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, but the liabilities below attach to the director’s capacity, not the shareholding. Wrongful trading (section 214 of the Insolvency Act 1986), preferences and transactions at an undervalue (sections 238 and 239) apply to directors and shadow directors — a shareholder who takes no part in running the company is not caught by them. Where a shareholder does also act as a director or officer, several scenarios could make them personally liable in that separate capacity:
- Continuing to trade in the interests of the shareholders after they knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation or administration, without taking every step to minimise the loss to creditors (wrongful trading);
- 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 directors and the transactions the company entered into before the insolvency. There is no single look-back period. The relevant window depends on the claim: for example, a preference given to a connected person can be challenged over a longer period than one given to an unconnected creditor, and transactions at an undervalue have their own timescale again. Wrongful trading is not limited by a fixed period at all: it runs from the point at which there was no reasonable prospect of avoiding insolvent liquidation or administration.
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
This is no longer a proposal. HMRC can give a joint and several liability notice under Schedule 13 to the Finance Act 2020, introduced by section 100 of that Act, making a director, shadow director or participator personally liable for a company’s tax where the company is insolvent or there is a serious possibility that it will become so. The Act received Royal Assent on 22 July 2020 and the power has been in use since.
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.
There are three cases, and they are not the same. The first is where the company engaged in tax-avoidance arrangements or tax-evasive conduct and the person was responsible for that conduct or benefited from it. The second is repeated insolvency: at least two companies have become insolvent in the last five years while the person was connected to them, a new company is carrying on a similar trade, and the old companies between them owe HMRC more than £10,000, being more than half of their unsecured debts. The third is where the company itself has incurred a penalty for enabling avoidance or evasion.
A notice can be issued to a director, a shadow director or a participator. It is aimed at the person responsible for the avoidance, the evasion or the repeated non-payment, not at shareholders as a class, and a notice in the repeated-insolvency case cannot be issued more than two years after HMRC first has the information to issue it.
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. wrongful trading and selling assets for undervalue, that will be the full extent of the shareholder’s loss.
Need advice?
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.