In the business world, there are two primary business structures to choose from: operating as a self-employed sole trader or incorporating as a limited company. Each has its own advantages and disadvantages, but one of the key benefits of becoming a limited company is limited liability protection.
What Does Limited Liability Mean for a Company?
Limited liability is a feature of all limited companies in the UK and protects shareholders by making them responsible for the company’s debts only to the extent of their share investment. This acts as a shield for directors and shareholders, providing valuable protection in the event of financial difficulties or insolvency.
Limited companies are separate legal entities, distinct from their directors, with their own finances and assets separate from those of their shareholders. If a limited company faces financial challenges and is unable to repay its debts, its directors will not be personally responsible for repaying these debts.
Differentiation between Limited by Shares and Limited by Guarantee
Incorporating a business as a limited company provides protection through limited liability. This means that shareholders are only responsible for the company’s debts up to the value of their shares.
Limited liability acts as a barrier between the company and its directors/shareholders. This protection is valuable in case the company faces financial difficulties or the threat of insolvency.
Limited companies are considered a separate legal entity from their directors, meaning that the company’s finances and assets are separate from those of the directors/shareholders. The company is responsible for its own affairs and paying its own debts. If a limited company is unable to meet its liabilities, directors will not be held responsible for repaying them.
Limited companies can be either private limited companies (LTDs), public limited companies (PLCs), or limited liability partnerships (LLPs) and all types of limited companies have limited liability. However, some limited companies are limited by guarantee rather than by shares, often applying to non-profit organisations like charities, sports clubs, and community projects. In this case, the company is owned by guarantors rather than shareholders and their liability is limited by the guarantee amount noted in the Memorandum of Association, which is typically a nominal amount like £1. Regardless of the type of incorporation, limited liability protects both directors and shareholders.
Exceptions to the Limited Liability Protection
While being a director of a limited company provides protection with limited liability, there are certain circumstances where a director may become personally liable for the debts of the company.
Personal Guarantees – Personal guarantees (PGs) are a common factor that may cause a director to become personally liable for the debts of an insolvent company. PGs are often requested by lenders before lending money to a company. If the company becomes insolvent or unable to repay the loan, the PG activates and the responsibility of repaying the loan falls on the individual who signed the PG (usually the director), even though it overrides limited liability.
Fraudulent Trading – When a company becomes insolvent, its directors have specific responsibilities to protect the interests of creditors who are likely to face financial loss due to the company’s failure. One such responsibility is to prioritise creditors over the company and its directors and shareholders. As a result, the company should not engage in activities that worsen its financial position, such as obtaining further borrowing, disposing of assets, or making preference payments to creditors.
In most cases, trading must stop once the company becomes insolvent, but it may be allowed to continue under certain conditions with the advice of a licensed insolvency practitioner. Failure to comply with these responsibilities could be considered fraudulent trading, resulting in potential disqualification as a company director and personal liability for the losses suffered.
Limited liability and insolvency
If you’re concerned that your business may be facing financial difficulties and is at risk of insolvency, it’s important to seek professional help right away. Despite the protection offered by limited liability, you have a responsibility to take the financial stability of your company seriously. Neglecting this responsibility could result in personal responsibility for any losses.
InsolvencySupport.co.uk has a knowledgeable team who can assist you in understanding your situation and responsibilities as the director of a potentially insolvent company. They will walk you through your options and explain various rescue and recovery solutions that might be appropriate. Based on your company’s financial position and potential for future viability, they can also discuss if liquidation should be considered. Contact our team today for immediate support.