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Limited liability

From Wikipedia, the free encyclopedia

Limited liability is where 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. If a company with limited liability is sued, then the claimants are suing the company, not its owners or investors. A shareholder in a limited company is not personally liable for any of the debts of the company, other than for the amount already invested in the company and for any unpaid amount on the shares in the company, if any.[1] The same is true for the members of a limited liability partnership and the limited partners in a limited partnership.[2] By contrast, sole proprietors and partners in general partnerships are each liable for all the debts of the business (unlimited liability).

If shares are issued "part-paid", then the shareholders are liable, when a claim is made against the capital of the company, to pay to the company the balance of the face or par value of the shares.

Although a shareholder's liability for the company's actions is limited, the shareholders may still be liable for their own acts. For example, the directors of small companies (who are frequently also shareholders) are often required to give personal guarantees of the company's debts to those lending to the company.[3] They will then be liable for those debts in the event that the company cannot pay, although the other shareholders will not be so liable. This is known as co-signing.

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Transcription

We've all come in contact with corporations. You might work for a corporation. You might buy something from a corporation. You might, I don't know, you might own shares in a corporation. So we kind of have a sense of what they are, but I want to make that sense a little bit more precise in this video and also give an understanding of why corporations even exist. And so a corporation, and you might already kind of have a feeling for this, it's a legal entity. It's a legal entity that can kind of act ... that can act, that can act like a person ... like a person, I put the act in quotes because obviously there's some things that a person can do that a corporation can't. A person can smile. I guess one can debate whether a corporation can. When I say act, I mean legally. So a corporation can sue another corporation or person. A corporation can be sued by another corporation or a person. A corporation can own things, just like a person owns things. A corporation can owe other people or corporations things, so that's what I mean by "act". A corporation can't jump like a person or laugh like a person. Well, that ... maybe that'll be a a philosophical discussion for another video. But what I want to focus on, other than just what a corporation is, is why they exist. So what's the "why" of a corporation? And in my mind, there's two big reasons and the first reason and this is the real biggest one is limited liability. Sounds like a very fancy word, but we'll see it with an example, it's not too ... it's not too fancy. So there is limited liability and there's also kind of transferrable share ownership. Share ownership. But what I want to do in this, which is you know essentially more than one person can own the corporation, they can transfer the shares between people, they can trade them. But what I want to focus on is the limited liability because even if there's only one person who owns the corporation, if they own the whole thing. It still makes sense for them to create it because of limited liability. And to understand this, let me give you a little example. Let's say that ... Let's, let's say that there's some guy. Let's say he's Bill. Let's say it's Bill's ,,, Bill's assets right over here and let's say that he has a house. Let's say that he has a house that is worth $500,000. Let's say he has a car, maybe he has a very nice car. Let's say he has a car that is worth 100 ... No, that's too much for a car. That's very ... Well, cars can cost that much but let's be ... that's ... $50,000 is still a nice car. Let's say that he has some investments, some investment properties or maybe some stocks that are worth another ... another $500,000 and let's say that he's interested, you know, he looks around his town, he sees that there's a lot of people who could use a ride. So to make some extra money, he wants to start a cab or car service business. So he goes out there and he doesn't think about starting a corporation and he just goes out there and he buys a car, let me call a cab, plus licenses. A cab plus licenses. And these things are actually much more expensive than what you would imagine. You could ... could talk to a, the next time you're in a cab, it costs much more than the cost of the car, which would probably be $20,000 or $30,000. It comes up close to six figures, but let's say that it costs him $80,000. And let's say that he spends $1,000, at least for this first year. Let's say he spends $1,000 on insurance, on liability insurance. He realizes, "Hey look, maybe you know, "maybe something bad happens." "This is a cab I could run into somebody" "and I get sued. So, I want to get liability insurance." So this is liability insurance, in case anything like that happens and let's say that it is a ... Let's say that it is a $100,000 policy. He says, "You know, how can I ...", you know, he ... he's maybe a little bit optimistic and he thinks that no one can sue him for more than $100,000. So it's a $100,000 ... It is a $100,000 policy. Now, he goes out there. He starts driving that cab around, picking up people, dropping them off and by accident one day, he rolls over someone's foot and that person whose foot he just crushed happened to be a ... you know, a world-class soccer player. So he ruined this person's career. He ruined the career. So right here, here's the soccer ... the soccer player right over here, whose career is ruined or if you're watching this outside of the United States, a futbol player. But anyway, you have this soccer player. His crushed ... His foot is crushed. And so he sues Bill because Bill owns the cab. And the court ... so he sues. Let me write it. He sues Bill ... sues Bill for $1,000,000. $1,000,000 because it ruined his career. In fact, that's probably ... probably deservers more than that if he was a world-class player. And the court, you know, rightfully says, "Look, you crushed this guy's player." "You ... you ... you were kind of ... this guy's foot," "you were kind of negligent." "You got a little bit too close to the curb." "His foot was crushed." So it rules in the soccer player's favor. And so essentially, now Bill's on the line for the entire $1,000,000. So Bill is going to have to sell his house. He's going to have to see his car. Well, he wouldn't have to sell his car because he has investments, sell his investments and give his house or the proceeds from his house and investment to the soccer player. And so now all Bill is left with is a car and a cab and not much else, so what did this ... this cab business didn't work out too well for Bill. It's a small part of his portfolio. He didn't even have a chance to make much money from it and it really just wiped him clean. Now, what Bill should have done is create a separate corporation, is create a separate corporation called ... called Bill's ... Bill's Car Service ... Car Service, Inc. and transferred enough money so that the cab, the licenseses and the insurance could be owned by this legal entity, by this corporation. So here you would have the cabs ... cab + the license. So he would have transferred $80,000 to the corporation and the corporation would have bought it in the corporation's name. Remember, it can act like a person. It can buy things in its name. The owner of this cab is Bill's Car Service not Bill. It could also get the insurance, the $100,000 of insurance, maybe this is what people think is a reasonable amount for anyone who is running a cab business. You have to have at least $100,000. The reality is probably it's a much larger number than that and he spends $1,000 to have that policy and remember, this is $100,000 of liability insurance. Now, let's play out the same situation. The cab still rolls over the soccer player's foot. The soccer player's foot gets crushed, can't play soccer anymore, sues whoever owned that cab for a $1,000,000. But now the owner of that cab is no longer Bill. It's Bill Car Service. So he sues this, sues Bill's Car Service and let me make it clear. In this reality, Bill's assets wouldn't include the cab, the licenses and the insurance anymore. It would now include, 100% ownership ... ownership of car service, of Bill's Car Service. So the asset is now the shares, the 100% ownership in this but this is a separate legal entity. So now the soccer player sues the cab service for $1,000,000. The court rightfully says, "Hey, yeah you owe this dude $1,000,000." "You ruined his career.", but unfortunate for the player and I guess fortunate for Bill, I don't want to take sides here. This is just how reality is set up and this is what limited liability is, is that now all the car service can produce is ... Well, they could sell ... They could sell maybe these assets for $80,000 and they'll get $100,000 ... They'll get $100,000 from the insurance, so all this corporation will be able to do is give the guy $180,000 and then the cooperation is just going to go bankrupt. So it's going to declare corporate bankruptcy. It's going to go bankrupt. So this thing that Bill owed, this car service which maybe originally he could write on his books as being worth $81,000, had insurance policy and all this other stuff. It's now worth 0. The corporation's worth 0, but the soccer player can't go after anything else. We'll talk about in the future, of reasons why they can. If he didn't have enough insurance or if he didn't ... if he was running this like his own personal business. If this car service didn't have its own bank account or if it didn't ... if it was undercapitalized, if it didn't have enough money in it, then maybe the court would let the soccer player or kind of "pierce the corporate veil" they say, which is a very fancy way of still going after the owners of the corporation. But as long as this corporation was reasonably capitalized, and I'm just made up these numbers here, the soccer player will only be able to go after this corporation. So what you see here is that Bill's liability was limited. This was limited liability. The most he could lose as long as he ran the car service properly and had enough insurance and had enough money in the actual organization. As long as he ran it in the right way, the most he could lose is the value of the organization. If this organization, you know, hits somebody or rolled over their foot, and ... but he ran the organization properly, they can;t go over the rest of his assets. So this is the number one reason why people have corporations, for the limited liability.

