What is the principle of limited liability?

 

Limited liability is often referred to as the ‘cornerstone’ of commercial law and, indeed it is crucially important to the effective functioning of companies today. It is designed to allow businesses to raise money and credit without their directors and shareholders becoming personally liable.

Visit our company structure pages to learn more about the legal background to this topic.

Separate legal entities

Limited liability is connected very closely to the concept of a company being a ‘separate legal entity’. This means that, when a company becomes incorporated, it is considered to have a separate legal personality from its owners.

It is this characteristic that allows companies to own property, sell property, lease property, enter into contracts, and be held responsible for its activities.

The concept of limited liability refers to the fact that the shareholders of a company are liable only to the extent of capital that they invested in the company. This means that if the company falls into unsustainable debt and ends up in the hands of administrators, the personal assets of the company’s shareholders are not at risk.

Only their capital contributions can be used to pay the company’s debts.

Advantages and disadvantages of limited liability

Limited liability minimises the risk that shareholders bear personally when they invest in a business. It is this principle that has allowed entrepreneurial spirit to flourish, as it encourages people to take on risks in the pursuit of profits.

Generally, most businesses that are not sole traders or specialist partnerships eventually seek to incorporate and this is considered to be good for the economy as a whole.

There are two main downsides however:

  • Firstly, the company will no longer be completely controlled by its founders; its board of directors are compelled to act in the company’s best interests even if it this is prejudicial to their personal lives
  • Secondly, incorporation can put vendors and creditors at risk, since they know that if the company ceases trading their options for recovering the money they are owed will be limited

However, these two factors are only usually of concern to very small businesses.

Process of incorporation

For a business to get limited liability, it needs to incorporate the company by registering it with Companies House. This is quite a simple procedure but it can have far reaching affects, particularly regarding the aims and objectives of the company as set out in its constitution.

It is important to take legal advice before incorporating, in order to avoid complex disputes at a later date.

If you would like to obtain legal advice on limited liability, we can put you in touch with a local specialist company and commercial solicitor free of charge. Please call us on 0800 1777 162 or complete the web-form above.

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