Limited Liability

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INTRODUCTION

The limited liability corporation is the greatest single invention of modern times”- Columbia University President, Nicholas Murray Butler. 

        

        Limited Liability is vital in every incorporated company. Since 1844, incorporation by registration was introduced. With incorporation, comes separate legal personality and limited liability is just one of its consequences. Section 15(4) of the Companies Act 2006 effectively gives the company its separate personality as long as the requirements under the Act regarding registration and incorporation had been satisfied.

        However, it cannot be denied that even until today, there are many efforts in analysing the legal responses to limited liability and how the courts would act in the future. The courts have to start asking themselves how well have it been in disregarding or avoiding the consequences of, separate personality, when justice requires it to do so?

CONSEQUENCES OF LEGAL PERSONALITY AND LIMITED LIABILITY

        In 1987, English court gave judgment to Salomon v A Salomon and Co Ltd, which then became the most important authority when defining separate personality. The House of Lords had also effected the doctrine of limited liability as a result of this case. 

Salomon v Salomon 

        Mr. Salomon was originally a sole proprietor, who later sold his business to an incorporated company, ‘A Salomon and Co. Ltd’. The company later failed and the liquidator sought to ignore the fact that Mr. Salomon had sold his business to a separate person and now enjoy limited liability. 

At first instance, the court held that the company was carrying out business as Mr. Salomon’s agent. Thus, Mr. Salomon as a principal would be responsible for the debts incurred by its agent. The Court of Appeal also held that Mr. Salomon would be personally responsible for the company’s debts, as he had abused the privileges of incorporation and limited liability. However, the House of Lords had unanimously overturned these decisions and uphold the doctrine of separate personality. Only the company will be liable for its own debts and Mr. Salomon have no liability in it.

This basically means that as a result of incorporation, a company will be a legal entity distinct from its members where it would bear and enjoy different obligations and rights from its members.

Limited Liability

        As noted, limited liability is a consequence of separate personality. A limited liability company will have its own pool of assets which are separate from the personal assets of its members and these members will not be liable or whatsoever towards the company’s obligation. 

        Of course, there are other benefits or consequences of legal personality. Namely, the company conducts the business as a separate person; its members have no interest in the company’s assets; it has perpetual succession; and can sued and be sued in it’s own name.

IMPORTANCE AND RATIONALE FOR LIMITED LIABILITY

        There must have some concrete importance and rationale for limited liability since all modern company law system had accepted its existence. 

The first importance of limited liability would be the fact that limited liability minimise member’s risk and encourage investment by the public. Members only run the risk of losing their shares in the company. Personal assets of the members remain untouched. This is a very attractive scheme, as the members of a company know that they will not lose everything and will be prepare to invest. With investment, economy growth will flow together as a result.

As mentioned above, company’s creditor cannot pursue against a member. If an unlimited liability company wishes to enjoy this and enter into a contract where liability of members would be limited, it involved extremely high transaction cost. 

        Next, limited liability is also very important in order for the Board of Directors to take on risk. As we all know, high risk, high returns! By having knowledge that the members will not lose everything is crucial for the management to take healthy risk when they are making decisions.

        Limited liability is also said to facilitate the public share market. In an unlimited company, the value of shares is dependent on the wealth of individual shareholder. In such a case, the value of shares of a member who is less wealthy will be higher. This is so because creditors will be more prone to institute legal proceedings against wealthier members and the less wealthy members would most likely pay a smaller proportion of the company’s debts. Thus, the rationale of limited liability is such that it facilitates the trading of the company’s shares at a uniform price. This ensures smooth operation of public share market.

If some of the monitoring cost of managers can be shift to the company’s creditors, this can reduce cost governing a firm. Character of limited liability is such that creditors will only be entitled to the company’s assets. Thus, it is logical that a creditor would want to monitor the business, which he is a stakeholder, closely. It also allows a company to divert its resources to other areas, which need more attention.

Reducing cost can also be achieved by lowering the decision making cost. With limited liability, each and every share is of the same value. This successfully means that all members would experience the same proportional gains and losses from the company’s policies regardless of the wealth or identity of each shareholder. Consequently, limited liability gives company’s members a homogeneous economic interest in the firm decision. This greatly stimulates the decision making process by not wasting time keep balancing up interest of different members.  

Surprisingly, creditors too enjoy advantage from limited liability due to the “asset partitioning” rationale. Creditor of a company cannot assert any claims towards the members and member’s personal creditor cannot assert towards the company. The company’s creditor will not face any competition with the member’s creditors as both have interest in different range of assets. Each creditor thus, can confine his monitoring efforts to either the company or the shareholders. Life is thus made easy for creditors.

Lastly, one of the many reasons to incorporate a company is that its members can transfer the ownership of their shares freely. This is the whole point of having share capital- so that shares can be trade. Shares can only be transfer easily if it is separated from the member’s personal assets and the personal assets of other members.

ANAYSIS OF LEGAL RESPONSES TO LIMITED LIABILITY

Lifting the Veil of Incorporation 

The courts will only look at the facade of the company. Beyond this, the court will not go. However, at times, courts do lift the veil of incorporation to reveal the true form of the company. With this, legal responses of limited liability are much explains. Courts either stick close with separate legal personality or “pierce” the corporate veil as to fix the company or its members with civil or criminality or enable one to be liable for another’s debts.

Before going further discussing when the courts will lift the veil, it is important to point out that courts have no say when a statue requires it to do so. In such situation, it is not whether the courts will lift the veil but the courts must lift the veil. Hence, discussion on the court’s responses to limited liability will not be focus on statutory lift, but veil lifting by courts.

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There are four ways in which corporate veil can be lifted. 

Analysis

Even if there is much effort in trying to explain courts’ decision on when the courts will lift the corporate veil, none however are satisfactory. It remains true that it is very difficult to predict whether the courts will lift the veil. Perhaps, the most accurate assumption on this is that sometimes the court will lift the veil and sometimes it refuses to. 

Timeline

From 1897(the year where decision for Salomon was passed) until 1966, it is known as the ‘classical veil lifting’ period. The principle of separate ...

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