Contents

History

By the 15th century, English law had awarded limited liability to monastic communities and trade guilds with commonly held property. In the 17th century, joint stock charters were awarded by the crown to monopolies such as the East India Company.[4] The world's first modern limited liability law was enacted by the state of New York in 1811.[5] In England it became more straightforward to incorporate a joint stock company following the Joint Stock Companies Act 1844, although 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.[6][7][8] 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 seven by the Companies Act 1856. Limited companies in England and Wales now require only one member.[9]

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. The development of limited liability facilitated the move to large-scale industrial enterprise, by removing the threat that an individual's total wealth would be confiscated if invested in an unsuccessful company. Large sums of personal financial capital became available, and the transferability of shares permitted a degree of business continuity not possible in other forms of enterprise.[4]

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.[10]

Although 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.[11] Such liability for directors of English companies was abolished in 2006.[12] 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,[13] requiring that member states make available legal structures for individuals to trade with limited liability. This was implemented in England and Wales by Statutory Instrument SI 1992/1699 which allowed single-member limited-liability companies.[14]

In the United States, decentralized corporate law and competition between states for corporate charters and investment led to widespread adoption of freely available limited liability beginning in the 1800s and culminating in the early 1900s. However, limited liability has been curtailed in specific contexts such as environmental liabilities or (in some states) employees unpaid back-wages.[1]

Justification

Limited liability is related to the concept of separate legal personality bestowed on the corporate form, which is promoted as encouraging entrepreneurship by various economists,[15][16][17][18] enabling large sums to be pooled towards an economically beneficial purpose.

Criticisms

An early critic of limited liability, Edward William Cox, a lifelong member of the Conservative Party, wrote in 1855:

[T]hat he who acts through an agent should be responsible for his agent's acts, and that he who shares the profits of an enterprise ought also to be subject to its losses; that there is a moral obligation, which it is the duty of the laws of a civilised nation to enforce, to pay debts, perform contracts and make reparation for wrongs. Limited liability is founded on the opposite principle and permits a man to avail himself of acts if advantageous to him, and not to be responsible for them if they should be disadvantageous; to speculate for profits without being liable for losses; to make contracts, incur debts, and commit wrongs, the law depriving the creditor, the contractor, and the injured of a remedy against the property or person of the wrongdoer, beyond the limit, however small, at which it may please him to determine his own liability [19]

Some critics argue that limited liability favors creditors who are in the position to negotiate secured terms, whereas small creditors' debts are left unsecured.[1] Others argue that while some limited liability is beneficial, the privilege ought not to extend to liability in tort for environmental disasters or personal injury.[1][20][21][22]

Some argue that limited liability provides investors with insurance-like benefits, without the cost of insurance premiums or safety regulations that usually accompany insurance, and that it therefore be advisable to charge firms for limited liability a rate that reflects risks of limited liability imposing costs on the government or the public. Critics also argue that this would accelerate the spread of information about poorly understood risk.[1]

Anarcho-capitalist Murray N. Rothbard, in his Power and Market (1970), criticized the need of limited liability laws, observing that similar arrangements emerge upon mutual and voluntary agreement in a free market:

Finally, the question may be raised: Are corporations themselves mere grants of monopoly privilege? Some advocates of the free market were persuaded to accept this view by Walter Lippmann's The Good Society. It should be clear from previous discussion, however, that corporations are not at all monopolistic privileges; they are free associations of individuals pooling their capital. On the purely free market, such individuals would simply announce to their creditors that their liability is limited to the capital specifically invested in the corporation, and that beyond this their personal funds are not liable for debts, as they would be under a partnership arrangement. It then rests with the sellers and lenders to this corporation to decide whether or not they will transact business with it. If they do, then they proceed at their own risk. Thus, the government does not grant corporations a privilege of limited liability; anything announced and freely contracted for in advance is a right of a free individual, not a special privilege. It is not necessary that governments grant charters to corporations.

