Limited liability is a fundamental principle in corporate law, and for good reason. Within the restriction of reasonable regulation (and there are widely different views on what constitutes 'reasonable'), shareholders need to be confident that when they invest in a venture, be it a start-up tech company or a publicly listed conglomerate, they will not be personally liable if the company defaults on its debt payments or contractual obligations. If limited liability was not in place, economic growth would be severely impacted as few investors, individuals or businesses would be prepared to risk becoming a company shareholder.
Are Shareholders Liable for a Company's Debts?
Shareholders, as investors in a company, are not liable for a company's debts because a company is a separate legal entity. However, there are exceptions and specific situations where this protection may not apply (see below).
How Does Setting Up a Company Protect Shareholders?
Specific business structures, namely a limited liability partnership (LLP) or a limited liability company (Ltd), create a separate legal personality. A company incorporated under Part 2 of the Companies Act 2006 is a separate entity. It is a 'person' within the meaning of the Interpretation Act 1978 unless there appears to be a contrary intention. This means the company itself is responsible for its debts and liabilities rather than its directors and shareholders. The company can also enter into and be bound by legal contracts, own property, and be sued in court.
Shareholders' risk is generally limited to the amount they have invested in the company. If the company falls into insolvency, they are not at risk of losing their property and assets to pay back creditors.
What is Limited Liability?
Limited liability is a legal concept that means the owners of a company (i.e. its shareholders) are not liable for its debts.
What is a Company Limited by Shares?
In companies limited by shares, shareholders' liability is limited to their shares' value. Shareholders invest capital in the company by purchasing shares representing their ownership interest. The primary responsibilities of shareholders include voting on major company decisions, such as appointing directors and approving significant transactions.
On the other hand, directors are responsible for the day-to-day management of the company and ensuring it complies with legal and regulatory requirements. The law recognises that a company, although a separate personality, requires a human mind to function. Lord Chancellor Viscount Haldane stated in Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705: "…a corporation is an abstraction. It has no mind of its own any more than it has a body of its own...". Therefore, a director is seen as an agent of the company and under the law of agency, any acts or omissions by a director are seen as acts and omissions of the company, and the director will not be liable for such matters unless they breach their directors' duties or act as a personal guarantee.
What is a Company Limited by Guarantee?
In companies limited by guarantee (often NGOs or charities), there are no shareholders but guarantors. The guarantors agree to pay a set amount towards the company's debts if it winds up or becomes insolvent, often a nominal amount such as £1. Their liability is limited to this guaranteed amount, providing similar protections as those enjoyed by shareholders in a company limited by shares. However, a creditor may demand that guarantors provide security for the total loan amount, which means they could be liable for thousands of pounds if the company cannot pay its debts. Always have a guarantor agreement checked by an experienced Solicitor to protect your best interests.
The Benefits of Limited Liability
The primary benefit of limited liability is the safeguard it offers to shareholders' personal assets, which are protected from being sold to pay creditors in the case of insolvency. This encourages investment and entrepreneurship, as people can invest in companies without risking their personal financial security. Without this protection, the economy would struggle to grow, and innovative products (always risky) would hardly ever come to the market.
When Can Shareholders be Liable for Company Debts?
Although shareholders enjoy significant protection thanks to limited liability, there are situations where they can be held personally liable for company debts.
Personal Guarantee Liability
Shareholders will be personally liable for company debts if they provide personal guarantees. Personal guarantees are agreements where shareholders commit to covering specific debts if the company cannot pay. This is common when companies seek loans or credit facilities, especially start-ups with little capital or assets.
Piercing the Corporate Veil
There are circumstances where the Court will look beyond the company to fix liability on shareholders. This is known as 'piercing the corporate veil'. Historically, this was done when the company owner had committed wrongdoing and was the single shareholder, owning 100% of the shares.
The leading case for piercing the corporate veil is Petrodel Resources Ltd v Prest [2013] UKSC 34, [2013] 2 AC 415. Here, the Supreme Court confirmed that a principle of English law enables a court, in limited circumstances, to pierce the corporate veil. It applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction that they deliberately evade or frustrate through the use of a company under their control. The Court may then pierce the corporate veil to remove any advantage gained by relying on the company's separate personality.
Piercing the corporate veil is not a step taken lightly, and it was emphasised in Petrodel that if another legal remedy is available, it should be used instead.
Prosecutions under the Proceeds of Crime Act 2002 (POCA)
In R v Sale [2013] EWCA Crim 1306, the Court of Appeal stated that piercing the corporate veil in POCA proceedings is justified if:
- The Defendant attempts to shelter behind a corporate façade or veil to hide their criminal behaviour and any benefits obtained from it.
- An offender intentionally does acts in the name of the company that constitute a criminal offence which leads to the offender's conviction.
- A transaction or business structure creates a 'device', 'cloak' or 'sham', to disguise the true nature of the transaction or structure to deceive third parties or the courts.
Fraud
If a director who is also a shareholder commits wrongful or fraudulent trading, they can be personally liable for the company's debts.
Can Company Debts Be Written Off?
If a company faces insolvency and cannot pay its debts, various mechanisms can be used to address the outstanding liabilities, such as a Creditors' Voluntary Agreement (CVA).
A CVA is a formal arrangement between a company and its creditors to repay a portion of its debts over a specified period. It allows the company to continue trading while making regular payments to creditors based on what it can afford. Creditors agree to accept these payments, often writing off a portion of the debt.
CVAs can benefit the company and its creditors. The company avoids liquidation and continues operating, while creditors receive a more favourable outcome than they might through bankruptcy proceedings. A CVA requires the approval of most creditors and is supervised by an insolvency practitioner.
Shareholders generally enjoy protection from company debts due to limited liability. However, this protection may not apply in some circumstances, such as when personal guarantees are provided or in cases of misconduct.
How We Can Help
As experts in insolvency law, Witan Solicitors can provide expert advice and representation on all insolvency matters. Contact us on 0330 173 6983 or send us an email for more information.
