.

However, there are almost no circumstances in which an individual who is responsible for a debt arising by virtue of a position that they hold (for example a Director or Trustee) that guarantees that they could never be liable in relation to it. 

It is certainly the case that if a limited company director has behaved in an entirely proper manner that it would be unlikely for him or her to be personally liable for a debt owing to a supplier of goods and services to the limited company.

Does Liquidation Make A Company Director Personally Liability?

The answer is a Liquidation in itself does not make a Company Director personally liable for company debts.

The key difference between a limited company that is in liquidation and a limited company that is trading in a normal way is in essence who controls the company. In the case where the company is in liquidation, the company is under the control of its Liquidator. Whereas the company trading normally will be under the control of the company directors.

When a company is trading normally the directors are required to comply with their director duties under the Companies Act 2006. When a company goes into liquidation however the directors lose their powers and the person who acts instead of the directors is the Liquidator who is guided by the provisions of the Insolvency Act 1986.

When a company goes into liquidation the Liquidator has a duty to get in, realise and distribute the company’s property for the benefit of the creditors. When a company is trading normally the directors have a duty to act in the interests of the company’s shareholders.

What Changes When A Company Goes Into Liquidation?

What changes when a company goes into Liquidation is that apart from the fact that the company is no longer under the control of its directors and is now under the control of the Liquidator, there are new assets that arise due to the creation of rights of action. These arise as a consequence of the company entering into insolvent liquidation that previously did not exist. Such rights of action are unique to a company that has gone into liquidation or administration. 

What Is A Right Of Action?

A right of action is in effect a potential asset of the company. However, the distinction between a company’s normal assets and a right of action is that its normal assets such as stock, debtors, cash and fixed assets are more widely understood and easier to quantify. A right of action however is in effect a piece of litigation or the right to issue a claim against somebody in relation to the receipt of money that typically arises as a result of some conceivable wrongdoing.

The rights of action that arise as a consequence of liquidation are typically in relation to transactions that have been entered into in the build-up to liquidation that does not appear in the company’s best interests.

Personal Liability For Preference Transactions

It is not unusual for directors dealing with the stress and strain of dealing with a struggling insolvent company, that they enter into transactions that compromise their position.  An example of how a Director could compromise their position is if they had lent money to the company to enable it to continue trading, then if they were to receive that money or part of it back in a manner that was disproportionate to other creditors who had also assisted it by either supplying credit or goods and services, then it could be considered that such a director had been preferred relative to other creditors. This is known as a preference and as a result of Section 239 of the Insolvency Act 1986, if such a transaction is entered into by director within two years of the company going into insolvent liquidation, then there is a significant risk that a director who has received the benefits of a preference could be called upon to repay it by a Liquidator.

This is not quite the same thing as personal liability but what it does mean is that directors are not free to apply the company’s assets in their own personal benefit without taking adequate account of the interests of the creditors as a whole. It is part of the duties of a director to act with sufficient regards to the interests of creditors when a company is insolvent.

If a director does not take adequate account of the interests of creditors as a whole when a company is either insolvent or is at real as opposed to remote risk of becoming insolvent, then there will always be the risk that such director could be called upon by a Liquidator to compensate the company for the loss caused by a transaction that was entered into at such a time, particularly if it did not appear to be in the best interests of the company.

Personal Liability For Transactions At An Undervalue

Another example of a right of action that is created as a consequence of the Insolvency Act 1986 that belongs to a Liquidator which can be pursued for the benefit of the company’s creditors in the event of liquidation, is what is known as a transaction at an undervalue. Any transaction entered into within two years of the company going into insolvent liquidation and when the company is insolvent that gives rise to an asset of the company in some way being lost to the company because anything that the company receives in exchange is not sufficient to compensate for the loss the arises could potentially be deemed to be a transaction at an undervalue. 

If a director in particular personally benefits from such a transaction at an undervalue then it is probable that a Liquidator could seek to rely upon Section 238 of the Insolvency Act 1986 to demand that the director compensates the company for the relevant loss that is suffered.

Personal Guarantees – What Is A Personal Guarantee?

A personal guarantee is an agreement between the supplier of goods or services to a limited company and typically one of its directors, that in the event that the company is unable to pay for the same the Liability will be paid by the company director instead of the company in liquidation.

