Limited liability
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Limited liability is a legal status in which a person's financial liability is limited to a fixed sum, most commonly the value of a person's investment in a corporation, company, or joint venture. If a company that provides limited liability to its investors is sued, then the claimants 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 corporate stock refers to an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the ...
in a corporation or
limited liability company A limited liability company (LLC) is the United States-specific form of a private limited company. It is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of ...
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 that permit "
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 as the rights or liabilities of its shareholders. Usually a corporation is treated as a separate legal person, which i ...
." 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 aspects of both partnerships and corporations. In an LLP, each partner is n ...
and the limited partners in a
limited partnership A limited partnership (LP) is a type of partnership with general partners, who have a right to manage the business, and limited partners, who have no right to manage the business but have only limited liability for its debts. 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 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 guarantee A personal guarantee is a promise made by a person or an organization (the guarantor) to accept responsibility for some other party's debt (the debtor) if the debtor fails to pay it. In the case of a personal guarantee made by an individual on beha ...
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 that have not been 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 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 (law), company completely or partially owned or controlled by another company, called the parent company or holding company, which has legal and financial control over the subsidia ...
is declared
insolvent In accounting, insolvency 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 in ...
and owes
debt Debt is an obligation that requires one party, the debtor, to pay money Loan, borrowed or otherwise withheld from another party, the creditor. Debt may be owed by a sovereign state or country, local government, company, or an individual. Co ...
to its
creditor A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some propert ...
s. As a general principle of
corporate law Corporate law (also known as company law or enterprise law) is the body of law governing the rights, relations, and conduct of persons, companies, organizations and businesses. The term refers to the legal practice of law relating to corpora ...
, in the United States, a parent entity and the sole owner are not liable for the acts of its subsidiaries. However, they may be liable for its subsidiaries' obligations when the law supports "piercing the corporate veil". 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 veila 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 In finance and accounting, par value means stated value or face value of a financial instrument. Expressions derived from this term include at par (at the par value), over par (over par value) and under par (under par value). Bonds A bond selli ...
of the shares.


History

By the 15th century,
English law English law is the common law list of national legal systems, legal system of England and Wales, comprising mainly English criminal law, criminal law and Civil law (common law), civil law, each branch having its own Courts of England and Wales, ...
had awarded limited liability to
monastic Monasticism (; ), also called monachism or monkhood, is a religious way of life in which one renounces worldly pursuits to devote oneself fully to spiritual activities. Monastic life plays an important role in many Christian churches, especially ...
communities and trade
guilds A guild ( ) is an association of artisans and merchants who oversee the practice of their craft/trade in a particular territory. The earliest types of guild formed as organizations of tradespeople belonging to a professional association. They so ...
with commonly held property. In the 17th century,
joint stock A joint-stock company (JSC) is a business entity in which shares of the company's capital stock, stock can be bought and sold by shareholders. Each shareholder owns company stock in proportion, evidenced by their share (finance), shares (certifi ...
charters were awarded by the crown to monopolies such as the
East India Company The East India Company (EIC) was an English, and later British, joint-stock company that was founded in 1600 and dissolved in 1874. It was formed to Indian Ocean trade, trade in the Indian Ocean region, initially with the East Indies (South A ...
. The world's first modern limited liability law was enacted by the state of New York in 1811. 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. The 1855 Act allowed limited liability to companies of more than 25 members (shareholders).
Insurance Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to protect ...
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 Companies Act 1862 ( 25 & 26 Vict. c. 89) was an act of the Parliament of the United Kingdom regulating UK company law, whose descendant is the Companies Act 2006. Provisions *s 6 'Any seven or more persons associated for any lawful purpos ...
. 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 A corporation or body corporate is an individual or a group of people, such as an association or company, that has been authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law as ...
needed to demonstrate its creditworthiness by having its shares only
partly paid A partly paid share is a share in a company which has only partial been paid compared to the par value, with the understanding that as the company requires more funds, calls will be made from time to time to request more money until the shares are ...
, 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, beginning in Panic of 1873, 1873 and running either through March 1879, or 1899, depending on the metrics used. It was most severe in Europe and the United States, which had been e ...
(1873–1896) many companies fell into
insolvency In accounting, insolvency 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 i ...
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 supranational union, supranational political union, political and economic union of Member state of the European Union, member states that are Geography of the European Union, located primarily in Europe. The u ...
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 Legal capacity is a quality denoting either the legal aptitude of a person to have rights and liabilities (in this sense also called transaction capacity), or the personhood itself in regard to an entity other than a natural person (in this sen ...
bestowed on the corporate form, which is promoted as encouraging
entrepreneurship Entrepreneurship is the creation or extraction of economic value in ways that generally entail beyond the minimal amount of risk (assumed by a traditional business), and potentially involving values besides simply economic ones. An entrepreneu ...
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, 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 is a civil wrong, other than breach of contract, that causes a claimant to suffer loss or harm, resulting in legal liability for the person who commits the tortious act. Tort law can be contrasted with criminal law, which deals with cri ...
for environmental disasters or personal injury 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 that 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. The notion of corporate limited liability has met criticism from certain figures among the libertarian right. In ''For a New Liberty: The Libertarian Manifesto'', Murray N. Rothbard approvingly quoted Robert Poole, a fellow libertarian, who stated that a "libertarian society would be a full-liability society where everyone is fully responsible for his actions and any harmful consequences they might cause."


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 United States-specific form of a private limited company. It is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of ...
* ''
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 ...
'' * Unlimited liability company * No liability – for mining companies only *
Proprietary company A proprietary company, the characteristic of which is abbreviated as "Pty", is a form of privately held company in Australia, Namibia and South Africa that is either limited company, limited or unlimited company, unlimited. However, unlike a p ...


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. 344–357 * * * * * * * Select Committee on the Limited Liability Acts (1867) ''Parliamentary Papers'' (329) X. 393, p. 31 * , reprinted in Carus-Wilson ''op. cit.'', pp. 358–379 * {{Authority control Corporate law Public liability