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Published: Fri, 02 Feb 2018

The advantages and disadvantages of the limited liability company

A piece of the New York Stock Exchange board, carved this line: the creation of limited liability system, people can say that as Watt steam engine of epoch-making significance. Some even believe that the limited liability system “is unique in modern society, the greatest discovery, even if the steam engines and trams are also far from it’s comparable.” [1] As a modern company’s most notable feature, limited liability system living in the heart of company law which as the “traditional foundation stone” of company law by some scholars. However, modern society, respected the limited liability system does not reduce its own limitations, from all of them oriented to the analysis, help the company more robust rule of law and company law practice more perfect. To this end, this paper attempts to make a systematic system of limited liability and the panoramic view of the analysis. At first, the article will introduce the concept of limited liability, its key characteristics and how those characteristics are manifest in the group of companies, existence the value of the limited liability, then the article will be thinking of the negative effect of Limited Liability Company

Limited liability originated in the United Kingdom. After the middle of the 17th century, the understanding of limited liability companies gradually formed in trade cases of reflection. (M. A. White 2004) in 1768, when Dubois studied the Warmley Company in the proceedings of the motive, first proposed the concept of limited liability. After this, gradually limited liability was public knowledge; limited liability system was an important feature of the company had also popular. (M. A. White 2004) In 1851, the British legislature made the Limited Liability Bill, after several years of debate, the bill passed in the House of Commons, and in August 1855 the final approval of the British royal family. (J. H. Farrar, 1988) Limited liability system is not far-reaching legislative history. From the UK 1855 “Limited Liability Act,” the date was only 150 years of history. California until 1931 until the adoption of limited liability system, the United States is considered a final and comprehensive adoption of the system, dating back more than seven decades. (A. Gore, S. Maxwell 1992)

Before Legislation generally accepted the limited liability system, often given by charter (joint stock) company limited privileges. The limited liability shareholders are often granted a charter to trade with some government functions related to public interest companies and other special company, and manufacturing firms are excluded (A. Gore, S. Maxwell 1992). Perhaps this is the limited liability system be promoted in the initial pretext. (P. 1.Blumberg 1987), but thereafter, people will forget the basis upon which to build the system, and under the guise of laissez-faire, economic democracy and other slogans, (P. 1.Blumberg 1987) to expand the limited liability regime applies to all types of companies. Can be seen, at first legislators to adopt the limited liability system, maintain very cautious, do not blindly believe this was generally known as a good system in modern society.

Finally, the British legislative process in 1885 that limited liability system is naked interest groups competing with each other, rather than the legislature carefully measure and decision-making, fully consistent with rational results. (P. 1.Blumberg 1987) British “Law Times” to “Limited Liability Act,” known as Rogues Charter, and the Manchester Chamber of Commerce claims: the origin of the bill has been subverted High degree of moral responsibility a long time (P. 1.Blumberg 1987). Can be seen in the limited liability system has been heavily criticized at the time, [i] 

Limited liability company that provided by law composed of a certain number of shareholders, the shareholders limited to the amount of its contribution to the company liable for the debts, the company of its liability to its debt to total assets of the enterprise legal person.

Debtor does not fulfill its responsibility is to act shall be the legal consequences of what happened. Responsibility is the premise of the debt, no debt that is no obligation; there only have the debt, then may have liability. In general, a debtor should be held to its debt to its total assets to settle the obligation, therefore, the debtor’s liability is unlimited (F.H.Easterbook & D.R.Fischel 1991), independent. Unlimited liability is a civil settlement of the basic form. Limited liability should be an exception. The so-called limited liability and unlimited liability, whether based on civil law in all its main commitments of all property, debt as a standard. Usually in the main civil law all the property of all its called unlimited liability for the assumption of debt, and as part of its commitment to all the property known as limited liability debt. Generally there are two forms of limited liability: general limited liability and limited liability shareholders (F.H.Easterbook & D.R.Fischel 1991). The former is by law or contract, the debtor only need part of the property to assume all of its responsibility to repay the debts, Correspondingly, Creditors can only request of the debtor to pay part of the property and enforcement, Even if their claims are not to receive a full repayment, the debtor’s other property can not be executed. For example, the heirs inherit the property, only to be limited to the debts of the decedent during his lifetime responsibility. The latter refers to the company should bear all the property of their responsibility to repay the debts, the creditor is entitled to all the property in payment of the company’s request. However, all of the company property is insufficient to pay off all debt cases, the creditor shall not request more than the shareholders bear the responsibility of their capital; the company shall not convert its debt to the shareholders (F.H.Easterbook & D.R.Fischel 1991). Therefore, the company responsible for its debts with all its assets is determined by its independent character. It is because of the company’s property and the property of shareholders segment, which makes the company’s property, can only assume their responsibility to repay the debts. Therefore, the separation of the company’s personality and its members’ personality is limited conditions produced; independent system of personality and limited liability shareholders can not be separated even for a moment.

