Limited liability

Limited liability is a legal status where a person's financial liability is limited to a fixed sum, most commonly the value of a person's investment in a company or partnership. If a company with limited liability is sued, then the claimants are suing the company, not its owners or investors. A shareholder in a limited company is not personally liable for any of the debts of the company, other than for the amount already invested in the company and for any unpaid amount on the shares in the company, if any. The same is true for the members of a limited liability partnership and the limited partners in a limited partnership.[1] By contrast, sole proprietors and partners in general partnerships are each liable for all the debts of the business (unlimited liability).

Not to be confused with limited company or limited liability company.

If shares are issued "part-paid", then the shareholders are liable, when a claim is made against the capital of the company, to pay to the company the balance of the face or par value of the shares.

Although a shareholder's liability for the company's actions is limited, the shareholders may still be liable for their own acts. For example, the directors of small companies (who are frequently also shareholders) are often required to give personal guarantees of the company's debts to those lending to the company.[2] They will then be liable for those debts in the event that the company cannot pay, although the other shareholders will not be so liable. This is known as co-signing.

An issue in liability exposure is whether the assets of a parent entity and the sole owner need to be subject to the subsidiary’s liabilities, when the subsidiary is declared insolvent and owes debt to its creditors.

As a general principle of corporate law, in the United States, a parent entity and the sole owner are not liable for the acts of its subsidiaries.[3] However, as a caveat, they may be liable for its subsidiaries’ obligations when the law supports piercing the corporate veil.[4]

Provided that the parent entity or the sole owner do not maintain separate legal identities from the subsidiary (through inadequate/ undocumented transfer of funds and assets), the judgment is likely to be in favor of the creditor.[5] In the same regard, if a subsidiary is undercapitalized from its inception, that may be grounds for piercing the corporate veil.[6] Further, if injustice/ fraud to the creditor is proven, the parent entity or the owner may be held liable to compensate the creditor.[7] Thus, there is not one characteristic that defines the piercing of a corporate veil - a factors test is used to determine if piercing is appropriate or not.[8]

History

By the 15th century, English law had awarded limited liability to monastic communities and trade guilds with commonly held property. In the 17th century, joint stock charters were awarded by the crown to monopolies such as the East India Company.[9] The world's first modern limited liability law was enacted by the state of New York in 1811.[10] In England it became more straightforward to incorporate a joint stock company following the Joint Stock Companies Act 1844, although investors in such companies carried unlimited liability until the Limited Liability Act 1855.

There was a degree of public and legislative distaste for a limitation of liability, with fears that it would cause a drop in standards of probity.[11][12][13] The 1855 Act allowed limited liability to companies of more than 25 members (shareholders). Insurance companies were excluded from the act, though it was standard practice for insurance contracts to exclude action against individual members. Limited liability for insurance companies was allowed by the Companies Act 1862. The minimum number of members necessary for registration as a limited company was reduced to seven by the Companies Act 1856. Limited companies in England and Wales now require only one member.[14]

Similar statutory regimes were in place in France and in the majority of the U.S. states by 1860. By the final quarter of the nineteenth century, most European countries had adopted the principle of limited liability. The development of limited liability facilitated the move to large-scale industrial enterprise, by removing the threat that an individual's total wealth would be confiscated if invested in an unsuccessful company. Large sums of personal financial capital became available, and the transferability of shares permitted a degree of business continuity not possible in other forms of enterprise.[9]

In the UK there was initially a widespread belief that a corporation needed to demonstrate its creditworthiness by having its shares only partly paid, as where shares are partly paid, the investor would be liable for the remainder of the nominal value in the event that the company could not pay its debts. Shares with nominal values of up to £1,000 were therefore subscribed to with only a small payment, leaving even a limited liability investor with a potentially crushing liability and restricting investment to the very wealthy. During the Overend Gurney crisis (1866–1867) and the Long Depression (1873–1896) many companies fell into insolvency and the unpaid portion of the shares fell due. Further, the extent to which small and medium investors were excluded from the market was admitted and, from the 1880s onwards, shares were more commonly fully paid.[15]

Although it was admitted that those who were mere investors ought not to be liable for debts arising from the management of a corporation, throughout the late nineteenth century there were still many arguments for unlimited liability for managers and directors on the model of the French société en commandite.[16] Such liability for directors of English companies was abolished in 2006.[17] Further, it became increasingly common from the end of the nineteenth century for shareholders to be directors, protecting themselves from liability.

