Personal guarantees: When liability isn’t so limited
July 22, 2021
The concept of limited liability is not new. English law granted this status to monastic communities and trade guilds as early as the 15th century and the protection was extended more generally by the Limited Liability Act of 1855, despite fears expressed at the time that it would lower standards of commercial behaviour.
Over the past hundred years, the idea that trading through a limited company should give shareholders and directors absolute protection from its debts has been steadily whittled away.
The most common dilution comes when a lender asks for personal guarantees, sometimes requiring the shareholders or directors to give security, often in the form of a charge over their residential properties or other tangible personal assets. Landlords can also ask for personal guarantees, especially when granting a lease to a newly formed company or one with minimal assets. When the going gets tough for a business, concerned suppliers have been known to seek guarantees from directors.
Quite apart from guarantees, directors are also accountable for their conduct in a variety of ways. Some behaviour can result in them being held personally responsible for some or all of a company’s debts in the event of an insolvency. Some examples are wrongful trading, fraudulent trading and misfeasance.
2019 saw HMRC take draconian new powers under the Finance Act 2020 to serve Joint Liability Notices on directors and some connected parties under certain circumstances, requiring them to make good unpaid tax liabilities.
More recently, easy access to the government guaranteed loans aimed at helping businesses survive the Coronavirus crisis has created even more pitfalls for directors. In the scramble to secure funds to get through the pandemic, some have unfortunately lost sight of the importance of keeping their personal liabilities strictly separate from the company’s. Using a Bounce Back Loan to repay a loan made by a director or a connected party liability, settle a personal debt or meet personal expenses will be breaches of the terms and can lead to the bank demanding immediate repayment of the whole loan.
In addition, many directors pay themselves out their companies by way of regular monthly drawings, which are then totalled up and allocated between a small salary processed through the payroll and a dividend declared when the end of the year accounts are prepared. There is nothing wrong with this, until the business is forced into a formal insolvency process such as Liquidation or Administration. If losses have eliminated or reduced distributable reserves, then no legal dividend can be declared, leaving the directors liable to asked by the Liquidator or Administrator to repay any drawings not covered by their salaries.
Separating business and personal assets
The issue of separating business and personal assets and liabilities also crop up when unlimited partnerships fail. Traditionally, all sorts of enterprises have been run this way and many more have been set up on an informal basis during the pandemic. In this instance, the partners will be jointly and severally liable for the debts, which is a fancy way of saying that unpaid creditors can choose which partner to pursue. One partner could end up paying all the debts, even if they only owned half the business or even just a third.
Dealing with the burden
Fortunately, there are ways to deal with the burden when business liabilities suddenly become personal ones without losing everything. There may be the prospect that there will be some surplus income in future years to pay down the debts; perhaps a family member or a third party is willing to make a contribution towards settling them. Alternatively, there may be sufficient personal assets, but ones that will take time to turn into cash.
In these circumstances, directors and partners may be able to negotiate a deal with the business creditors to accept a percentage of the liabilities or wait for repayment. This can either be done informally or through an Individual Voluntary Arrangement (IVA) or a Debt Arrangement Scheme (DAS). This will avoid the need to file for bankruptcy and the potential loss of all personal assets, not to mention the stigma and restrictions on future business activities.
How can Opus help?
One thing is certain: if you are concerned about these risks and you believe that your business may fail, you should be taking independent expert advice on your situation at the earliest possible opportunity so that you know what personal as well as corporate options there are. The longer you wait, the narrower the range of options there will be and the less positive the outcome will be.
Opus is experienced in advising business owners and directors on these matters and will be pleased to assist. Our ethos is to help and support people facing financial difficulties, not to judge them. If you need to take advice, please contact one of our Partners through your nearest office.