Limited liability is the rule that a shareholder can never be asked to pay more than the amount they agreed to pay for their shares. If the company fails, its debts stay with the company, and the most a shareholder loses is the money they put in, plus any amount still unpaid on their shares. It is the reason so many Australian small businesses are run through proprietary companies limited by shares rather than as partnerships or sole traders, and it is the core of what you get when you buy into a company. This article explains how the rule works, the elements that make it up, and the situations where it does not protect you, in particular personal guarantees, director exposure and the circumstances in which a court may disregard the company's separate identity.
The company is a separate legal entity
The first element of limited liability is the company's separate legal identity. A company is a legal person in its own right. It enters contracts in its own name, owns its own assets, employs its own staff, owes its own taxes and can sue and be sued. Shareholders are not the company. They are its members, holding shares that give them a set of rights against the company, and they are not personally responsible for what the company does or owes.
This principle has been part of company law in Australia since the late nineteenth century, following the English House of Lords decision in Salomon v A Salomon & Co Ltd [1897] AC 22, and it is applied strictly. The Federal Court recently confirmed how strict the approach is in Revill v John Holland Group Pty Ltd (No 2) [2021] FCA 1056, where an injured worker tried to hold the parent company of his employer liable by arguing that the way the corporate group was structured meant the court should disregard the separate identity of the companies involved. The court refused to do so, holding that mere control within a group is not enough to pierce the corporate veil.
The cap: liability limited to the unpaid amount on your shares
The second element is the cap itself, and it is set out in s 516 of the Corporations Act 2001 (Cth). For a company limited by shares, a member need not contribute more than the amount, if any, unpaid on the shares in respect of which they are liable. Put simply, your exposure is capped at the issue price of your shares.
If your shares are fully paid, which is the case for almost all proprietary company shares in Australia, the cap has already been reached: you have paid everything you can ever be asked to pay, and a liquidator cannot call on you for more no matter how large the company's debts. If your shares are partly paid, the unpaid balance can be called up. That usually happens on a winding up, when the liquidator makes calls on members to raise money to pay creditors. So the practical question for any shareholder is whether their shares are fully paid and, if not, how much remains unpaid.
The rule applies to members of companies limited by shares. In a company limited by guarantee, which is common for charities and not-for-profits, members instead face a capped guarantee that is called on only if the company is wound up insolvent. The concept this article is concerned with is the former.
Who the protection applies to: becoming a shareholder
Limited liability attaches to people who are members of the company. Under s 231 of the Corporations Act 2001 (Cth), you become a member in one of two ways: you are a member on the company's registration, or you agree to become a member after registration and your name is entered on the register of members. The register is the record that matters. The company must keep it and it must show each member's name, address and shareholding.
Membership is also what gives you your rights. Depending on the class of shares you hold and what the company's constitution and any shareholders' agreement say, those rights typically include attending and voting at general meetings, receiving dividends if and when the directors resolve to pay them, and sharing in any surplus left after creditors are paid if the company is wound up. You also have information rights. Under s 173 of the Corporations Act 2001 (Cth), members can inspect the company's registers free of charge and can ask for copies, which the company must provide within 7 days. And if the company wants to vary the rights attached to a class of shares you hold, s 246B requires it to follow the procedure in its constitution or, where there is none, to pass a special resolution of the company and of the class, or obtain the written consent of members holding at least 75% of the votes in the class. It must give written notice of the variation to the members of the class within 7 days.
Class rights and the balance of power between shareholders are usually set out in the company's constitution, the replaceable rules that apply where the constitution does not displace them, and any shareholders' agreement. The replaceable rules in the Corporations Act deal with matters such as appointing directors, paying director remuneration and removing directors of proprietary companies. This is the context in which your liability sits: the same documents that define your rights also define the shares you hold and therefore the cap on what you can lose.
