Business Directory

Limited Liability Company and Directors Duties

Entrepreneurs that have never set up a limited company before, need to be aware of the ever changing practical and legal implications of doing so. A limited company exists as a separate legal entity in that it's financial assets and liabilities are entirely separate from those of its shareholder owners....

What is a Limited Liability Company?

With the exception of a personal guarantee, shareholders are not liable for business debts of the company, beyond the value of the shares of each shareholder. So if the business fails and can no longer trade, all shareholders stand to lose is their investment. Conversely, the profits and cash surpluses of the company, are the property of the company and not the Director or Shareholder. Profits are provided to shareholders in the form of dividends. Directors of the company are also employees of the company and are liable to pay any applicable income tax and national insurance accordingly. The company must pay corporation tax from company profits. The companies shareholders may receive a dividend and will eventually have to pay own income tax on the dividend received.

All UK limited liability companies are registered at companies house in Wales. Each company must have at least one Director. The role of the company secretary is to maintain the registered office, arrange company meetings, document and take minutes of meetings, submit more appropriate annual returns to Companies House. There are millions of small limited companies in the UK across all types of industries and trades. Each limited company must have a registered office located somewhere in England or Wales.

The origins of the principal that separates the liability of an owner from an enterprise dates back to the Companies Act 1856. By 1989, the EU enacted the Twelfth Council Company Law Directive which required member states to provide a legal structure for any individual wishing to trade on a limited liability status. Critics of the legal liability law point towards business failures where unsecured creditors have been left with nothing, at the expense of securing preferential creditors.

If a limited company goes into insolvency the personal assets of the owners are usually completely safe and protected. The exceptions to this principle apply to fraudulent activity on a half of a Director or where a Director has broken company laws. A Director and a Shareholder have distinct roles. Typically, Directors of small firms are also shareholders.

To raise business finance, Directors may have to provide personal guarantees to underwrite any business loans obtained form their bank. If the business fails and enters into administration or liquidation, to repay these loans, the Director's home or other personal assets may be seized to repay the debt. Directors of limited companies can apply for a business loan from a bank on behalf of the limited company. The business debt comes from the bank account of a limited company, not the shareholders or Directors. Although the Director controls the company bank account, it is not their money, it is owned by the business, along with all other assets and liabilities. The Director is not personally liable for repaying the business loan (unless they have signed some sort of personal guarantee). So in practice, a Directors liability is not always limited.

Directors Salary Versus Dividend?

Many Directors want to know the most tax efficient method of compensating themselves. There is no right or wrong answer to this question because every business owners' situation and priorities may be different. Dividends are not subject to PAYE or National Insurance and can only be paid from 'distributable profits available to the purpose'. However, dividends can only be paid from surplus net profits (that means incurring corporation tax first). So a controlling Director has the flexibility to set their income level as tax efficiently as possible. For example, higher rate taxpayers can choose to leave profits within the limited company at the end of a fiscal year, thereby avoiding paying higher income-tax. This has drawbacks in that the company will pay a higher corporation tax bill, even though the individual shareholders income taxes may be lower. The overall balance between the two is the measure Directors use to find the most tax efficient method of drawing an income.

Using a limited company for ex-employees can be contentious with the introduction of the IR35. The Inland Revenue is cracking down on individuals who are avoiding income tax, by providing solely dedicated personal services to one company, via a limited company, instead of as an employee of that company.

Directors Duties

Directors main responsibilities and duties come under the Companies Act 1985 an are summarised as follows:-

  • Duty to exercise reasonable care, skill and diligence (174) - this duty aims to assess and compare how a diligent and experienced person in the same role would have been expected to behave in the same circumstances. Failure to exercise this duty could result in the accompanying paying damages via a court case.
  • Duty to promote the success of the company (172) - a Director must act in good faith to promote the best interests for the company as a whole, as opposed to acting for a minority interest. The Director must consider a number of factors when making decisions including its employees, suppliers, community and the environment, the reputation and contact of the company in the long term. In effect, it concentrates the mind of the Director to assess the impact of their decisions within a limited company in the wider business and social context.
  • Duty to act within powers (171) - every Director must operate within the constitution and any resolutions that the company has set out in the articles of association.
  • Duty to exercise independent judgement (173) - in delicate and complex situations, all Directors are expected to take appropriate guidance and to remain neutral in their decision-making processes. By obtaining third-party Directors must show they have exercised good judgement.
  • Duty to avoid conflicts of interest (175) - each Director must avoid situations where there is a conflict of interest between themselves and the company. For instance, a conflict will would occur in situations where a director's spouse, family members or associated business connections may benefit from actions implemented via the company.
  • Duty not to receive benefits from third parties (176) - any benefits must be declared an authorised by the company shareholders. The aim of the duty is to prevent underhand or secretive financial gain by an individual director, merely because they hold that position within the company.
  • Duty to declare any Director interest in a proposed transaction (177) - Directors must disclose the nature of any proposed transaction before it occurs to the company, in situations where a conflict of interest is expected to rise.

