Both companies and individuals can fall into debt when they’re unable to repay the money owed to their creditors. While company debt and personal debt are separate entities that don’t affect each other, unless a Personal Guarantee is involved, there can be instances when a business’ debt could affect your personal finances.
What are personal debts?
Personal debt can be the result of unexpected expenditure, a sudden change of circumstances, or poor control of finances. As a result, your disposable income will be depleted, and your credit score could be damaged, this will make it harder to secure personal loans and other finance in the future.
If you’re a business owner, your personal finances should be separate from your company as a legal entity, unless you invest your own money, or if you’re one of the following:
If you’re a self-employed sole trader, you and your business are the same legal entity. If you get into debt, even if it’s related to your business, the lender will see your personal finances as part of it. So, if there are any losses, you could be personally responsible for repaying the debt, meaning you may have to use your own money and potentially sell your assets. Doing so could negatively impact your credit rating.
Partnerships operate like sole traders but involve more people. As with a sole trader, each partner has unlimited personal liability, and all partners have a legal responsibility to repay business debts.
Limited Liability Partnerships (LLP) have a similar structure to a partnership and are used by professional firms to reduce personal liability. If they become insolvent, an LLP will be treated more like a limited company than a partnership.
Your company will have outgoings towards its running and operations. These can include:
- Company loans and mortgages
- Credit cards
- Hire and purchasing costs
- Stock costs
Aside from not maintaining the payments on these outgoings, your company can fall into debt bought on by:
- Low sales
- High overheads
- Inability to repay loans
- Growing too quickly
- Loss of a large contract, or client
Before you have nightmares about strongly-worded letters from creditors or bailiffs knocking at the door to take your personal belongings, you should consider the following circumstances:
Limited companies offer a level of protection for directors. Your personal finances are legally separate from the company’s, and liabilities are limited to what’s invested. If the company becomes insolvent, the debts will stay with the company and not be passed on to the director, unless in extreme circumstances where the director has breached his duties.
When are you personally responsible for company debt?
As a director outside of partnerships and sole trader arrangements, you won’t be liable for the liabilities of a company. However, there are instances where that might not be the case:
If you’ve applied for business funding, lenders may insist on a personal guarantee before providing loans and financial aid. Personal guarantees may have to be provided for:
- Bank loans
- Trade supplies
- Invoice financing
These guarantees act as security for the lenders and bypass the limited liability. If your business becomes insolvent, or it’s not able to make the agreed repayments, and you as director have provided personal guarantees, you will be held personally responsible, and you may have to use your personal finances to repay the debt. These guarantees will either have a cap or be unlimited, which guarantees the lender can recover all their debt and legal fees.
Director’s loan account
Director’s loan account is a record of transactions between a company and its director not covered by their salary. You may have lent the company your own money to maintain operations and as well as a director; you are then a creditor.
If you borrow from the company, this is an ‘overdrawn director’s loan account’ (ODLA). The director is then a debtor of the company, which isn’t a problem if it is paid back, but if the borrowed amount isn’t, within 9 months of the company’s year-end, HMRC will see the DLA as an interest-free loan and demand income tax.
What if the director is overdrawn?
If you have an overdrawn director’s loan account upon commencement of a company’s liquidation, you could be personally liable for repaying that loan. The director’s loan is in effect, a debt to the company, and it is the duty of the insolvency practitioner to act in the creditor’s interest so can make demand repayments on that loan.
If a director does not cooperate, legal action can be taken, which may even result in the repossession of personal assets. If you have any concerns related to these issues, you should contact us without delay.
Personal Liability Notice
Personal Liability Notices (PLN) are issued by HMRC to limit losses of public money from directors misusing National Insurance. HMRC sends these notices to directors where there is evidence that the company has failed to pay the required National Insurance contributions, and their actions are deemed neglectful or fraudulent.
HMRC will conduct an inquiry, and if directors or officers are found guilty, they may have to pay a portion of the company’s penalty.
Wrongful or Fraudulent Trading
If a business becomes insolvent and can’t cover its outgoings, directors could face allegations of wrongful or fraudulent trading if the company continues to trade.
These two allegations are not the same; wrongful trading is continuing to trade as if nothing has changed. Doing so is a civil offence.
Fraudulent Trading involves continuing to trade in a manner that deliberately deceives and defrauds customers and creditors. Doing this is a criminal offence.
If found guilty of either of these, you could face fines, jail sentences, a director’s ban, and being personally liable for the company’s debts.
Company debt and personal debt are separate entities, although business debt can affect you personally. If you’re a director of a limited company that becomes insolvent, the company’s debt should be separate from your personal finances. Unless you have signed personal guarantees, have been served a Personal Liability Notice or been convicted of wrongful or fraudulent trading. If you’re a sole trader, you and your business are one and the same, and you are personally responsible for any debts. The same applies in a partnership, where the debt is spread amongst the partners.
How we can help
Whether you’re struggling with company debt and personal debt; grappling with debts in your partnership, as a sole trader, or if you’re stressing over company outgoings and risks becoming insolvent, contact us today. We can offer you free, impartial advice on the best way forward, with no obligation.
If your company is in debt
Even if your personal finances are unaffected, having bad debt in your company can still be a stressful experience that can harm your business. We offer several debt relief solutions for limited companies; including Company Voluntary Arrangements (CVA), which allow you to maintain control of the company while repaying your debt. Alternatively, we can explore administration as an option to restructure the company.
If your personal finances are affected
If for one of the reasons described in this article, a company’s debt has affected you personally, we can offer an Individual Voluntary Arrangement (IVA); an agreement between you and your creditors allowing you to repay your debts in monthly instalments. All creditor action against you will cease for the duration of the arrangement.
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