A worked example
Maya and Tom decide to run their catering business through a proprietary company limited by shares. The company issues 100 fully paid ordinary shares to each of them at $10 per share, so each pays $1,000. The company signs a lease, takes out a business loan and hires staff. Two years later the business fails. The company owes its bank, its landlord and its suppliers around $400,000, and a liquidator is appointed.
Maya and Tom each lose their $1,000. They are not asked to contribute anything further, because their shares are fully paid and s 516 caps their liability at the amount unpaid on their shares, which is nil. The bank, landlord and suppliers must look to the company's assets, not to Maya and Tom personally. If instead the shares had been issued partly paid, say $2 paid on each $10 share, the liquidator could have called on each of them for the remaining $8 per share, an additional $800 each.
Now change one fact. Before advancing the loan, the bank asked Tom to sign a personal guarantee, and Tom signed. When the company defaulted, the bank enforced the guarantee against him personally. That claim sits entirely outside the company structure, and limited liability does nothing to stop it. This is the single most common way limited liability fails in practice.
Misconceptions that cost shareholders money
The first misconception is that owning shares means owning the company's assets. It does not. The company owns its own assets, and you own a bundle of rights attached to your shares: to vote, to receive dividends if declared, to receive a share of any surplus on a winding up, and to sell your shares. If the company becomes insolvent, its assets are applied to pay creditors first, and shareholders share in what is left, which in most insolvencies is nothing. You cannot deal with company assets as your own, and you cannot insure them in your own name.
The second misconception is that limited liability means you can never be pursued personally. The protection only operates within the company structure. If you sign a personal guarantee, you have stepped outside it. Banks and other lenders routinely require personal guarantees from the shareholders of small and medium companies, and sometimes from their spouses and family members as well. The guarantee is a separate contract between you and the lender, and it can expose you to the full value of the company's debt, plus interest and costs.
The third misconception is that limited liability also protects you when you act as a director. It does not. Directors have their own liabilities, which sit alongside the company's. Under s 588G of the Corporations Act 2001 (Cth), a director must prevent the company from incurring a debt while it is insolvent, and a director who fails to do so when there are reasonable grounds to suspect insolvency can be ordered to compensate the company's creditors, with criminal exposure where the failure is dishonest. This duty can catch people who act in the position of a director even without a formal appointment. In addition, directors owe statutory duties of care, good faith and proper purpose, and a person who is knowingly concerned in a contravention can be treated as involved in it under s 79 of the Act and face liability that way. Courts can also, in exceptional circumstances, disregard the separate identity of a company where it is being used to perpetrate a fraud or evade legal obligations, although Revill shows that the bar is high and mere control or group structure will not get there.
When you need a lawyer
Limited liability is a powerful protection, but it is only as good as the paperwork around it. Before you invest in a company, a lawyer can review the constitution, the share classes on issue and any shareholders' agreement, and confirm whether your shares are fully paid, whether your rights could be varied, and what happens if you want to sell. If you are being asked to guarantee a company debt, a lawyer can negotiate the scope of the guarantee, cap it at a dollar amount, limit it in time, and make sure it releases when the debt is repaid or refinanced. And if you are a shareholder in a company heading into financial difficulty, early advice can explain your exposure, your rights against the directors, and what steps the company can lawfully take, before a liquidator is involved.
For founders and small business owners, the review matters most at the start. A shareholders' agreement that sets out dividend policy, how new shares can be issued, and what happens on a sale of the business will also protect the value of what you hold, and a lawyer will usually draft it alongside the constitution so the two documents work together. The cost of that advice is small compared with the cost of discovering, after a company fails, that the protection you assumed you had was signed away.
The question to ask before you invest
Before you put money into a company, ask what you could actually be asked to pay. The honest answer has three parts: the amount you paid for your shares, any amount still unpaid on them, and anything you have signed separately, such as a personal guarantee, that reaches past the company. If you are also going to act as a director, add the insolvent trading and director duty exposures to that list. Limited liability is real, and it protects shareholders in Australia every day, but it only covers the first of those items. Work out the rest before you sign, because the register and the guarantee are where shareholder liability is actually decided.