Member Article

Is limited liability alive in limited companies?

James Lamont, a partner in the Hart Brown commercial team, shares his expertise on limited liability.

The concept of limited liability in small to medium sized limited companies has not changed under the Companies Act 2006 (the “Act”) but the commercial reality and the difficulty in attempting to limit your personal liability as an owner of such a company in the face of more aggressive requests for security for potential debts has perhaps become more pronounced since the Act came into force.

However the extent to which you might be “liable for debts” really does still depend on which corporate hat you are wearing.

As a director of a company, you are required to comply with your duties under the Act and those fiduciary duties placed under common law. Provided you do comply with these provisions (and it is strongly recommended that these are always minuted in the necessary board meetings) then, under the law, a director’s liability for the debts of the company is pretty much non-existent and for an action to be brought against a director is extremely unlikely unless the director is acting fraudulently or with gross negligence or with criminal intent.

Please note that the duties of non-executive directors are now equal to those of executive directors and therefore, even if not involved in the day to day running of the business, non-executive directors need to have a clear understanding of the business.

As an owner of a company the fundamental principle of law is that you are protected from the liability of the company by the “corporate veil” and that your potential liability is limited… again, unless of course there is a criminal element to a shareholder’s activities.

However, as has been identified, irrespective of what the legal position is, banks, investors, landlords, other shareholders and other third parties, will often require directors or the owners of the business to stand behind the actions of the company. There is nothing new in this in that those lending money will look to obtain water tight security where ever possible. The banks now require security held up by “belt, braces and elasticated waistbands” and in so doing they will look behind the corporate veil. It is therefore extremely common for banks in particular to require a personal guarantee secured over the personal property of a majority shareholder. It is less likely though for a non shareholder director to be required to give such a guarantee (and unlikely that such a director would agree to do so).

By way of a brief case study, Hart Brown recently acted for a client who is a 33% shareholder and director of a limited company and the bank in question required a personal guarantee backed by a second charge over his family home. The amount was capped and the intention was for the guarantee to relate to a specific project to be undertaken by the company and, once repaid the personal guarantee would be discharged. The bank maintained that this was the agreed position but the documents we were asked to advise on stated that the client was “on the hook” for any debts (past, present or future) incurred by the company (rather than on a specific project) and the guarantee was not limited to time. In other words our client was now on the hook, not just for the one specific project but whilst he continued to be an owner and director of that company, the bank could look to him as a guarantor for any debts of the company.

Much of the above is not particularly new. The Companies Act 2006 retains the clear distinction between the shareholders as owners of the business and the directors who are appointed by the shareholders to operate and run the business. What has certainly changed (or been more clearly prevalent in recent years) is that whereas the Act looked to simplify the processes for smaller companies, the banks and landlords, investors and other third parties have continued to chip away at the protection afforded shareholders and the distinction between the company as a separate legal entity and the directors and shareholders as individuals.

If we go back to the wearing of hats - so far as a director is concerned, as a rule of thumb, provided he is purely a director rather than owner, then he should not be liable for the debts of the company whereas, as a director and owner of the business, third parties will continue to look to them for security for the actions and omissions of the company itself.

This was posted in Bdaily's Members' News section by James Lamont .