Personal guarantees and director liabilities in insolvent contracts are issues that many directors must face at some point. The insolvency of a company can create significant challenges, and understanding the personal liabilities that directors may face is essential in navigating these situations. This blog post will explore personal guarantees, how they relate to director liabilities in insolvent contracts, and what directors should be aware of when their company enters insolvency.
What are personal guarantees?
Personal guarantees are legal promises by company directors or owners to personally repay a business debt if the company fails to meet its financial obligations. Essentially, a director’s personal assets, such as property or savings, can be at risk if they’ve given a personal guarantee for a loan or contract entered into by the company.
Personal guarantees are common in cases where small or medium-sized businesses borrow money from banks, suppliers, or lenders and may be required to offer personal guarantees to secure funding. This is particularly true for unsecured loans or if the company has insufficient credit history or assets to back the debt.
The role of directors in insolvent contracts
When a company becomes insolvent, it’s unable to pay its debts as they become due. This may lead to the company entering a formal insolvency process, such as liquidation. One of the primary concerns for directors during insolvency is the potential for personal liability for company debts; this is where director liabilities in insolvent contracts become particularly important.
As a director, you must act in the best interests of the company and its stakeholders. If a company is heading towards insolvency, directors must be careful to avoid actions that may worsen the company’s position or lead to personal liability. In the case of contracts entered into while the company is insolvent, directors could be personally liable if found to have acted inappropriately or in bad faith.
How director liabilities in insolvent contracts can arise
There are several ways in which director liabilities in insolvent contracts may arise, especially in situations where personal guarantees have been signed. Below are the main circumstances where directors could face personal liability:
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Breach of fiduciary duties
Directors have legal duties to act in the best interests of the company, its shareholders, and creditors. If a director continues to sign contracts, incur debts, or make financial commitments when they know the company is heading towards insolvency, they could be accused of breaching their fiduciary duties, resulting in personal liability for any resulting debts, including those tied to contracts signed during the period of insolvency.
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Wrongful trading
Under the Insolvency Act 1986, wrongful trading occurs when directors allow a company to continue trading when they know or should know that the company is insolvent and has no realistic prospect of avoiding liquidation. If a director is found to have engaged in wrongful trading, they could be personally liable for some or all of the company’s debts. This includes debts from contracts signed while the company was in financial distress.
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Fraudulent trading
Fraudulent trading is another serious offence under UK law. It happens when a director knowingly carries on business with the intent to defraud creditors or for any fraudulent purpose. If a director is found guilty of fraudulent trading, they could be personally liable for the company’s debts and face severe penalties, including fines and imprisonment. This type of liability can extend to contracts entered into during insolvency.
Personal guarantees and their impact on director liabilities
In insolvency, personal guarantees pose significant risks for directors. If a director personally guarantees a loan or credit, the lender can pursue the director for repayment if the company can’t meet its obligations. These guarantees can apply to loans, leases and supplier agreements and, in insolvency directors may have to sell personal assets to cover debts. Directors should be cautious when offering personal guarantees and carefully consider the company’s financial health and the potential consequences if it fails to meet its obligations.
Steps directors can take to mitigate personal liability
While personal guarantees and director liabilities in insolvent contracts can pose serious risks, there are steps directors can take to reduce their exposure:
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Seek professional advice early
One of the most important steps a director can take is getting professional advice as soon as financial difficulties arise. Insolvency practitioners can provide guidance on the most appropriate course of action and help directors navigate complex legal and financial issues. Early intervention can help avoid personal liability and ensure the company enters insolvency in the most orderly manner possible.
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Review personal guarantees
If a director has signed personal guarantees, it may be possible to negotiate with creditors or lenders to release or reduce the guarantee. In some cases, directors may be able to reach a settlement or arrangement that limits their personal exposure.
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Consider alternative restructuring options
Before the company becomes insolvent, directors may want to explore options such as a Company Voluntary Arrangement (CVA) or Company Rescue. These processes allow the company to continue trading while paying off creditors in a structured manner, potentially reducing the risk of personal liability.
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Act quickly to minimise damage
Directors must act quickly and appropriately if the company is already in financial distress. This means ceasing trading or making decisions that could increase the company’s debt and liabilities. Taking action fast can limit personal exposure and help reduce insolvency’s negative consequences.
Mitigating director liabilities in insolvency
Dealing with personal guarantees and director liabilities in insolvent contracts can be a daunting experience for directors, but understanding the risks and taking appropriate steps can help avoid exposure. It’s essential that directors seek expert advice, act responsibly, and make informed decisions when managing an insolvent company.
Get in touch
If you’re concerned about personal guarantees or director liabilities in insolvent contracts, our team is here to help. We can advise on the best insolvency solution for your individual needs. Our experienced Insolvency Practitioners, authorised by the Institute of Chartered Accountants in England and Wales, offer free, impartial advice to ensure you liquidate your business most effectively. Get in touch via the form below, by live chat, email at mail@Simpleliquidation.co.uk, or by calling 0800 246 5895. We’re here to help!