Legal characteristics of limited liability companies can be summarized as follows (A.L.Diamond 1982):   (1) the number of shareholders is limited. Limited liability companies generally have the highest number of provisions, such as Japan, Ltd., the UK private limited liability companies and Chinese companies stipulate a maximum number of shareholders are 50 people. Shareholders of a limited liability company, limited to natural persons, legal persons and the government could become a limited liability company’s shareholders.

   (2) Shareholders only limited to the amount of their contribution to the company to assume responsibility (P. Abbey 2009). Shareholders just have limited liability to company; however, shareholders assume direct responsibility to the company’s creditors. Shareholder capital contributions decide by the shareholders themselves or between the shareholders agreement, articles of association. Limited Liability Company is its total assets liable for the debts of the company. All the assets of the company include the contributions of the shareholders when the company set up, after the establishment of business generated by the company or control all property, claims and other rights.

   (3) The company can not issue stock. Limited liability Company with share certificates to shareholders when they are funded, it is a right certificate, not trading. Shares are not allowed in the public sale of stock, so called “non-listed companies.” If the limited liability company operating in the need for additional funds through other means such as applying for loans to banks to raise funds, but not to the public fund-raising.

   (4) Shares are generally not transferable. If shareholders want the transfer of capital must be agreed by a majority of the shareholders for approval and registration of the company; other shareholders have a preemptive right of shares it wishes to transfer.

   (5) The establishment of procedures is simple; the establishment of one or several persons can be initiated by the shareholders of the contribution to be paid when the company was established (P. Abbey 2009). Comparison of organization and management is flexible streamlined, fast. Its business, dissolution, closure are relatively simple, business accounts can not open. Because the limited liability company can not raise funds to the public, so it will be under no obligation to publicly operating conditions, laws are generally not provided on this account must be announced.

Since the limited liability system has been appeared, it gradually formed to promote economic development in a strong legal tool. American scholar Bernard Schwartz had talked about the company system in the evaluation of the role of the United States economic development, “because of the company system so that people can come together to conquer this continent needs the economic wealth and wisdom (Hansmann & Kraakman 1991). Company’s creation has provided the appropriate enterprise organization form to large-scale social production, and have promoted development of market economy in broad and deeper field, it made capitalism creating out productivity much bigger than all society in the previously within short period thereby. However the company is to take limited liability as whose notable characteristic, company system produces a marked effect by the fact of limited liability and other system. Therefore, in 1911 the former U.S. Columbia President N. N. Butler has pointed out: “Limited Liability Company is the greatest invention, which produces a sense even more than the steam engine and electricity invention” (T. Orhniai 1982). Former Harvard University President Charles W. Eliot also believes that “limited liability is based on the purpose of commercial production of the most limited legal invention” (P. L. Blumberg 1987). Many scholars believe that the limited change in the entire economic history. Then, the function of the limited liability what is it? According to the views of many scholars, it has the value of the following aspects:

1. Reduce and transfer risk. Competition in the market is full of risk, profit and investment risk is always accompanied. As Diamond pointed out, ‘hope that the profit gaining is increasingly big , risk is then also increasingly big, only when the expected benefits of investment are more than expected risk, it can encourage investors to forecast, and the forecasting and risk reduction to be achieved depends on limited liability. “(P. L. Blumberg 1987)” If there is no limit on the liability of shareholders, while the individual shareholders can not fully control the company, so when the company owed a large debt, may hire a large number of individual shareholders bankruptcies. Therefore, limited liability is the best form of risk reduction. Some scholars believe that the value of limited liability transfer risk. On the one hand, limited liability prompted investors to spread, no matter how complicated the investment, the shareholders are not subject to recourse. On the other hand, limited liability shareholders promote the free transfer of their investments because of the existence of limited liability, the shareholders will make more investment, but because of the risk reduction and restrictions to freedom of investment possible transfer. If the risk is unlimited, the company’s responsibility and individual responsibility is difficult to separate, and then the shares can not freely transfer, the securities market is also difficult to form. Therefore, Limited liability broad to the investor participates in the effective stimulation having invested in formation “(T. Orhniai 1982)

2. Encouraged to invest. A maximum advantage of limited liability is through the shareholder limited liability, which will help encourage investment. Social and economic development needs by promoting investment, but encouraging investment should come true by fine law form. “When the legislators for capital design a special form of limited liability which investors can freely through this form to expand its power.” (Eastetbrook 1985) Limited liability not only reduce the investment risk so that investors do not bear the enormous risks, but also making investment risk of shareholders can be pre-determined, Investors can know in advance that the maximum risk is limited to its investment losses in its investment, which give investors a guarantee, from the development of limited liability system history, this system is mainly the role of history by encouraging investment Role to achieve.

