Limited liability

A company can fail owing far more than its shareholders ever put in. Limited liability is the rule that stops that shortfall from becoming the shareholders' personal problem. If a company's creditors cannot recover what they are owed, its equity shareholders will not be asked to pay up to cover the gap.

The liability of an equity shareholder is capped at their contribution to the equity capital, or on any amount left unpaid on shares they agreed to pay for.

The cap has two components, and both come from what the shareholder agreed to put in — not from the size of the company's losses:

1. The amount already paid for the shares; and
2. Any amount unpaid on partly-paid shares that the shareholder has committed to pay.

Beyond that combined figure, a shareholder's personal assets — a house, a salary, other investments — are untouchable by the company's creditors, however large the company's losses turn out to be. This is what allows equity capital to be raised from the public at all: an investor can buy shares in a business without becoming liable for that business's entire universe of obligations.

Mrs Fernandes buys 1,000 fully paid-up equity shares of Rs 10 each in Konkan Textiles Ltd for Rs 10,000.

Three years later, Konkan Textiles collapses under Rs 40 crore of debt it cannot repay. The company's creditors — banks, suppliers, bondholders — can pursue the company's own remaining assets, but they cannot ask Mrs Fernandes for a single extra rupee. Her maximum possible loss was fixed the day she paid for the shares: Rs 10,000. If the shares are now worthless, she has lost her Rs 10,000 — no more, however large the Rs 40 crore shortfall is.

Compare this to a shareholder who bought 1,000 partly-paid shares of Rs 10 each, Rs 6 paid up. That shareholder's cap is Rs 6,000 paid + Rs 4,000 still owed = Rs 10,000 — the company (through its liquidator) can call for the unpaid Rs 4 per share, but nothing beyond that Rs 10,000 total.

Chapter 1, section 1.2 (Features of Equity Capital and Benefits to Equity Investors), the first feature listed after the definition of equity itself — before ownership rights, dividend rights and transfer rights. Expect a direct recall question on what limited liability caps a shareholder's exposure to, and a scenario question distinguishing a fully paid from a partly-paid holding.

• The cap is the shareholder's own contribution (paid plus any unpaid-but-committed amount), not the company's total loss. A candidate who reads "limited liability" as "limited loss" without tying it to the contribution figure will miss scenario questions.
• Partly-paid shares still carry an unpaid call obligation — limited liability caps it at the unpaid amount already agreed to, it does not erase that obligation.
• Limited liability protects shareholders from the company's creditors; it says nothing about the company's own liability to its creditors, which remains unlimited up to its assets.
• Do not confuse this with a debt investor's position — a bondholder is a creditor, not an owner, and limited liability is specifically an equity shareholder concept.