When a company faces insolvency, it can feel like the end of the road for its directors. But not everything you hear is true. Here are six common misconceptions about director insolvency.
You Can Never Be a Director Again
Many people believe that once your company goes insolvent, you’re automatically banned from ever being a director again, but this simply isn’t true. As long as you haven’t broken any laws or acted dishonestly, you can become a director of another company, even right away.
2. You Are Automatically Liable
Another common fear is that directors are personally responsible for the debts of a failed business, but this isn’t usually the case. Unless you’ve signed personal guarantees, acted irresponsibly, or broken the law, you shouldn’t have to cover the company’s losses with your own money.
If you’re unsure about the legal use of a company name post-insolvency, a London law firm can explain the rules and help you stay compliant. Forsters are a London law firm that would be able to provide guidance on this restructuring.
3. The Insolvency Will Show Up on Your Personal Credit Report
Company insolvency is recorded against the business, not the individual. Unless you have personally guaranteed any loans or debts, your own credit score should remain unaffected by your company’s financial troubles.
4. You Can’t Use a Similar Name
It’s often said that you can’t use a similar name or trading style after your company closes. You can use a similar name, as long as you follow specific legal guidelines and get the proper permissions from the insolvency practitioner.
5. You Can’t Rehire Staff You Let Go
Another misunderstanding is that once you make staff redundant, you can’t hire them again. As long as the redundancy was handled correctly, there’s nothing stopping you from offering jobs to former employees in a new company or for a different role.
6. Your Suppliers Will Leave You
Some suppliers may be open to continuing the relationship, especially if you’re honest and show that you have a plan moving forward.
When a director can be personally sued
In law, a company and its directors are separate legal entities. A contract with the company does not create a contract with its directors, so in most cases a claimant would need a separate contractual relationship with the director to hold them personally liable.
Good faith is the deciding factor. A director generally cannot be sued for persuading a company to breach a contract if they acted in good faith, but case law shows that personal liability can follow where they did not. Directors can also be personally exposed in cases of bribery, fraudulent trading or fraudulent misrepresentation, or where they failed to make clear they were acting for a limited company.
The other common route is a director’s personal guarantee, often signed when a company takes out a loan or credit agreement, particularly a young company with few assets. It commits the director to pay if the company does not, putting their own assets at risk, so independent legal advice should always come first.
When directors do take on personal liability
Because a limited company is a separate legal entity from its directors, they are not usually liable for its debts. If the company fails, creditors are generally treated alike and may or may not be paid in full. Directors can be held personally liable in exceptional cases, such as where wrongful trading is proven.
A personal guarantee changes that position. It is a legally binding promise by a director to accept personal responsibility for the company’s debts and pay them from their own funds if the business goes under. Suppliers trading with a newer or smaller limited company often ask for one as part of the contract. Most directors who believe in their business will agree, so strong resistance can be a warning sign.
Directors also give guarantees to lenders, as offering one can unlock business loans that would otherwise be out of reach. Anyone signing one should understand that, if the company becomes insolvent, the guarantee may be called on and their personal assets could be at risk.
When personal guarantees put directors at risk
A limited company is a separate legal entity, which is why directors are usually protected from its debts. That protection has limits, and the most common one is a personal guarantee. Banks and suppliers dealing with a company often ask a director to guarantee its debts personally in case the company fails, particularly when the business is new or is raising finance such as an overdraft.
Any director asked to sign a guarantee should take independent legal advice first. The lender may even want a solicitor’s certificate confirming that the director understands what the guarantee means and when it can be called in.
If a company with guarantees in place runs into financial trouble, the directors should get advice straight away and talk to creditors early. Leaving it too late can mean the guarantee is called in and the director becomes liable for the debt. Directors can also be held personally liable without any guarantee if they act fraudulently or beyond their authority.
