Are Shareholders Liable for Company Debts?

Are Shareholders Liable for Company Debts?

Shareholders

Benefits of Shareholder Limited LiabilityAre shareholders liable for company debts? If you are the shareholder and/or director of a limited company that’s struggling to pay its outstanding debts, it’s only natural that you’ll be concerned about the prospect of those debts passing to you personally.

Shareholders are not usually liable for company debts that exceed the nominal value of their shares, or the sum of any personal guarantees they have given. This is because companies limited by shares are incorporated as separate legal entities with their own identity, so they are responsible for their own actions and debts.

A company limited by shares has separate legal personality from that of its owners (shareholders). The liability of a shareholder for the company’s liabilities is generally limited to the amount, if any, that remains unpaid on that shareholder’s shares. A company limited by shares must have an issued share capital comprising at least one share. The Companies Act 2006 (CA 2006) contains rules on a company’s share capital.

Why are Shareholders not Usually Liable for Company Debts?

Shareholders in private and public limited companies and partners in limited liability partnerships benefit from something called ‘limited liability’. Limited liability is a legal status that limits a person’s financial liability to a fixed sum. In the case of company debts, the shareholders are only personally liable for the debt to the value of the money they have invested in the company. 

This is not the case with all business structures. In sole proprietorships and general partnerships, there is no limited liability protection. That means the business and its owners/shareholders are considered to be a single legal entity. The finances of the business and its shareholders are considered to be one and the same. Therefore, the shareholders are legally liable for the debts of the business. 

What is a Shareholder’s Liability for Company Debts?

One of the main reasons why so many people choose to incorporate their business is to benefit from the protection limited liability provides. Incorporating a business is the act of turning it from a sole trader or partnership into a private limited company (LTD) or limited liability partnership (LLP). Once a limited company has been formed, the business has a separate legal and financial identity from its owners.

That means any debt the company incurs in the course of its business is the company’s debt alone, and not the responsibility of its owners.

Benefits of Shareholder Limited Liability

When shareholder liability for a company is limited, this encourages investment into the company and attracts new shareholders who can remain confident that they will not be liable in the case that the company gets into debt. Shareholder’s liability being limited also facilitates the transfer of shares, since other people are more confident to buy shares in a company with the protection of limited liability.

The limited liability of shareholders also provides clarity and certainty as to the assets available to creditors of a company.

Is a Shareholder ever Personally Liable for Company Debts?

There are some circumstances when the shareholder of a limited company can become personally liable for its debts. One example is when a shareholder of the business provides a personal guarantee on a loan that the company takes out. In that case, the shareholder(s) who gave the guarantee will be personally liable if the loan cannot be repaid.

Where a shareholder is also involved in the day-to-day operations as a director or officer of the company, they could also be made personally liable for company debts if they:

  • Know the company is insolvent but keep trading in the interests of the company shareholders;
  • Dispose of company assets below market value or for free during insolvency;
  • Creating an overdraw directors loan account by making over payments;
  • Have raised funds to repay creditors via fraudulent means.

Shareholder Liability in a Company Limited by Shares

There are two different ways the liability of the business’s owners can be limited. It can be limited by shares or it can be limited by guarantee. A company limited by guarantee is one that does not distribute profits to its members but typically retains them for some other purpose, such as a charity or community project.

In a company limited by shares, the shareholders must pay the company for the shares they have taken. Once those shares have been paid for in full, no further money is typically payable by the shareholders for company debts. Simply put, the only money a shareholder risks losing if the business should fail is the money they have already invested in the business. 

What is the Liability of Company Shareholders?

The liability of shareholders is limited to the ‘nominal’ value of the shares they take in the company. Typically, the nominal value of a share is set at £1, thus minimising the personal financial liability of shareholders if the company fails and can’t pay its own debts.

Example 1

  • A company has 1 shareholder
  • The company issues 1 share with a nominal value of £1
  • The liability of the shareholder is £1

Example 2

  • A company has 1 shareholder
  • The company issues 10 shares with a nominal value of £1 per share
  • The liability of the shareholder is £10 (10 x £1) 

Shareholders are only personally liable for company debts beyond the nominal value of their shares if:

  • they provide personal guarantees on loans, leases, or other contractual agreements on behalf of the company; or
  • they are also directors of the company and engage in certain actions that constitute an offence

It is common for a shareholder to also be the director of the same company, especially if the business is set up and operated by just one or two people. Whilst of great benefit, it is important to bear in mind that setting up a limited company will not provide blanket protection from certain debts and liabilities if you are appointed as a director.

Shareholder Concerns about Liability for Company Debts?

If you are a shareholder and made an investment into a business that is under preforming, you maybe worried about your position financially and legally, simply give us a call or send us an online enquiry and we will help to run though your options.

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