Limited in Limited Company??

I receive a question on Quora which may interest readers of this Blog. The question is –

“What is limited in private limited company? I understand limited means limited liability but can someone explain with a detailed example about how this liability turns out to be limited. Please use numerical in the example. Lets consider 4 owners, each one has 25% stake in the company & the total investment is say 1 lac INR.”

My reply is as under –

Sometimes, laymen assume in a limited or private limited company, liability of a company is limited. Limit of liability of a company is unlimited always or can say, limited to total liability a company have incurred. It is liability of members or shareholders of the company, which is limited.

In legal terms, limited company (whether private or public) has liability of its members (shareholders) limited to the extent of unpaid amount on shares held by them or guarantee provided by them.

In simple words, liability of members or shareholders limited to pay debt of the company.  Such liability of members or shareholders arises in event of winding up/insolvency/bankruptcy only not otherwise. In these cases, a member or shareholder shall pay to the limited extend to unpaid amount on shares held by him or guarantee provided by him.

Usually, general public see two types of limited companies – first, called private limited company and second usually called company or limited company. However, with regard to limited liability, there are two type of limited companies – first, limited by shares and second, limited by guarantee.

Most companies are limited by shares as also the company given as example in query. I explain above example with additional assumed fact –

Total Authorised Capital – Rs. Five lakh  – This is just a government limit to which company may raise money as capital from public. It has no direct relation with liability of company.

Total issued Share Capital – Rs. Two Lakh – This is sum of total liability of the all members combined. In day to day business, shareholders/members as investors see it total limit of investment promised by them.

Total paid – up share capital – Rs. One Lakh – This is sum total amount paid by all members/shareholders till date. This is amount of promise already paid by them. They will not get this amount back from a company as going concern. They may sale this investment in market or wait for winding up when excess of assets over liability may be distributed among them.

In above example given, 4 owners, each one has 25% stake in the company and present total investment Rs. 1 Lakh. As I assumed issued capital two lakh, They will have liability to unpaid capital amount.

Total unpaid share capital – Rs. One Lakh – This is difference of total issued share capital and total paid –up share capital. In event of winding –up/ Insolvency/ Bankcruptcy, shareholders/members shall be liable for this part of amount as their pending promise.

In case of all shares are fully paid, there will be no liability of shareholders/members. In case of listed companies, all listed shares are usually fully paid up, hence, there will be no liability for members in event of winding –up/ Insolvency/ Bankcruptcy.

In case of company limited by guarantee – liability will be unpaid amount of guarantee held by them. In case guarantee amount is fully paid (which is usually not a case), there will be no liability for member.

Exceptions –

However, there are some circumstances where this liability made unlimited by governing law, like reduction of number of members below prescribed minimum.

Practice making limited liability unlimited –

More interestingly, practically most small private limited companies, few or more shareholders have their liability unlimited. This is due to borrowing or loan agreements signed by companies where these shareholders stand as guarantor towards that borrowing/loan. This is quite interesting to incorporate a company with limited liability and loose it very next day to a lender.

Readers may reach original reply written here.