Limited liability refers to the extent a company director or shareholder is personally responsible for the debts of their business. Limited liability is often one of the advantages that sways business owners to incorporate as a limited company rather than to operate as a self-employed sole trader. This is because it provides a valuable element of personal financial and legal protection in the event of the company encountering problems in the future.
Companies which have limited liability are only responsible for the debts of their company up to the value of the shares they have in the business. This means that if the company becomes insolvent and subsequently enters a formal liquidation process, such as a Creditors’ Voluntary Liquidation (CVL), while directors and shareholders will lose any investment already in the company, they will not be held personally responsible or be pursued for any debt which remains outstanding.
In order to get limited liability, a company must be incorporated at Companies House and registered as a limited company. The business can be registered as a private limited company, a public limited company, or a limited liability partnership; so long as the company is incorporated, limited liability will be given to its directors and shareholders. Limited liability also applies if the company is limited by shares or limited by guarantee; while the type and structure may be different, limited liability is still granted.
Once a company is incorporated it is classed as its own legal entity, separate from its directors. This means the company is responsible for any borrowing it takes out, rather than its shareholders. This also applies if the company is threatened with litigation at any point; it is the company which is being sued, not its directors.
A company can either be limited by shares or limited by guarantee. While these different operating structures do have some important differences, namely how money is extracted from the company, when it comes to limited liability, they follow a similar premise. In simple terms, for a company which is limited by shares, liability of shareholders is limited to the amount they have paid for their shares in the business; in a company which is limited by guarantee, personal liability is limited to the amount of the guarantee set out in the company's Memorandum of Association – this is typically a nominal amount which is often set at £1.
There are certain occasions when limited liability will not fully protect a company’s directors or shareholders and they may subsequently be held responsible for the debts of their company.
The main reason why limited liability would not protect a director would be if there was evidence of fraudulent trading or misfeasance. Directors have certain responsibilities when running their company, and these become even more numerous if the company is knowingly insolvent.
Once a director or shareholder knows their company to be insolvent, they must place the interests of their creditors above those of themselves and any other director/shareholder. This means not engaging in any activity which could worsen the position of creditors or increase their losses any further. Directors should not obtain any further borrowing, dispose of assets below market value, or increase any overdrawn directors’ loan.
If a director fails to adhere to their duties as the director of an insolvent company, they could be held liable for some or all of the company’s debts.
In order to obtain funding, directors may be asked to provide a personal guarantee; this is typically the case for smaller or more recently established companies. A personal guarantee is a form of security given to the lender which means that in the event of the company being unable to repay the borrowing taken out, the director will assume personal responsibility for paying back the money owed.
The reason a personal guarantee is requested is much to do with the fact that directors are given limited liability when incorporating their company. Banks and other lenders know that - because of limited liability - if a company becomes insolvent and is subsequently liquidated, then they will be unable to recover any of the borrowing which remains outstanding. A personal guarantee is therefore requested so that they can ask the director to repay the remaining amount and therefore maximise their change of recovering the loan.
Just because your company may provide you with limited liability, does not mean that you can ignore matters if financial problems arise. On the contrary, you have a legal obligation as the company’s director to adhere to certain standards, particularly when it comes to shielding creditors and protecting their interests.
If your limited liability company is under financial distress, you should take advice from a licensed insolvency practitioner as a matter of urgency. They will be able to talk you through your options for rescuing the company, giving you the best chance possible of effecting a successful turnaround, while also ensuring you are adhering to your responsibilities as the director of an insolvent company.
For immediate help and advice, or to arrange a free no-obligation consultation, call the experts at Real Business Rescue today on 0800 644 6080.