Are you a shareholder of a limited company?

Are shareholders liable for company debts? If you are a shareholder or director of a limited company Oliver Elliot can help you address your concerns.

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Limited Companies

Shareholders are not liable for company debts unless they have provided personal guarantees.

Why Are Shareholders Not Liable For Company Debts?

Shareholders are not liable for company debts because a company is a separate legal person from its directors and shareholders.

What Is A Company?

A limited liability company is a form of business structure. It is separate from its owners and directors.

The owners are otherwise known as the shareholders.

Why Do People Set Up Companies?

The reason people set up companies is that a company provides protection known as limited liability.

In addition, people set up limited companies because there may be tax benefits associated with them. For example, it is quite common in the case of owner-managed businesses for a limited company to be used as the trading structure and in doing so the company is liable for corporation tax. The rate of corporation tax is currently 19% and following the budget in March 2021, it will increase to 25% from 2023. However, that is significantly lower than the top rate of income tax. Another tax benefit from setting up a limited company is when the owners extract dividends from the company they can potentially make savings in relation to National Insurance Contributions.

If you want to set up a limited liability company you can do so at Companies House.

What Is Limited Liability?

Limited liability is the concept that applies to companies and it means that because a company is a separate legal entity or separate legal person from the owners and the directors that run it, nevertheless the debts that the company incurs as a result of its trading and other activities are the sole and exclusive responsibility of the company, not of the owners or the directors.

This is potentially one of the most important reasons and motivations behind setting up a limited liability company.

What Types Of Limited Liability Company Exist?

There are two types of limited liability company. A company limited by shares and a company limited by guarantee.

Company Limited By Shares

A company limited by shares may give the shareholders certain rights in relation to the operation of the company but not in relation to its day-to-day management which will be dealt with by the directors. This is by far the most common structure for a limited company.

The main influence that the shareholders may have is the entitlement to vote in relation to any changes concerning the structure of the limited company. Each shareholder will be provided with a holding that determines what the rights are under its shares, particularly with reference to entitlement to dividends or otherwise entitled to the company’s capital on a winding-up or otherwise

Some shareholders will have voting rights and therefore the empowered to influence and vote on any changes concerning the company’s structure and constitution. It is also possible for shareholders to have no voting rights and simply be restricted to having dividend rights at the discretion of the board of directors.

Shareholders usually will only be liable to the company in relation to the payment of their shares. Once the shares are fully paid up then ordinarily a shareholder will have no other liability in relation to the company.

Companies Limited By Guarantee

You must have at least one guarantor and a ‘guaranteed amount’.

Guarantors are company members. They control the company and make important decisions but they do not usually take any profits from the company. Instead, the money is kept within the company or used for other purposes.

The guaranteed amount is the guarantor’s promise of an agreed amount of money to the company if it cannot pay its debts. They must pay the company the full amount of their guarantee.

This payment covers guarantors for situations such as the company being closed down. The guaranteed amount is not linked to how much the company is worth.

Circumstances In Which Shareholders Could Be Liable For Company Debts

The answer to the question is yes there are circumstances in which a shareholder could be liable for a company’s debts or for some of them.

Personal Guarantee Shareholder Liability

The most common situation in which this can arise is when an individual shareholder has provided a personal guarantee which has enabled the company to obtain credit from a supplier of finance, such as from a bank to enable the company to trade. In the event that the company defaults on its obligations and its liability in relation to such a debt, then the party that is owed money by the company can make a call upon the personal guarantee. They can insist that the shareholder personally discharges the liability on behalf of the company.

In doing so the shareholder having carried this out on behalf of the company in satisfying a company debt or company liability can claim against the company. In the event that the company is able to subsequently pay, it can at that point legitimately satisfy the shareholder concerned.

Shareholder Liability Arising From Misconduct

Although shareholder misconduct is not something that exclusively relates to companies that have gone into liquidation it is probably the most common instance in which shareholders are ultimately liable for company debts. This typically will arise when a Liquidator has been appointed in either a Creditors Voluntary Liquidation and Compulsory Liquidation and investigates the conduct of the directors and the shareholders in respect of the running of the company and the circumstances giving rise to the company’s demise such that it entered insolvent liquidation. It is much less common for misconduct to be discovered in a solvent Liquidation, known as a Members Voluntary Liquidation.

Having undertaken investigations if the Liquidator discovers director and shareholder misconduct, he or she can then potentially bring legal proceedings for the purposes of obtaining compensation from these directors and shareholders personally for the benefit of the company and its creditors. Examples of scenarios where shareholder liability can arise are detailed below.

Breach Of Duty

In small owner-managed businesses that operate through the structure of a limited liability company, it is the norm for the owners or the shareholders of the company and the directors to be the same people. As a result, if the directors engage in conduct that gives rise to some liability when they breach their duty to the company, then in effect the results of that means that the shareholders have become liable as well.

Transaction At Undervalue

Typical examples of shareholder directors acting incorrectly and in breach of their duty will be when engaged in conduct that causes the company to suffer an avoidable loss and acting to its detriment, instead of acting in its best interests. One specific example of such conduct might be selling assets for less than their true value to connected parties, thereby potentially enabling the shareholders to personally benefit from such a transaction at the expense of the company.

Unlawful Dividends And Overdrawn Loan Accounts

Another example would be if the shareholders of a company received unlawful dividends. If they were the same person as the directors they are taken to have known that the dividends were unlawful and would typically be liable to repay them. The same sort of position can arise from an overdrawn director’s loan account that a director / shareholder would be liable to repay to the company. This is in essence no different from being overdrawn at the bank except in this instance the debt or liability is to the company instead.

Fraudulent Trading

Obtaining credit by deception and fraud to enable the company to continue trading is another example in which shareholders can clearly be liable for company debts. There are many different examples of how company directors may act in an impermissible manner and obtain credit inappropriately. One such egregious situation might be what is known as fresh air invoicing.

Fresh Air Invoicing Shareholder Liability

When a company has a factoring facility, the finance company will provide potentially up to 80% of the value of an invoice that the company raises. This is to ease the company’s cash flow requirements. Then upon receipt of payment from the customer the factoring company will commonly pay the residual 20% less any factoring charges. It has been known for company directors to issue invoices in relation to goods and services that were not provided and as a result, obtain the benefits of credit and finance facilities to which it was not entitled. This is essentially fraudulent invoicing, otherwise known as fresh air invoicing. In such circumstances in the case of a small owner-managed company where the shareholders and directors of the same person, fresh air invoicing upon discovery, in all likelihood would lead to certain director shareholders to be personally liable to the factoring company.

Can Shareholders Be Liable For company Debts When There Is No Misconduct?

In the event that there is no misconduct by the shareholder directors that might be discoverable by a company’s Liquidator, then it is unlikely that there would be circumstances other than a call upon a personal guarantee, which would give rise to shareholder liability.

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