Academic journal article University of Western Sydney Law Review

Rethinking Limited Liability

Academic journal article University of Western Sydney Law Review

Rethinking Limited Liability

Article excerpt


I.   Introduction
II.  Arguments For the Limited Liability Company
III. Argument Against Limited Liability: Undermine Personal
IV.  The Flawed Arguments that Sustain the Limited Liability
V.   Need for the Large Corporation
VI.  Moderating the Potential Negative Impact of the Limited
     Liability Corporation

I. Introduction

The justification for the existence of companies and company law underpins the western model of capitalism and 'provides the theoretical justification for the basic organisation of industry and commerce throughout most of the western world.' (1) Even though

   the ownership and control of business enterprises, and the
   distribution of profits arising in them, can be structured in any
   number of ways ... the important question is how we came to accept
   as so fundamental the structure which we now have? (2)

That is, how did we come to accept the structure of the limited liability company? In other words how is it that the corporate form of business organisation is accepted almost unquestioningly as the basic form of business organisation in the western world?

The purpose of the paper is to examine the flawed arguments that lead to the acceptance of limited liability as the corporate form and modern arguments that support the continuance of limited liability. The paper proposes that the negative impacts of limited liability be moderated by replacing boards of directors with public auditors, and to make senior corporate investors and substantial corporate shareholders personally liable for corporate violations of the law.

Examining the history of the limited liability company discloses that the traditional arguments raised for the necessity for limited liability as a pre-condition of the success of the corporate form were flawed. The continuation of limited liability as an acceptable corporate form has lead to disastrous consequences for victims of limited liability companies. These victims can include shareholders, other investors, creditors, employees, customers and the environment.

This paper limits the discussion of limited liability to corporations of publicly traded shares. The small private company, called the closely held company in some jurisdictions, is not considered here. This is because, first, in small companies shareholders have the ability to control, (3) and, second, in practice,

   limited liability is not of particular consequence for the very
   closely held corporation, given the likelihood that voluntary
   creditors will ask for personal guarantees and that shareholders,
   acting as corporate agents, will already be liable for their own
   torts. (4)

The concept of the company as a legal person distinct from its shareholders was not finally settled until 1897. In the case of Salomon v Salomon & Co Ltd (5) it was finally, on appeal from two earlier contrary decisions, (6) decided unanimously by the House of Lords that the modern limited liability company was legally acceptable. As Lord Herschell stated,

   [t]he very object of the creation of the company and the transfer
   to it of the business is, whereas the liability of the partners for
   debts incurred was without limit, the liability of the members for
   the debts incurred by the company shall be limited. (7)

In England 'the trading company was a direct development from the medieval gilds and companies formed by charter for the regulation of specific trades and skills.' (8) Trading charters were granted from about the 1530s.9 However it took over 350 years, that is, until 1897 for the distinct legal personality of companies and the limited liability of their members to be legally recognised. This makes all the more surprising that, in the barely 100 years since the decision in Salomon v Salomon & Co Ltd, the concept of limited liability is now taken for granted. …

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