Limited companies = limited debt recovery?

Posted onMarch 8, 2019

Saunders Law regularly recovers large value debts for a mixture of clients, from individuals, professional advisers and SMEs through to large PLCs; our lawyers are able to do so often without recourse to court proceedings.

This article addresses some common difficulties that can arise in breach of contract claims or debt recovery matters against limited companies.

Directors of limited companies which owe significant amounts of money or which have breached commercial contracts often try to wind the company up to avoid paying. The article outlines some key considerations and concludes with some tips to try and protect your position.

If you have a contract or debt dispute with a limited company, or otherwise, get in touch on 0203 553 6318 to see how we can help.

Benefits of operating as a limited company

Creditors often mistakenly presume, if a limited company has no money, that they can go after the directors personally instead, but that is not always the case.

A private limited company is often chosen as a vehicle for individuals to set up businesses as it can offer attractive safeguards in the event the company runs into financial difficulty later on.

English law has long held that a private limited company has a separate legal personality distinct from the directors who run it, and the general position is that the company's debts die with the company, and directors are not usually held personally liable.

The position is different if the debtor is a sole trader or operates in a partnership with unlimited liability, and liability can then attach to individuals. The directors may be personally liable if they have acted fraudulently, but this can be hard to prove.

Risks for debt recovery / compensation

Whilst a limited company offers an attractive vehicle for small business owners, this can conversely make it very tricky for creditors to recover substantial debts or damages from the limited company in the event of a sizeable debt or breach of contract.

The limited company may appear to be flourishing and appear a safe bet to do business with, and may have established a good reputation in its line of work, but this does not guarantee that the limited company is necessarily financially stable, and does not guarantee the company is able to meet significant debts, or pay compensation in the event it breaches a valuable contract. False assumptions about a limited company's finances, can leave a creditor with a sizeable loss with no prospects of recovery if a dispute arises.

It might only transpire very late on in a valuable commercial contract, that the limited company is failing to deliver and will likely breach the contract, and also transpire that it has no money, no assets, and cannot pay if it is sued. The directors may well escape personally liability for the debt if they have done nothing fraudulent and if there are no guarantees or indemnities in place.

Security / guarantees

Savvy companies, alive to the risks of dealing with limited companies, therefore often seek personal guarantees from directors, so that in the event the limited company runs into financial difficulty, the directors will agree to pay the company's debts instead. Security can be sought against the director's personal assets, such as their house.

Savvy companies may also request accounting information relating to the limited company to see how many assets it has, to assess the number of current creditors or amounts of existing debts it has, and to see how financially stable it is.

If the company or director genuinely have no assets, it may be sensible to seek an indemnity and guarantee from a third party which is more financially stable, for example from a parent company, although further due diligence against the parent company may be required.

If absolutely no security has been sought, this could make recovery of debts or compensation very difficult later on.

All is not necessarily lost however, as there may be other ways of recovering against the directors directly, in line with some examples below.

Actions against the director

In the event that the director of a limited company has acted in breach of their director duties, and tried to hide or move company monies around fraudulently or artificially to avoid debts, creditors may have recourse to a claim against the director personally. There are usually some early warning signs whether the director is legitimate or not, but sometimes these only come to light late on.

For example, if you hear rumour or suspect that the director is breaching their duties as director, allowing their company to trade when they know it to be insolvent, is treating creditors more favourably than others, is stripping the assets of the companies, has made fraudulent statements to encourage you to enter into business, then you may be able to bring a claim against the director personally. The risk is of course that the director doesn't have any money either, however!

Economic torts

There may also be avenues of recovery against directors under claims of economic torts. English courts have historically treated claims in economic torts as a last resort and lawyers often suggest that they are best avoidable, but if the elements of the economic torts are satisfied, and no other simpler cause of action exists, then these may well be feasible.

A claim in economic tort might arise, for example when the separate corporate personality of the limited company is being abused by directors to avoid debts; if so, it may be possible to bring a claim against the directors personally.

Economic torts might permit recovery against directors, when the original company has already been wound up and declared insolvent.

Economic torts are equitable claims, and the court can sometimes brush aside the separate legal personality of the limited company, to see if the directors have acted unlawfully, known as "piercing the corporate veil". See for example, the article here on Palmer Birch v Lloyd.

Sometimes recovery of monies from a limited company will however genuinely be very difficult, especially when early safeguards have not been put in place, and the debts may genuinely die when the company is wound up; there are some practical tips below that may help protect against this risk.

Mitigating risk when dealing with limited companies

Some sensible precautions are outlined below:

Undertake due diligence on the limited company's assets and liabilities with reference to accounts. Don't be afraid to ask about the financial stability of the company, as it may affect whether working with them is viable.
Seek personal guarantees from the directors, and if they refuse, consider what that might mean, either in terms of risk or their financial status.
Seek security over directors' personal assets, and if granted, ensure the security is fully registered prior to starting work.
Seek third party indemnities or guarantees from more financial secure institutions.
If the contract value is high, seek regular payment intervals, and take early advice if payments are missed.
Find out who is really running the company, is it the named director or someone else? If someone else, can you bring them into the mix to pay if necessary?
Ask for other independent parties' experiences of dealing with the company, and whether the director appears to be running the company properly, or has a reputation of not doing things by the book.
If you are relying on certain statements made by the limited company or director, press for these in writing and keep accurate records of all discussions. Try and keep paper trails.
If it appears the limited company or director is making statements to assure you which you know are false, take early advice what you can do about it at the earliest opportunity.
Do not agree blindly to enter the limited company's standard terms and conditions, and ensure the terms of the contract are tailored to give you sufficient protection. Take advice before entering any formal agreement.
If you need delivery of something by a particular time or date, make time of the essence and include financial penalties.
Set out clear termination rights, and do not agree blindly to fixed term contracts with not termination provisions.
Do not allow too large a debt to accumulate before taking advice or action, as you may simply be racking up losses which may prove to be irrecoverable.

If you have a substantial debt or contract dispute against a limited company, contact us on 0203 553 6318 to see how we can help.