Limited Liability | Company Law - CLAT PG PDF Download

What is Limited Liability?

• Limited liability refers to the degree of financial responsibility a company shareholder or director has for the company's debts.

How to Benefit from Limited Liability

• To enjoy limited liability, a business must be incorporated at Companies House and become one of the following:
• Private Limited Company (LTD)
• Public Limited Company (PLC)
• Limited Liability Partnership (LLP)

Separation of Legal Entities

• Once incorporated, the business is considered a separate legal entity from its owners.
• This means that the finances and assets of the individual owners are distinct from those of the company.

Protection for Owners

• If the company faces legal action or cannot pay its debts, the owners are only liable for the debt up to the amount they have already invested in the business.

Understanding Limited Liability

Limited liability is a fundamental principle in corporate law that provides a clear distinction between individuals and their companies. This concept is particularly relevant for shareholders, directors, and members of Limited Liability Partnerships (LLPs) or Limited Partnerships.

Key Aspects of Limited Liability

• Shareholder Liability: In limited companies, shareholders are only liable for the company's debts up to the value of their shares. This means that their personal assets are protected, and they cannot be held responsible for debts beyond their investment in the company.
• Director Liability: Directors are generally not personally liable for the company's debts, unless they are also shareholders. In such cases, the same rules regarding liability apply as for shareholders. This separation helps protect directors from personal financial risk related to the company's obligations.
• Legal Actions Against Companies: When a company is sued, it is the legal entity of the company that is being targeted, not the individuals involved, such as directors or shareholders. This legal structure helps shield individuals from personal liability in legal disputes involving the company.
• Limited Liability Partnerships (LLPs) and Limited Partnerships: The same principles of limited liability apply to members of LLPs and Limited Partnerships. Members are protected from personal liability for the partnership's debts, similar to shareholders in a limited company.

Advantages of a Limited Liability Company

• No Personal Liability for Company Debts: One of the main reasons people choose to set up a limited liability company (LLC) is to protect themselves from being personally responsible for the company's debts. This means that if the company runs into financial trouble, the owners' personal assets, like their house or savings, are safe. As long as the owners follow the rules and do their jobs properly, creditors can only claim money from the company's bank account and assets, not from the owners' personal belongings.
• Tax Efficiency: Limited liability companies are taxed on their profits at a rate of 19%, which is generally lower than the personal tax rates that apply to sole traders and partnerships, which can go as high as 45%. Additionally, directors of limited companies can pay themselves a salary up to the personal allowance limit and take the rest of their income as dividends, which are taxed at a lower rate. This strategy helps reduce the overall tax burden and allows directors to keep more of their earnings.
• Succession Planning: Since a limited liability company is considered a separate legal entity from its owners, it can continue to exist even if the directors or members retire or become unable to work. This ensures that the company can operate smoothly and provides stability for employees and other stakeholders, regardless of changes in leadership or ownership.
• Employee Buy-In: Limited liability companies can offer key employees the opportunity to buy shares in the company through a share scheme. This can motivate employees and provide them with financial rewards beyond just their salary. When employees have a stake in the company's success, they are often more loyal and committed to helping the business thrive.
• Protection of the Company Name: When registering a limited liability company, choosing a unique company name is important. Company names can become valuable assets over time. By registering a name with Companies House, businesses can prevent others from using the same name. However, it's possible for similar names to be registered, so it may be wise to register different variations or spellings of the name and keep those as inactive companies for added protection.

Limited Liability Company Agreement

Documents Required for Limited Liability Company Registration

• Articles of Association: Outlines the rules for company officers in managing the company.
• Memorandum of Association: Indicates an individual's intention to become a shareholder in the company.

Limited Liability Company Agreement

• Definition: A limited liability company agreement, also known as a shareholders' agreement or LLP agreement, is a document that formalizes the relationship between shareholders or partners in a limited liability company.
• Purpose: The agreement outlines how the business will be run, establishes ground rules for the relationship, and addresses what happens in case of differing opinions about the company's direction.
• Comparison with Articles of Association: While similar in content to the Articles of Association, the key difference is that the Articles must be made public, whereas the limited liability company agreement is a private contract between shareholders.

Private Company Limited by Guarantee

• A company limited by guarantee is typically a not-for-profit organization, such as a charity, sports club, society, or community project. Unlike traditional companies, these organizations are not set up to generate profits for shareholders. Instead, any surplus funds are retained within the organization or used for specific purposes.
• A private company limited by guarantee functions as a separate legal entity, responsible for its own income, assets, debts, and liabilities. This is similar to other limited liability companies.
• Ownership in a company limited by guarantee is not through shares but by guarantors. The personal liability of these guarantors for the organization's debts is limited to a fixed amount, known as a guarantee. This guarantee is specified in the company's Memorandum of Association and typically requires guarantors to cover the company's debts up to a fixed sum, often £1.
• To operate, a company limited by guarantee must have at least one director, although most have multiple directors. These directors may be referred to by different titles, such as trustees, governors, board of managers, or management committee. Regardless of their title, they are responsible for the day-to-day management of the organization.

Liability of a Limited Liability Company

The core principle of a limited liability company is that all debts incurred are the responsibility of the company, not the individual shareholders or directors. In a company limited by shares, shareholders are only obligated to pay for the shares they have agreed to purchase. Once these shares are fully paid for, no additional payments are required from the shareholders.

Limited by Guarantee

• In a company limited by guarantee, each guarantor is liable for the company's debts only up to the amount specified in the Memorandum of Association.

Personal Liability

• Directors or shareholders can become personally liable for company debts beyond their initial shareholding or guarantee only if the court imposes personal liability. This typically occurs in cases of wrongful or fraudulent trading.

Personal Guarantees

• Certain creditors, such as banks and financial institutions, may require directors to provide personal guarantees for loans, overdrafts, and leases. If the business fails, the director is then responsible for repaying these debts from personal funds.

Director's Personal Liability in a Limited Company

While limited liability offers significant protection to company shareholders and directors, there are specific situations where they can be held personally liable for business debts. These include:

• Signing a personal guarantee.
• Continuing to trade in the interest of shareholders rather than creditors when knowing the business is insolvent.
• Disposing of assets below market value.
• Overpaying themselves from the company’s account, leading to an overdrawn director’s loan.
• Raising funds to repay creditors through fraudulent means.

Limited Liability Company Debt Obligations

Company debts can be a significant source of stress and concern for directors, even with the protection of limited liability. Their livelihoods are at stake, and they must remain vigilant about their evolving obligations.

Impact of Cash Flow on Business

• If cash flow is compromised, a business can decline rapidly.
• Directors need to monitor their financial position closely.

Insolvency and Creditor Prioritization

• If a business becomes insolvent, directors must prioritize the interests of creditors.
• Failure to do so could result in personal liability for a portion of the company’s debts in the future.

Types of Company Debts

• Company debts can include unpaid supplier invoices, unpaid rent, and wages owed to employees.
• Debts owed to HMRC, such as VAT, PAYE, and corporation tax, are particularly concerning for directors.

HMRC Debt Recovery

• HMRC has significant powers to pursue arrears aggressively, making tax debts especially stressful for directors.

Seeking Help and Support

• It is crucial to obtain help and support to manage limited liability company debts, especially tax debt.
• Proactive cash flow management and identifying areas of waste within the business are important initial steps.

Debt Refinancing and Consolidation

• Company debt experts can assist directors in exploring debt refinancing and consolidation options.
• These options may provide the necessary working capital to repay creditors and propel the business forward.