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Limited liability is a concept whereby 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. A shareholder in a limited liability company is not personally liable for any of the debts of the company, other than for the value of his investment in that company. 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 frequently 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, though the other shareholders will not be so liable.

History

In the UK, it became more straightforward to incorporate a joint stock company following the Joint Stock Companies Act 1844, though 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.^[1]^,^[2]^,^[3] 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 7 by the Companies Act 1856. Limited companies in England and Wales now require only one member.^[4]

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.

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.^[5].

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 commandite^[6]. Though such liablility for directors is still permitted for directors of English companies, its abolition is planned as of 2006^[7]. 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^[8], 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 companies^[9].

Economic and social justification and criticism

Limited liability is supposed to encourage enterprise^[10]^,^[11]^,^[12] but it has also been argued, from a libertarian perspective, that it distorts the free market by allowing the entrepreneur to externalise some risk and impose it on society at large^[13]. 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 to only non-managing investors but, as of 2006, these have been resisted in the UK^[14]. The general legal response to such concerns has been to make directors liable for any dishonesty.^[15]

There is evidence that shares in public companies would be at a disadvantage if liability were unlimited^[16] and the experience of partly-paid shares in the nineteenth century (supra) seems to confirm this^[17]. A single counter point, limited to a narrow span of time and a single company in a growth economy, existed in the 1950s where there was a healthy market in unlimited liability American Express shares^[18].

In the U.S. lawyers have suggested 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 injury^[19]^,^[20]^,^[21].

Notes

^ Shannon (1931)
^ Saville (1956)
^ Amsler et al. (1981)
^ Mayson et al. (2005), p.55
^ Jefferys (1954)
^ Lobban (1996)
^ DTI (2005)
^ 89/667/EEC
^ Edwards (1998)
^ Meiners et al. (1979)
^ Halpern et al. (1980)
^ Easterbrook & Fischel (1985)
^ Rozeff, M.S. "Limited Liability" (HTML). Retrieved 2006-07-03.
^ DTI (2000)
^ Ohrnial (1982)
^ Halpern et al. (1980)
^ Mayson et al. (2005), p.57
^ Grossman (1995)
^ Hansmann & Kraakman (1991)
^ Grundfest (1992)
^ Grossman (1995)

External links

Bibliography

Amsler, C.F.; et al. (1981). "Thoughts of some British economists on early limited liability and corporate legislation". History of Political Economy. 13: 774–93. {{cite journal}}: Explicit use of et al. in: |author= (help)
Bagehot, W. (1867). "The New Joint Stock Companies Act". The Economist. 25: (31 Aug) 982-3., reprinted in St John-Stevas, N. (ed.). Collected Works of Walter Bagehot. London: Economist Publications. ISBN 0-85058-083-8. {{cite book}}: |author= has generic name (help), ix, p.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. {{cite book}}: |author= has generic name (help)
Department of Trade and Industry (UK) (2000). Modern Company Law for a Competitive Economy: Developing the Framework. London. URN 00/656.{{cite book}}: CS1 maint: location missing publisher (link)
- (2005). "Company Law Reform Bill - White Paper (Cm 6456)". Retrieved 2006-07-03. {{cite web}}: |author= has numeric name (help)
Easterbrook, F.H & Fischel, D.R. (1985). "Limited liability and the corporation". University of Chicago Law Review. 52: 89.{{cite journal}}: CS1 maint: multiple names: authors list (link)
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. "The market for shares of companies with unlimited liability: the case of American Express". Journal of Legal Studies. 24: 63.
Grundfest, J.A. "The limited future of unlimited liability: a capital markets perspective". Yale Law Review. 102: 387.
Halpern, P.; et al. (1980). "An economic analysis of limited liability in corporation law". University of Toronto Law Journal. 30: 117. {{cite journal}}: Explicit use of et al. in: |author= (help)
Hansmann, H. & Kraakman, R. (1991). "Toward unlimited shareholder liability for corporate torts". Yale Law Review. 100: 1879.{{cite journal}}: CS1 maint: multiple names: authors list (link)
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: 931–958.{{cite journal}}: CS1 maint: multiple names: authors list (link)
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., pp344-57
Livermore, S. (1935). "Journal of Political Economy". 43: 674–687. {{cite journal}}: 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. ed.). London: Oxford University Press. ISBN 0-19-928531-4. {{cite book}}: |edition= has extra text (help); Explicit use of et al. in: |author= (help)
Meiners, R.E.; et al. (1979). "Piercing the veil of limited liability". Delaware Journal of Corporate Law. 4: 351. {{cite journal}}: Explicit use of et al. in: |author= (help)
Orhnial, T (ed.) (1982). Limited Liability and the Corporation. London: Croom Helm. ISBN 0-7099-1919-0. {{cite book}}: |author= has generic name (help)
Saville, J. (1956). "Sleeping partnership and limited liability, 1850-1856". Economic History Review. 8: 418–33.
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., pp358-79
- (1932). "The first five thousand limited companies and their duration". Economic History. 3: 421. {{cite journal}}: |author= has numeric name (help)

