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Reaching a compromise between social justice and economic growth has never been an easy
task. However, every jurisdiction must struggle to adopt economic policies that also take into
account social fairness. Otherwise, their very societies seriously risk falling apart and
collapsing.

As regards conducting business through incorporated companies, limited liability has been
identified, in thewake of the industrial revolution, as the most suitable mean to foster the
economic activities of developed countries. That doctrine follows from the neat separation
between the incorporated company and its shareholders: the former is a different legal entity
from the latter.

According to the doctrine of limited liability, on the one hand, the investors-
shareholders¶liability, for the company debts, is limited to what they have paid or agreed to
pay for its shares. In other words, the company creditors cannot lay a claim against the
shareholders¶ personal assets, but only against the ones of the company. On the other hand,
once the company creditors have been paid, its shareholders can benefit from its success with
no cap.

Theconceptof limited liability was really innovative asit encouragedmassive investmentsof a

great number of individuals, unprofessional investors, in big ventures. However, it was also
deeply controversial. Regarding the United Kingdom, it was immediately criticized by
eminent economists and jurists. In particular, it was mainly objected that limited liability
could be used by under-capitalised concerns to the detriment of creditors and the investing
public. Thus, that theory was not universally accepted. Instead, it was strongly challenged as,
shifting the risk of the failure of the business to its creditors, it promoted a moral hazard.

In the opinion of the present writer, that criticism still makes a good point. As a matter of
fact, limited liability encourages incorporated companies to go on trading even though they
do not have the required financial means as there is a cap on their shareholders¶ liability.
Hence, investors are in a far better position than the creditors of their company.

Nonetheless, in the following paper it will be shown, after a brief analysis of that doctrine and
its jurisprudential application, that the advantages of limited liability still outweigh its
disadvantages, but only for a peculiar category of incorporated companies: the ones that refer
to the public to raise capitalsand whose equity is listed for trading on a stock exchange (the
so-called public companies).1In particular, it will be outlined that limited liability represents,
in the actual economic climate of global recession and credit crisis,their only wayto raise
capitals. Consequently, requiring its abolishmentwill be considered as an irrational choice.
All the same, the need of a partial modification of that doctrine will be outlined.

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Notably, it will be shown that the use of that concept is unjustified for small firms-private
companies and corporate groups. In fact, it will be underlined that, in the first case, the very
structure of private companies refrains limited liability from pursuing its main objective. In
fact, those kind of companies openly do not refer to the public to raise their capital.On the
contrary, they are usually contributed and managed by a small number of shareholders.2
Thus, limited liability is only used to exempt shareholders from personal liability. The same
aim is also pursued in corporate groups to separate the liability of a parent company to the
one of its subsidiaries. Thus, it will be stressed that, in both cases, the recourse to limited
liability is completely abusive.

Finally, as regards public companies, the starting point will be the observation that aseparate
company personality has never been totally achieved. In fact, itwill be stressed that its
directors invariably take decisions in favour of shareholders, and not of the company.
Consequently, it will be suggested that, contrary to the dominant literature, the company must
be considered as an agent. Particularly,it is an agent of those shareholders who
havesubstantially managed it, through the directors that they have nominated. Whereby, the
company will remain a complete different person with regard to the shareholders that did not
have any role in the company decisions. Eventually, pursuant to that distinction, it will
predicated that the creditors of the company could also lay a claim on the assets of the first
category of shareholders. In that way, the interests of social justice mentioned at the
beginning of this introduction and the one concerning economic growth will be both taken
into consideration.

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B Cheffins, „ „

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 c ‘ The doctrine of limited liability and its jurisprudential application

The application of the limited liability in the United Kingdom, now mentioned in section 3
Company Act 2006, is the result of several statutory and jurisprudential developments.

