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Limited liability is a legal status where a person's financial
liability Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, retai ...
is limited to a fixed sum, most commonly the value of a person's investment in a corporation, company or partnership. If a company that provides limited liability to its investors is sued, then the
claimant A plaintiff ( Π in legal shorthand) is the party who initiates a lawsuit A lawsuit is a proceeding by a party or parties against another in the civil Civil may refer to: *Civic virtue, or civility *Civil action, or lawsuit *Civil affai ...
s are generally entitled to collect only against the assets of the company, not the assets of its shareholders or other investors. A
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal en ...
in a corporation or
limited liability company A limited liability company (LLC) is the US-specific form of a private limited company A private limited company is any type of business entity in Privately held company, "private" ownership used in many jurisdictions, in contrast to a Publ ...
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, except under special and rare circumstances permitting "piercing the corporate veil." The same is true for the members of a
limited liability partnership A limited liability partnership (LLP) is a partnership in which some or all partners (depending on the jurisdiction) have limited liabilities. It therefore can exhibit elements of partnerships and corporations. In an LLP, each partner is not r ...
and the limited partners in a
limited partnership A limited partnership (LP) is a form of partnership A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, business ent ...
. By contrast,
sole proprietors A sole proprietorship, also known as the sole trader, individual entrepreneurship or proprietorship, is a type of enterprise owned and run by one person and in which there is no legal distinction between the owner and the business entity In l ...
and partners in
general partnerships A general partnership, the basic form of partnership A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, business en ...
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 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 guaranteeA personal guarantee is a promise made by a person or an organization (the guarantor) to accept responsibility for some other party's debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to ...
s of the company's debts to those lending to the company. They will then be liable for those debts that the company cannot pay, although the other shareholders will not be so liable. This is known as co-signing. A shareholder who is also an employee of the corporation may be personally liable for actions the employee takes in that capacity on behalf of the corporation, in particular torts committed within the scope of employment. Limited liability for shareholders for ''contracts'' entered by the corporation is not controversial because this could and probably would be agreed to by both parties to the contract. However, limited liability for shareholders for ''torts'' (or harms not agreed to in advance) is controversial because of concerns that such limited liability could lead to excessive risk taking by companies and more negative externalities (i.e., more harm to third parties) than would be produced in the absence of limited liability. According to one estimate, negative corporate externalities on an annual basis are equal to between 5 and 20 percent of U.S. GDP. An issue in
liability Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, retai ...
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 A subsidiary, subsidiary company or daughter company is a company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal personality, legal or a mixture ...
is declared
insolventInsolvency is the state of being unable to pay the debts, by a person or company ( debtor), at maturity; those in a state of insolvency are said to be ''insolvent''. There are two forms: cash-flow insolvency and balance-sheet insolvency. Cash-flow i ...
and owes
debt Debt is an obligation that requires one party, the debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to ...

debt
to its
creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

creditor
s. As a general principle of
corporate law Corporate law (also known as business law or enterprise law or sometimes company law) is the body of law governing the rights, relations, and conduct of persons, companies, organizations and businesses. The term refers to the legal pract ...
, in the United States, a parent entity and the sole owner are not liable for the acts of its subsidiaries. However, as a caveat, they may be liable for its subsidiaries’ obligations when the law supports
piercing the corporate veil Piercing the corporate veil or lifting the corporate veil is a legal decision to treat the rights or duties of a corporation A corporation is an organization—usually a group of people or a company—authorized by the state to act as a singl ...
. 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. In the same regard, if a subsidiary is undercapitalized from its inception, that may be grounds for piercing the corporate veil. Further, if injustice/ fraud to the creditor is proven, the parent entity or the owner may be held liable to compensate the creditor. 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. 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 Par value, in finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money ...
of the shares.


