ARTICLE
2 December 2019

When Shareholders' Limited Liability Becomes Unlimited

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Many believe that as a shareholder of a limited-liability company they will not be liable for the debts of the company with their own assets.
Hungary Corporate/Commercial Law
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Many believe that as a shareholder of a limited-liability company they will not be liable for the debts of the company with their own assets. In most cases this is true, yet there are situations, when the rule of limited liability shall not prevail and the shareholder of the LLC will be directly and unlimitedly liable for the company's debts. In this short article we summarize the most important cases when the limited liability becomes unlimited.

  1. The breakthrough" of limited liability

In general the shareholders of the limited-liability company (LLC) are not liable for the debts of the company with their own assets if they have provided the contribution set forth in the articles of association (eg. in cash contribution, in-kind contribution).

That means that if a contractual partner has a claim against the LLC, he can only sue the company itself, but not the shareholders of the company. As general rule the shareholder of the company shall not be liable with his private fortune for the debts of the company.

The reason of the "breakthrough" of the limited liability is the protection of the creditors. Unfortunately it is very common that a company goes bankrupt, liquidated and during the liquidation procedure it turns out that it has no assets. In this case it would be unfair if the shareholders of the debtor company could get away and the creditors should bear all of the financial risk.

Under Hungarian law, the three (3) most important cases when the limited liability turns into unlimited liability are the following:

- the unlimited liability of the shareholder who abused the limited liability,

- the unlimited liability of the majority (75 %+) shareholder because of his disadvantageous corporate strategy,

- the unlimited liability of the majority ( 50%+) shareholder who transfers his business share.

  1. The abuse of the limited liability

If the shareholder of the company abused its limited liability and due to this creditors' claims remain unsatisfied, the shareholder shall be unlimitedly liable with his private assets for such debts.

What are the cases when a shareholder abuses its limited liability? The list of these activities covers a wide range of actions, such as:

- if the shareholders implements a business strategy disadvantageous for the company (eg. entering into unreasonable loan agreements, concluding contracts with unreasonable risk),

- if the shareholder disposes over the assets of the company as if those were his own assets (eg. the shareholder buys himself a car from the money of the company),

- if the shareholders make a decision which is obviously against the interests of the company (eg. the shareholders decides on the payment of dividends without the fulfilment of the statutory conditions).

According to the Hungarian Civil Code the former shareholder of the company who sold his business share earlier can also be liable for the debts of the company if it is proved that he abused the limited liability in the time when he was shareholder.

A special case of the above shareholder liability is when the company has tax debts: in this case the tax authority may establish the transmission of the liability to the former shareholder of the company.

  1. Liability of the 75 %+ shareholder for disadvantageous corporate strategy

In case the company is liquidated, the former shareholder of the company who had a qualified majority (75 %+ stake) and implemented disadvantageous business strategy shall be liable with his own assets for all those debts that are not covered by the assets of the controlled company.

The creditor of the company may file a claim to establish this liability before the court within 90 days as of the termination of the liquidation procedure. If the court establishes the shareholder's liability, the creditor can file a claim directly against the shareholder.

It is important to mention that the disadvantageous corporate strategy shall be examined on the level of the controlled company, and not on corporate-group level.

For this reason, a decision which shall be regarded as reasonable on corporate-group level will be disadvantageous for the controlled subsidiary and the parent company may be held liable for the consequences.

  1. The liability of the 50%+ former shareholder

When the debts of the company being liquidated exceed the half of its subscribed capital (eg. if a company with a HUF 3 million subscribed capital has more than HUF 1,5 million debts) the former 50%+ shareholder of the company may also be liable for the debts of the company.

The creditor can file a claim against the former 50%+ shareholder who sold his business share within 3 years before the starting of the liquidation and ask the court to establish his liability for the debts of the company not covered by the assets of the company.

The former shareholder may defend himself by contending that

- when he has sold his business share the company was solvent and it has been indebted after that;

- the company has been already indebted by the time of the transfer of the business share but the former shareholder has taken into account the interest of the creditor, eg. he has sold the business share to the new investor so that his investments could save the company.

If the former shareholder cannot prove the fulfilment of one of the above conditions in the procedure he may be liable for the debts of the company with his own assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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