[1] Shannon (1931)

[2] Saville (1956)

[3] Amsler et al. (1981)

[4] Mayson et al. (2005), p.55

[5] Jefferys (1954)

[6] Lobban (1996)

[7] DTI (2005)

[8] 89/667/EEC

[9] Edwards (1998)

[10] Meiners et al. (1979)

[11] Halpern et al. (1980)

[12] Easterbrook & Fischel (1985)

[13] Rozeff, M.S. "Limited Liability" (HTML). Retrieved 2006-07-03.

[14] DTI (2000)

[15] Ohrnial (1982)

[16] Halpern et al. (1980)

[17] Mayson et al. (2005), p.57

[18] Grossman (1995)

[19] Hansmann & Kraakman (1991)

[20] Grundfest (1992)

[21] Grossman (1995)

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@@ Line 18: / Line 18: @@
 Limited liability is supposed to encourage enterprise<ref>Meiners ''et al.'' (1979)</ref><sup>, </sup><ref>Halpern ''et al.'' (1980)</ref><sup>, </sup><ref>Easterbrook & Fischel (1985)</ref> but it has also been argued, from a [[libertarian]] perspective, that it distorts the [[free market]] by allowing the [[entrepreneur]] to [[externality|externalise]] some [[risk]] and impose it on society at large<ref>{{cite web | url=http://www.lewrockwell.com/rozeff/rozeff28.html | title=Limited Liability | author=Rozeff, M.S. | format=HTML | accessdate=2006-07-03 }}</ref>. 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 to only non-managing investors but, [[as of 2006]], these have been resisted in the UK<ref>DTI (2000)</ref>. The general legal response to such concerns has been to make directors liable for any [[dishonesty]].<ref>Ohrnial (1982)</ref>
-There is evidence that shares in [[public companies]] would be at a disadvantage if liability were unlimited<ref>Halpern ''et al.'' (1980)</ref> and the experience of partly-paid shares in the nineteenth century (''supra'') seems to confirm this<ref>Mayson ''et al.'' (2005), ''p.''57</ref>. A single counter point, limited to a narrow span of time and a single company in a growth ecomony, existed in the [[1950s]] where there was a healthy market in unlimited liability [[American Express]] shares<ref>Grossman (1995)</ref>.
+There is evidence that shares in [[public companies]] would be at a disadvantage if liability were unlimited<ref>Halpern ''et al.'' (1980)</ref> and the experience of partly-paid shares in the nineteenth century (''supra'') seems to confirm this<ref>Mayson ''et al.'' (2005), ''p.''57</ref>. A single counter point, limited to a narrow span of time and a single company in a growth economy, existed in the [[1950s]] where there was a healthy market in unlimited liability [[American Express]] shares<ref>Grossman (1995)</ref>.
 In the [[U.S.]] lawyers have suggested that, while limited liability towards creditors is socially beneficial in facilitating investment, the privilege ought not to extend to liability in [[tort]] for [[environmental disaster]]s or [[personal injury]]<ref>Hansmann & Kraakman (1991)</ref><sup>, </sup><ref>Grundfest (1992)</ref><sup>, </sup><ref>Grossman (1995)</ref>.