A limited liability company is a type of company structure where members are not made personally liable. For example, you may have opened a bar in the city with three of your friends. You have put your money together and incorporated your business. If your business went under, you would not be made personally liable to pay for the company’s debts. If your business was sued for underage drinking you would not be made personally liable for the fine.
It stands in stark contrast with the business structure of a partnership or of a sole trader. If a sole trader or partnership goes into liquidation, they are personally liable. For example, if you are the sole trader of an optometry business that goes into liquidation, you may be made to sell your family home to recover the debt.
The only money at risk is the corporation’s money. You can only lose the personal sum that you initially invested. The rationale for limited liability is to encourage entrepreneurship and investment.
Exceptions to limited liability
There are some circumstances where you may no longer be protected by the rule of limited liability. You may be personally liable if:
- You are the personal guarantor of the company’s debt and the company defaults on payment;
- You do something intentionally illegal or fraudulent and it causes harm;
- On the facts, the corporation is not a separate legal entity. Rather, you are using it as a means for your own personal affairs;
- Your corporate constitution includes a clause that states otherwise;
- You trade insolvently against your duty to prevent insolvent trading; and
- You are a director and you breach your directors duties as set out in the Corporations Act.
Understanding the value of limited liability is crucial to decide which corporate structure is best suited to your business and circumstances.
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