What is limited liability?

Limited liability for company directors and shareholders

When it comes to running a business, there are two main ways in which you can choose to trade; one is by operating as a self-employed sole trader; the other option is to incorporate the business as a limited company. While there are pros and cons to each operating structure, one of the main benefits of incorporating as a limited company is being able to enjoy the benefits of limited liability.

What is limited liability for a company?

Limited liability is afforded to all limited companies incorporated in the UK, and essentially means that shareholders are only legally responsible for the debts of a company up to the value of their shares, e.g., the amount already invested in the business.

Limited liability acts as layer of protection between the company and the individual directors/shareholders of the business. This can be extremely valuable if the company ever finds itself in financial difficulty or is threatened with insolvency.

A limited company is classed as its own legal entity, separate to that of its directors. This means that the finances and assets of the company belong to the company rather than its directors/shareholders; likewise, the debts and liabilities of the company belong to the company and not the individual directors.

The company is responsible for its own affairs and for paying its own debts. If a limited company is unable to meet its liabilities, falls into arrears, or accumulates debt which it cannot afford to repay, the responsibility for settling these amounts will not be passed to its directors.

Limited by shares vs limited by guarantee

All limited companies, whether private limited companies (LTDs), public limited companies (PLCs) or limited liability partnerships (LLPs) are given limited liability upon incorporation. From the point of incorporation, shareholder liability is limited to the value of their shares, which for many is a nominal amount.

However, some limited companies are limited by guarantee, rather than limited by shares. This often applies to not-for-profit organisations such as charities, sports clubs, and community projects. All profits are retained within the company and shares are not issued.

Instead, the company is owed by guarantors rather than shareholders; their liability for company debts is limited by the guarantee amount noted in the company’s Memorandum of Association. This is also typically a nominal amount, often just £1.

Regardless of whether a company is limited by shares or limited by guarantee, both models of incorporation provide directors with the protection of limited liability.

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Are there any exceptions to limited liability?

While limited liability provides directors of limited companies with a huge amount of protection in the event of the company failing, there are some notable exceptions where directors can be held personally liable for the actions (and debts) of their company should it become insolvent. Here are some of the most common reasons directors may find themselves liable to paying some of the debts of their company:

Personal Guarantees 

Personal guarantees are the most common reason why a director would be held personally liable for the debts of an insolvent company. Personal guarantees are often requested by a lender before funding is given to a company.

A personal guarantee provides additional security to a lender in the event of the borrowing company becoming insolvent or otherwise unable to repay the money which has been lent. In this instance, the personal guarantee crystalises, and responsibility for repaying the outstanding amount of the loan falls to the individual who signed the guarantee (typically the director).

The signing of a personal guarantee overrides limited liability regarding this finance agreement.

Fraudulent and Wrongful Trading 

Once a company becomes insolvent, its directors have a series of duties and legal responsibilities they must adhere to; these are to protect the interests of outstanding creditors who are already likely to suffer some form of financial loss as a result of the company’s failure.

One of these responsibilities is to place the interests of creditors above those of the company and its directors and shareholders as soon as they become aware the company is insolvent. In practice this means the company should not partake in any activity which may worsen the company’s financial position, such as obtaining more borrowing, disposing of company assets, or making preference payments to creditors.

In many cases, trade will have to cease upon the company becoming insolvent, although in some instances the company may be permitted to continue operating if this is likely to improve the position of creditors. The decision to continue trading an insolvent company should not be made by yourself or your fellow directors; you should consult a licensed insolvency practitioner who will be able to advise you on whether trading should continue or cease immediately.

Failure to adhere to these legal responsibilities as the director of an insolvent company could be construed as fraudulent or wrongful trading depending on the severity and intention behind these actions. Directors found guilty of wrongful or fraudulent trading risk future disqualification as a company director, being made personally liable for the debts of the company, and even imprisonment in the most serious cases of fraudulent trading.

Limited liability and insolvency

If your business is experiencing financial difficulties and you are worried your company could be insolvent, it is vital that you get expert help and advice as a matter of urgency. Even with the protection afforded by limited liability, you still have a responsibility to take matters of company financial distress seriously. Failure to do this could see you being held responsible for the losses incurred.

The expert team at UK Liquidators are perfectly placed to help you understand your current situation and your responsibilities as the director of an insolvent company. They will be able to talk you through your options and explain the various rescue and recovery solutions which may be appropriate. Depending on your company’s financial position, and likely future viability, we will also be able to discuss whether liquidation needs to be considered. Call our team today for immediate assistance.