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When Does Shareholder / Member Of a Company Lose Limited Liability Protection and Become Severely Liable For The Debts Of The Company ?

  • March 31, 2024
  • 221 Views

A member or shareholder of an incorporated company is legally responsible for the company’s debts and obligations  only up to the value of his subscribed shares if the liability of members of the company is limited by the provisions of Memorandum of Association of the Company.  

Limited liability is one of the biggest advantages of investing in an incorporated company. Because, a shareholder can enjoy the growth of a company, while restricting their liability to the amount they have invested in the company. Their other personal possessions are protected, even if the company goes bankrupt while still having outstanding debt.

In the case of sole proprietorships and general partnerships, the law dose not allow limited liability protection, because they are not legal entities different from the persons who constitute them.

The limited liability protection is given by law only if the incorporated company follows,  during its existence , the basic conditions of  its formation.

A company can be formed for any lawful purpose by—

     (a) seven or more persons, where the company to be formed is to be a public company;

     (b) two or more persons, where the company to be formed is to be a private company; or

     (c) one person, where the company to be formed is to be One Person Company .

If at any time the number of members of a company is reduced, in the case of a public company, below seven, in the case of a private company, below two, and the company carries on business for more than six months while the number of members is so reduced, every person who is a member of the company during the time that it so carries on business after those six months and is cognisant of the fact that it is carrying on business with less than seven members or two members, as the case may be, shall be severally liable for the payment of the whole debts of the company contracted during that time, and may be severally sued therefor.

The possibilities are:

    1. Non  transmission of the shares of a deceased member to his legal heirs

    2. Improper transfer of shares

    3. Legal disqualifications such as unsound mind etc.

Once the minimum number of members goes below the threshold limit, the remaining shareholder(s)/member(s) shall be vigilant to increase the number to the legally required minimum number within six months to save himself from several liability of the company’s debts resulting out of the reduction of  minimum number of members below the threshold

Refer : Section 3 and  3A of the Companies Act 2013.