Exceptions to limited liability: Piercing the corporate veil

Exceptions to limited liability are a must-know for anyone interested in corporate governance training. Here’s a guide to explain the details. 

Limited liability, also known as the corporate veil, is essential for driving entrepreneurship as it helps manage financial risk and keeps company directors accountable. Business owners can build their companies without the looming threat of personal liability, which could otherwise hamper their appetite to take measured risks and invest in their company. 

Chelsea Williams, a corporate insolvency adviser at Scotland Liquidators, runs through the exceptions to limited liability and how piercing the corporate veil can have serious repercussions for company directors.

Limited liability is part and parcel of operating through a limited company, a limited liability partnership or a public limited company, all legal operating structures. While there are many benefits to pursuing the limited liability route, protection against personal liability is arguably the first and foremost advantage. 

Limited liability restricts director liability for company debts up to the value of their shares. It provides a safety net to company directors, providing they act responsibly, fulfil their statutory duties and prioritise the company’s and its stakeholders’ best interests. If company directors breach the rules, this risk could pierce the corporate veil, exposing them to personal liability, and the consequences could be devastating. 

As company directors strive to promote the company’s success, despite taking measured risks, they may accumulate debt. Should the business experience serious difficulty and become insolvent, providing that the company director acted properly, they will not be held personally liable for the company’s debts.

While limited liability provides cover under most scenarios, there are exceptions to ensure company directors act within the law and in the best interests of stakeholders. This caveat deters company directors from using limited liability as a cover for improper dealings while continuing to benefit genuine company directors.

Personal guarantees – Lenders often require personal guarantees when taking out commercial loans to provide security and mitigate financial risk in the event of insolvency. A personal guarantee agreement overrides limited liability and holds the director personally liable for the loan in question, regardless of the business’s financial health. 

Falling foul of director duties – If a company director falls foul of their legal obligations, they will no longer be protected by limited liability which means being held personally liable for company debts in part or in full. From abandoning the company’s best interests and making preferential payments to continuing to operate when the company is insolvent, company directors must act responsibly at all times. 

Fraudulent trading – If the company director engages in illegal activity, fraudulent trading or misfeasance, they will no longer be protected by limited liability. These serious offences will result in an investigation into director conduct, alongside possible legal action. 

The beauty of operating a business that offers limited liability is that the company is treated as a separate legal entity. Therefore, any financial and reputational damage is restricted to the business. However, once company directors overstep, this will pierce the corporate veil, and limited liability protections will dissipate.