Legal Tip 218: Are Shareholders Liable for the Debt of a Company?

Discussion in 'Legal Issues' started by Terry_w, 26th Jun, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    A worry for some people is that if they become shareholders of a company, they could somehow become liable for the debts of the company.

    This is not the case unless the shareholders give a personal guarantee or become directors of the company perhaps.

    Example

    Bart invests in Barney Pty Ltd which is a construction company. The company has virtually no assets. One day one of the staff members is seriously injured and sues the company. The company collapses and Bart is worried ‘they will come after him’.

    This is generally not possible because Bart is a separate legal person to the company. His shares will be worthless, but there is where it ends.


    However, there are some limited exceptions to this rule those for cases of fraud, the company acting as agent for the shareholder, shadow director roles, shams, parent companies and subsidiaries – all of which are very rare.


    Caselaw
    The King v Portus; ex parte Federated Clerks Union of Australia (1949) 79 CLR 42

    “The company...is a distinct person from its shareholders. The shareholders are not liable to creditors for the debts of the company. The shareholders do not own the property of the company...” (at 435)
     
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  2. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  3. Bma

    Bma Well-Known Member

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    Hi Terry, does a trustee (company) for a trustee regard as a holding company? Since it is not beneficially held the shares of its subsidiary.
    Thanks.
     
  4. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    A company could be a holding company potentially even if acting as trustee.
     
  5. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Under The Corporations Act 2001 (Cth) a company is a subsidiary if the other company:
    • controls the composition of its board of directors;
    • is in a position to cast, or control the casting of, more than 50% of the maximum votes at a shareholders meeting; and/or
    • holds more than 50% of the issued share capital of the company.
    A trustee company may have right to indemnification from trust assets and it is additional to the holding company issue.

    There can be benefits of the holding company structure
    - Asset segregation. A HC can own assets such as intangible rights etc and license these to a subsidiary. This may offer better asset protection. than each trading entity ownings its own assets
    - Spread of assets across the group so asset loss is firewalled
    - Leverage
    - Fee arrangements to spread costs and revenue between different trading entities. eg HC charges each trading entity for managemnet services, branding, marketing etc
    - Concentration of property assets in the HC rather than the trading companies

    There can also be sound reasons to not use a holding company. Air NZ did that with Air NZ and its lenders insistence on additional members of the board meant AirNZ wasnt in control of the board who would have acted to reflect needs of the lender and not AirNZ. Air NZ wasnt liable for Ansetts losses as a result.
     
  6. Bma

    Bma Well-Known Member

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    Hi Terry,

    Under what circumstances it could be a holding company potentially even if acting as trustee?

    Thank you.
     
  7. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Have a look at that section 588v at the definition of holding company. It doesn't exclude a company acting as trustee. So a company owning shares in another company could be liable for the debts of that company - whether it is acting as trustee or not potentially
     
  8. Mark F

    Mark F Well-Known Member

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    I am not sure whether they are still a legal possibility but there used to be a structure called a company by guarantee in which shareholders guaranteed the debts of the company. This is/was a structure mainly used by charities.

    Also in the day many mining companies had partly paid shares and the balance owing on the shares was able to be called to pay the companies debts. I think this one died when they removed the concept of par value (the issue price of the original shares)
     
  9. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    It's still possible to have partially paid shares but these days no real point as companies are generally $2 or $20 or so share values.
    Companies can be limited by guarantee but I have never had any experience with this. Not sure why someone would need to set one up
     
  10. jrc

    jrc Well-Known Member

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    Companies limited by guarantee are normally not for profits eg bowling clubs, independent schools, some charities. The guarantee is a promise by a member to pay an amount of the company goes bust. Amount is normally a nominal amount eg $10 per member. The member has no shareholding. Normally continued membership requires payment of a membership fee so you can keep your member register current easily
     
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  11. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Partly paid are a terrific strategy. One benefit of partly paid shares - it can remove capacity to vote to an otherwise eligible member if the constitution allows. There can be dividend streaming issues (eg a class of partly paid suddenly can be streamed to !!) and also reasons why you want to limit a vote. Often divs are scaled back for partly paid but they can also be fully entitled. Again its the constitution and subscription rights. Or reasons why partly paid or unpaid share capital is a wise choice. I have used partly paid shares where annual divs pay the capital. It can be useful for start ups especially where you want to give employee shares. And by being part paid you can save their divs and apply the div to the share capital to pay it off over time (better than a loan) . No cash changes hands. Ditto a buy back in reverse can pay down share capital and defer a CGT event. Partly paid can also have forfeiture rights if planned in a constitution.

    There is also the CGT benefit scheme. Good for exec shares etc. Company lends them $100K and a employee exec trust BUYS company shares at market. eg Pay back 20% of subscribed capital each year and reduces the loan. As long as share capital remains 1c the shareholder doesnt incur a CGT event on a return of capital. So in year 5 you do a buy back for what left and its a discount CGT gain on shares which have a costbase of 1c. I learned that one from the great Kerry Packers tax adviser.

    Employee then gets paid out and its a CGT event. Its a terrific retention strategy and gives exec some share based remuneration and because its a private trust its not reportable. Many companies do this every year so its a perpetual rolling benefit. If share values drop you can suspend buy back any year and it just stretches the time. If they leave the shares are sold and loan paid off. The only catch is if values drop it creates a loss which must be made good. Often paid as redundancy / ETP.

    Co's limited by guarantee are typically a co-operative style entity eg Credit Unions and even the well known plumbers co-op. The oldest continuous company in Australia isnt BHP. Its The RAC of Australia. It has a pre-1901 constitution that even predates the companies code and so it predates Corps Act. All members are shareholders...It used to only allow male shareholders. Touchy.
     
  12. Bma

    Bma Well-Known Member

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    Hi Terry, in this case does a trustee company owns another trustee company would be treated as a holding company owns a subsidiary? Please see my example as below:

    ABC Holdings Pty Ltd ATF ABC Holding Trust owns ABC Trading Pty Ltd which is a trustee for ABC Trading Trust and ABC Investments Pty Ltd which is a trustee for ABC Investment Trust.

    If ABC Trading Pty Ltd ATF ABC Trading Trust is bankrupt, does ABC Holdings Pty Ltd liable for its debt like a holding company to its subsidiary? Which also put ABC Investments Pty Ltd ATF ABC Investment Trust at risk?

    Thank you.
     
  13. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Have a look at the legislation. I don't think it excludes companies acting as trustee so it is a possibility.
     
  14. Trainee

    Trainee Well-Known Member

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    If you were willing to build that sort of spaghetti tower, just put the trading and investment entities under different trusts?
     
  15. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    that could still potentially make one entity liable for the debts of the other.
     
  16. Bma

    Bma Well-Known Member

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    Thank you Terry, I had a look but was not sure.

    Even though these two trusts were under two different trusts, they could still liable for the debts of the other? Seems like it does not make any difference?
     
  17. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    I think the trustee could be liable. but assets of the trust might be not exposed
     

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