Company Accounts and Statutory Forms - Directors must ensure that proper accounting records and bookkeeping matters are implemented, that the accounts of the company are prepared according to statutory guidelines and that these accounts are presented to the company shareholders, no later than 10 months after the end of the last fiscal year. The following forms need to be posted to companies house:-

  • Form 363 Annual Returns - a summary of the company information including details of any directors, shareholders, share capital allocations, the secretary.
  • Form 225 Change of Accounting Dates - each company has a fixed end of year accounting date which dictates when annual accounts for the company must be submitted. It is not necessarily the 31st of December, it could be any suitable date or a date when the company was formed.
  • Form 287 Change of Registered Office - to ensure that official correspondence, VAT and tax notices are sent to the correct address, this form allows a Director to change its registered office location, if appropriate.
  • Form 288 Change of Directors or Secretary - there are three versions... 288(a) is for the appointment of an officer. 288(b) is for an officer ceasing to act. Form 288(c) is for changes in personal details such as address.
The Drawbacks of Being a Director

Failure to understand or know of Directors duties is no excuse and the penalties for breaking these laws could be a fine or imprisonment. In addition, Directors are vulnerable to the shareholders of the company who may have voting rights to remove them. In addition, they may not exceed any powers listed in the Articles of Association. If a board of Directors exists, then there must be a collective agreement and all decisions must be recorded in writing. If a Director has any knowledge of a fellow Directors failings, that Director is obliged to report this to the Board in the best interests of the company.

Limited liability only extends to Directors where no statutory responsibilities have been the broken. If a statutory duty has been broken, a Director may be personally liable for any loss or criminal offence associated with the breach. If a Director fails in their duties, they may be struck off the Company Register. Their name will be added to the publicly available companies house register of 'Disqualified Directors'. This will have implications for future personal borrowing as it affects the credit history report of the individual concerned. Lastly, all accounts and shareholder details filed at companies house for the general public to view.

How to Start a Limited Liability Company

Practically speaking, the process is a relatively inexpensive and straightforward one. The first step is to find a suitable name for the company. It must have the word 'limited' at the end of it, and cannot be a clone of an existing limited company, or be offensive or misleading in regard to its activities. The business name must also not be associated with the Government, local authorities, Royalty, or use sensitive or common brand related words. A simple search facility is available at the companies house website. It also makes sense to check the trademarks index via the company's house website. Similarly, make sure the corresponding domain name has not already been taken up by a company elsewhere.

The next step is to incorporating the company. Most accountants or company formation agents can set up a company for you by using a dormant 'off the shelf company'. This means it has already been incorporated in the past and can simply be renamed with new Directors and shareholders. The whole process can be completed within days. Alternatively, to incorporate a brand new company you could use the Registrar of Companies same day service. The next step is to prepare and submit the documents to the Registrar of Companies (see below).

Preparation of Statutory Documents

You should retain a solicitor or a regulated accountancy firm, to prepare and submit the statutory to Companies House (see below). Once accepted, the registrar of companies will post a Certificate of Incorporation to the registered company address, confirming that the new private limited company has the right to begin trading on the date of incorporation. The documents include:-

  • Memorandum of Association - this states that at least one subscriber has agreed to take at least one share in the new company and this procedure has been witnessed. It will outline the authorised share capital and the names of the shareholders.
  • Articles of Association - this dictates the regulations and rules regarding the internal running of the company. This must also be signed by the subscribers to the memorandum and witnessed.
  • Form 10 - this form provides details of the Directors and company secretary and address of the registered office. The registered office may be different from the trading address and is the address where all formal companies house letters and correspondence will be sent. Typically, for small firms the registered company address is also the address of the company secretary, company formation agent or accountant of the company.
  • Form 12 - this form confirms that the proper procedure has been followed by the Directors in the formation of the company.
Other Types of Legal Entities

There are other methods of starting a new business, apart form a limited company. The most common is a sole trader. Being a sole trader means taking huge risks with personal investment and reaping all the rewards if it succeeds. Any business debt may also be recovered from the sole trader individuals personal assets. Whereas, a partnership involves at least two people who are carrying on a business enterprise together. All partners are liable for debts incurred by the business, which means that a mistake or misjudgement by one partner, can ruin the others.

A Limited liability Partnership (LLP) is a hybrid between a partnership and a limited company. It exists where there are two or more people wish to organise their company structure on traditional lines of a partnership, while enjoying the protection of limited liability. An LLP means that individual debts are limited to those of the company. However, where professional partnerships are created, negligence and fraud are still risks that must be indemnified with insurance and are not linked with the company, but instead with the individuals concerned.

 

This article is not exhaustive and does not purport to legal advice relating to any particular circumstances. Always seek qualified UK legal advice regarding specific issues.... We hope it helps!

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