One of the key reasons that so many people want to incorporate a company is because they have the protection of limited liability.
A corporation is incorporated by turning it into a private limited company (LTD) or limited liability partnership (LLP) from a sole trader or partnership.
The corporation has a separate legal and financial identity from its owners after a limited company has been set up.
This means that the company’s debt is not the fault of its owners and its debt alone.
Shareholders are benefitted from ‘limited liability’ in private and public limited companies.
Limited liability shall be a legal status that restricts the financial liability of an individual to a fixed sum.
The shareholders are only personally responsible for the debt of the value they have invested in the company in respect of the company’s debts.
However, this is not the case with all of the business structures. There is no limited liability protection in the case of sole proprietorship and partnerships, which means ensures that the company and its shareholders are to be seen as a single legal entity.
The finances of the company and its shareholders are deemed to be the same. Therefore, the shareholders are legally liable and responsible for the debts of the company.
When a company falls into bankruptcy, the only money the shareholder loses is the amount of the original investment in the company as mentioned earlier.
It is very important that it inspires people to own and invest in companies, knowing that they wouldn’t have to risk their homes and personal finances if the company fails.
Without the protection of limited liability, entrepreneurs would be unable to open new companies, and investors would refuse to make any investments.
Limited liability also ensures that assets can be sold to offset or repay the debt to the company’s creditors.
The company will sell and pay the proceeds to the creditors of all the properties which the company owns, such as machines, vehicles, equipment, stocks, and goods produced by the company. All personal assets, however, are off-limits, including vehicles, homes, and savings of the shareholders of the company.
Can a shareholder be held personally liable for company debts?
Despite the protection of limited liability provided, some situations exist where a limited company shareholder is liable personally for company debt.
One example is the signing of a personal guarantee for a business loan by a shareholder.
The creditor shall be entitled to intervene and take action against the shareholder who signed the guarantee in the event that the company cannot repay the debt.
In the case a shareholder acts as director of the company, many situations exist in which business obligations may be held directly liable:
1- If, despite the knowledge that the company is insolvent, the shareholder/director continues to trade in the interests of shareholders.
2- Disposition of the company’s assets during or before insolvency for free or below the market value.
3- Where shareholders have, for instance, used company funds for personal use and have acted inappropriately or fraudulently.
4- Collect funding to refund the creditors of the company through dishonest and fraudulent means.
5- Payments made of’ preferential payments’ to some of the creditors and not to the others.
6- Commit to fraudulent trading, for example, to provide misleading information on finance applications.
7- Knowingly enable the company to act illegally – for instance, , breaching employee contracts, by misusing sensitive data and disregarding health and safety and environmental laws.
Liability of shareholders in the UAE
The company’s shareholders in the UAE shall bear responsibility for the company’s actions, equivalent to those set out in the regulations of other international jurisdictions.
This means that the company’s shareholders shall be held accountable within their shareholdings in the course of ordinary business, as the company is incorporated in the form of a limited liability company.
If the company’s shareholder has issued a cheque on the company’s behalf, he shall then bear personal liability for the company.
In the United Arab Emirates, some particular aspects of corporate law relating to the rights of shareholders of the company, it is quite the normal case that a key account signatory remains a shareholder who signs the cheques, even though the company’s director exists.
Further, nominee shareholders’ rights and duties in the UAE also have some unique specificity.
In fact, United Arab Emirates legislation does not limit nominees’ rights and obligations.
Therefore, both in terms of rights and liabilities, nominees are considered to be actual owners of the company.
Moreover, article number 71 of Commercial Company Law (CCL) provides that a limited liability company is a company of a maximum number of fifty (50) and a minimum of two (2) partners, and each of them will be liable only to the extent of their share in the capital invested.
The claimant (a creditor of an LLC) attained a court judgment (First Action) against the debtor to pay a sum of AED 781,619.07 along with interest.
Upon a failed execution of the First Action, the claimant sought to go after the shareholders of its debtor through filing another commercial action against the respondents, which are shareholders of the LLC.
The claimant had demanded in its second action engaging the liability of the respondents and that their personal assets should pay the sum of the debt.
Additionally, the claimant also specified that the respondents who are the shareholders in the company are liable to pay the amount each in regards to the extent of his share in the capital.
According to the CCL, the second respondent, who is the manager of the company, is personally liable to the extent of personal assets for the company’s liabilities. Additionally, the respondents are also personally liable for their liability to comply with articles 238 and 255 of the law..
Court of Cassation
The respondents posed two arguments in challenging the Court of Appeals judgment:
1- The respondents contended that the lower court had erred in obliging the respondents to pay the sum granted or awarded in the first action based on the grounds that the lower court contradicted Res judicata’s principle.
In this regard, the Appeals Court allowed the claimant to receive a court order with the payment of the amount awarded twice from that transaction.
The court ruled that it was groundless in response to this point. It is a judicial principle of the courts to make each person liable to the injured party for full compensation where there are multiple sources of obligations, i.e., if one person’s liabilities arise from the contract and the liability of another person results from a detrimental act, each person will be liable against the injured party.
2- The respondents claimed that the Court of Appeals erred in finding that the respondents knowingly caused the claimant aggravated damages.
The appealed judgment failed to establish the harmful act or the respondents’ position in causing damage to their company’s creditor, who is the claimant
Therefore, it was held by the Court of Cassation that the above argument was groundless and further provided reasoning on the following basis:
1- Shareholders who are not directors have the freedom to audit the company’s activities, review its records and documents, and provide advice and guidance to the manager.
2- The company would have a general assembly made up of its shareholders that meets at least once a year during the four months after the end of the fiscal year.
3- The agenda for such a meeting would include hearing the manager’s briefing on the company’s operations and financial status over the fiscal year, the auditor’s report, and a review of the balance sheet and profit and loss account.
4- Any shareholder, in person or by an agent, has the right to review the minutes of the general assembly meeting and resolutions, as well as the balance sheet, profit and loss account, and annual report.
5- The company must set aside 10% of its net income to form the statutory fund, and the shareholders may vote to avoid putting money aside until the reserve hits one-half of the capital.
6- The court concluded from the above that shareholders in an LLC are required by law to be aware of and to be informed of the company’s profit and loss statements.