The limitation of the personal risk incurred by the shareholders to the amount of capital they
have contributed was recognized,for the first time, by the Limited Liability Act 1855.
Particularly, it was allowed only when theincorporated company had a minimum number of
shareholders who, in turn, had to own shares to a minimum value. In succession, those two
requirements were over time lowered to the point that, now, it is enabled the incorporation of
a private company with only one shareholder and with no minimum capital level. On the
other hand, the Second Company Law Directive set a minimum capital level of 50.000 £ for
public companies. 3

Significant developments to the corporate form as it is known today, are due to the key
caseå
å

Notably, in that case,the House of Lords argued, that
even when a company was under the absolute control of one shareholder, but the formal
legislative requirements were complied with, the company remained a separate legal entity
with limited liability. That case had a huge echo as it enabled the owner of a business to use
the corporate form as a shield against the liability for that business5. Consequently, basing on
that authority, the use of the corporate form was allowed also for small firms. That evolution
represented a fracture with the traditional understanding of company law. In fact, as yet, the
corporate form were solely justified to permit the massive investment of rentiersin a
business6. From that time onwards,the doctrine of limited liability was instead extended to
achieve completely different goals. Namely, it was applied to firms that, on the one hand, are
closely-held companies managed by fewshareholders; on the other hand, they don¶t refer to
the public to raise a capital for the business.

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 Another case in which the original scope of limited liability has been broadened is
represented by corporate groups. The last mentioned is characterized by the peculiar
relationship between a parent company and its several subsidiaries. Although the latterare
different entities from the former, they are substantially managed by it as it hasa relevant
holding of their shares.Nevertheless, pursuant to the concept of limited liability, the parent
company has not held liable for the debts of its subsidiaries and vice versa. Hence, once
again, that doctrine is used as a shield from liability and not to promote the investment into a
business.
As previously mentioned, English Courts have played a significant role in the
implementation of limited liability. In particular, that theory has been strictly applied, even
against fairness reasons. Therefore, the cases in which the corporate veil has been pierced are
few and residual7. In the opinion of the present writer, the å
case is an exemplar case
of that rigid jurisprudential approach for small firms. Instead, as regards corporate groups, the
example of the 
   
 
„
 
 casecan be given.8In that case, the Court of
Appeal has denied piercing the corporate veil against a parent company, arguing that the
creditors of its subsidiaries could have laid their claims against the former only if the parent
had owned all their shares (theory of the single economic unit).
The reaction of the statutory to the roughly exploitation of the corporate form was the
enactment of the fraudulent trading and the wrongful trading provisions (section 213 and 214
Insolvency Act 1986). Those measures are aimed at tackling directors¶misbehaviour.
However, they are proved to be difficult to apply and insufficient to curb the dishonest use of
limited liability9. Moreover, they don¶t address the problem of the moral hazard.
In conclusion, it has been shown that limited liability can be used in abusive ways too.
Therefore, in the next part of this paper, it will be analysed if that theory has still a positive
value. Otherwise, there would be no point in allowing its use by companies.


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 Ñ Do the advantages of limited liability outweigh its disadvantages yet?

As noted above, encouraging companies to embark on overly risky commercial decisions, at

the expense of their creditors, is the major drawback of limited liability. That moral hazard
will be analysed in depth in this paragraph and compared with the positive sides of limited
liability. In particular, that comparison will be made, firstly, with regard to public companies
and, then, with regard to private closely-held companies and corporate groups. By and large,
in this paragraph, it will investigated if that doctrine,after over one hundred years from its
enactment, can still create economic benefits for ³the economy and society as a whole´.10
Whereby, in the third paragraph, it will be tried to balance out limited liabilitywith the very
interest of social justice and fairness that it puts at risk.

     




As Goddard stated in its essay, ³business is all about risk´.11 Notably, each company is
interested by an ³unsystematic risk´ related to the various perils it has to face and that are
unique to that particular firm. 12

Goddard adds, in his analysis of corporate personality, that limited liability is an instrument
to reduce risk aversion and to ´encourage business to take socially desirable risks ± i.e. ones
which, while they involve a risk (even a substantial risk) of loss (even serious loss),
nonetheless have a positive net present value´. 13

So, according to that scholar, incorporation is a form of ³bankruptcy insurance´, protecting

the owner of the business from disastrous outcomes, by limiting exposure to an excess equal
to company¶s assets.

