If you’re a director or shareholder in a limited company or LLP, you may be wondering what limited liability means.
Particularly when a business runs into financial jeopardy, the meaning of this term becomes crucial in limiting the fallout from failed corporate enterprise.
Read on to discover our full guide to limited liability status.
Limited Liability
Limited liability means a shareholder’s liability is normally limited to the amount unpaid on their shares, and a director is not personally liable for the company’s debts merely because they are a director. That is the general position and it holds in most insolvencies.
It is not absolute, and it is worth being clear about that early. Personal exposure can arise separately, through a personal guarantee, through borrowing you took personally to fund the company, through an overdrawn director’s loan account, through share capital that was never paid up, or through certain breaches of duty and the insolvency provisions dealt with below. None of these makes company debt automatically personal. Each is its own route, with its own test.
The limited company structure hinges on what is known as the corporate veil: a line of distinction between the assets of the company and those of the individuals and investors behind it.
When an individual is working as a sole trader, there is no legal separation between their business and personal assets. Many directors find this choice of structure something they wish they’d thought through more carefully when creditors come knocking.
Company Limited by Shares
In a company limited by shares, a shareholder’s liability is limited to any amount still unpaid on their shares. Where shares are fully paid, a shareholder is not normally required to contribute further. Where they are only partly paid, a liquidator can call up the balance.
Company Limited by Guarantee
Companies limited by guarantee are often charities and other not-for-profit bodies. The structure revolves around a nominal guarantee, often £1, which is the amount each member undertakes to contribute if the company is wound up.
Can Directors Be Personally Liable for Debts in a Limited Liability Company?
In general, the structure is there to limit personal liability.
The main exceptions are not convictions. Misfeasance is a civil claim brought by an office-holder to recover money or property a director has misapplied or retained, and the court can order the director to repay or compensate the company. Wrongful trading and fraudulent trading are separate provisions again, and director disqualification is a separate regime that does not itself transfer debt to the director.
The more obvious exception involves personal guarantee documents which we discuss below.
Personal Guarantees and Limited Liability
The personal guarantee document, signed commonly by a director as additional security for a business loan, has one purpose, which is to put the director behind the company’s obligation. By signing it the guarantor gives up the protection of limited liability for that particular debt.
Most guarantees are unsecured. They name no asset. What they create is a personal debt, which the lender then has to enforce like any other — by demand, by judgment, and if necessary by a charging order over your home or a bankruptcy petition. A secured guarantee, backed by a charge over a named asset such as the family home, is a different and less common document, and the lender can go straight to that asset. Read which one you have been asked to sign before you sign it.
Personal guarantees are hard to get out of once signed, which is why the moment to negotiate one — a cap on the amount, a time limit, a release on refinancing — is before you sign it, while the company still has something to offer. Occasionally a guarantee turns out to be unenforceable because it was drawn up or executed badly, but that is a matter of luck rather than a plan.
We recommend that directors consider personal guarantee insurance before they sign a guarantee. It can cover part of what you would owe if the guarantee is called in, and it has to be in place before that happens.