3. To promote the ownership and management rights of the separation. Investors (shareholders) are the ultimate owners of the company, but investors do not actually involve in management, business. Whether investors should actually participate in the management and operation, in large part by the impact form of liability, in case of unlimited liability, investors avoid big bear unpredictable risks necessary requirement for effective management of a company, it is difficult to promote the separation of ownership and management. Therefore, in according to the laws of many countries, the shareholders of an unlimited company should be involved in the company’s management. However, in limited circumstances, the risk of uncertainty and limited in advance is no need to actually participate in the management shareholders to control the company. Therefore, Easterbrook & Fischel believe that limited liability has led to the separation of investment and management, and promote the rational division of labor. In their view, reason for this phenomenon is that limited liability to attract more shareholders and shareholders is bound to increase and many shareholders have no chance to participate in management, Dedicated to the operation and management rights exercise to some of the people. On the contrary, precisely because in a company, many shareholders can not actually participate in the management, and therefore by the shareholders of the Company is responsible for all debts, it is unfair to shareholders, therefore, limited liability system has greatly contributed to the separation of ownership and management. (Eastetbrook 1985)

4. Enhanced market transactions. New Zealand’s leading academics Faraar point out: Limited liability and the free transfer of shares is linked together, because of the limited nature of the investment risks, enhancing the market shares can be transferred, thereby enhancing the shares trading on the stock market promote the optimal allocation of resources. (P.Farrargs 1988) Since limited liability urges investment to increase, stock right disperses, the share can transfer, Therefore lead to the result that “there is nothing between the shareholders personal relationship with each other that they may not know each other, they will not bear the obligations beyond the interests of its shares, their hope is to maximize profits, when they sale of Stocks. They are as much as possible to get everything from the company “(P. L. Blumberg 1987) Therefore, a limited duty promotes the development of the stock market.

Some scholars believe, limited liability reduces the transaction costs. For example, the limited liability system avoid the creditor directly to the case of a single shareholder litigation, Creditors only sued the company directly in the company not fulfilling its obligations, without having to bring each shareholder of expensive, cumbersome procedures of litigation. The limited liability features allow the system to play out in the history of a great role. And with social and economic development, this system will definitely release new energy, play a greater role.

As for the value of the existence of limited liability, new evaluation and understanding are expected. Some scholars believe that these values themselves are questionable. To be specific, first, limited liability, although it can reduce and transfer the risk, can be replaced by insurance. For example, in the United States, the largest liability perplexing companies and shareholders is product liability, which however can be limited or avoided through the liability insurance method now. As the limited liability is reducing the investor risk, many people are keen to take risks because of their limited liability, which results in imprudent investments and excessive venture capital. Second, the limited liability is beneficial to encouraging investment, but fund-raising relies mainly on public offering of shares in the stock market, and in many countries, most of the existed limited liability companies are small and medium with limitations in scale, business risk and loss, therefore, limited liability has limited effect on fund-raising. Third, limited liability helps to promote the separation of ownership and management power, but some scholars believe that, even in the case of limited liability, investors should also be involved in the management, because management decisions will directly affect the company’s profits and shareholders’ investment return (P. L. Blumberg 1987). Therefore, the value of limited liability is limited

Many scholars not only raised doubts about the value of limited liability, but also made many critics on limited liability that the system has obvious defects, specifically, as follows:

Unfair to creditors. Creditors are usually not allowed to be involved in the company’s management process, even know nothing about the internal management of the company, but they suffer the greatest loss once the company makes a loss due to poor management and other causes. If the shareholders have limited liability, it is unfair to the creditors. From a legal point of view, shareholders are the ultimate owners of the company, and they enjoy the right of managing company, regardless of the actual situation, at least theoretically, they are entitled to the power of company management. However, shareholders are only responsible for their contribution, which is obviously not commensurate with their rights. So, limited liability system pays attention to the protection for shareholders, but neglects the protection for creditors.

