Shareholders And Directors Have Different Liabilities When A Business Is In Difficulty

When a company is insolvent the duties of the directors as its officers move from

a primary duty to shareholders to a primary duty to protecting the interests of its creditors.

The liabilities of shareholders are limited to the value of their equity and they are protected from liability to creditos under what is known as the "corporate veil".

However, if the shares are only partly paid for and the company enters formal insolvency the creditors can, via the appointment of a liquidator, demand that the shares be fully paid in order to discharge the creditors' liability.

Shareholders often think it is clever to only part pay for shares but if the company goes bust the liquidator will want to recover the unpaid portion of the shares. So, for example, if as a shareholder you own 1000 shares valued at 1 each and you have only paid 250 for them, the liquidator will ask for the remaining 750.

It is also possible that a company's shareholders might have given a personal guarantee at some stage during their involvement with the company. It might be that at start-up for instance, particularly when a family member has started a small business, or when the company subsequently entered a contract such as a lease, some or all of the shareholders personally guaranteed the contract and then later forget about it, especially if they are no longer directors or officers of the company as they may have been in its early days. This can also be an issue after the shareholders have sold their shares and failed to discharge their personal guarantees.

Directors, however, can be held personally liable under the Insolvency Act 1986 for money owed to creditors. They must not sell any assets under their market value. They must be fair and not pay some creditors in preference to others. The fiduciary duty imposed on the directors of an insolvent company leaves them with personal liabilities that are not imposed on shareholders.

However, it is often the case with small companies that the director and shareholder are one and the same and in those situations the director must remember that he or she wears different hats as director, shareholder, employee and also as a creditor, if they have lent money to the company. This is in particular an area where repaying director loans can attract a charge of preference referred to above.

In a recent case of a manufacturing company that went into liquidation where all the family members who were both shareholders and employees as well as creditors because they had lent the company money, as shareholders they had to pay in unpaid share capital even though they were creditors because they were not able to offset the money they were owed as creditors against the money they were liable to pay as shareholders.

When a company enters liquidation liquidators expect the unpaid share capital to be paid. While complicated, the unpaid portion of share capital is often not treated as an asset that can be set off against the loan as a liability, hence the reason that unpaid share capital can be claimed even when the shareholder is a creditor of the company.

It may seem complicated and unfair and therefore it is sensible to seek outside help from business turnaround or rescue adviser if you are involved in a business as both a shareholder and as a creditor.

Too many shareholders and directors fail to carry out regular reviews of their businesses before they reach this sort of situation, let alone carry out an emergency review if the company is close to or in insolvency before they make decisions on what they should do.

Working as an objective outsider with a company, a rescue adviser has the tools and experience to properly assess the company, establish where there is a part that is viable and then propose a plan to help it survive what may be relatively short term insolvency, perhaps because of a decline in orders thanks to a recession.

It is in the advisor's interests to offer realistic solutions to help restructure the company on a more stable basis, deal with the company's liabilities in a way that is sustainable and allow it to carry on trading then move forward into growth. Alternatively, when a business is no loger viable the adviser can assist in closing it down in a way that maximises the creditors'interests.

Copyright (c) 2010 Alison Withers

by: Alison Withers

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