Understanding limited liability during insolvency in Scotland

If your limited company is insolvent and you are thinking about closing it down, you may be worried about what that means for you personally. A common concern of the directors we speak to in this position is whether limited liability protects them when the company can no longer pay its debts, or whether their own home and savings could now be at risk.

The short answer is that for the vast majority of directors, limited liability continues to offer vital protection even if the company fails and becomes insolvent. Your personal assets are not at risk simply because the business has become insolvent. There are, however, some important exceptions that directors need to be aware of, and this guide explains exactly what they are.

When you incorporate a limited company, you create a separate legal entity from yourself as an individual. The company is treated in law as its own entity meaning it can own assets, owe money, enter into contracts, and be sued in its own name. You and the company are legally distinct.

For a company limited by shares, the liability of the members (the shareholders) is limited to any amount still unpaid on their shares. If your shares are fully paid up, your liability as a shareholder is effectively nil. For a company limited by guarantee, liability is limited to the amount each member has agreed to contribute if the company is liquidated.

What this means in practice is that if the company runs up debts it cannot pay, those are the company’s debts, not yours. Your house, your car and your personal savings are not normally at risk simply because the business has failed.

When you incorporate a limited company, you create a separate legal entity from yourself as an individual. The company is treated in law as its own entity meaning it can own assets, owe money, enter into contracts, and be sued in its own name. You and the company are legally distinct.

For a company limited by shares, the liability of the members (the shareholders) is limited to any amount still unpaid on their shares. If your shares are fully paid up, your liability as a shareholder is effectively nil. For a company limited by guarantee, liability is limited to the amount each member has agreed to contribute if the company is liquidated.

What this means in practice is that if the company runs up debts it cannot pay, those are the company’s debts, not yours. Your house, your car and your personal savings are not normally at risk simply because the business has failed.

In our experience, the most common worry of directors is whether they will be held personally liable for the debts of their company once it becomes insolvent. The good news is that the protection of limited liability remains even if the company enters into liquidation.

This means that the debts remain the company’s debts, and directors can not be held personally liable for repaying creditors in the vast majority of situations. There are, however, a number of notable exceptions where the protection of limited liability can be removed which directors need to be aware of.

The most common are:

• Personal guarantees. If you personally guaranteed a loan, lease, overdraft or supplier account, you remain liable for that debt regardless of limited liability. This is by far the most frequent reason directors end up personally exposed, as closing a company does not end outstanding personal guarantees.
• An overdrawn director’s loan account. If you have taken more out of the company than you have put in, this can create an overdrawn balance on your director’s account. During formal insolvency proceedings, any overdrawn director’s loan accounts are seen as an asset of the company, and the appointed insolvency practitioner can therefore require you to repay the balance personally.
• Wrongful trading. If you continued to trade and took on further debt when you knew, or ought to have known, that the company was insolvent and there was no reasonable prospect of turning the situation around, a court can order you to contribute to creditor losses personally.
• Fraudulent trading. Carrying on the business with the deliberate intention of defrauding creditors carries personal, and potentially criminal, liability.
• Misfeasance. Misusing company money or assets, or breaching your duties as a director, can lead to a personal claim against you.
• Unlawful dividends. Paying dividends when the company did not have sufficient distributable profits can be reclaimed from you personally.
• Personal liability for tax. In certain tax-related cases, HMRC can make a director personally responsible for some of the company’s tax debt, however, this is rare and in almost all of the liquidations we deal with, HMRC tax debt will be written off as part of the process.

While the above may seem scary, if you have run your company responsibly and simply reached the point where it can no longer continue, limited liability is very likely to protect you.

If you believe you have provided personal guarantees, or are running an overdrawn director’s loan balance, you should mention this to your appointed insolvency practitioner so they can explain how this is likely to affect you and what options there are for mitigating, or otherwise dealing with, your potential personal liability for company debt.

When it comes to the principle of limited liability, there is no difference no matter where in the UK you are based. Company law is set by the Companies Act 2006, which applies across England, Wales, Scotland and Northern Ireland. A Scottish company simply means one whose registered office is in Scotland, and limited liability works in exactly the same way as it does anywhere else in the UK.

If you are unsure where you stand, these practical steps from our licensed insolvency practitioners can help:

• Check whether you have signed any personal guarantees. Dig out loan agreements, the lease and any supplier accounts. This is the single most important thing to establish before making any decision about the company’s future.
• Don’t repay yourself or connected parties first. Paying off a director’s loan, a family member or an associated company ahead of other creditors can be reversed during the liquidation process creating a liability for ensuring this money is returned to the company.
• Don’t extract company funds once you know it is insolvent. Taking money out of a company you know to be insolvent can see the protection of limited liability removed.
• Keep records and be honest with your insolvency practitioner. Being able to show your appointed insolvency practitioner how decisions were made and how company money was used is your best protection.

In our experience, the vast majority of directors we speak to have acted entirely responsibly, yet many arrive worried that closing their company will leave them personally exposed. In most cases, we are able to reassure them that limited liability does exactly what it is meant to.

• Limited liability means your company is a separate legal entity from yourself as its director
• A company becoming insolvent does not remove the protection of limited liability
• Limited liability works the same way in Scotland as across the rest of the UK
• The protection of limited liability can be removed in specific situations, most commonly through personal guarantees

If your company is insolvent and you are worried about whether limited liability protects you, our licensed insolvency practitioners are here to help. With offices across Scotland, we deal with directors in your situation every single day. Contact the team today for immediate help and advice.