Are shareholders liable for company debts?

Why are shareholders not personally liable when a company fails?

A limited company is a separate legal and financial entity from those who run and invest in it. Whether you are a company shareholder, director or both, you benefit from something called limited liability. That limits your liability for company debts to the capital you invest in the business.

However, the situation is not always so straightforward. There are circumstances where shareholders can become liable for company debts. Here we discuss when personal liability issues can arise and what shareholders can do to protect themselves.

What are shareholders liable for when a company fails?

As we’ve discussed, shareholders will lose any money they have invested in the company when it fails. They will also be liable for the value of any unpaid shares. If you have signed a personal guarantee for a company debt, the supplier or lender you owe the money to will also be able to pursue you personally for the repayment if the company defaults. 

Aside from that, you are not ordinarily liable for company debts simply because you are a shareholder. However, you could become liable if the business fails and there is evidence of wrongdoing on your behalf.

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What are the rights of shareholders when a company fails?

If a company you invest in is insolvent and subsequently liquidated, your specific rights will depend on the company’s articles of association and the shareholder agreement you have in place. However, as a general rule, you should not expect to receive any return on your initial investment when the company enters liquidation.

As part of the liquidation process, the company’s assets are sold, with the proceeds used to repay the company’s creditors as far as possible. The creditors are then paid in a strict order, and the shareholders are last in line.

That means, by the time the other creditors have received the money they are owed, there is usually nothing left for the shareholders. In the unlikely event that there are any remaining funds, the preferential shareholders will be paid first.

What if you provide the company with a shareholder’s loan?    

As a shareholder, if you lend the company money over and above your initial investment, the situation is slightly different. You then become an unsecured creditor of the company, putting you one step higher in the repayment hierarchy. In this case, you have a better chance of receiving some of the money you are owed, but that could still be a small proportion of the debt, or nothing at all.

For that reason, if you do decide to lend the company money, and particularly if it’s intended to purchase particular assets, it’s worth thinking about taking security. As a secured creditor, you move to the top of the repayment hierarchy, which significantly increases the likelihood of being repaid.

Alternatively, you could ask one or more company directors to provide a personal guarantee for the shareholder’s loan. You could then pursue them for the money if the company fails.

When can shareholders be liable for company debts?

Shareholders are ordinarily protected from the debts of a failing company by limited liability. However, there are instances when a shareholder can become liable for its debts. One example is when a shareholder provides a personal guarantee for company borrowing.

There are also other instances when personal liability issues can arise relating to shareholder misconduct. They are most common in smaller owner-managed businesses where the shareholders are also company directors and officers. Examples of shareholder misconduct include the following:

Breach of duty

When a company is insolvent, its directors and shareholders must act in the best interests of its creditors. That usually means ceasing trading to avoid further losses that would worsen the creditors’ position. Continuing to trade the company while it is insolvent without seeking advice from an Insolvency Practitioner can lead to claims of breach of duty, and directors and shareholders can become liable for the losses. 

Transactions at undervalue

Another example of shareholders and directors not acting in the best interests of their creditors is selling or transferring assets away from the company at less than their market value. For example, they may sell an asset to a connected party, or even a shareholder, for less than its true worth. The shareholders may then have to compensate the company for the benefit of its creditors.

Unlawful dividends

A company can only pay shareholder dividends from profits. If a company does not have sufficient profits to pay a dividend and subsequently fails, its shareholders can be required to repay the money they received.

Overdrawn loan accounts

A shareholder or director creates an overdrawn loan account if they take money out of a company that is not a salary, dividend or money they’ve previously lent the company. That becomes an issue if the company enters liquidation and the shareholders haven’t repaid the money. At that point, the liquidator can pursue them to repay it personally.

Fraudulent trading

If a shareholder obtains credit by deception to keep the company trading or borrows money they know the company cannot repay, they can become personally liable for those debts. Another example is using company funds for personal purposes rather than repaying the creditors.

What happens when a shareholder becomes liable for company debts?

If you personally guarantee a loan or credit that the company cannot repay, the creditor can call on the guarantee and make you liable for the debt. If you cannot pay what you owe, your personal assets may be at risk and it could potentially even lead to bankruptcy.

In the case of shareholder misconduct, the liquidator will investigate the directors and any shareholders who had a controlling influence over the company and report their findings to the Insolvency Service. The Insolvency Service will then decide whether to take further action. That could include making shareholders personally liable for company debts, director disqualification or even prosecution for fraudulent trading.

Protecting your position

As a company shareholder, if you are worried about personal liability issues, the key is to seek advice from company rescue specialists early on. At Real Business Rescue, we will answer your questions and provide confidential, no-obligation advice about the likelihood of personal liability issues arising and how to avoid them.

Our licensed Insolvency Practitioners can also explore business rescue methods to help you avoid formal insolvency and maintain the value of your shareholding. On the other hand, if the company is no longer financially viable, we can guide you through the insolvency process while taking steps to protect your position. Please get in touch for a free consultation or arrange a meeting at one of our 100+ local offices throughout the UK.