Limited liability is the extent to which a company shareholder or director is financially responsible for their company’s debts.
To benefit from limited liability, a business must be incorporated at Companies House to become a private limited company (LTD), public limited company (PLC) or limited liability partnership (LLP).
Once it has been incorporated, the business becomes a separate legal entity from its owners. That means the finances and assets of the individual and the finances and assets of the company are completely separate. If the company is sued or cannot pay its debts, the owners are only liable for the debt to the value of the money they have already invested in the business.
What Does Limited Liability Mean?
The clear separation between individuals and their companies is a pivotal aspect of corporate law.
In the case of limited companies, this means that shareholders can only be held liable for company debts up to the value of their shares.
Directors cannot be held personally liable for company debts (unless they are shareholders in which cases the rules already explained apply)
The same goes for legal threats. When a company is sued, it is the legal structure that is the company which is being sued, not the individuals involved.
The same rules apply for members of LLP’s (Limited Liability Partnerships) or Limited Partnerships.
What are the Advantages of a Limited Liability Company?
There are a number of compelling advantages associated with a limited liability company. That includes:
No personal liability for company debts
One of the primary reasons the owners choose to incorporate their business is to avoid personal liability for company debts.
This allows the directors to trade without putting their personal property, cash and other assets at risk. As long as they adhere to their duties and responsibilities as directors then in the case of insolvency, the creditors will only be able to recover money they are owed from the bank account and assets of this business.
Limited companies are taxed on their profit at a rate of 19 percent. They are not subject to the personal tax rates placed on sole traders and partnerships (unlimited companies) which can be as high as 45 percent.
Directors of limited companies can pay themselves a salary at the personal allowance level and take the rest of their pay as dividends, which are taxed at a lower rate. This will reduce the tax burden and keep more money in their pocket.
As a limited liability company is deemed to be a separate legal entity from its owners, the company will continue to exist beyond the life of its members. That means, if directors or members retire or experience ill-health, the company will continue to exist and operate. This can provide security for employees and other company members.
Another benefit of a limited liability company is the ability for key employees to be granted shares via a company share scheme. This can boost employee motivation and provide a monetary reward beyond a mere salary. Having a vested interest in the company’s success can also improve employee loyalty.
Protection of the company name
As part of the process of registering a limited liability company, a company name must be chosen. Company names can become valuable assets. Registering a name at Companies House prevents other businesses from using the same name. However, Companies House will accept the registration of a name which is very similar, so it may be worth registering alternative spellings or versions of the same name and keeping those as dormant companies.
What is a Limited Liability Company Agreement?
As part of the limited liability company registration process, by law, you have to create certain documents. That includes the Articles of Association, which sets out the rules company officers have to follow in the running of the company, and a Memorandum of Association, which gives notice of an individual’s intention to become a company shareholder.
Another document that isn’t required by law is a limited liability company agreement.
Also known as a shareholders’ agreement or an LLP agreement, this document intends to formalise the relationship between shareholders or partners. It formalises what will happen when there are differing opinions about the direction the company will take, establishes how the business will be run and sets the ground rules for the relationship.
A simple way to think of a limited liability company agreement is as the terms & conditions for company directors.
Although similar to the Articles of Association in its content, the main difference is that the Articles of Association has to be made public, while the limited liability company agreement is a private contract between shareholders.
What is a Private Company Limited by Guarantee?
Companies limited by guarantee are usually not-for-profit organisations like charities, sports clubs, societies and community projects. They are not set up to make a profit for the shareholders. Instead, any money they make is retained within the organisation or used for some other purpose.
A private company limited by guarantee is a separate legal entity that’s responsible for its own income, assets, debts and liabilities, just like any other limited liability company.
However, instead of issuing shares, the company is owned by guarantors. Their personal liability for the debts of the organisation is limited to a fixed amount of money called a guarantee. This guarantee is written into the company’s Memorandum of Association and requires the guarantors to pay the company’s debts up to a fixed sum, which is usually £1.
A company limited by guarantee must have at least one director, although most have several. The directors may also be given some other name like trustees, governors, the board of managers or the management committee. Whatever their title, they are responsible for the day-to-day running of the organisation.
What is the Liability of a Limited Liability Company?
The basis of a limited liability company is that all debts incurred are the debts of the company and are not the responsibility of the shareholders or directors. In a company that’s limited by shares, the shareholders’ obligation is to pay the company for the shares they have. Once those shares have been paid for in full then no further money is payable.
In the case of a company that’s limited by guarantee, each guarantor will be liable for the company’s debts up to the value written into the Memorandum of Association, which is usually just £1.
The only way a director or shareholder can become liable for company debts over the value of their original shareholding holding or guarantee is where personal liability is imposed by the court. This can be the case in instances of wrongful or fraudulent trading.
Some creditors such as banks and other finance providers may ask directors to give personal guarantees for loans, overdrafts and a lease of premises. If the business does fail then the director will be obliged to pay those debts from their personal funds.
Directors Personal Liability in a Limited Company
Although limited liability provides a great deal of protection for company shareholders and directors, there are some circumstances when they can become personally liable for business debts. That includes:
- If they sign a personal guarantee;
- If they continue to trade in the interest of shareholders (instead of the creditors) despite knowing the business is insolvent;
- If they dispose of assets at less than market value;
- If they overpay themselves from the company’s account creating an overdrawn director’s loan;
- If funds are raised to repay creditors via fraudulent means.
What are Limited Liability Company Debt Obligations?
Despite the protection of limited liability, company debts can still be very stressful and worrying for the directors. Not only is their livelihood at risk, but they also have to be aware of their changing obligations.
Once cash-flow is compromised, a business can decline very quickly. Directors then have to monitor their financial position very carefully. If the business becomes insolvent (you can check using this free insolvency test) then they must prioritise the creditors’ interests. Failure to do so could lead to personal liability for a proportion of the company’s debts further down the line.
Company debts can include unpaid supplier invoices, unpaid rent and even wages owing to employees. However, one of the most worrying debts of limited liability companies are those owing to HMRC. VAT, PAYE and corporation tax debts are a common issue for company directors. HMRC has its own range of powers to pursue arrears aggressively which can make this situation incredibly stressful.
Obtaining help and support to deal with limited liability company debts, and specifically tax debt, is essential. Being proactive about controlling cash-flow and putting a firm plan in place is an important first step, as is identifying areas of the business where money is being wasted.
Company debt experts can help struggling directors to explore debt refinancing and consolidation options which could provide the working capital required to repay creditors and drive the business forward.
How can we help?
As a UK leader in limited liability company rescue and recovery, we can provide you with the expert advice and practical assistance to support you as a director. Please call us on 08000 746 757, email [email protected] or call our senior consultant Sue directly on 07949 969 006