University of Wollongong – LAW302 – Laws of Business Organizations – HD 81/100

Proposing the question

Taking a new approach to study limited liability companies, Ireland (2010) deducted, ‘the corporate legal form was, and is, in large part a political construct developed to accommodate and protect the rentier investor’. It seemed that the emergence of limited liability companies and the legislation around the entity have derived from and later served the interests of investors. To discuss this matter, this paper should hereby analyse the legislative history of limited liability as well as its advantages and disadvantages with the issue of investors’ interests in question.

Taking a look into limited liability

One of the early studies on the emergence of limited liability is Robert (1992)’s approach focusing on the legal premise of these entities. A limited liability company is identified as a noncorporate entity which offers its owners the protection against unlimited liability of enterprises, as well as the tax treatment of partnerships. By nature, limited liability is somewhat close to corporate liability and limited partnership, where investors are not liable for any debts, obligations, and liabilities of either the entities or other investors. At the same time, to avoid the double taxation corporations are undergoing as the results of taxation applicable for corporation earnings at the prevailing rates as well as taxes paid by investors at the rates applicable to their status (Keatinge et al., 1991), limited liability companies can choose a more ‘noncorporate’ approach. That is, limited liability companies must lack some of the corporate characteristics provided by regulations: continuity of life and free transferability of interests. Over the decades, the model of limited liability companies has been considered a ‘natural’ corporate legal form, and as worded by adult scholars, ‘induced by economic exigencies’ (Kraakman et al., 2004). Due to the combination of favorable attributes, limited liability companies have also emerged as the preferred structure for many businesses.

Reviewing the legal treatment towards limited liability entities

Adult literatures have taken different approaches to the study of limited liability companies, ranging from identifying the lessons for corporate laws (Macey, 1995), understanding the legislative and case law developments (Murdock, 2001), to decoupling its privilege from rights of control (Ireland, 2010). One important aspect of these studies is the analysis of the legal treatment influencing the emergence of limited liability companies throughout the history.

As mentioned above, limited liability companies are enabled to qualify for pass-through tax treatment due to the recognition as partnerships according to criteria stated by the Internal Revenue Service. This was one of the key elements contributing to the development of this corporate form. However, Ireland (1996) and Ireland (2010) illustrated how the operation of limited liability companies might have been in violation of the law of partnerships. One of the key principles of partnerships from the nineteenth century is the unlimited liability and mutual agency, whereby partners – including those not involved in management activities – were joint owners of property and severally liable for any partnership debt. The premise of partnerships whereby is to ensure the principles of justice and the conscientious operation of business. The distinction legal form of limited liability companies, however, was allowed by the Companies Acts of 1844-62 in the U.K – free incorporation by simple registration – to create a separate legal entity from its members. Similarly, under the U.S law, Macey (1995) also explained the premise of a simple registration procedure where a filing of documents to state officials would be the critical feature to distinguish enterprises in which investors enjoyed limited liability from enterprises with unlimited personal liability.

The emergence of this novel corporate legal form also led to the rise in rentier investors. Limited liability acted as an alternative for rentiers seeking for profitable investment outlets as they faced limitations of partnerships – taking part in unlimited liability investment that may put their whole personal wealth at stake (Ward, 1852) or becoming creditors with fixed rate of returns limited by the usury laws. Prior studies (Ireland et al., 1987; Ireland, 1996; Ireland, 2010) once again shed light on the accommodation of legislation for limited liability companies and its rentier investors. The 40s of the nineteenth century marked several modifications to the law of partnership applying to joint-stock companies. For example, the judicial redefinition of shares led to the separation of property, where the company owned concrete assets and shareholders held the intangible rights to profit as shares. Another legal protection of the rentier investors is the Companies Act 1844, implementing on companies a compulsory incorporation coupled with ‘publicity’, which hoped to keep rentiers well informed with detailed information about company operations. Similarly, the effect of the Companies Act 1844-82 redefined the relationships between investors, creditors, and the company. ‘The company’ was held responsible to creditors as a separate, property-owning entity, whereas investors owe their liability to ‘the company’ and not directly to the creditors.

The final emergence of limited liability companies lied in the modern doctrine of separate corporate personality within the last quarter of the nineteenth century. As corporations reified the ‘complete separation’ of shareholders and company, the law concerning this form of entity also emerged as a legal corporate form category in its own right, instead of being a branch in the law of partnerships (Ireland, 2003).

 

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