Legal personality and limited liability

Question 1

What is separate legal personality?

Answer 1

A company has a separate legal personality from its owners. This means a registered company is a distinct legal entity from its members (shareholders)

• A properly formed registered company is a separate legal entity from its shareholders and has distinct rights and liabilities as an autonomous legal person

Question 2

When does a company become a legal person?

Answer 2

From the date of incorporation (date of issue of certificate of incorporation). From this date the company has its own existence and personality

Question 3

What are the consequences of separate personality of a company?

Answer 3

• Company is responsible for its own debts and liabilities
• Company continues to exist even if shareholders and directors change
• Company owns its own property
• Company enters into contracts
• Company sues and is sued in its own name

Question 4

What is limited liability?

Answer 4

Limited liability arises due to the legal separation of a business entity from those who own it. It means the liability of shareholders is limited to the amount unpaid on shares.

• It means the owners of the business are not personally liable for the debts or obligations beyond their investment
• Shareholders are not liable to pay debts which the company owes its creditors
• This distinguishes them from sole traders and general partnerships where owners are personally liable

Question 5

What is the commercial significance of limited liability?

Answer 5

• Shareholders can invest without putting their personal assets at risk
• Allows groups of companies to develop: riskier business divisions can be conducted through separate companies within the group without the less risky companies becoming vulnerable to creditors of the riskier companies
• Encourages investment and encourages businesses to take risks

Question 6

Can the advantage of limited liability be negated?

Answer 6

Potentially - a commercially strong counterparty may negate it by a contract requiring the shareholders to provide a guarantee

E.g., a bank could require a guarantee from shareholders as part of lending the company money, which means the shareholders do not benefit from limited liability

Question 7

How can creditors check the financial viability of a company?

Answer 7

Check publicly filed documents at Companies House

Question 8

Who do directors owe their duties to?

Answer 8

In general, directors owe their duties to the company, not the shareholders

Question 9

Who do shareholders have rights against?

Answer 9

Shareholders have rights against the company, rather than directors

Question 10

Consequences of limited liability

Answer 10

Company is obliged to pay its creditors

• creditors to whom the company owes money must claim against the company itself alone
• if company has insufficient funds to meet its liabilities, creditors cannot pursue claims against shareholders

Question 11

What happens to shareholders in the case the company becomes insolvent?

Answer 11

Shareholders are liable to lose money invested in subscribing to the shares. They may liable to make payment for any shares not paid for (but this is extent of shareholder liability)

Shareholders of a limited company are not liable to a liquidator in the event of the company’s insolvency