Goddard is not the sole author that outlines that investors try pursuing an above-average
return at the expense of greater risks.14Consequently, almost all the literature, applying that

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assumption to incorporated businesses, maintains that shifting the risk of business failure to
the creditors is one of the main (negative) features of limited liability.15

It has even been argued that,undertaking a risky investment, for an incorporated company
that it is going to face insolvency, is a rationale choice.16As a matter of fact, shareholders,
once the value of their investment is lost, are strongly encouraged to gamble with the funds
provided by the creditors of the company as they won¶t incur in any further liability.17In
addition, it hasbeen submitted that limited liability would unacceptably promote individuals
to makeover-investment in hazardous industries and offer a shield with regard to the claims
of tort victims.18

As a result, the concept of limited liability is remained very controversial in the juridical
literature. Some authors have requested, in turn, a total or a partial abolishment of that
concept.19 Others have tried offering different techniques to curb the moral hazard without
requesting the abolishment of limited liability.In particular, various strategies have been
proposed in favour of voluntary (trade creditors, institutional lenders, bond-holders and
employees of the company) and involuntary creditors (tort victims).Notably, in the opinion of
the present writer, especially the remedies in favour of voluntary creditors are notsatisfactory
and they will briefly analysed.

As regards that category of creditors, the main remedies offered to tackle moral hazard are: 1)
diversification; 2) screening; 3) contracting an higher yield.20

Diversification permits creditors to face the risk of default of a company in a better way by
granting credit to a big number of different debtors operating in different economic areas.
Thus, they can balance the loss incurred with one debtor with the profits obtained with

c
P Halpern, M Trebilcock, S Turnbull , ³An economic analysis of limited liability in
corporation law´, The University of Toronto Law Journal, Vol. 30, No. 2 (Spring, 1980),
140. (hereafter P.Halper et al., ³³An economic analysis´).!   0 Landers, A Unified
Approach to Parent, Subsidiary, and Affiliate Questions in Bankruptcy (1975) 42 U. Chi.
L.R. 589,
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others.In spite of this, it is submitted that not all voluntary creditors are able to manage this
mechanism. In particular, in the opinion of the present writer, only institutional lenders,
especially banks have the required organization to handle it. Instead, that instrument will be
more difficult to use by small traders who traditionally are more worried about the day-to-day
negotiations. Finally, the employees of the company can have strong difficulties to find an
alternative job in a short time.

Screening is the activity of ³acquiring information to determine the probability of a

default´.21 However, this activity is not only time consuming, but also very expensive. So it
would be rarely taken into consideration by the creditors of a company.

Finally, creditors couldcharge higher interest rateswhen dealing with incorporated

companies, so as the internalise the risk of insolvency of the company. Nonetheless, once the
credit has been granted, the company will unlikely be refrained from embarkingondifferent
and more risky activities that thosepreviously taken into consideration,by the creditor, at the
moment of the issuance of the credit.Hence, even this mechanism cannotefficiently tackle the
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As mentioned above, raising a capital between outsider investors is the main feature of
public companies. Notably, that effect would not be possible without limited liability. In fact,
on the one hand,rentiers would not be encouraged to contribute in a business whose activities
can put at risk their all personal assets. On the other hand, as outlined by Goddard,
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That is not the only positive consequence of the doctrine of limited liability.

As a matter of fact, that doctrine also reduces monitoring costs: due to the fact that there is a
limited liability for the debts of the enterprise, shareholders have no interest in monitoring the
directors¶ activity of the company. Consequently, they are exempted from those monitoring
costs and, more importantly, they are enabled to diversify their portfolio. In fact, one of the
weaknesses of the companies with unlimited liabilityis that, due to high monitoring costs,
shareholder are forced to stick to one or two firms. Instead, in the companies with limited
liability, shareholders can investtheir money in various companies for the very reason that
their personal assets will never be at stake.26

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From the beginning of this paper, it has been outlined thatthe use of limited liability has also
been allowed by Courts to pursue goals that are not consistent with its original aim:
encouraging individuals to engage in business activity. That is the case of private companies
and corporate groups.

As regards the former, a neat contrast between its structure and the mission of limited
liabilitycan be underlined. In fact, as above noted, private companies typically do not refer to
outsider investors to raise their capital. In particular, in that case, investors help to run the
company and they contribute to its growth.27 Consequently, shareholders usually have little
interest in selling their shares and they regard their investment as being long-term in nature.28

In particular, Freedman outlined that in the case of small firms (closely-held companies),
where shareholders are also the managers of the company, limited liability does not produce
any of the advantages above mentioned. Firstly, as regards the reduction of the monitoring

