Can a Creditor Claim Company Debt From a Director Personally?

When a company cannot pay its debts, directors often worry that creditors will simply pursue them personally for the money. In most cases, this is not how company debt works. A company is a separate legal entity from its directors and shareholders. This means that debt incurred by the company generally belongs to the company. A director or shareholder does not automatically become personally responsible simply because the company cannot afford to pay its creditors. There are, however, important exceptions. Personal exposure can arise because of an agreement signed by the director, legislation, or the director's own conduct.

Understanding the difference is particularly important when a company is becoming insolvent.

If the Company Owes the Money, Do I Owe It Personally?

Generally, no.

A private company has its own legal identity and can own assets, enter into agreements, incur debt and owe money independently of its shareholders and directors. If a company purchases stock from a supplier, incurs an overdraft, owes rent or cannot pay another creditor, the starting point is therefore that the company owes the debt.

The fact that you are a director or shareholder does not, by itself, transfer that debt to you personally.

This separation between the company and the individuals behind it is one of the fundamental principles of operating through a company.

What If I Signed Personal Surety?

Personal surety is different.

When a director signs personal surety for company debt, the director has agreed to accept a separate personal obligation in relation to that debt. Depending on the terms of the surety, the creditor may therefore have rights against both the company and the person who signed surety. This article is not about company debt where personal surety has been signed. We deal with that separately in What Happens to Personal Surety When a Company Is Liquidated? Here we are considering whether a director can become personally exposed to company debt where no personal surety exists.

Can Reckless or Fraudulent Trading Create Personal Liability?

Potentially. Limited liability should not be treated as permission to continue incurring company debt regardless of the company's circumstances. South African company law prohibits reckless or fraudulent trading and contains provisions dealing with director liability arising from certain conduct.

This does not mean that a director becomes personally liable simply because a business failed.

Companies can become insolvent for legitimate commercial reasons. Customers disappear, contracts are lost, costs increase and businesses can experience severe cash-flow problems.

The concern becomes greater where a director knowingly continues conducting business improperly, incurs obligations in circumstances where there is no reasonable basis for believing the company can meet them, acts fraudulently, or uses the company in a manner that prejudices creditors.

What If the Company's Debtors Have Been Ceded to a Creditor?

This is an important area that directors sometimes overlook. A bank, finance provider, supplier or other creditor may have taken a cession of the company's debtors or book debts as security for money owing to it.

If customers subsequently pay money owing to the company, the director cannot simply assume that those funds are freely available to be diverted elsewhere without considering the rights created by the cession.

For example, moving collections into another business or account in an attempt to place them beyond the reach of the creditor may create problems quite separate from the company's original inability to repay its debt. Before moving or disposing of funds or assets subject to security, directors should establish exactly what rights the creditor holds.

Can Moving Company Assets Create Problems for a Director?

Yes. There is a significant difference between a company genuinely being unable to pay its creditors and deliberately stripping value out of a company before liquidation. Transferring assets to another company controlled by the same director, selling assets to related parties for substantially less than their value, concealing property or diverting company funds can have serious consequences.

South African company law allows courts to intervene where the separate juristic personality of a company has been used in an unconscionable manner. The protection created by a separate company should therefore not be treated as a mechanism for deliberately placing assets beyond the reach of legitimate creditors.

What About a Landlord Owed Rent?

Commercial lease agreements frequently contain personal surety clauses. If personal surety was signed, the position must first be considered under the terms of that surety. Where no personal surety exists, unpaid rent remains, in principle, a company liability.

However, landlords may also have security rights over certain movable property situated at leased premises through the landlord's tacit hypothec. Those rights and the steps taken to perfect them can become important when rent is unpaid.

Directors should therefore be cautious about removing, selling, concealing or transferring company assets once legal proceedings or attachment processes have commenced. The absence of personal surety does not give a director permission to interfere unlawfully with a creditor's security or with assets that should properly form part of the company's estate.

Can SARS Hold a Director Personally Liable for Company Tax Debt?

In certain circumstances, yes.

Company tax debt does not automatically become the director's personal debt. However, the Tax Administration Act contains specific provisions allowing SARS to pursue a person involved in the management of a company's financial affairs where that person's negligence or fraud resulted in the failure to pay tax debt. This is why directors should not ignore outstanding returns, SARS correspondence, demands or enforcement notices.

A director who is experiencing genuine financial difficulty should continue communicating with SARS and attempt to address outstanding compliance and payment issues. Where the company cannot resolve its tax position and the SARS debt is contributing to insolvency, liquidation should be considered before the situation progresses into more serious enforcement action and potential personal-liability proceedings.

We deal with this issue in more detail in Can SARS Hold a Director Personally Liable for Company Tax Debt?

Are Shareholders Personally Responsible for Company Debt?

Generally, shareholders are not personally responsible simply because they own shares in the company. Their position can change where they have separately signed personal surety, received or participated in improper transfers, or where specific legislation creates liability.

Being both a shareholder and director also does not automatically make every company debt personal. The person's agreements, conduct and role in the company's financial affairs must be considered.

What About Members of a Close Corporation?

A close corporation is also a legal entity separate from its members. Company debt should therefore not automatically be treated as the personal debt of a member merely because the close corporation cannot pay. The Close Corporations Act does, however, contain circumstances in which members or other persons may incur personal liability. The particular conduct and circumstances therefore need to be considered rather than assuming that limited liability will always apply.

When Should a Director Consider Liquidation?

The important question is often not simply whether the company currently owes money. It is whether the company can realistically recover.

If the company cannot pay SARS, suppliers, landlords, employees or finance providers and there is no realistic prospect of restoring its financial position, continuing to accumulate debt can increase the risk for everyone involved.

Considering liquidation at the appropriate time can prevent an ordinary company insolvency from developing into a more complicated situation involving disputed transactions, creditor enforcement and allegations concerning the director's conduct.

Company Debt Does Not Automatically Become Personal Debt

A company failing financially does not automatically mean that its directors, shareholders or members have failed personally. Where there is no personal surety, the starting point is that company debt belongs to the company.https://landing.solvendi.co.za/

The position can become more complicated where there has been reckless or fraudulent conduct, interference with secured assets, improper transfers, tax non-compliance or other conduct capable of creating separate personal exposure.

The earlier the company's financial position is assessed, the more opportunity there is to deal with insolvency correctly before those additional problems arise.

Contact Solvendi for a confidential assessment of your company's financial position. We can assess the company's debt, creditor exposure, personal sureties and potential director liability and explain whether liquidation is an appropriate way forward.

Disclaimer: This article is intended for general informational purposes only and should not be regarded as legal advice. The appropriate solution will depend on the company's particular financial position, tax affairs and liabilities. Professional advice should be obtained regarding your individual circumstances.

Contact us to discuss your current situation and receive a free detailed assessment of how the process works and what your costs will be. We have legal experts with 20 years experience that can guide you through the process. Our main aim is to be as informative as possible. Let's Chat.

If you require advice with regards to Sequestration, Business Liquidations, Insolvency, Bankruptcy or Credit Rehabilitation kindly contact SOLVENDI as follows:

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Email: consultations@solvendi.co.za 

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