Sometimes in order to enable a company to continue to trade and be afforded the supply of goods and services or where a company is not well established (such as a new business or a start-up), it would not be unusual for example only, for a company’s landlord to seek a personal guarantee from its directors in order that it could be assured that it would receive payment for the rent. The same position could apply in relation to a whole range of other services being supplied to the company, such as payment for plant and machinery being provided by an asset-based lender and other forms of loan that might be supplied by a bank for the benefit of working capital.

In the event that a company goes into insolvent liquidation and it is unable to repay the debts which have been personally guaranteed by directors, then those relevant creditors could make a call upon the director’s personal guarantee, thereby demanding that the director compensates them and pays off the relevant debt. 

It is important however that a director who has provided a personal guarantee takes professional advice because there may be circumstances in which a call on the guarantee is undertaken prematurely relative to the ability of a company in administration or liquidation to satisfy some or all of the relevant debt. In any event, even if the party is entitled to be paid under the terms of the personal guarantee, once the same has been settled by the director personally they will be able to lodge their own claim against the company for the monies that they have laid out on its behalf.

The Point Of Insolvency And Its Wider Implications For Director Personal Liability

The underlying theme here is that if the director has acted whiter than white and strictly in accordance with the duties required of them then with the exception of the aforementioned matter of the personal guarantee, it would be unlikely that they could be personally liable in the event of the company going into insolvent liquidation. However, that is not necessarily the end of the story because there is an element of subjectivity to such matters.

The critical matter that frequently causes difficulty for both directors and liquidators is what is known as the point of insolvency. The point of insolvency is not always easy to determine and can arise over time. In particular, directors are not free to simply make use of the company’s property and assets when the company is insolvent. They are also at risk during the period shortly prior to the point of insolvency when it could be seen that the company was at the risk of becoming insolvent as opposed to actually being insolvent.

That position is likely to be one of even greater subjectivity than simply when the company was actually insolvent. 

The Test For Insolvency

The test for solvency is twofold; either the company‘s liabilities exceed the level of its assets which is known as balance sheet insolvency. Alternatively, a company is unable to pay its debts as and when they fall due which is otherwise known as cashflow insolvency.

If a company is balance sheet insolvent or cashflow insolvent, then in either instance it is deemed to be insolvent. That position is set out in Section 123 of the Insolvency Act 1986.

In view of the matter of the subjectivity as to either point of insolvency or the point at which the company might be at real as opposed to remote risk of becoming insolvent, there is clearly an element of uncertainty as to whether or not transactions which may have arisen at that time and which the directors may have personally benefited from could be capable of being challenged by Liquidator. Such transactions could give rise to claims pursuant to a breach of director duty in light of Section 212 of the Insolvency Act 1986 or alternatively as mentioned above such transactions may fall within the parameters of being transactions at an undervalue or preferences. 

Subjectivity Of Director Liability For Transactions

That places company directors at a risk that they can have their conduct challenged by a Liquidator who with the benefit of some hindsight could come along and apply to the court for an order to say that a transaction or series of transactions should not have taken place i.e. that as a result the director or directors should be personally liable for the loss suffered by the company as a consequence of such transactions.

The risk to a company director in relation to personal liability for transactions entered into by a company when it was insolvent or on the verge of becoming insolvent is not a precise science and can be down to the views of the Liquidator or those who are advising Liquidator. 

The risk therefore that a company director faces is not confined to the matter of whether or not they are actually personally liable for such transactions. It is also a question of whether or not somebody thinks that they ought to be liable that can be relevant as well. 

Once a Liquidator has embarked upon legal proceedings seeking to recover money from such directors, costs will be incurred in bringing those legal proceedings. This can place company directors at further risk because, in the event that they were to lose the legal action after going through a court process and a trial, they could find themselves being liable for the legal costs of the Liquidator who brought those legal proceedings. The rationale for such an approach is that having lost such legal action, the directors could and arguably should have settled the legal action at an earlier date to avoid the costs of litigation being incurred. That’s the theory but of course, in practice, it might not be so straightforward, particularly if a director has been advised that they have a strong defence. Ultimately however that is the way legal proceedings and litigation works i.e. the usual rule in litigation is that the loser pays the winner’s legal costs.

Director Personal Liability Risk When There Are Inadequate Books And Records

It is important that directors keep and retain proper books and records of a company’s transactions to ensure that the merits and purposes of transactions which have been undertaken can be considered later on. 

It is widely accepted that directors who run companies with an element of informality cannot rely upon their failure or to maintain proper books and records to excuse them from liability in the event of transactions being subject to challenge later by a liquidator.

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