In Short
- Limited companies usually protect directors’ and shareholders’ personal assets, but some situations can expose them to personal liability.
- Shareholders may be liable for unpaid share amounts, personal guarantees, security over company debts, or unlawful conduct.
- Directors may be liable for breaching legal duties, personal guarantees, security over company debts, or involvement in illegal activities.
Tips for Businesses
Understand when directors and shareholders can be personally liable and take steps to minimise risk. Avoid giving unnecessary personal guarantees, ensure directors meet their legal duties, and steer clear of unlawful conduct. Seek professional advice early to protect both the business and individual assets.
One of the key benefits of operating a business as a private limited company is the protection it affords to the personal assets of those involved in the business. However, there are certain circumstances in which the directors or shareholders of a company may be held personally responsible for the company’s debts or sued for its own or the company’s actions.
A company is its own legal person. This means that it has similar legal rights to a person, including:
- the right to enter into contracts;
- the right to sue and be sued; and
- the right to own assets and property.
The directors and shareholders are responsible for making decisions on behalf of the company; however, they do not own its assets. Due to this ‘separate legal personality’, the general position is that personal assets of directors and shareholders (such as their homes) are not at risk if the company is sued or becomes insolvent.
This article explains when company directors and shareholders can be personally liable for debts or legal breaches despite limited liability protections.
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What are a Shareholder’s Risks?
1. Partly-Paid Shares
Shareholders can be liable to a company for any unpaid amounts on their shares. To own shares, shareholders have to pay the full price of their shares. Usually, shares are ‘fully paid’, meaning the shareholder paid the full price of the shares upfront. However, shares can also be ‘partly paid’, which means the shareholder still owes some money in respect of those shares.
If this is the case, a shareholder is responsible for paying the company for the unpaid amounts. The company can demand repayment at its discretion. This means that if the company goes into liquidation, shareholders who hold partly paid shares will need to pay the unpaid amount on their shares.
2. Guarantees and Secured Assets
A shareholder may also be responsible for the debts of a company if they provide:
- a personal guarantee over a company debt; or
- security over a company debt.
Under a personal guarantee, you promise to pay a debt the company has taken on if the company cannot do so itself. Providing security over a company’s debt means that an individual grants a creditor an interest in some or all of the company’s valuable assets. This means that if a company cannot repay a debt, the creditor can take possession of those assets and sell them to recover the debt.
It is much more common for a company director to provide a personal guarantee. However, in the rare case that a shareholder provides a personal guarantee or security, that shareholder will be personally responsible for the company’s debt if the company does not or cannot repay it.
3. Breaching the Law
In some circumstances, the law can hold shareholders personally liable for company debts even if they do not provide a personal guarantee. Generally, this occurs when a shareholder has engaged in fraudulent or other illegal activity that has caused the company to incur debts.
What are a Company Director’s Risks?
1. Directors’ Duties
Company directors are responsible for managing the company and are bound by certain legal duties to act in the best interests of the company. Examples include the duties to:
- act within their powers as a director;
- act in good faith, in the best interests of the company and for a proper purpose;
- exercise care, diligence and independent judgment when managing the company;
- ensure that a company is not trading while it is insolvent;
- disclose any significant personal interests they have that relate to the company’s affairs; and
- not use their position for personal gain at the expense of the company.
If a director fails to fulfil their directors’ duties, they may be found by a court to be personally responsible for doing so. Potential consequences for directors include:
- having to pay financial penalties;
- having to pay off company debts personally;
- prison sentences; and
- disqualification from managing a company.
2. Guarantees and Secured Assets
It is common for directors, particularly of small or newly established companies, to have to provide personal guarantees for company debts. For example, if the company takes out a business loan, the lender may ask for a director to provide a ‘director’s guarantee’ to guarantee the company’s repayment of the loan.
Directors are typically seen as the most appropriate people to take on these risks. This is because they:
- have the best understanding of the company’s financial position; and
- must manage the company in the best interests of the company and its shareholders.
If a director guarantees a loan on behalf of a company, and the company cannot repay that loan out of its own cash and assets, the director’s personal cash and assets will be at risk. This is because they will have to repay the company’s loan personally.
Most commonly, a company will provide security for a loan over its own assets. However, in the rare case that a director agrees to secure a loan, that director will have to risk losing their own assets to satisfy repayment of the loan if the company fails to meet its repayment obligations.
3. Breaching the Law
A director will be personally liable for some of the company’s unlawful breaches. Typically, these breaches involve criminal activity, such as:
- fraud;
- money laundering;
- illegal phoenixing (where a company cannot pay its debts); and
- further acts of dishonesty.
Key Takeaways
A private limited company usually protects directors’ and shareholders’ personal assets, but certain situations can still expose them to personal liability. Shareholders risk liability if they owe money on partly paid shares, give personal guarantees or security for company debts, or engage in illegal conduct that causes company losses. Directors risk liability if they breach their legal duties, personally guarantee loans, or take part in unlawful activities such as fraud or insolvent trading. Both directors and shareholders can reduce these risks by meeting legal obligations, avoiding illegal conduct, and getting professional advice to protect their position.
If you need assistance in navigating these risks, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to solicitors to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Shareholders may be liable if they hold partly paid shares, provide personal guarantees or security for company debts, or engage in fraudulent or illegal activity that causes the company to incur debts.
Directors may face personal liability if they breach their legal duties, give personal guarantees or security for company debts, or take part in unlawful activities such as fraud, money laundering, phoenixing, or other dishonest conduct.
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