Understanding the Legalities and Directors Liabilities when a Company Goes into Administration with Debts

When a company in the UK enters Administration, directors could be held personally liable for outstanding debts. This article touches on where to find pertinent legalities and how to avoid being held liable.

One of the most common misunderstandings held by many directors is that they cannot be held liable for debts incurred by the company since they are technically separate legal entities. In general, this should be the case but there are several instances in which a director or directors can be held personally liable for a company’s debts when it goes into administration.

Although, as a rule of thumb, directors’ liabilities are most often prevalent in cases of fraud or misfeasance, there have been times when directors have been held liable for debts even when acting in their regular capacity. Over the years, a great number of company directors found themselves in just such a position.

Where Legal Definitions of Directors’ Responsibilities and Liabilities Can Be Found

Usually a company is insolvent when entering Administration, so it is a logical conclusion that there will be unpaid debts. Since the purpose of this procedure is to undergo a turnaround or rescue in most cases, an interim director (Administrator) will be appointed to oversee the process. The Administrator will first seek to understand if the company and its directors acted according to rules and regulations and then they will make a thorough assessment of the company’s financial state.

When seeking to analyse whether or not the directors can be found guilty of misfeasance or fraud, Administrators base their conclusion on three major sources:

  • The Insolvency Act 1986
  • Company Directors’ Disqualification Act 1986
  • Companies Act 2006

If, for any reason, it is determined that directors can be held liable for any part of a company in Administration’s debt, the supporting documentation will be found in one of these three Acts. There are times when disputes will arise, so case law is also considered when brought before the Court.

Typical Cases in Which Directors Are Held Financially Liable

In order to understand typical cases of directors being held personally liable, it is important to understand the concept of wrongful trading. If a company is insolvent and has no realistic prospects of paying debtors, the directors should cease trading immediately. This is detailed quite specifically in the Insolvency Act 1986 and is the most common way in which a director will be held accountable for any debts accrued during that time period.

It is also important to understand that a director may be responsible for contributing to repayment of debts if they gave a personal guarantee to a creditor. Although shareholders, members and directors are seen as separate entities from the company, a personal security or guarantee voids the limited liability. Also, if a director still owes the company money for any shares he or she holds, that person will be responsible for paying that amount towards outstanding debt.

HMRC, VAT Security Notices and Personal Liability Notices

Directors should be especially concerned with HMRC if there are outstanding taxes due when a company is in Administration. Commonly, HMRC will issue a Personal Liability Notice if they feel there is any fraud or misfeasance involved in terms of National Insurance Contributions. Sometimes it is simply a matter of neglect on the part of a director to pay taxes and other times Her Majesty’s Revenue and Customs feel that the director was trying to defraud the government. In this case, the responsible director will be held personally liable as opposed to the company as outlined in the Social Security Administration Act 1992.

VAT, on the other hand, tends to get a bit more complicated. Usually this type of liability is the result of a director who previously was associated with another company that failed to pay VAT upon winding up. The VAT Act 1994 states that when a director is engaged in running a new business, he/she may be required to leave an amount equivalent to approximately 6 months on deposit with HMRC as ‘insurance’ against this from happening again. During Administration, HMRC is likely to be made aware of the fact that a given director left a previous business without paying VAT and will then issue what is called a VAT Security Notice.

Be cognizant of the fact that when entering Administration with debt, directors can be held personally liable. Whilst it is true that a limited liability company is a separate legal entity from directors, they can still be held personally liable for any debts resulting directly or indirectly from their actions. If there is any doubt, a licensed Insolvency Practitioner can help sort it out and assist in solutions which may avoid severe penalties being imposed. Directors can be held liable so understand the legalities and liabilities during Administration. It could save a great deal of time and legal representation in the long term.

For futher reading, visit realbusinessrescue.co.uk