The principle of limited liability underpins the corporate structure and benefit of running a business within a limited company. It can provide directors and shareholders with personal protection from business liabilities. This concept is pivotal for business owners seeking to safeguard their personal assets while growing a business. Although limited liability provides a sound starting point to distance the individuals from risk there are circumstances where the liabilities of the company, and claims deriving from the company, can be pursued against them personally. It is particularly important for the directors to understand the circumstances in which liability extends beyond the company in order to limit their exposure to personal financial risk.
The Principles of Limited Liability
In a limited company the directors and shareholders enjoy limited liability – their personal assets are generally shielded from the company’s debts and liabilities. This protection is a cornerstone of the corporate structure, fostering entrepreneurship and investment by mitigating the risks associated with business ventures. Limited liability allows directors to take business decisions without fear of bearing personal financial burdens in the event of business failure.
When Doesn’t Limited Liability Apply?
Despite the robust protection afforded by limited liability company directors may still find themselves personally liable in certain circumstances:
- Personal Guarantees. Directors may be required to provide personal guarantees to lenders or creditors in order to secure loans or credit facilities for the company. In such cases, directors assume personal liability for the debt should the company be unable to pay. If the company defaults on its obligations the creditor may pursue the director personally to recover the outstanding amount. Directors may find that certain forms of lending or supplies cannot be obtained without providing a personal guarantee, reflecting the power imbalance between a large bank or supplier and the smaller business. The risks should always be understood before granting such guarantees, particularly when the solvency of the company is uncertain. In the event of insolvency the directors must ensure all creditors are treated equally and payments to liabilities subject to personal guarantees are not preferred. Preferring payments to one creditor over another can bring a claim under the insolvency legislation and a recovery action against a director. If the actions taken are deemed sufficiently improper in the eyes of the Insolvency Service a director can be disqualified from acting in the same capacity for a period of 2 – 15 years. Professional advice should be taken when the future of the company becomes uncertain to avoid potential liabilities arising later on as a result of the operation of the insolvency legislation.
- Fraudulent or Wrongful Trading. Directors who engage in fraudulent activities or wrongful trading can be held personally liable for the resulting debts. Fraudulent trading involves intentionally deceiving creditors or engaging in dishonest conduct, while wrongful trading occurs when directors continue trading despite knowing that the company is insolvent and unable to meet its financial obligations. In such instances directors may be held personally liable for the debts incurred and disqualification can follow. It is important to seek professional advice when the directors recognise the company is facing financial difficulties to avoid actions that can be criticised later on.
- Claims by Liquidators and Administrators. In the event of company liquidation and administration the appointed insolvency practitioner has a duty to investigate the conduct of directors, particularly in the final period of trading when the company was insolvent. If a director is found to have acted in breach of their duty of good faith, to the company and creditors, they may be held personally liable to compensate the company for losses caused. Where the conduct is deemed sufficiently improper in the eyes of the Insolvency Service this can lead to a person being disqualified from acting as a director of any UK company for a period of 2 – 15 years. Directors should exercise diligence, act in the interests of the company and the creditors as a whole, and adhere to their legal obligations in order to mitigate the risk of proceedings against them personally. Professional advice should be taken when the future of the company is in doubt to avoid personal claims being raised later on.
The limited liability afforded by company status provides directors and shareholders with essential protection from personal liability for the company’s debts and liabilities. A degree of personal liability may be necessary to secure company bank lending or supplier accounts by granting personal guarantees. Acting properly in accordance with the duties of good faith to the company and creditors can ensure claims cannot be made later on should the company enter liquidation or administration. In order to understand their duties and the potential pitfalls directors should seek professional advice when there are concerns about the long term solvency of the company.
Whiteoak Morris is an insolvency practise licensed by the Institute of Chartered Accountants in England and Wales (ICAEW). Call us today for free and confidential initial professional advice.