In 1989, the European Union enacted its Twelfth Council Company Law Directive,[18] requiring that member states make available legal structures for individuals to trade with limited liability. This was implemented in England and Wales by Statutory Instrument SI 1992/1699 which allowed single-member limited-liability companies.[19]

Justification

Limited liability has been justified as promoting investment and capital formation by reassuring risk averse investors.

Some argue that limited liability is related to the concept of separate legal personality bestowed on the corporate form, which is promoted as encouraging entrepreneurship by various economists,[20][21][22][23] enabling large sums to be pooled towards an economically beneficial purpose.

Criticisms

An early critic of limited liability, Edward William Cox, a lifelong member of the Conservative Party, wrote in 1855:

[T]hat he who acts through an agent should be responsible for his agent's acts, and that he who shares the profits of an enterprise ought also to be subject to its losses; that there is a moral obligation, which it is the duty of the laws of a civilised nation to enforce, to pay debts, perform contracts and make reparation for wrongs. Limited liability is founded on the opposite principle and permits a man to avail himself of acts if advantageous to him, and not to be responsible for them if they should be disadvantageous; to speculate for profits without being liable for losses; to make contracts, incur debts, and commit wrongs, the law depriving the creditor, the contractor, and the injured of a remedy against the property or person of the wrongdoer, beyond the limit, however small, at which it may please him to determine his own liability [24]

Others argue that while some limited liability is beneficial, the privilege ought not to extend to liability in tort for environmental disasters or personal injury.[25][26][27]

Anarcho-capitalist Murray N. Rothbard, in his Power and Market (1970), criticized the need of limited liability laws, observing that similar arrangements emerge upon mutual and voluntary agreement in a free market:

Finally, the question may be raised: Are corporations themselves mere grants of monopoly privilege? Some advocates of the free market were persuaded to accept this view by Walter Lippmann's The Good Society. It should be clear from previous discussion, however, that corporations are not at all monopolistic privileges; they are free associations of individuals pooling their capital. On the purely free market, such individuals would simply announce to their creditors that their liability is limited to the capital specifically invested in the corporation, and that beyond this their personal funds are not liable for debts, as they would be under a partnership arrangement. It then rests with the sellers and lenders to this corporation to decide whether or not they will transact business with it. If they do, then they proceed at their own risk. Thus, the government does not grant corporations a privilege of limited liability; anything announced and freely contracted for in advance is a right of a free individual, not a special privilege. It is not necessary that governments grant charters to corporations.

See also

• Limited liability company
• Salomon v A Salomon & Co Ltd
• Unlimited liability company
• No liability – for mining companies only
• Proprietary company

Notes

1. Hannigan, Brenda (2018). Company Law. Oxford University Press. ISBN 978-0198787709. Retrieved 9 March 2019.
2. "When LLC Owners Can Be Liable". Retrieved 2011-12-04.
3. "Piercing the Corporate Veil". LII / Legal Information Institute. Retrieved 2020-04-09.
4. "Piercing the Corporate Veil". LII / Legal Information Institute. Retrieved 2020-04-09.
5. Macey, Jonathan; Mitts, Joshua (2014-11-01). "Finding Order in the Morass: The Three Real Justifications for Piercing the Corporate Veil". Cornell Law Review. 100 (1): 99. ISSN 0010-8847.
6. "The Three Justifications for Piercing the Corporate Veil". corpgov.law.harvard.edu. Retrieved 2020-04-09.
7. Jimerson; Jimerson, Cobb P. A.-Charles B.; Snell, Brittany N. "The Five Most Common Ways to Pierce the Corporate Veil and Impose Personal Liability for Corporate Debts | Lexology". www.lexology.com. Retrieved 2020-04-09.
8. "Piercing the corporate veil", Wikipedia, 2020-03-12, retrieved 2020-04-09
9. Reekie, W. Duncan (1996). Adam Kuper and Jessica Kuper (ed.). The Social Science Encyclopedia. Routledge. p. 477. ISBN 978-0-415-20794-2.
10. "The key to industrial capitalism: limited liability". The Economist. December 23, 1999.
11. Shannon (1931)
12. Saville, J. (1956). "Sleeping partnership and limited liability, 1850–1856". The Economic History Review. 8 (3): 418–433. doi:10.2307/2598493. JSTOR 2598493.
13. Amsler, et al. (1981)
14. Mayson, et al. (2005), p. 55
15. Jefferys, J. B. (1954). "The denomination and character of shares, 1855–1885". The Economic History Review. 16 (1): 45–55. doi:10.2307/2590580. JSTOR 2590580.
16. Lobban (1996)
17. DTI (2005)
18. 89/667/EEC
19. Edwards (1998)
20. Meiners, et al. (1979)
21. Halpern, et al. (1980)
22. Easterbrook & Fischel (1985)
23. David Millon. "Piercing the Corporate Veil, Financial Responsibility, and the Limits of Limed Liability" (PDF). Archived from the original (PDF) on 2013-09-16.
24. Ireland, P. (2008). "Limited liability, shareholder rights and the problem of corporate irresponsibility". Cambridge Journal of Economics. 34 (5): 837–856. doi:10.1093/cje/ben040.
25. Grossman (1995)
26. Hansmann & Kraakman (1991)
27. Grundfest, J.A. (1992). "The limited future of unlimited liability: a capital markets perspective". Yale Law Journal. 102 (2): 387–425. doi:10.2307/796841. JSTOR 796841.

