Limited liability
Encyclopedia
Limited liability is a concept where by 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 with limited liability. If a company with limited liability is sued, then the plaintiff
s 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 value of their investment in that company. This usually takes the form of that person's dividends in the company being zero, since the company has no profits to allocate. The same is true for the members of a limited liability partnership
and the limited partners in a limited partnership
. By contrast, sole proprietors and partners in general partnerships are each liable for all the debts of the business (unlimited liability).
Although a shareholder's liability for the company's actions is limited, the shareholder may still be liable for its 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. 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.
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
. 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. 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.
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.
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.
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. Although such liability for directors is still permitted for directors of English companies, its abolition is planned as of 2006. 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, 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.
for environmental disaster
s or personal injury
.
Anarcho-capitalist Murray N. Rothbard
, in his Power and Market
(1970), criticized limited liability laws, while also maintaining that similar arrangements may emerge in a free market
, stating:
Legal liability
Legal liability is the legal bound obligation to pay debts.* In law a person is said to be legally liable when they are financially and legally responsible for something. Legal liability concerns both civil law and criminal law. See Strict liability. Under English law, with the passing of the Theft...
is limited to a fixed sum, most commonly the value of a person's investment in a company or partnership with limited liability. If a company with limited liability is sued, then the plaintiff
Plaintiff
A plaintiff , also known as a claimant or complainant, is the term used in some jurisdictions for the party who initiates a lawsuit before a court...
s are suing the company, not its owners or investors. A shareholder
Shareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....
in a limited company
Limited company
A limited company is a company in which the liability of the members or subscribers of the company is limited to what they have invested or guaranteed to the company. Limited companies may be limited by shares or by guarantee. And the former of these, a limited company limited by shares, may be...
is not personally liable for any of the debts of the company, other than for the value of their investment in that company. This usually takes the form of that person's dividends in the company being zero, since the company has no profits to allocate. The same is true for the members of a limited liability partnership
Limited liability partnership
A limited liability partnership is a partnership in which some or all partners have limited liability. It therefore exhibits elements of partnerships and corporations. In an LLP one partner is not responsible or liable for another partner's misconduct or negligence. This is an important...
and the limited partners in a limited partnership
Limited partnership
A limited partnership is a form of partnership similar to a general partnership, except that in addition to one or more general partners , there are one or more limited partners . It is a partnership in which only one partner is required to be a general partner.The GPs are, in all major respects,...
. By contrast, sole proprietors and partners in general partnerships are each liable for all the debts of the business (unlimited liability).
Although a shareholder's liability for the company's actions is limited, the shareholder may still be liable for its 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. 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.
History
By the 15th century, English lawEnglish law
English law is the legal system of England and Wales, and is the basis of common law legal systems used in most Commonwealth countries and the United States except Louisiana...
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
East India Company
The East India Company was an early English joint-stock company that was formed initially for pursuing trade with the East Indies, but that ended up trading mainly with the Indian subcontinent and China...
. It became more straightforward to incorporate
Incorporation (business)
Incorporation is the forming of a new corporation . The corporation may be a business, a non-profit organisation, sports club, or a government of a new city or town...
a joint stock company following the Joint Stock Companies Act 1844
Joint Stock Companies Act 1844
The Joint Stock Companies Act 1844 was an Act of the Parliament of the United Kingdom that expanded access to the incorporation of joint-stock companies....
, although investors in such companies carried unlimited liability until the Limited Liability Act 1855
Limited Liability Act 1855
The Limited Liability Act 1855 was an Act of the Parliament of the United Kingdom that first allowed limited liability for corporations that could be established by the general public in the UK.-Overview:...
.
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. The 1855 Act allowed limited liability to companies of more than 25 members (shareholders). Insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
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
Companies Act 1862
The Companies Act 1862 was an Act of the Parliament of the United Kingdom regulating UK company law, whose descendant is the Companies Act 2006.-Provisions:...
. 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.
Similar statutory regimes were in place in France
France
The French Republic , The French Republic , The French Republic , (commonly known as France , is a unitary semi-presidential republic in Western Europe with several overseas territories and islands located on other continents and in the Indian, Pacific, and Atlantic oceans. Metropolitan 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.