See also

Notes

  1. ^ a b c d e "Limited Liability and the Known Unknown". Social Science Research Network. 2018.
  2. ^ Hannigan 2003
  3. ^ "When LLC Owners Can Be Liable". Retrieved 2011-12-04.
  4. ^ a b Reekie, W. Duncan (1996). Adam Kuper and Jessica Kuper, ed. The Social Science Encyclopedia. Routledge. p. 477. ISBN 0-415-20794-0.
  5. ^ "The key to industrial capitalism: limited liability". The Economist. December 23, 1999.
  6. ^ Shannon (1931)
  7. ^ Saville, J. (1956). "Sleeping partnership and limited liability, 1850–1856". The Economic History Review. 8 (3): 418–433. doi:10.2307/2598493. JSTOR 2598493.
  8. ^ Amsler, et al. (1981)
  9. ^ Mayson, et al. (2005), p. 55
  10. ^ Jefferys, J. B. (1954). "The denomination and character of shares, 1855–1885". The Economic History Review. 16 (1): 45–55. doi:10.2307/2590580. JSTOR 2590580.
  11. ^ Lobban (1996)
  12. ^ DTI (2005)
  13. ^ 89/667/EEC
  14. ^ Edwards (1998)
  15. ^ Meiners, et al. (1979)
  16. ^ Halpern, et al. (1980)
  17. ^ Easterbrook & Fischel (1985)
  18. ^ David Millon. "Piercing the Corporate Veil, Financial Responsibility, and the Limits of Limed Liability" (PDF). Archived from the original (PDF) on 2013-09-16.
  19. ^ Ireland, P. (2008). "Limited liability, shareholder rights and the problem of corporate irresponsibility". Cambridge Journal of Economics. 34 (5): 837–856. doi:10.1093/cje/ben040.
  20. ^ Grossman (1995)
  21. ^ Hansmann & Kraakman (1991)
  22. ^ Grundfest, J.A. (1992). "The limited future of unlimited liability: a capital markets perspective". Yale Law Journal. 102 (2): 387–425. doi:10.2307/796841. JSTOR 796841.

References

  • Amsler, C.F.; et al. (1981). "Thoughts of some British economists on early limited liability and corporate legislation". History of Political Economy. 13 (4): 774–93. doi:10.1215/00182702-13-4-774.
  • Bagehot, W. (1867). "The New Joint Stock Companies Act". The Economist. 25: 982–83., reprinted in St John-Stevas, N. (ed.) (1986). Collected Works of Walter Bagehot. London: Economist Publications. ISBN 0-85058-083-8., pp. ix, 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.
  • Department of Trade and Industry (UK) (2000). Modern Company Law for a Competitive Economy: Developing the Framework. London. URN 00/656.
  • "Company Law Reform Bill – White Paper (Cm 6456)". 2005. Archived from the original on 2006-05-27. Retrieved 2006-07-03.
  • Easterbrook, F.H; Fischel, D.R. (1985). "Limited liability and the corporation". University of Chicago Law Review. 52 (1): 89–117. doi:10.2307/1599572. JSTOR 1599572.
  • 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. (1995). "The market for shares of companies with unlimited liability: the case of American Express". Journal of Legal Studies. 24: 63. doi:10.1086/467952.
  • Halpern, P.; et al. (1980). "An economic analysis of limited liability in corporation law". University of Toronto Law Journal. 30 (2): 117–150. doi:10.2307/825483. JSTOR 825483.
  • Hannigan, B. (2003). Company Law. Oxford University Press.
  • Hansmann, H.; Kraakman, R. (1991). "Toward unlimited shareholder liability for corporate torts". Yale Law Journal. 100 (7): 1879–1934. doi:10.2307/796812. JSTOR 796812.
  • 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 (4): 931–958. doi:10.1017/S0022050703002493.
  • 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., pp. 344–57
  • Livermore, S. (1935). "Journal of Political Economy". 43: 674–687.
  • 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.). London: Oxford University Press. ISBN 0-19-928531-4.
  • Meiners, R.E.; et al. (1979). "Piercing the veil of limited liability". Delaware Journal of Corporate Law. 4: 351.
  • Orhnial, T (ed.) (1982). Limited Liability and the Corporation. London: Croom Helm. ISBN 0-7099-1919-0.
  • 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., pp. 358–79
  • "The first five thousand limited companies and their duration". Economic History. 3: 421. 1932.
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