One of the most significant advantages of the limited liability company is that once members have paid the full nominal value of their shares, they no longer face the prospect of any further liability. Even where the shares are not fully paid, the shareholders at least are clearly aware of the maximum potential payments that they stand to make, i.e. the amount remaining unpaid on their shares. This is precisely the meaning of limited liability – shareholders know exactly, and can control, the amount that they stand to lose if their company goes into insolvent liquidation. This situation can be contrasted with the situation of the ordinary partnership where the liability of the partners is not only uncertain, but also unlimited.
Personal guarantees are the means by which powerful lenders avoid the limited liability of the members of the company to which they lend money. Rather than merely relying on the capital of the company, the lenders require the members to enter into a contractual agreement that they will back the debts of the company with their own personal wealth. Effectively this device removes limited liability with respect to those lenders who are in a position to demand personal guarantees, although not ordinary trade creditors. In that way it undermines the theoretical effectiveness of limited liability by refusing to recognise it in practice.
When companies borrow money from a bank it is usual for them to provide security for any loans, known as debentures, given to them. ‘Security’ means that, in the event of the company being wound up, the creditor with a secured debt will have priority as regards repayment over any unsecured creditor. A fixed charge represents a legal claim against a particular item of property owned by the company issuing the debenture. The company cannot dispose of the property charged without the consent of the charge holder and in the event of the company failing in its duties, the creditor can have that property sold to realise the amount of their claim. A floating charge, on the other hand, is most commonly made in relation to the ‘undertaking and assets’ of a company and does not attach to any specific property whilst the company is meeting its requirements as stated in the debenture document.
Applying the foregoing to facts in the problem scenario it can be seen that the company has debts totalling £40,000; £30,000 owed to Oop bank plc, of which £20,000 is secured by a fixed charge over the company’s land and £10,000 to ordinary trade creditors, with assets of £27,750.
Oop bank plc will be able to assert its priority over the creditors to the extent of its fixed charge and thus it will recover its original loan for £20,000 from the sale of the company’s land. That will leave the company with unsecured debts of £10,000 to the trade creditors and £10,000 to Oop bank plc. However, as the shareholders have only partly paid for their shares, they will be required to make good the difference, up to the nominal value of their shares, to pay off the debts. In effect this means that Mat, Mary and Norm will each have to provide a further £750, making a total of £2,250. As a result the company will have a total of £10,000 to pay unsecured debts of £20,000. Consequently all the unsecured debts will be paid off from the company’s remaining assets at the rate of 50 pence per £1 owed. It remains, however, to consider Mat’s personal guarantee to Oop bank plc for the company’s debts. As the company has outstanding unpaid debts of £5,000 owed to the bank, Mat will have to make good that amount from his personal assets.
In conclusion it can be seen that:
– the bank will receive all of the money owed to it by the company, either from the company or from Mat personally;
– the unsecured creditors will receive 50% of the debts owed to them by the company;
– both Mary and Norm will have to pay £750 towards the company’s debts;
– Mat will have to pay both £750 on his unpaid shares and a further £5,000 on the basis of his personal guarantee.
Tutorial note
In the problem scenario Oop bank plc held a fixed charge over the land owned by the company. The situation would have been different had its debt been secured by a floating charge. In order to improve the position of unsecured creditors, the Enterprise Act 2002 introduced the concept of ring-fencing some of a company’s assets for the exclusive use of unsecured creditors. Under the new regime, s.176A of the Insolvency Act 1986, which applies to floating charges created after 15 September 2003, a liquidator, administrator or receiver is required to make a prescribed part of the company’s net assets available for the satisfaction of unsecured debts before any money can be paid in satisfaction of a floating charge. The procedure does not apply if the company’s assets are less than £10,000; thereafter, the prescribed amount is set at 50% of the first £10,000 and 20% of any assets above that value up to a maximum of £600,000. |