References

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• Bagehot, W. (1867). "The New Joint Stock Companies Act". The Economist. 25: 982–83., reprinted in St John-Stevas, N. (ed.) (1986). Collected Works of Walter Bagehot. London: Economist Publications. ISBN 978-0-85058-083-9.CS1 maint: extra text: authors list (link), pp. ix, 406.
• Davis, J.S. (1917). Essays in the Earlier History of American Corporations (vols. 1–2 ed.). Cambridge, MA: Harvard University Press.
• Carus-Wilson, E.M. (ed.) (1954). Essays in Economic History (vol.1 ed.). London: Edward Arnold.CS1 maint: extra text: authors list (link)
• Department of Trade and Industry (UK) (2000). Modern Company Law for a Competitive Economy: Developing the Framework. London. URN 00/656.
• "Company Law Reform Bill – White Paper (Cm 6456)". 2005. Archived from the original on 2006-05-27. Retrieved 2006-07-03.
• Easterbrook, F.H; Fischel, D.R. (1985). "Limited liability and the corporation". University of Chicago Law Review. 52 (1): 89–117. doi:10.2307/1599572. JSTOR 1599572.
• Edwards, V. (1998). "The EU Twelfth Company Law Directive". Company Law. 19: 211.
• Freedman, C.E. (1979). Joint-Stock Enterprise in France 1807–1867: From Privileged Company to Modern Corporation. Chapel Hill: University of North Carolina Press.
• Grossman, P.Z. (1995). "The market for shares of companies with unlimited liability: the case of American Express". Journal of Legal Studies. 24: 63. doi:10.1086/467952.
• Halpern, P.; et al. (1980). "An economic analysis of limited liability in corporation law". University of Toronto Law Journal. 30 (2): 117–150. doi:10.2307/825483. JSTOR 825483.
• Hannigan, B. (2003). Company Law. Oxford University Press.
• Hansmann, H.; Kraakman, R. (1991). "Toward unlimited shareholder liability for corporate torts". Yale Law Journal. 100 (7): 1879–1934. doi:10.2307/796812. JSTOR 796812.
• Hickson, C.R.; Turner, J.D. (2003). "The trading of unlimited liability bank shares in nineteenth-century Ireland: The Bagheot Hypothesis". Journal of Economic History. 63 (4): 931–958. doi:10.1017/S0022050703002493.
• Hunt, B.C. (1936). The Development of the Business Corporation in England, 1800–1867. Cambridge, MA: Harvard University Press.
• Jefferys, J.B. (1954) "The denomination and character of shares, 1855–1885", in Carus-Wilson Op. cit., pp. 344–57
• Livermore, S. (1935). "Journal of Political Economy". 43: 674–687. Cite journal requires |journal= (help)
• Lobban, M. (1996). "Corporate identity and limited liability in France and England 1825–67". Anglo-American Law Review. 25: 397.
• Mayson, S.W; et al. (2005). Mayson, French & Ryan on Company Law (22nd ed.). London: Oxford University Press. ISBN 978-0-19-928531-0.
• Meiners, R.E.; et al. (1979). "Piercing the veil of limited liability". Delaware Journal of Corporate Law. 4: 351.
• Orhnial, T (ed.) (1982). Limited Liability and the Corporation. London: Croom Helm. ISBN 978-0-7099-1919-3.CS1 maint: extra text: authors list (link)
• Select Committee on the Limited Liability Acts (1867) Parliamentary Papers (329) X. 393, p. 31
• Shannon, H.A. (1931). "The coming of general limited liability". Economic History. 2: 267–91., reprinted in Carus-Wilson Op. cit., pp. 358–79
• "The first five thousand limited companies and their duration". Economic History. 3: 421. 1932.