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Limited liability (LL) is a liability that is limited to a partner or investor's investment. Shareholders in a corporation or in a limited liability company cannot lose more money than the value of their shares if the corporation runs into debt, as they are not personally responsible for the corporation's obligations. The same is true for partners in a limited liability partnership and the limited partners in a limited partnership. Except in special circumstances of government. This is in contrast to sole proprietorships and general partnerships, in which the owner or partners are each liable for business debts (unlimited liability or UL).
Note that even though a shareholder's liability is limited in its capacity as a shareholder, the shareholder may still be directly liable for its own acts. For example, if the president (who happens to be a shareholder) of a small corporation negligently runs over someone while on company business, the president (as well as the company) is still liable for his own negligence; however, the other shareholders are not liable for the president's negligence, unlike a general partnership.
History
In the UK, it became generally straightforward to incorporate a joint stock company following the Joint Stock Companies Act 1844. However, investors in such companies carried unlimited liability until the Limited Liability Act 1855. There was some general public and legislative distaste for a limitation of liability and fears that it would entail a drop in standards of probity.Shannon (1931), Saville (1956), Amsler et al. (1981) The Act of 1855 allowed limited liability to companies of more than 25 members (shareholders). Insurance companies were excluded from the Act though it was general 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 7 by the Companies Act 1856. Limited companies in England and Wales now require only one member.Mayson et al. (2005), p.55
Similar statutory regimes soon followed 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.
However, the early experience in the UK was of a widespread belief that a corporation needed to demonstrate its creditworthiness by the fact that its shares were partly paid. Thus, shares with nominal values of up to £1,000 were subscribed with only a small payment, leaving even the 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.Jefferys (1954).
Though 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 commanditeLobban (1996). Though such liablility for directors is still permitted for directors of English companies, as of 2006 its abolition is plannedDTI (2005). 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 Directive89/667/EEC, requiring that member states make available legal structures for individuals to trade with limited liability. This was implemented in England by Statutory Instrument SI 1992/1699 which allowed single-member limited-liability companiesEdwards (1998).
Economic and social justification and criticism
Limited liability is supposed to encourage enterpriseMeiners et al. (1979), Halpern et al. (1980), Easterbrook & Fischel (1985) but it has also been argued, from a libertarian perspective, that it distorts the free market by allowing the entrepreneur to externalise some risks and impose them on society at large. Moreover, there has been some concern that present structures favour large creditors who are in the position to negotiate secured terms whereas small creditors' debts are left unsecured. There have been calls to restrict limited liability only to non-managing investors but, as of 2006, these have been resisted in the UKDTI (2000). The general legal response to such concerns has been to make directors liable for any dishonesty.Ohrnial (1982)
There is evidence that shares in public companies would be at a disadvantage if liability were unlimitedHalpern et al. (1980) and the experience of partly-paid shares in the nineteenth century (supra) seems to confirm thisMayson et al. (2005), p.57. However, in the 1950s there was a healthy market in unlimited liability American Express sharesGrossman (1995).
In the U.S., there have been recent suggestions that, while limited liability towards creditors is socially beneficial in facilitating investment, the privilege ought not to extend to liability in tort for environmental disasters or personal injuryHansmann & Kraakman (1991), Grundfest (1992), Grossman (1995).
See also
- Types of companies
- Limited liability company
- Limited liability partnership
- Limited partnership
- Corporation
Notes
External links
Bibliography
- , reprinted in , ix, p.406.
- Jefferys, J.B. (1954) "The denomination and character of shares, 1855-1885", in Carus-Wilson Op. cit., pp344-57
- Select Committee on the Limited Liability Acts (1867) Parliamentary Papers (329) X.393, p.31
- , reprinted in Carus-Wilson Op. cit., pp358-79
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"Limited liability"