When a company incurs a debt, it is only the company, as a discrete legal personality, which is liable to pay it. This means that the company’s owners, shareholders and directors are not personally liable to pay the debt, these individuals are protected by the ‘corporate veil’.
However, there are some limited circumstances when an individual director would be held to be personally liable to pay a debt. Here we explain, in brief terms, when those circumstances may arise.
Director’s personal guarantee
It is common for banks and other funders to the company to obtain the personal guarantee of the directors before lending to the company, and some suppliers of goods and services will also require such security.
Some suppliers will only agree to deliver goods or provide services to a company on credit terms if they have the personal guarantee of a director to pay for them, if the company does not.
In these cases, the director’s personal guarantee may be given in a separate document or may be contained within the supplier’s terms of business, which are then signed by the director in his capacity both as agent for the company and in his own right, as guarantor.
Where a director has given a personal guarantee, he or she will be personally responsible for the monies owed to the supplier, if the company does not make payment.
Directors signing terms of business issued by a supplier should carefully check all of the terms to ensure that no personal guarantee is being given unwittingly.
Fraudulent misrepresentation
Where an individual director has induced another party to enter into a contract with a company by making a false (or fraudulent) statement or representation, knowing it to be untrue or being reckless as to its truth, which the third party relied upon in deciding to enter into the contract, then the director may be held to be personally liable for any losses sustained by the third party, including the value of any goods delivered or services rendered by the third party.
There is also the possibility that a director may be held liable for such a fraudulent misrepresentation if, rather than making the statement himself, he induced, directed or persuaded another person to make it, or where he participated in a joint design with others which was designed to induce the third party to enter into a contract with the company.
In these cases, the director would be personally liable for the losses suffered by the third party because it was he that committed the fraud.
Acting beyond the powers granted to the director by the company
A director is only entitled to act in accordance with the powers granted to him by the company. These are usually set out in the company’s articles of association.
If a director incurs a debt on behalf of the company which he was not entitled to incur, because he did not have the authority to do so, he will have acted outside his powers and that may give rise to the director being held personally liable to the third party owed the debt.
This situation may arise if the director enters into a contract with a third party which involves the company becoming liable to make payments to that third party, which contract the director did not have the permission to enter into. In that case, the third party may seek to recover its losses from the director as well as, or instead of, the company.
Additional situations: insolvency of the company
Where a company has become insolvent, a director may find himself held liable to pay the value of some or all of the company’s debts if he had allowed those debts to accrue at a time when the director knew, or ought to have known, that the company was, or was likely to become, insolvent.
This is known as wrongful trading. A claim on this basis is not made by the creditor to whom the debt is owed but by the liquidator or administrator of the insolvent company.
Summary
Generally, directors are not personally liable for the debts of the company. Such a liability will only arise in certain specific circumstances, as outlined above.If in any doubt, a director should seek professional advice on his personal liability.
Stephensons’ commercial team has a range of specialists in the areas mentioned above and would be happy to advise and assist directors on these issues. Call us for advice on 0161 696 6170.
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