When a company is incorporated at Companies House, it benefits from limited liability. Below, we explain what this actually means for you and your company, and why limited liability is one of the biggest draws for so many business owners.
When you register a limited company, your liability for business debts is limited to what you invest in the company. This is because a limited company becomes a legal ‘person’ in its own right when it is incorporated at Companies House. Therefore, the liability, finances, and assets of the company are completely separate from the liability, finances, and assets of the people who own and manage the business.
If your company becomes insolvent or has legal action taken against it, you will only be responsible for debts up to the nominal value of your shares or personal guarantees. If you have already invested this money in the company, you should not have any additional financial liability.
That being said, limited liability does not provide blanket protection. If you are guilty of negligence, wrongful or fraudulent trading, or engage in any other criminal acts in the course of carrying out your company-related duties, you can be held personally liable and may face prosecution.
Limited liability of company shareholders
Private companies limited by shares and public limited companies (PLCs) are owned by shareholders (members), each of whom holds one or more shares.
When shareholders agree to take shares, they agree to pay the ‘nominal’ value of those shares to the company. The nominal value of most company shares is £1, but it can be any amount. Shareholders usually pay for their shares immediately, but some companies allow shares to be partly paid or unpaid for a specified on indefinite period of time.
The liability of shareholders is determined by the total nominal value of all of the shares that they hold. If they have already paid for their shares, they should have no further financial liability to the company.
Limited liability of company guarantors
Private companies limited by guarantee are ‘owned’ by guarantors, each of whom is bound by a personal guarantee in which they agree to pay a fixed sum of money to the company if it becomes insolvent.
The nominal value of a guarantor’s personal guarantee is usually £1, but it can be any sum.
Limited lability of company directors
Normally, directors do not have any personal liability toward the companies they manage, unless:
- they are also members, and/or
- they provide personal guarantees to the company’s creditors, commercial landlords, or when entering into any other type of business contract on behalf of the company
However, there are a number of situations in which company directors can be held personally liable by the courts or have legal action taken against them by lenders, suppliers, clients, employees, members of the public, government agencies such as Companies House and HMRC, the courts, and other individuals or businesses.
Exceptions to limited liability protection
Limited liability is not applicable in all situations. It does not apply if a director breaches his or her statutory duties, as outlined in the Companies Act 2006. Limited liability protection can also be lost as a result of negligence or unlawful acts.
The situations that can give rise to company directors being personally liable for debts, compensation, and other legal claims include:
- Failing to file Confirmation Statements and company accounts
- Not keeping statutory company records or registers
- Failing to disclose conflicts of interest
- Misusing company funds
- Pre-incorporation contracts that a director entered into on behalf of a company before it was set up
- Breach of warranty of authority – i.e. binding a company to a contract when not authorised to do so, which could result in the company seeking redress against the director
- Engaging in wrongful trading whilst a company is insolvent, such as:
- paying dividends to shareholders
- continuing to trade with no intention of repaying debt to creditors
- trying to repay company debts through fraudulent means
- disposing of business assets below their market value
- choosing to repay only certain creditors
- Wilfully ignoring court orders issued to the company
- Breaching data protection, either knowingly or on account of negligence
- Failing to comply with the requirements set out in the Companies (Trading Disclosures) Regulations 2008
- Price-fixing and competition offences
- Acting in the capacity of company director when disqualified from doing so, or knowingly acting on the instructions of a disqualified director
- Making negligent or fraudulent misrepresentations whilst negotiating a contract on behalf of the company
- Attempting to deceive shareholders and/or creditors by making false statements regarding the affairs of the company
- Committing bribery offences under the Bribery Act 2010
- Committing Health and Safety offences
- Manslaughter by gross negligence
- Discrimination and harassment offences
- Environmental offences, committed either knowingly or through negligence, during the course of carrying out the company’s activities
- Paying company employees less than the statutory minimum wage, or making illegal deductions from their wages
The vast majority of these liability situations can be avoided. However, even the most vigilant and conscientious of individuals can find themselves in difficult situations, simply by virtue of being a company director. This is why it is incredibly important to have insurance to protect both your company and yourself against third-party claims and other legal issues.
The most popular types of business insurance for limited companies and directors include:
- Public Liability insurance
- Employers’ Liability insurance
- Professional indemnity insurance
- Directors’ & Officers’ Liability insurance
Company directors have a great deal of responsibility. It is of the utmost importance that the role is taken seriously, that all company-related decisions are given the careful consideration they require, and that adequate insurance policies are in place. By doing so, company directors can protect the interests of the company and its members, whilst also minimising the risk of personal liability.
Do sole traders have limited liability?
The liability of sole traders is very different because the law treats the individual and the business as one and the same. This means that there is no legal distinction between the finances, assets, and liability of the business and the finances, assets, and liability of the individual. As such, sole traders have unlimited liability for business debts and legal claims.
This is one of the main reasons why setting up a limited company is the preferred choice for many business owners in the UK.