In the history of corporation law, the case of Salomon v. Salomon Ltd in Britain pioneered the extrajudicial interests for shareholders. Salomon Company had only 7 shareholders, Salomon himself, his wife and his five sons. Directors of the company were Salomon and his two sons. After its establishment, Salomon evaluated a price of £ 38,782 of his business and transferred it to the company. The company paid £ 8,782 cash to Salomon, another £ 10,000 for the company debts owed to Salomon, which were issued by the company to Salomon £ 10,000 secured bonds and the rest as the price of subscribing shares, so Salomon Ltd owned actually 20,007 shares, in which 20,001 shares were held by Salomon himself, the other six shares went to the families with one share in each member, which is in line with the provision that UK company must have seven founders. The company was forced to disband after one year of its establishment, and the liquidation showed that the corporate debt is £17,773, the company assets is £ 10,000, so if Salomon’s secured £ 10,000 get paid, other unsecured creditors of the company will not receive any liquidation. Liquidator of the company insisted that the company’s business is actually Salomon’s own business, and the company was established for avoiding debt as he estimated that his career would not go well, so made a request that Salomon should pay off the company debts, and denied claims of secured debt(P. L. Blumberg 1987). In this regard, the British court agreed that Salomon had no responsibility for the company and its creditors, and the secured creditor’s rights held by himself should take precedence over the company’s unsecured creditors rights to be cleared. There is no doubt that Salomon established the company for enjoying the benefits of limited liability company, and Salomon is the only actual shareholder of the company, but shareholders have limited liability, which is the legitimate rights and interests of the shareholders endowed by law, provided that the conditions of establishing companies are satisfied, the company will be separated from its shareholders and becomes a separate legal entity. This case established such a principle: as long as a company is established by law, it can obtain independent personality legally, even if the company’s control power belongs to only one or minority shareholders and the other shareholders of the company have only symbolic interests, the company’s independent status is not affected. The principle makes the idea that company property is independent and shareholders have only limited liability receive the highest expression in the legal form, and also makes the case of Salomon v. Salomon Ltd become an important case of law of corporation. However, for the same reason, the judgment is also seen as an unfortunate decision with no end of trouble, which provides opportunity for individual shareholders or minority shareholders to seek for the extrajudicial interests, and is unfair to creditors of the company.

2. Providing an opportunity for shareholders especially the director to abuse the legal personality of the company. The company is operated by people, in some cases, the director may use the company’s personality in a variety of fraud, and seek for their own illegal gains, and even if such a situation occurs, due to the existence of limited liability, the request of the creditors for requiring the director to be responsible is hindered. Such a situation may also occur in the group corporations: a subsidiary company of the group corporation may not have property, and it is only used as a tool by the parent company to cheat others and circumvent the law. The existence of limited liability hinders the direct request of creditors for the director.

3. Avoiding liability for tort. Many scholars name the creditor of contractual obligation as Voluntary creditor, and the creditor of tort obligation as involuntary creditor. In real life, any unspecific party is likely to suffer the loss because of the company’s tort and becomes involuntary creditor. Now especially, the violations of product damage have been increasingly common, and the victims are also increasing. But, due to the presence of limited liability, it is impossible for the victim suffering from personal injury and death to obtain excessive compensation. Therefore, some scholars believe that the limited liability provides inadequate protection for victims of violations, and it only protects the investors, while is not conducive to protecting the general consumers (stone 1980). There are also some scholars who believe that the limited liability system hinders the effect of tort system (H. Trebilcock1980). However, some American scholars such as Halpen, Trebiicock, Turnbull and others believe that in considering whether there is damage to the tort system, it is suggested to judge what kinds of benefits are infringed, if it is the personal interests of the individual, the victims enjoy the right of requesting full compensation, but if it is the commercial interests the issue on victim’s compensation can also be solved by insurance method, without involving limited liability system. (H. Trebilcock1980) However, these scholars also suggested that in order to protect tort victims, the law should cover the shortage of limited liability system by taking measures such as proposing the minimum amount of capital to the company, implementing compulsory insurance, increasing liability without fault, etc.( Clark 1979)

Companies can set up subsidiaries, and subsidiary companies can have corporate legal personality and independently bear legal responsibility. However, in Group Corporation, it is not scarce that the parent company takes the advantage of the holding posotion in subsidiaries, ignoring the interests of a subsidiary, and using the subsidiary as the implementation tool of commercial policy. Legal entities of parent company and subsidiaries are confused, and there is no independent and clear account, which causes that parent company pockets operating results of subsidiaries, and also uses the subsidiary as a means of evading legal liability, which is absolutely unfair to the subsidiary creditors.

