The Limited Liability company or corporation has been called the "greatest single discovery of modern times", but do its special features have a down side too?
The first business that might be recognised as having the characteristics of a modern Limited Liability Company was formed in 1600 by Royal Charter. The Honorable East India Company was granted the exclusive rights to manage the entire trade of the United Kingdom with peoples and places to the east of the Cape of Good Hope. It was also the first where investors in the company, some 218 merchants that were its founding shareholders, were also granted limited liability.
In a limited liability company a shareholders' financial liability is limited to a fixed maximum sum - often the value of that person's investment in the shares of the company. If a company with limited liability is sued, then the claimants are suing the company, not its owners or investors. The same is true for the members of a limited liability partnership and the limited partners in a limited partnership.
By contrast, sole proprietors and partners in general partnerships are each liable for all the debts of the business with unlimited personal liability. The liability is not necessarily shared equally either, it is "joint", meaning that if your partners don't have the personal funds to meet the liability you may end up paying their share too.
In return for being granted the status of limited liability in law, there are obligations to submit information to Companies House:
This information is made publicly available by Companies House and is widely used by suppliers to decide how much credit it is prudent to extend to a company. Our Company Check tool uses publicly available information from Companies House and other sources to check whether a business is still trading.
Before the advent of limited liability companies, how many people would be willing to join with others to invest in forming a business if they might lose their entire wealth should it to get into trading difficulties? Would you be happy to invest along with other people you didn't know if you were all jointly liable for any and all of the business' debts?
Many of the industries that built the modern world required and continue to need enormous upfront investments. Building the railways and manufacturing factories, inventing and testing new medicines, scaling up technology companies - all these require huge sums of money to be invested before there are financial returns and it was only the invention of the limited liability company that allowed thousands of individuals to pool their investments together to finance such businesses.
Without the limited liability company the world would be a much different place. However, there are circumstances where it feels like the protections offered to the owners of a limited liability company can be abused.
If you are owed money by a limited company, or limited liability partnership then it is the company you take to court for the debt, not the owners or the shareholders. A company that is wound up or put into administration may not have the assets to pay all its debts, especially since your debt is likely to be unsecured and will rank at the back of the queue behind anything owed to employees, the Inland Revenue and banks.
(See this article on what happens when a company that owes you money is put into administration).
It is possible for any size of company to be formed as a limited company, even those with a single owner who is also the director. It can be hard to accept that the owner is still driving around in a fancy car, and living in an expensive house if you are owed money by a their now closed down business. Why can't we force them to sell their car/ home/ HiFi system in order to pay their debts?
The answer is unfortunately that the car/ home / HiFi belong to the person and the person is a different legal entity to the limited company. The only assets that you can recover against debts owed by the company are the assets of the company - desks, computers, and so on. The BMW is off-limits unless it belongs to the company itself.
The only time you can 'pierce the corporate veil' and go after the owners is if they are guilty of wrongful trading, favoring certain creditors over others or if they have entered into a personal guarantee with you.
Even more antagonising to businesses harmed by a company going bust is to see the owner of "Joe Blow Plumbing and Heating Ltd." set up shortly afterwards as "Joe Blow Heating and Plumbing Ltd." and continue trading as if nothing has happened.
This is perfectly legal, and unfortunately since the new company is a completely separate legal entity to the closed-down company it owes nothing to the creditors of the old company. The new company might even pick up ongoing contracts of the old company as the customers have lost nothing from the event.
It is this serial 'phoenixing' of businesses that really grates. Individuals running up large debts in their company, paying themselves well and then just closing it down and starting another up to do it all again.
Society has concluded that the relatively small number of people abusing the protections offered by limited liability companies is a price worth paying for the enormous benefits that they bring. If you are a small company owed money by a limited liability company that then goes into liquidation, this will feel like scant comfort.
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