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In Australia, a company is legal entity, separate from its owners. This means that a company has the same rights as an ordinary person. For example, a company can enter into contracts or sue someone. A company also has shares which are held by its shareholders. These shareholders are the owners of the company through the shares that they hold. However, they remain separate from the company, regardless of how many shares they hold. Therefore, whenever the company enters into any contracts or takes certain actions, the company is performing these tasks, not the shareholders. As a result, a shareholder will generally not be liable for debts that the company sustains. However, there are some exceptions to this rule. This article will explain these exceptions and when shareholders are responsible for company debt.

How Does a Company Take on Debt?

A company can take on debt in many ways, commonly by borrowing money from a bank or from another individual. When the company enters into an arrangement where they are taking on this debt, the company now has an obligation to repay the lender. Importantly, this is an obligation on the company itself, rather than on any of its individual shareholders or directors. Subject to the terms of the arrangement, the company will have to use its funds to pay back the lender. However, there are some situations when a shareholder might be responsible to repay the company’s debt.

Fully Paid vs Partly Paid Shares

A shareholder can either fully or partly pay their shares in the company. Fully paid shares means that the shareholder has paid full price for their shares. A partly paid share means that the shareholder has paid part of the issue price upfront and will pay the remaining amount in the future. If the shares are partly paid, a shareholder is liable to pay the company for the amount that is unpaid. They will still not be required to pay any company debts however they do have liability to the company. If the company were to go into liquidation, the company’s liquidator can require those shareholders who are holders of partly paid shares to pay the unpaid amount on their shares.

Personal Guarantees

If a shareholder provides a personal guarantee over a debt that the company sustains, then the shareholder may be liable for this debt. A personal guarantee is a promise by the person providing the guarantee (the ‘guarantor’) to pay the amount in the event that the company does not repay the debt.

When Are Shareholders Responsible?

Creditors often ask for personal guarantees to ensure that an individual is responsible to repay the debt, if the company fails to do so. It is much more common for a director to provide a personal guarantee rather than a shareholder. This is because the directors are responsible for managing the day-to-day operations of the company and are better placed to provide this guarantee. Though uncommon, there are times in which a shareholder will be asked to provide a personal guarantee. If the shareholder does so, then they will be personally responsible for the debt. So, if the company takes out a $1,000,000 loan and the shareholder guarantees this loan, if the company doesn’t repay this amount, the shareholder may be responsible to repay this $1,000,000.

Secured Assets

Similar to a personal guarantee, there are circumstances where a shareholder may provide security over the company’s debt. It is far more common that a director will secure the debt. However, if a shareholder decides to provide security, then they will be responsible.

By securing the debt, the shareholder is providing a valuable asset to guarantee the company’s debt. For example, a shareholder may secure the debt with their house or car. If a shareholder provides security over a debt that the company sustains and the company is not able to repay the debt, the lender will have the right to take the shareholder’s asset. For example, if the company takes out a $1,000,000 loan and the shareholder secures this loan with their house, then the shareholder may lose their house.

Key Takeaways

Since a company is a separate legal entity, in most instances, it is separate from its shareholders. If a company sustains a debt, the company must repay it. However, in some instances a shareholder may be responsible to pay a company’s debt. This would arise where a shareholder provides a personal guarantee or secures a debt of the company with their own assets. In either of these instances, if the company fails to repay the debt, the shareholder will be responsible to either repay the debt (in the case of a personal guarantee) or, where they provide security over a debt, the asset may be seized by the lender. If you have any questions about company debts, you can contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.

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