Shareholder Liability For Corporate Debt
Shareholder liability for corporate debt is covered by limited liability protection and is subject to state laws.3 min read
Updated November 25, 2020:
Shareholder liability for corporate debt is covered by limited liability protection and is subject to state laws. In general, LLC members and shareholders are not personally responsible for the liabilities and debts of an LLC or corporation, but they are held responsible for the value of their investment in the company. This means that a corporation may not request members or shareholders to pay for corporate income taxes, to pay a creditor of the company, or to pay a judgment against the company.
How Does a Shareholder Become Liable?
Individual shareholders often consider themselves the “owners” of the company, however they actually simply own stock in the corporation that owns the business. Owning stock does not automatically make the owners liable for the corporate debt, but there are numerous ways that shareholders might become liable for such debt, including the following:
- Liability by agreement and personal guarantees.
This is the most common form of shareholder liability. A shareholder might become liable for that corporation's debt if they guarantee the debt. In other words, the shareholder might make a contractual agreement and hold personal liability to the company's creditor on that particular debt.
Sometimes this liability might arise on accident, for instance when a shareholder mistakenly signs his or her own name on a contract or lease, rather than as an employee or officer of the company. Depending on the state, signing just your name (e.g. “Jane Smith”) might make you personally liable. In this example, the correct way to sign on behalf of the corporation would be “Jane Smith, President, Ultracorp, Inc.”
In other cases, an owner may intentionally make a personal guarantee, such as if he or she decided to sign limited or unlimited personal guarantees in order for their company to borrow money. If outstanding payments remain, the individual must pay back either the entire defaulted amount (plus court fees) or just the amount for which he or she is liable. If two or more shareholders make the personal guarantee, then each individual (depending on the contractual terms) might be held jointly and severally liable if the corporation defaults.
Taking out home equity loans or personal loans to fund the corporation is another way a shareholder might be held personally liable. In addition, even though a credit card might have a corporation's name associated with it, the individual is generally personally liable for debts incurred, according to the credit card agreement.
If it becomes necessary for the corporation to consider bankruptcy, it's important to determine which corporate debts, if any, become the shareholders' responsibility. If an individual, guarantor, or other corporate entity makes an agreement with a creditor, the corporations' bankruptcy filing does not revoke their liability. Nor does the bankruptcy discharge any liability that others associated with the company might have.
- “Piercing the veil” of the corporation or LLC.
A few reasons might cause the courts to allow the piercing of the veil, including fraud and wrongdoing, non-adherence to corporate formalities, failure to maintain separation between company and owners, failure to sufficiently capitalize the entity, and in circumstances where not piercing the veil would cause suffering to creditors or other third parties.
- Omission or tortious act by members or shareholders.
Another common cause of shareholder liability for corporate debt is when a member or shareholder commits a tortious act or omission.
- Consenting to unlawful distribution.
The board of directors can approve distributions to shareholders, but state laws and contractual restrictions exist regarding distributions. In general, state laws require that the corporation satisfy its debts before making distributions to shareholders.
In states that require sales tax, taxes must be paid at least quarterly. If the collected sales taxes are not turned over to the state, criminal liability may apply for theft of state funds. In these cases, state tax laws might enforce personal liability.
Nonprofit Organization Liability for Corporate Debt
Nonprofit organizations, including societies, charities, and community projects, are typically formed as private companies that are limited by guarantee. Nonprofit organizations are separate legal entities that are responsible for generating their own income and paying off their own debts, but instead of issuing stock, the organization is owned by guarantors. The personal liability of such organizations' debts is limited to a specific amount of money (the guarantee).
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