How does shareholders' limited liability work in practice?

Question

Given that:

A shareholder in a limited company is not personally liable for any of the debts of the company, other than for the amount already invested in the company and for any unpaid amount on the shares in the company, if any.

— how much would the shareholders be liable in the following scenarios:

A)

1. Bob creates Bob Limited where he owns 100% shares. He does not invest anything — just creates the legal entity. At no point he needs to pay anything to anyone for the shares;
2. Bob Limited starts trading, makes some profit and buys some assets;
3. Bob Limited incurs a large debt, fails to pay it off and gets sued.

B)

Same as above except for that Bob sells half of his shares to Matt for $50 before the company incurs debt.

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I guess the jurisdiction does not matter much in this question, but if it does, let's assume the USA and/or New Zealand.

Answer 1

First, shares are a form of raising capital. A company must have some capital, and Bob receives the shares in exchange. So it is not free (the exact minimum would depend of the requirements for incorporating).

In both cases, Bob is not only a shareholder but the manager of Bob Limited. Bob will not incur liabilities for being a shareholder, but he can be at fault for his actions as a manager (for example, if he gives false financial data about Bob Limited in order to get credit for investing). Do not confuse Bob the Managerand Bob the Shareholder, as they are different roles.

Of course, if you are a trading company and Bob the Manager approachs you asking for credit for Bob Limited, you will have to consider which assets Bob Limited has to cover possible debts, and you will ask him the books or other proof. If Bob the Manager provides you the correct information about Bob Limited and does nothing "funny"¹, Bob the Manager is off the hook; you did provide credit hoping to get profits but you knew that there was a risk, and you were given the data needed to evaluate that risk.

If Bob the Manager did things the wrong way (he did "cook" the books, he did provide false data or he did appropiate Bob Limited money) then Bob the Manager will probably be prosecuted. But Bob the Shareholder will not be liable for this, he will only lose the assets he did put forward as capital as the Bob Limited value will drop to zero.

B) does not change much the situation, Matt still only loses his part of the company². The difference here is that if Bob the Manager did "funny" things and did not manage the company correctly then Matt may sue Bob the Manager, too.

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¹For example, using the assets borrowed to buy a nice mansion and then selling it to Bob the Shareholder (or to Bob the Manager) for $1.

²Which is not valued at $50 but as half the net worth of the company. Of course, if the company was valued at $100.000.000 and Bob the Shareholder sold half of its shares for $50, people from the tax office are likely to come asking lots of questions.

Answer 2

As other answerers have noted, Bob's liability is only limited as a shareholder. In practice, the creditors of a one-person company would usually require a personal guarantee from the company owner to ensure that they have some recourse if the company fails, and the owner can also be personally liable for torts and crimes.

However, it is worth clarifying what the word 'limited' applies to here. Technically, the shareholders are not liable to 'lose their shares' – it's just that if the company has more debts than assets, the shares are worth nothing, and they may cease to exist if the company is liquidated and dissolved. Rather, as explained in the Wikipedia article you quoted, the shareholders are liable for the 'unpaid amount on the shares in the company, if any.'

In the early history of limited liability companies, it was common to issue partly-paid shares, which gave the company the right to call for the shareholders to pay the outstanding value of the shares later. The shareholders' liability for the company's debts was 'limited' to this outstanding value, which would also have to be paid if the company was liquidated. See Jefferys, 'The denomination and character of shares, 1855–1885' (1954), which is also cited in the Wikipedia article:

Shares only partly paid up were a feature of the opening years of limited company finance. In some cases, mainly co-operative ventures, this was the result of a decision to call up the capital by instalments. For example, the Airedale Building and Manufacturing Company Ltd. of Yorkshire had shares of £2. 10s. each on which one shilling was called up monthly. But in the majority of cases there was no intention, initially, of calling up the whole of the amount of the share and a common announcement in the prospectus of a company was: 'It is not intended to call up more than 25 L per share' (£100), or: 'It is not anticipated that more than 10 L per share will be required' (of a £20 share). After the crisis of 1866 this system found fewer supporters.

Today, companies like Bob Limited rarely issue unpaid or partly paid shares, so it would be more accurate to call them no liability companies: the shareholders are never liable (as shareholders) to contribute more money to cover the company's debts.

Answer 3

Generally, a company is held responsible for debts in the company's name and the shareholder/owner of the company is not unless he is personally listed as such on the contractual agreement. In the event that the company becomes insolvent, the majority shareholder is not held financially accountable.

There is however personal liability for the majority shareholder if he is found liable for fraudulent behavior. This can include misrepresentation to the issuer of the loan as to how the funds would be used.

Answer 4

In the UK, you can easily start a limited company with 100 shares of £1 each, so £100 is the maximum loss for the shareholder(s).

There are a few things that can get you into trouble: Paying too much in dividends so the business runs out of cash. Just taking money out of the company (if the shareholder is the manager and has access to the bank account). If the company gives a loan to the shareholder, that loan has to be paid back. Especially if the company goes bankrupt. (If the shareholder gives a loan to the company, he might end up just as one of many debtors, and paying that loan back ahead of other debts would cause trouble).

Not paying income tax on behalf of employees - in many places, that will be about the worst thing you can do. Because it is the employees money, so you will pay that money out of your own pocket.