History

By the 15th century,
English law English law is the common law In law, common law (also known as judicial precedent or judge-made law, or case law) is the body of law created by judges and similar quasi-judicial tribunals by virtue of being stated in written opinions. ''Black ...
had awarded limited liability to
monastic Monasticism (from Ancient Greek , , from , , 'alone'), or monkhood, is a religion, religious way of life in which one renounces world (theology), worldly pursuits to devote oneself fully to spiritual work. Monastic life plays an important role in ...
communities and trade
guilds A guild is an association of s and s who oversee the practice of their craft/trade in a particular area. The earliest types of guild formed as organizations of tradesmen, belonging to: a , a , a , and/or a . They sometimes depended on grants ...
with commonly held property. In the 17th century,
joint stock A joint-stock company is a business entity in which shares of the company's stock can be bought and sold by shareholders. Each shareholder owns company stock in proportion, evidenced by their share (finance), shares (certificates of ownership). ...
charters were awarded by the crown to monopolies such as the
East India Company The East India Company (EIC), also known as the Honourable East India Company (HEIC), East India Trading Company (EITC), the English East India Company or (after Acts of Union 1707, 1707) the British East India Company, and informally known a ...
. The world's first modern limited liability law was enacted by the state of
New York New York most commonly refers to: * New York City, the most populous city in the United States, located in the state of New York * New York (state), a state in the Northeastern United States New York may also refer to: Film and television * New ...
in 1811. In England it became more straightforward to
incorporate Incorporation may refer to: * Incorporation (business), the creation of a corporation * Incorporation of a place, creation of municipal corporation such as a city or county * Incorporation (academic), awarding a degree based on the student having a ...
a joint stock company following the
Joint Stock Companies Act 1844The Joint Stock Companies Act 1844 (7 & 8 Vict. ''c.''110) was an Act of the Parliament of the United Kingdom The Parliament of the United Kingdom is the Parliamentary sovereignty in the United Kingdom, supreme Legislature, legislative body of ...
, although investors in such companies carried unlimited liability until the
Limited Liability Act 1855 The Limited Liability Act 1855 (18 & 19 Vict c 133) was an Act of the Parliament of the United Kingdom The Parliament of the United Kingdom is the Parliamentary sovereignty in the United Kingdom, supreme Legislature, legislative body of the ...
. 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 is a means of protection from financial loss. It is a form of risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something bad happening. R ...

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 1862The Companies Act 1862 (25 & 26 Vict. c.89) was an Act of the Parliament of the United Kingdom The Parliament of the United Kingdom is the Parliamentary sovereignty in the United Kingdom, supreme Legislature, legislative body of the United Kin ...
. The minimum number of members necessary for registration as a limited company was reduced to seven by the
Companies Act 1856 The Joint Stock Companies Act 1856 (19 & 20 Vict. c.47) was a consolidating statute, recognised as the founding piece of modern United Kingdom company law The United Kingdom company law regulates corporations formed under the Companies Act 2006 ...
. 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 A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law "born out of statute"; a legal person in legal ...

corporation
needed to demonstrate its
creditworthiness A credit risk is risk of default (finance), default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal sum, principal and interest, disruption ...
by having its shares only
partly paidA partly paid share is a share Share may refer to: * Share, to make joint use of a resource (such as food, money, or space); see Sharing * Share (finance), a stock or other financial security (such as a mutual fund) * Share, Kwara, a town and LGA in ...
, as where shares are partly paid, the investor would be liable for the remainder of the nominal value in case 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 The Long Depression was a worldwide price and economic recession In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spend ...
(1873–1896) many companies fell into
insolvency In accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been call ...
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''. Such liability for directors of English companies was abolished in 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 The European Union (EU) is a political and economic union of that are located primarily in . The union has a total area of and an estimated total population of about 447million. has been established through a standardised that apply in ...

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 in the Companies (Single Member Private Limited Companies) Regulations 1992, which allowed single-member limited-liability companies.


Justification

Some argue that limited liability is related to the concept of separate
legal personality In law Law is a system A system is a group of Interaction, interacting or interrelated elements that act according to a set of rules to form a unified whole. A system, surrounded and influenced by its environment, is described by its b ...
bestowed on the , which is promoted as encouraging
entrepreneurship Entrepreneurship is the creation or extraction of value. With this definition, entrepreneurship is viewed as change, generally entailing risk beyond what is normally encountered in starting a business, which may include other values than simply ...
by various economists,Halpern, et al. (1980) enabling large sums to be pooled towards an economically beneficial purpose. Limited liability has been justified as promoting investment and capital formation by reassuring risk averse investors.


