In what sense is your liability limited if you run a company?

One of the main attractions of working through your own company is that the liability of shareholders is limited. So, to what extent is the liability of company directors limited?

One of the most appealing aspects of running a contracting business through a company is the limited liability it provides.

This means that, as a general rule, if something goes horribly wrong with the business, your personal assets should be protected from claims by company creditors.

However, having a limited company doesn’t mean you can throw caution to the wind. There are circumstances where a director can become personally liable.

If you’re not careful, you could be putting your personal assets at risk without realising it. In this concise guide, we examine some of the more common risks associated with limited liability.

What does limited liability mean?

A limited company is a distinct legal entity – separate from its owners and directors.

If your company owes money to a supplier, bank or other creditor, it is normally the company that owes the money.

If the business fails, creditors can’t simply come after your house or savings because you happen to be a director.

The liability of shareholders is generally limited to any amount still unpaid on their shares.

Most limited companies issue a small number of fully paid shares, so in practice there is usually nothing further to pay.

If you decide to run a business as a sole trader, by contrast, there is no legal distinction between you and the business.

What about company directors?

Strictly speaking, “limited liability” refers to a company’s shareholders rather than its directors. This doesn’t mean directors are personally responsible for company debts.

If you run the company properly and within the law, you won’t normally have to pay a company debt yourself if the business can’t afford to.

There are exceptions, however, where a director can become personally liable. We look at the main ones below.

Personal guarantees

The most obvious example is when you provide a personal guarantee.

A bank, landlord or other creditor may ask you to personally guarantee a company debt. If the company can’t pay, you could then be liable for the money yourself.

Be very careful before giving a personal guarantee. Make sure you know exactly what you’re guaranteeing, whether there’s a financial limit and when the guarantee ends.

Your legal duties as a director

The company’s limited liability doesn’t protect you from your own conduct as a director.

The Companies Act 2006 codifies a number of directors’ duties, including requirements to act within your powers, exercise reasonable care, skill and diligence and avoid conflicts of interest.

If you breach any of these duties, you may face personal consequences.

One of the main areas where directors can get into trouble is when a company is facing insolvency.

If your company becomes insolvent

If your company is struggling to pay its debts, your responsibilities as a director change.

You need to consider the interests of creditors and avoid taking actions that worsen their position. Depending on what happens, directors can face personal liability for matters such as wrongful trading, fraudulent trading or misfeasance.

This doesn’t mean that every director whose company fails is personally liable for its debt, as many businesses go under for perfectly legitimate reasons.

But if you think your company may be, or is about to be, trading insolvently, seek professional advice as soon as possible rather than allowing debts to continue to build up.

Money you’ve extracted from the company

There are several other areas of potential risk that commonly affect small company directors.

Dividends can only be paid when the company has sufficient distributable profits. If you take more than the company is legally allowed to pay, you may have to repay the excess. See our guide to overpaid dividends.

The same applies to money you owe through a director’s loan account. If the company goes into liquidation while you owe it money, the liquidator can pursue you for repayment.

Always act in the company’s name

When you’re dealing with clients, suppliers and other businesses, make it clear that you’re acting on behalf of your limited company.

Use the company’s full legal name where required on contracts, invoices, correspondence and your website. Read more in our guide to displaying your limited company name.

Always keep your business and personal finances strictly separate. Company funds belong to the company, and can only be paid to directors as salary, dividends, expenses or in another appropriate way.

Limited liability isn’t unlimited

As a company director, you won’t normally be personally responsible for debts incurred by your limited company.

There are exceptions, particularly if you’ve personally guaranteed a debt, owe the company money, breach your duties as a director or continue trading when the company is insolvent.

Limited liability gives you valuable protection, but there are circumstances where you can still be personally liable.

If your company is in financial difficulty or you’re concerned that you may be personally liable for a company debt, seek professional advice tailored to your circumstances.