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.
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.
Could a shareholder ever be made personally liable for company debts?
Despite the protection limited liability provides, there are certain circumstances when a limited company shareholder could be made personally liable for business debts.
One instance is when a shareholder signs a personal guarantee for a company loan. In that case, if the business is unable to repay the debt, the creditor will be able to take action against the shareholder who signed the guarantee.
In a limited company, it’s common for the directors and the shareholders of the business to be one and the same. Where a shareholder acts as a director or officer of the company, there are several other scenarios when they could be made personally liable for company debts:
- Where the shareholder/director continues to trade in the interests of the shareholders despite knowing the company is insolvent;
- Disposing of company assets for free or for below market value during or leading up to insolvency;
- Creating an overdrawn director’s loan account by taking money out of the company in the form of a director’s loan rather than dividends or salary, or taking illegal dividends, which are dividends not out of profits.
- Raising funds to repay the company’s creditors through fraudulent means.
In the case of an insolvent liquidation, a liquidator will be appointed to sell the company’s assets, distribute the funds to the creditors and close the business down. They will also investigate the conduct of the company’s shareholders/directors in the two to three years leading up to the insolvency.
If they find examples of any of the above, they could take action to make the shareholders’ personally liable for the company’s debts.
Shareholder liability for company tax debts
Following the outcome of a recent government consultation, it has been decided that the government will legislate in 2019 and 2020 to make directors and shareholders ‘jointly and severally liable’ for tax liabilities that result from tax avoidance, tax evasion and phoenixism. This will undoubtedly be a cause for concern for some shareholders.
It’s already the case that in the deliberate non-payment of company tax debts, in some cases, the liability for those debts can be switched to the company’s shareholders/directors.
However, the new legislation will give HMRC more powers to tackle the problem of limited companies closing down while owing significant sums of money in unpaid taxes – typically VAT and PAYE.
Although the exact form the new rule will take is yet to be seen, the consultation suggests that HMRC will extend the current legislation to include ‘the persons responsible for the avoidance, evasion or repeated non-payment of taxes’ when a company cannot pay its tax debts.
That would apply to those who ‘own or manage’ a company.
The benefits of shareholder limited liability
There are many benefits associated with the limited liability a company shareholder receives.
Firstly, it encourages investment in the UK’s thriving small business economy from shareholders who can be confident that the only money they will lose is the value of their original investment if the company gets into debt.
Shareholder limited liability also facilitates the transfer of shares, giving other prospective investors the confidence to invest in a business offering limited liability. It can also provide more clarity as to the assets that will be available to creditors if the business were to collapse.
If a company were to collapse, the shares in the business may be worth nothing and the shareholders would rank behind the creditors of the company, which means they’re unlikely to receive any dividend on liquidation.
However, as long as there are no instances of the actions described above i.e. trading while insolvent and selling assets for undervalue, that will be the full extent of the shareholder’s loss.
Do you have any questions about your potential personal liability as a director or shareholder for your company’s debts? Please get in touch with our team to discuss your circumstances confidentially and receive expert advice.