Criticisms

An early critic of limited liability,
Edward William Cox Edward William Cox known as Serjeant Cox (1809–1879) was an English lawyer and legal writer, who was also a successful publisher. He has been described as "the greatest entrepreneur of 'class' journalism". Early life Cox was born in Taunton ...

Edward William Cox
, a lifelong member of the Conservative Party, wrote in 1855: Others argue that while some limited liability is beneficial, the privilege ought not to extend to liability in
tort A tort, in jurisdiction, is a (other than ) that causes a claimant to suffer loss or harm, resulting in for the person who commits the tortious act. It can include intentional infliction of emotional distress, negligence, financial losses, ...

tort
for
environmental disaster An environmental disaster or ecological disaster is defined as a catastrophic event regarding the natural environment that is due to human activity.Jared M. Diamond, '' Collapse: How Societies Choose to Fail or Succeed'', 2005 This point distin ...
s or
personal injury Personal injury is a legal term for an injury to the body, mind or emotions, as opposed to an injury to property. In common law, Anglo-American jurisdictions the term is most commonly used to refer to a type of tort lawsuit in which the person bring ...
because this leads to excessive risk taking and negative externalities by corporations.Grossman (1995) Others argue that limited liability should be permitted, but should be taxed more heavily to offset the harm limited liability causes. Such taxes could be structured to generate information for regulators about how risky the activities companies are undertaking are to third parties.
Anarcho-capitalist Anarcho-capitalism is a political philosophy Political philosophy is the philosophical study of government, addressing questions about the nature, scope, and legitimacy of public agents and institutions and the relationships between them. It ...
, in his ''
Power and Market ''Power and Market: Government and the Economy'' is a 1970 book by the economist Murray Rothbard Murray Newton Rothbard (; March 2, 1926 – January 7, 1995) was an American Heterodox economics, heterodox economist of the Austrian School, ...
'' (1970), criticized the need of limited liability laws, observing that similar arrangements emerge upon mutual and voluntary agreement in a
free market In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goo ...
.


Maritime claims

The 1957 Brussels Convention and the 1976 London Convention on Limitation of Liability for Maritime Claims permit the charterer, manager, operators and salvors of a ship, and the master and members of the crew, to limit their liability for damage caused by events occurring “on board or in direct connection with the operation of the ship, or with salvage operations" and for "consequential loss resulting therefrom”.Convention on limitation of liability for maritime claims, 1976 (with final act). Concluded at London on 19 November 1976
no. 24635, Article 2(1)(a), accessed 18 October 2020


See also

*
Limited liability company A limited liability company (LLC) is the US-specific form of a private limited company A private limited company is any type of business entity in Privately held company, "private" ownership used in many jurisdictions, in contrast to a Publ ...
* ''
Salomon v A Salomon & Co Ltd is a landmark UK company law case. The effect of the House of 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 c ...
'' *
Unlimited liability company An unlimited company or private unlimited company is a hybrid company (corporation) incorporated with or without a share capital (and similar to its limited liability, limited company counterpart) but where the legal liability of the members or sh ...
*
No liability A no-liability company in Australia (suffix NL) is a company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal personality, legal or a mixture of b ...
– for mining companies only *
Proprietary company A proprietary company, (abbreviated as 'Pty.'), is a form of privately held company in Australia and South Africa that is either limited company, limited or unlimited company, unlimited. However, unlike a public company there are, depending on ju ...


Notes


References

* * , reprinted in , pp. ix, 406. * * * * * * * * * * * * * * Jefferys, J.B. (1954) "The denomination and character of shares, 1855–1885", in Carus-Wilson ''Op. cit.'', pp. 344–57 * * * * * * * Select Committee on the Limited Liability Acts (1867) ''Parliamentary Papers'' (329) X. 393, p. 31 * , reprinted in Carus-Wilson ''Op. cit.'', pp. 358–79 * {{DEFAULTSORT:Limited Liability Business law Shareholders Corporate governance Public liability