Because the limited liability system has such defects, people criticized it and began to explore the transformation of limited liability and type option of Reconstruction Company. Limited liability system, as the basic system of modern company law determined through a long-term practice test, is the inevitable result with social development and legal evolution. It should not be totally negated just because the existed defects. Therefore, meaningful research is to discuss in depth how to improve the limited liability system of companies rather than focusing on whether the company’s limited liability system should be implemented. A lot of countries with more developed market economy have done many explorations in the legislative and judicial practice and proposed a variety of programs. In a nutshell there are two kinds: One is “lifting the veil of corporation”; the other is providing direct regulations for the legal relationship between the parent company and subsidiaries through a specialized law of Group Corporation.

The main viewpoint of “lifting the veil of corporation” is as follows: as legal person, the company has independent legal personality and is independently liable for its legal actions and debts based on its total assets, while the company’s shareholders only bear limited liability according to the amount of capital commitment, so the company’s independent personality and limited liability of shareholders are just like a veil, which separates the shareholders from the company to protect shareholders from creditors recourse. However, shareholders are entitled the rights of the company’s management because of investment, as its contribution reaches to a certain level, the shareholders will have the control power of the company, which may make shareholders use the control power to impose adverse impact on the company, and in many cases , the shareholders are most likely to use the company’s personality to engage in various illegal acts and circumvent the law, which will result in damage to the creditors. Therefore, from the angle of maintaining social order and protecting the interests of creditors, in certain circumstances, the veil of corporation should be lifted to make shareholders be directly responsible for creditors. With the development of social life, the court comes to realize in practice that “the corporate veil” is often used by the company’s shareholders to engage in various illegal acts, which often obscures the individual behaviors of shareholders and protects shareholders from creditors’ recourse, so in special circumstances the corporate veil should be lifted. In accordance with the explanations of Anglo-American scholars, “lifting the veil of corporation” includes two elements, one is to confirm that a company and its members, directors share the same personality, and the other is to confirm that a group company is a purely commercial entity. (V. stott 1992) The important aim of “lifting the veil of corporation” is to implement the special provisions on “lifting the veil of corporation” in statutory law, to prevent fraud, and to prevent circumvention of legal obligation by using the corporate form. If limited liability is used by the escape debt, the purpose of avoiding obligations, then the system does not meet the purpose of existence. If the one-sided emphasis on the absolute nature of the system, Law that can not be “lifting the corporate veil” under any circumstances, then it is bound to the interests of creditors can not be guaranteed, social and economic order can not be upheld, while the limited liability system can not really play a role . In cases of Giclford Motor Co., Ltd V. Horne l933 and Jones V. Lipman 1962, the court did not consider the company’s independent personality, but ordered the company’s shareholders to be responsible for creditors. In the case of Unit Construction Co Ltd V. Bull-cock l960, a British company has three companies registered in Kenya, although the articles of corporation confirm that the board of directors of each company should be held in Kenya, but in fact the three companies are entirely managed by holding company. The court held that registration in Kenya is indeed a fraud; the three companies should be domiciled in the UK, and should pay tax in the UK.

The law of corporate group in developed countries issues some special regulations for the relationship between parent company and subsidiary companies. The law of corporation in developed countries generally entitles the parent company and subsidiaries independent legal personality, but as for their relationship makes specifications different from general regulations on independent legal person. For example, in 1965 the Federal German Stock Corporation Act made special provisions as follows: (1) In the case of pure subordinate, if the enterprise with control power orders the enterprises be controlled to carry out the measures which are not in favor of the latter, the enterprise with control power must compensate for the damage; (2) In the condition that the control contract or profit transfer contract and other contracts are linked between the parent company and subsidiaries, the parent company is obliged to make up for the annual loss of subsidiaries; (3) As for the combination, besides making up for the net loss of subsidiaries, the parent company should also be directly responsible for the debts of subsidiaries.

Sources of Economic Growth from the effective institutional arrangements, the company key development is to set a reasonable system. Institutional change by the unlimited liability to the limited liability system is in a more efficient system to replace the existing system or a more effective system for the production process, Settlement system is the shortage of the main system, thus expanding the supply system to obtain the behavior of the potential benefits. Form in today’s enterprises, limited liability companies is dominated. Define the form of limited liability companies, most of all core business forms the basis for the research in depth, to improve operational performance of the system, on the economic development is undoubtedly an important guiding significance. From a historical development, the limited liability system through the basic principles of free → single → a single basic principle of the basic principles of the process of differentiation, form from a limited liability → limited liability system →Lifting the veil of Incorporation → reverse Lifting the veil of Incorporation, institutional change and innovation is a continuous process. The establishment of limited liability and limited liability system, the system of denial, enabling investors and creditors in the collision of different claims in a legal relationship to reflective equilibrium, so that the value of law and justice are complete, the dynamic implementation.

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