Forming a company – what is the meaning of ‘limited liability’?

In the UK, companies can take several different forms, including private companies limited by shares, private companies limited by guarantee, private unlimited companies and public limited companies.

What is the meaning of ‘limited liability’?

The question is, in what sense do any shareholders and directors have limited liability should things go wrong in one of these types of business structures?

What does limited liability mean in reality, and in what circumstances might a director still be found liable?

In a nutshell, limited liability means that any debts incurred by a company remain the company’s debt or liability and do not normally carry over to the company’s directors or shareholders.

In other words, under current UK law, the company is treated as a legal entity or ‘person’ separate from the directors and shareholders.

This separation normally protects a director’s personal assets from the company’s creditors. However, there are circumstances in which directors can become personally liable.

So, it is perhaps more accurate to say that directors have limited financial responsibility when it comes to paying off company debts, if not a free pass.

We’ll look at some instances where personal liability for company debts might arise later.

How liability applies

In a private company limited by shares, liability is limited to any amount due for unpaid shares. No additional liability applies to shareholders once their shares have been fully paid.

In companies limited by guarantee, members agree to contribute up to a specified amount towards the company’s assets if it is wound up.

For a private unlimited company, the members’ liability is unlimited; in a public company limited by shares, members’ liability is limited to the amount, if any, unpaid on their shares.

In a general partnership, the partners can be personally responsible for the debts of the business.

Sole traders also have unlimited liability and are treated as the same legal entity as the business.

With limited liability partnerships, the LLP is a separate legal entity and its members normally have limited liability. However, members can still incur personal liability in some circumstances, for example through their own wrongdoing or a personal guarantee.

When can a director become personally liable?

Limited liability does not protect a director from every possible claim.

One of the most common examples is a personal guarantee. A bank, landlord, finance provider or supplier may require a director to personally guarantee a company debt.

If the company cannot pay that debt, the creditor may then be able to pursue the director personally under the terms of the guarantee. Depending on the guarantee and the amount owed, personal assets may therefore be at risk.

Directors can also face personal liability because of their own conduct, particularly if a company becomes insolvent.

In what circumstances might a director still be found liable?

If a company becomes insolvent, the directors still have statutory duties and their priorities shift towards protecting the interests of creditors.

They should protect the company’s assets, avoid worsening the position of creditors and take appropriate steps to minimise potential losses.

Directors should also consider taking professional insolvency advice as soon as they believe the company may be unable to pay its debts.

If a director is found to have breached their duties or engaged in misconduct, they could face personal liability and may also be disqualified from acting as a director.

You can read the Insolvency Service guidance on directors’ duties when a company becomes insolvent.

Some examples of inappropriate actions

A director may face personal liability or other legal consequences in circumstances including:

• Paying unlawful dividends when there are insufficient distributable profits or when doing so improperly removes money from an insolvent company.
• Breaching the terms of a personal guarantee or other personal agreement with a lender or creditor.
• Using company funds or assets improperly for personal purposes, which may amount to misfeasance.
• Attempting by fraudulent means to raise funds to pay off creditors. This includes trying to obtain finance from a lender by providing misleading information.
• Accepting payment for goods or services whilst knowing the goods or services can’t be delivered.
• Selling or otherwise disposing of company assets at below market value in circumstances where this prejudices creditors.
• Having an overdrawn director’s loan account which remains repayable to the company.
• Wrongful or fraudulent trading.

Wrongful trading

Wrongful trading is particularly relevant when a company is heading towards insolvency.

Broadly, a director can face a claim where they knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding insolvent liquidation or administration and failed to take the steps required by insolvency law to minimise losses to creditors.

This is different from fraudulent trading, which involves carrying on the company’s business with intent to defraud creditors or for another fraudulent purpose.

Potential consequences for directors

In the event of a company’s insolvency, the insolvency practitioner, such as a liquidator or administrator, will examine the directors’ conduct where required and may investigate transactions and decisions made before the insolvency.

If evidence of misconduct is found, action may be taken to recover money or assets for the company or its creditors. The conduct of directors may also be reported to the Insolvency Service, which can investigate and take enforcement action where appropriate.

Possible consequences can include personal liability, compensation orders and director disqualification. A director can be disqualified for up to 15 years. :contentReference[oaicite:2]{index=2}

If a director has an overdrawn director’s loan account when the company enters liquidation, the amount outstanding is an asset of the company and the liquidator will normally seek repayment.

Limited liability therefore provides important protection, but it does not protect directors from personal guarantees, their own wrongdoing or breaches of their legal duties.