Partnerships: Participant Liability, Right of Recourse, and Risk Limitation

A responsible company is a company form that differs markedly from limited liability companies and public companies regarding the participants' liability for company obligations. While shareholders in limited liability companies have limited liability that ends with their share contribution, participants in responsible companies are exposed to significantly greater risk. This article outlines the liability form in responsible companies, the options for agreeing on alternative liability forms, and the rules on recourse among participants.

The Liability Form in a Responsible Company

Personal, Direct and Unlimited Liability

The liability for participants in responsible companies is regulated by the Company Act. Two provisions are particularly central to understanding participant liability:

1. The Company Act § 1-2 first paragraph letter b defines a responsible company as a "company where the participants have unlimited, personal liability for the company's total obligations, undivided or for parts that together constitute the company's total obligations and act as such to third parties."

2. The Company Act § 2-4 first paragraph first sentence states that "the participants are liable all for one and one for all for company obligations."

This means that the liability in a responsible company is:

• Personal: Participants are liable with their entire private fortune

• Unlimited: The liability is not limited to a specific amount

• Direct: A creditor can demand the individual participant directly (with certain limitations)

The main rule is that the liability is joint and several (undivided), which means that a creditor can choose which participant they want to claim for the entire debt. This is a non-compulsory rule, cf. The Company Act § 2-4 third paragraph, which allows participants to agree on another form of liability, typically divided (pro rata) liability.

Consequences of Joint and Several Liability

Joint and several liability in responsible companies means that:

1. A company creditor can choose who among the participants they want to approach for the company’s debt

2. The creditor can choose how much to seek from each participant (within the total debt limit)

3. The participants are liable "for each other" and for the company - there is solidarity both among the participants and between the participants and the company

This can have dramatic consequences for an individual participant, especially because there is no correlation between the share of the company the participant owns and the liability the participant may be asked to bear. A participant with a small ownership share (e.g., 0.2 percent) can, in principle, be held liable for the entire company's debt.

Limitations on Direct Liability

Although the liability is direct, it is not unconditionally principal. The Company Act § 2-4 second paragraph establishes a so-called "weak" beneficium ordinis (order of claim) for the benefit of the participants:

"The company creditor must first make their claim against the company. If the creditor does not achieve coverage from the company within 14 days from the demand, they can demand the participants directly. The same applies when the company obviously cannot pay, and when the company cannot be found."

This means that the creditor must first direct their claim against the company and wait 14 days before they can claim from the participants. However, the creditor does not need to resort to collection or enforcement before claiming the participants. If it is obvious that the company cannot pay or the company cannot be found, the creditor can go directly to the participants.

Alternative Liability Forms

Divided Liability as an Alternative

The Company Act allows participants to agree on a different liability form than joint and several liability, typically divided (pro rata) liability. Under divided liability, each participant is liable only for their share of the company's total obligations. The liability is still personal and unlimited, but it is limited to the agreed portion of the company’s obligations.

For an agreement on divided liability to take effect against third parties (the company's creditors), the different liability form must be registered in the Business Register, cf. The Company Act § 2-4 third paragraph second sentence. This does not apply to a creditor who knew or should have known about the different liability form at the time the obligation was incurred.

Liability for New Participants

For a participant entering the company after its establishment, the following applies:

1. The participant may agree to divided liability, e.g., that they should only be responsible for one third of the company’s obligations

2. It can be agreed that the participant will not be liable for older company obligations (obligations related to the time before joining the company)

3. If nothing is agreed, the participant is jointly and severally liable alongside the other participants, including older company obligations

Practical Ways to Limit Risks

In practice, participants in responsible companies often seek to limit the risk of direct, unlimited, and joint and several liability. This can be done in several ways:

1. Indirect Participation: Participants can participate indirectly in the responsible company through a limited liability company that is given a participant position. Although the liability in the responsible company remains direct, unlimited, and joint and several for the limited company as a participant, the shareholders' liability is, in practice, limited to share contributions.

2. Guarantee Arrangements: There have been constructions where banks or others guarantee the participants' obligations in the responsible company. However, such guarantees are often very costly.

3. Liability Limiting Agreements: Participants can agree with creditors that liability can only be made against the company, or that the creditor must exhaust their possibilities with the company before the participants can be claimed. Such agreements, however, require agreement with each creditor.

For businesses with significant risk, however, the limited liability company form is often a better choice than a responsible company.

Recourse Among Participants

The Principle of Recourse Rights

The joint and several liability in a responsible company implies that creditors can choose to direct their claims against specific participants, typically those with the best financial standing. To balance this "lottery principle," the Company Act § 2-5 provides participants with a mutual right of recourse.

The right of recourse means that a participant who has paid more than their share of the company’s debt can recover the excess from the other participants. This is in line with general contractual principles for joint and several liability.

Recourse Rights Against the Company

The Company Act § 2-5 first paragraph gives the participant who has fulfilled a company obligation the right to immediately recover their entire outlay from the company. There should be no deduction for what the participant should be liable for internally. This reflects the principle that the company is primarily responsible for the company's debt.

In practice, this right of recourse is often of limited value. If a creditor has chosen to claim a participant directly, it is often because the company is in poor financial condition. The provision is therefore mostly a formality, but still logical given the liability form between participants and the company.

Recourse Rights Against Other Participants

If the paying participant does not receive coverage from the company, they can seek recovery from each of the other participants that should fall on each of them according to the company relationship, cf. The Company Act § 2-5 second paragraph first sentence.

This right of recourse is subsidiary in relation to the recourse claim against the company. The paying participant must first have sought their outlay from the company and waited 14 days from the demand before recourse claims can be directed against the other participants.

Unlike the principal liability to creditors, which is joint and several, the liability in recourse proceedings is essentially divided (pro rata). This means each participant should pay their share of the obligation based on the internal relationship between the participants.

Subsidiary Joint Liability in Recourse Proceedings

The law anticipates that not all participants will necessarily be able to pay their share in recourse settlements. The Company Act § 2-5 second paragraph second sentence states that if one of the other participants does not pay, that participant's share is divided among the remaining participants.

This implies a subsidiary joint and several liability in the recourse proceedings. Hence, the recourse liability is principally pro rata and subsidiarily joint and several.

An example can illustrate this: A participant has paid a company debt of 150,000 kroner, which according to the internal relationship should be shared equally among three participants. The paying participant can claim against the other two for 50,000 kroner each. If one of these does not pay, the 50,000 kroner should be divided with 25,000 on the paying participant themselves and 25,000 on the participant who paid their original share.

Deviable Regulation

The recourse rules in the Company Act § 2-5 are deviable, cf. third paragraph. It can therefore be agreed that there should be no right of recourse, or that it should be implemented in a way other than the statutory scheme.

Conclusion

The liability form in responsible companies involves significant risk for the participants. The personal, unlimited, and joint and several liability can result in a participant being liable for the entire company's debt, regardless of ownership share.

This risk is balanced to some extent by:

• The opportunity to agree on divided liability

• The rules on beneficium ordinis (order of claim)

• The right of recourse against the company and the other participants

Nevertheless, the risk of participating in a responsible company is significantly greater than investing in a limited liability company. For businesses with significant risk, the limited liability company form should therefore be considered as an alternative.

For potential participants in responsible companies, it is important to consider not only who the other participants are but also their financial solidity - both regarding who the creditors might choose to target first, and the possibility of recovering recourse claims if needed.