Limited Liability
Following from the fact that the company is a separate legal person, its members are not liable for its debts or other obligations of the company thus courts are very reluctant in looking beyond this “corporate veil” to place any further responsibility on the shareholders. This limitation provides great security to shareholders who are able to profit from the activities of the company knowing that under the Insolvency Act their obligation is only limited to the face value of their shares (which is normally already paid up front and therefore there is no further liability). But lower risk can also mean lower returns; there is also a limit on the benefits they can reap from the company which is no more than their share of the profits. However, members who are involved in the management of the company are not necessarily protected from personal liability. On the other hand limited liability has at first glance created a potentially unfavorable environment for prospective creditors. They have to bear the burden of the risks intrinsic in dealing with limited liability companies. Large creditors such as banks have a number of possible methods to overcome such risks; however trade creditors, employees and tort creditors don’t often have this luxury. However there are social economic benefits such as a reduction in need for monitoring by shareholders thus reducing monitoring costs and fostering an efficient market for shares. But the drawback is that these benefits are absent in small or private companies. The reduction in monitoring costs doesn’t apply because the owners are the ones managing the companies. Furthermore the benefit of fostering an efficient market for shares also does not apply since a market of shares of small companies does not exist. Limited liability also encourages these companies to undertake highly risky projects because the directors of small companies have more to gain personally by shifting the risk of insolvency to creditors than is the case with public companies' directors. In this way limited liability provides an ideal channel for fraud and anti-social activity due to its flexibility and facility for protecting managers and members against the liability to creditors.
Property
Property of the corporation belongs solely to the corporation and the members have no proprietary rights they only have the right to the value of their shares. As directors exit and are replaced through death, resignation or otherwise, the effect on incorporated companies is much smaller than in a partnership. This is because on the physical level the corporation is left unconcerned, the change simply results in the transfer of shares. Of course a change in a manager plays a huge role but much smaller than in a partnership where a change in membership which would cause division of property and other assets, hugely altering the standing of a company. For shareholders and employees this promotes stability and security. Most cases share prices are paid upfront thus entry and exit is relatively simple, and done by only transferring shares. This ease of change makes a shareholder’s investment much more liquid and attractive. However after incorporation, a trader will cease to have an insurable interest in the company’s assets even if he is the owner of all the shares. Thus if he forgets to assign the insurance policies, nothing will be payable. This was the case in Macaura v. Northern Assurance Co. (1925). Mr. Macaura owned an estate and some timber. He agreed to sell all his timber for the entire share capital of Irish Canadian Saw Mills Ltd. The timber, amounting to approximately the entire assets of the company, was stored on the estate. Mr. Macaura then insured the timber under his own name. Two weeks later when a fire destroyed all the timber, Mr Macaura made a claim under the policy. The insurance company however refused to pay suggesting that Mr. Macaura had no insurable interest in the timber as it belonged to the company. The court decided in favor of the insurance company. Similarly a parent company will not have an insurable interest in its subsidiaries even if they are wholly owned.
Transferable shares
The separation of the business from its members facilitates the transfer of member’s interests (shares). The exchange of these interests on the open market requires firms to become transparent. This facilitates the market for corporate control and acts as an incentive for management to perform efficiently. Investors entering into contract with limited liability companies can obtain the information they require to fully evaluate the company. However for the companies themselves this can often expose their proprietary information, letting out information on plans and strategies making them more vulnerable to competitors. On a social level, transparency puts companies under more scrutiny and thus reduces the chances of fraudulent behavior. The public trade of shares allows shareholders to diversify their holdings. Also the marketability of shares improves the information fed to the market place and the liquidity also increases volume of transactions which encourages much more investment opportunities and growth for the economy as a whole. Issuing shares is an ideal way to raise capital however often small traders are attracted simply as a means to escape unlimited liability.
Perpetual succession
Being created by law, the company can only be destroyed by law thus whatever the change, the company continues to exist. Unlike a person however a corporation is immortal i.e. has perpetual succession. The death, imprisonment etc. of a manager obviously has some effect on the company in terms of morale, initial profits, popularity, share price but the actual company itself is unmoved. Similarly the resignation of a partner with substantial shares also doesn’t affect the actual company. The partner is automatically dissolved because the members are not entitled to be paid out by the firm. If he wishes to realize the value of his shares they must be sold. And upon death they are simply passed on in a will. This has no effect on the company and so can go on as usual. Being a separate entity, members are simply the agents of the company. Thus they can come and go but the company will irrespective of this go on forever. The benefit for shareholders is that in an incorporated company, the removal of a corrupt or ineffective manager or member is made easier than in a partnership where business would change drastically with half the capital. Furthermore, this provides more stability for employees because the death of a manager doesn’t mean a loss of a job. Furthermore when one sells his company many complications arise regarding knowledge required etc. Where the firm is incorporated this only involves the buying of shares which doesn’t have these complications. The company remains proprietor continuing with the company’s duties and transactions as usual with no regard for who owns shares today.
Conclusion
The balance of benefits and drawbacks in incorporation varies with respect to the types of firms. For large corporations the arguments for incorporation hold the most weight. This is due to this type’s need for capital which is facilitated by the division between shareholders and the board, transferable shares, and the limited liability on shareholders. Large professional firms that do not require as much capital often happily perform under partnerships. Incorporation extended to a single trader or a small partnership facilitates the access to capital without which they may not prosper. However the real issue is how easily these small firms should be allowed to become incorporated. The main concern is the benefit of limited liability since it has a huge impact on potential third parties (often creditors) engaging in business with these companies. The fear is that rather than to raise capital from the public, these firms are aiming to create an entity between themselves and their creditors. The decision in Salomon v Salomon & Co Ltd exemplifies this double-edged sword of the principle. On one hand it enables corporations to possibly become capital rich. But on the other hand extending these benefits of incorporation to small companies, it has promoted fraud and the evasion of legal obligations. The flaw lies in the fact that it creates the ability for some to hide behind the “corporate veil” which can be a very powerful and dangerous weapon in the hands of those with fraudulent tendencies. The courts have thus decided to ignore the limited liability doctrine in specific cases, and “lift the veil” for those companies formed or used for fraudulent behavior.
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