Staking your house ‘makes a mockery of Ltd liability status’
Incorporated business-owners make a “mockery” of the limited liability that they are supposed to enjoy when they use their homes to back loans to their firms, a BoE study says.
But almost half of new loans to SMEs are financed this way, mainly as such firms lack their own tangible assets or steady cashflows to pledge to lenders, wrote the bank’s Saleem Bahaj.
The study explains: “In effect, the director contracts away some right to limited liability in order to increase their firm’s borrowing capacity.
“In the UK this is advantageous in the sense that the firm’s tax shield is then transferred to the director."
A BoE blog acknowledges some good for the economy, as by putting their family home on the line, ‘Ltd’ directors are “able to finance projects that otherwise wouldn’t come to fruition.”
“Personal housing wealth, which is a simple asset to borrow against, ends up greasing the financial wheels of smaller enterprises,” Bahaj wrote, hailing the funding route as “crucial.”
The Bank of England (BoE) study blog goes further, calling the route for SMEs “great” -- as long as house prices are rising, in which case directors were found to hike their business investment.
By contrast, a fall in house prices could adversely affect -- and expose -- incorporated business-owners whose homes are backing loans to their PSCs. This is in addition to “risks for the economy.”
“With limited liability removed, this form of financing can also result in large personal costs,” added Bahaj, the study and blog author.
“Even if a director’s home does not explicitly secure a guarantee, it can still implicitly back it because if a director fails to fulfill a personal guarantee, the creditor can obtain a court order to seize the director’s house.”
The study adds that guarantees for firm directors are typically joint and several, and that lenders can seize the assets of "any and all" directors in order to recoup the amount owed.