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J Freedman, "Limited Liability: large company theory and small firms" (2000) 63 MLR 328
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costs, it is stressed that they are, in any case, very low,as there are only few shareholders and
they can control each other. Secondly, it is outlined that the shares are not marketed, sothey
do not need to be controlled by the agents.29Thirdly, it is submitted that the very structure of
closely-held companies refrain their owners from diversifying their investments. In fact, they
will usually be required,by major lenders with a big bargaining power, to provide themselves
personal guarantees for the debts of the company. Consequently, they are forced to put all
their assets at stake and they cannot diversify their investments. Finally and more
importantly, Friedman stresses thatclosely-held corporation are typically inefficient risk
bearers. In fact, limited liability stimulates the owners to invest small sums of money in risky
commercial
activities and to massively rely on outsiders creditors. Thus, in that categories of companies
the risk is all shifted all to creditors and, especially, to small trade creditors.30
For those reasons, in the opinion of the present writer the recourse, by small firms-private
companies, to limited liability should not be permitted anymore as it is, with no doubt,
abusive.

It is submitted that the same result should be achieved also for corporate groups.

As noted above, the last mentioned are characterized by the peculiar relationship between a
parent company and its subsidiaries. Particularly, Hansmann and Kraakman have justified
that application of limited liability in that case through the ³assets portioning rationale´.
According to that theory, limited liability would facilitate the separation of the assets both in
a single company and in corporate groups. In the opinion of those two scholars, that
segregation of asset would even result in an advantage for creditors: the assets that could be
subjected to their claims would be clearly identified. 31

Nevertheless, that theory should be challenged. Notably, it has been objected that the
creditor monitoring costs increase with regard to corporate groups as between the members of
a group exist complex interconnected economic relationships.32Therefore, in my view,
corporate groups, even if they are not wholly owned by the parent company, are mainly
created, not for economic reasons, but to curb the liability of that company.33 In fact, the
point to be remembered is that, %   + ' %  %  
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In conclusion, according to the present writer, limited liability produces negative effects for
both small held companies and corporate groups and it should not be allowed anymore.


 


 




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 Ireland has underlined, the law on separate personality is intolerably unbalanced in favour
of the shareholders. They can sum up the advantages of this form (not only limited liability
but also, shareholders¶ primacy and control rights) while they don't have any responsibility
"for the losses arising out of corporate failure or the damage caused by corporate activities or
malfeasance´.35

Therefore, in the opinion of the present writer, as it is actually impossible deprive

shareholders of their power to manage a company (even a public one), an alternative solution
must be found to curb that form of ³corporate irresponsibility´ and, in the meantime, to save
the positive effects of limited liability.

In particular, it is submitted that limited liability can still have a beneficial effect for
economy and society recurring to a model similar to the French „
 
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The
last mentioned, is a partnership characterized by a neat distinction between active and
rentiers. Notably, while the former manage the business and they have an unlimited liability,
the latter only provide capitals and benefit from a limited liability regime.

In the opinion of the present writer, that model can be substantially applied also in a public
company. In fact, even in that corporate form, it is possible to distinguish between active
shareholders and rentiers. The former are those who substantially manage the company
through the directors they have nominated. Instead, the latter have only contributed capital to
the company. Thus, applying that model to incorporated companies, it would follow that
investors would maintain all the incentives, generated by limited liability, to confer their
money in that legal regime, while themanaging shareholders would be prevented from
gambling with creditors¶ funds as, in case of insolvency, their personal assets would be put at
stake.

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(draft), 13 Paper first delivered at the  
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„ „Conference, SOAS, July 2007

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 That modification of the doctrine of limited liability appears the only way to keep it and to
point it, not only to economic interests, but also to social ones.

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 onclusion

In this paper, it has been strived to argue against a complete abolishment of limited liability.
As noted above, limited liability represent a huge incentive to invest in businesses and thus, it
can contribute to foster economic growth. However, it has been underlined that that
beneficial effect is limited to public companies. Instead, it has been stressed that limited
liability is mainly used for abusive goals in the majority of closely-held firms and in
corporate groups. Consequently, in the opinion of the writer, there is no reason to allow its
application in those kind of companies. On the other hand, encouraging companies to
undertake overly risky commercial decisions, at the expense of their creditors, remain the
major drawback of limited liability even in the public companies. As a result, it has been
proposed to limit the use of that legal regime only for therentiers shareholders, so as to allow
them to keep on investing in listed companies. Instead, a residual unlimited liability of the
managing shareholders has been proposed to curb the risk of moral hazard. In that revised
structure, limited liability can still create economic benefits for ³the economy and society as
whole´,36 after over one hundred years from its enactment.

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