In the UK there was initially a widespread belief that a corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
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
Long Depression
The Long Depression was a worldwide economic crisis, felt most heavily in Europe and the United States, which had been experiencing strong economic growth fueled by the Second Industrial Revolution in the decade following the American Civil War. At the time, the episode was labeled the Great...
(1873–1896) many companies fell into insolvency
Insolvency
Insolvency means the inability to pay one's debts as they fall due. Usually used to refer to a business, insolvency refers to the inability of a company to pay off its debts.Business insolvency is defined in two different ways:...
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.
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. Although such liability for directors is still permitted for directors of English companies, its abolition is planned as of 2006. 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
European Union
The European Union is an economic and political union of 27 independent member states which are located primarily in Europe. The EU traces its origins from the European Coal and Steel Community and the European Economic Community , formed by six countries in 1958...
enacted its Twelfth Council Company Law Directive, 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
Statutory Instrument
A Statutory Instrument is the principal form in which delegated or secondary legislation is made in Great Britain.Statutory Instruments are governed by the Statutory Instruments Act 1946. They replaced Statutory Rules and Orders, made under the Rules Publication Act 1893, in 1948.Most delegated...
SI 1992/1699 which allowed single-member limited-liability companies.
Criticisms
Some critics argue that limited liability favors creditors who are in the position to negotiate secured terms, whereas small creditors' debts are left unsecured. Others argue that while some limited liability is beneficial, the privilege ought not to extend to liability in tortTort
A tort, in common law jurisdictions, is a wrong that involves a breach of a civil duty owed to someone else. It is differentiated from a crime, which involves a breach of a duty owed to society in general...
for environmental disaster
Environmental disaster
An environmental disaster is a disaster to the natural environment due to human activity. It should not be confused with the separate concept of a natural disaster.-History:...
s or personal injury
Personal injury
Personal injury is a legal term for an injury to the body, mind or emotions, as opposed to an injury to property. The term is most commonly used to refer to a type of tort lawsuit alleging that the plaintiff's injury has been caused by the negligence of another, but also arises in defamation...
.
Anarcho-capitalist Murray N. Rothbard
Murray Rothbard
Murray Newton Rothbard was an American author and economist of the Austrian School who helped define capitalist libertarianism and popularized a form of free-market anarchism he termed "anarcho-capitalism." Rothbard wrote over twenty books and is considered a centrally important figure in the...
, in his Power and Market
Power and Market
Power and Market: Government and the Economy is a 1970 book by Murray Rothbard in which he analyzes the negative effects of the various kinds of government intervention, and denies that the State is either necessary or useful...
(1970), criticized limited liability laws, while also maintaining that similar arrangements may emerge in a free market
Free market
A free market is a competitive market where prices are determined by supply and demand. However, the term is also commonly used for markets in which economic intervention and regulation by the state is limited to tax collection, and enforcement of private ownership and contracts...
, stating:
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
- Types of companies
- Limited liability companyLimited liability companyA limited liability company is a flexible form of enterprise that blends elements of partnership and corporate structures. It is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions...
- Limited liability partnershipLimited liability partnershipA limited liability partnership is a partnership in which some or all partners have limited liability. It therefore exhibits elements of partnerships and corporations. In an LLP one partner is not responsible or liable for another partner's misconduct or negligence. This is an important...
- Limited partnershipLimited partnershipA limited partnership is a form of partnership similar to a general partnership, except that in addition to one or more general partners , there are one or more limited partners . It is a partnership in which only one partner is required to be a general partner.The GPs are, in all major respects,...
- CorporationCorporationA corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
- Unlimited liability companyUnlimited CompanyAn unlimited company or private unlimited company is a hybrid company incorporated either with or without a share capital but where the liability of the members or shareholders is not limited - that is, its members or shareholders have a joint, several and unlimited obligation to meet any...
- Utopia Limited
- Salomon v. Salomon & Co.Salomon v. Salomon & Co.Salomon v A Salomon & Co Ltd [1897] AC 22 is a landmark UK company law case. The effect of the Lords' unanimous ruling was to uphold firmly the doctrine of corporate personality, as set out in the Companies Act 1862, so that creditors of an insolvent company could not sue the company's shareholders...