Can Directors Be Made Bankrupt If Their Business Fails?

Limited companies provide protection to directors through the ‘corporate veil’. The fundamental principle of limited liability means directors shouldn’t face personal financial consequences even if the business fails. However, this protection can be stripped away through a legal process when directors are found to have acted wrongfully or fraudulently during their leadership.

Who Can Become a Director?

The first thing we should look at is who is an eligible candidate for a director in a company. The question ‘Can a bankrupt be a director?’ has a clear answer under UK law: no. A bankrupt individual is legally prohibited from acting as a company director.

If you’re thinking about becoming a company director, there’s one absolute rule in UK law to answer ‘can you be a company director if you are bankrupt? No, you cannot. There’s no grey area here – it’s forbidden.

The question ‘can you be a director if you have been bankrupt’ is however less straightforward. If you’ve been discharged from bankruptcy, you can generally become a director unless there are specific restrictions in place. However, there are some important factors to consider:

• The length of time since your discharge – many companies prefer to see a significant gap between discharge and directorship
• Any additional restrictions imposed during your bankruptcy

To serve as a company director in the UK, you must meet several eligibility requirements including age and must not be disqualified by a court order or be currently bankrupt. Many people ask this question perhaps out of concern or fear wondering whether the person leading their company is qualified or may destroy the company, but it’s important to understand that bankruptcy automatically disqualifies you from holding this position.

What Are Director’s Liabilities?

Now that we have a clear answer to the question ‘can a bankrupt person be a director of a company’, let’s look at the liabilities that can cause a director personal bankruptcy if the company fails.

The first and most crucial issue is recognising when your company is in financial distress. Cash flow problems are typically the first indicator, and directors must take immediate action when these arise.

Once insolvency becomes apparent, directors have a legal duty to prioritise creditors’ interests over that of shareholders. Failing to do so can result in personal liability for company debts. The liquidator will investigate all transactions leading up to insolvency, including:

• Preferential payments to certain creditors
• Selling company assets below market value
• Taking excessive salaries or dividends when the company was struggling
• Continuing to trade when the company was clearly insolvent

As mentioned earlier, if a director doesn’t fulfil their basic obligations and is deemed to have been acting against the company’s best interest, the corporate veil can be removed making them legally and personally liable for any problems.

Wrongful Trading

Wrongful trading occurs when directors continue to trade despite knowing or when they should have known that there was no reasonable prospect of avoiding insolvency. The liquidator will investigate all transactions leading up to insolvency, focusing particularly on when directors became aware of the company’s financial difficulties. If found guilty of wrongful trading, directors can be held personally liable for some or all of the company’s debts from the date they knew about the insolvency.

This is one of the most common ways directors find themselves facing personal bankruptcy, leading to automatic disqualification from directorship.

Personal Guarantees and Loan Accounts

Personal guarantees represent one of the biggest risks to directors. Many lenders require directors to personally guarantee company loans, effectively bypassing limited liability protection.

If the company fails, these guarantees become immediately enforceable, potentially forcing directors into bankruptcy if they cannot meet the obligations. Similarly, overdrawn director’s loan accounts pose a substantial risk. While taking temporary withdrawals during profitable periods is common practice, any outstanding balance becomes immediately repayable if the company enters insolvency.

For directors facing potential personal liability, alternatives to bankruptcy exist. An individual voluntary arrangement (IVA) might offer a structured way to manage personal debts while avoiding bankruptcy’s severe restrictions and the automatic disqualification from directorship that follows.

Professional insolvency practitioners like Irwin Insolvency can provide crucial guidance when a company faces financial difficulties. Getting them involved early in the process often leads to better outcomes for both the company and its directors, potentially avoiding personal bankruptcy altogether.

Whether you’re currently facing financial difficulties or concerned about future risks, get in touch with us for a free consultation to understand your legal position.