Limited Liability Company

Introduction:

As the name itself defines a limited liability company is the company where the shareholders liability towards the loss or deficit is limited by shares. Here the only investment a shareholder does is by investing to buy the shares distributed. And in any case the company collapses or goes bust then the shareholders do not have to use their personal property or balance to cover the loss. Shareholders have limited and determined risk in the company. The main idea behind this is that the legal behaviour and the performance of a company are different from that of its members or partners. The main aim of this system is to give the investors minimum insurance in the business over their own personal lives. Therefore only the amount paid for the shares and the value of the investment are at risk without taking into consideration of his personal wealth and belongings. In a company which is incorporated with limited liability status where ownership is divided into shares that were paid fully at once by its shareholders will not be liable for any debts of that company. Incorporation by registration was introduced in 1844 and the doctrine of limited liability followed in 1855. Subsequently in 1897 in Solomon v. Solomon & Company the House of Lords effected these enactments and cemented into English law the twin concepts of corporate entity and limited liability. In that case the apex court simply laid down that a company is a distinct legal person entirely different from the members of that company. What this means is that the company has life of its own, can own property, can sue and be sued in its own name, has perpetual life and existence to name a few of the benefits of incorporation. It is a trite law that a rather hefty veil is drawn between these two that can be lifted only in a limited number of circumstances that seem to be fluctuating according to current judicial thinking. However the courts have not always applied the principal lay down in Solomon v. Solomon & Co. In a number of circumstances, the court will pierce the corporate veil or will ignore the corporate veil to reach the person behind the veil or reveal the true form and character of the concerned company. The rationale behind this is probably that the law will not allow the corporate form to be misused or for the purposes which is set out in the statute. In those circumstances in which the court feels that the corporate form is being misused it will rip through the corporate veil and expose its true character and nature disregarding the Solomon principal as laid down by the House of Lords.

Salomon v Salomon & Co Ltd

Where a sole trader (A. Salomon) turned his leather making business into a company (A. Salomon and co. Ltd.) later company collapsed, the creditors tried to enforced their debts from Mr. Salomon himself. The very facts of the case was that Mr. Salomon has sold his business to a company that he formed for £40000 in return of the fully paid up share to himself and his family members £20000 in form of shares(£1 per share) among its family members. Company issued him debentures of £10000 and rest £10000 in cash. Mr. Salomon become debenture holder, shareholder and he was director of the company. At the time when company collapsed and went into liquidation, Mr Salomon won his claim to be paid off in priority to other creditors, as secured debt ranked at a higher priority to those debts and successfully proved that he did not have to indemnify the company in respect of its debt, as it had a separate legal personality. [1] There was no fraud was involved, the court found that Mr Salomon was not personally liable for the company’s debts. The principle of separate identity is today known as the veil of incorporation and allows higher parent companies to own subsidiary companies, yet not be responsible for many of their liabilities. Where owners of companies are unable to claim the protection of separate identity, for instance in the case of fraud, this is referred to as lifting the veil.

Advantages of a limited company

“Limited liability does not provide rational encouragement to business initiative but rather, by eliminating the fear of incurring personal liability, gives an unbalanced incentive to risk taking.”

The above statement clearly indicates that a shareholder or investor takes the risk only at the initial stage of investment. The concept of the company about the liability of the investors in case of loss which is zero encourages investors to invest which in turn helps for the economic development. Whilst many businesses prefer to trade as a sole trader or a partnership, nearly all significant businesses operate as an incorporated company. The main advantages of incorporation via a limited company are summarised below:

Separate Legal Identity

A limited company has a legal existence separate from management and its members (the shareholders). This separate legal entity helps promote stability and peace of mind for new investors and existing investors as well.

Members’ liability is limited (“limited liability”)

The protection given by limited liability is perhaps the most important advantage of incorporation. The members’ only liability is for the amount unpaid on their shares. Since most private companies issue shares as “fully paid”, if things go wrong, a members’ only loss is the value of the shares and any loans made to the company. Personal assets are not put at risk. The protection of limited liability does not, however, apply to fraud. Company directors have a legal duty not to incur liabilities in their companies which they have reason to believe the company may not be able to pay. If creditors lose money through director fraud, the directors’ personal liability is without limit.

Protection of Company Name

The choice of company names is restricted and, providing a chosen name complies with the rules, no-one else can use it. The only protection for sole traders and partnerships is trademark legislation.

Continuity

Once formed, a company has everlasting life. Directors, management and employees act as agent of the company. If they leave, retire, die – the company remains in existence. A company can only be terminated by winding up, liquidation or other order of the courts or Registrar of Companies.

New Shareholders and Investors can be easily introduced

The issue, transfer or sale of shares is a relatively straightforward process – although existing shareholders are protected via their “preemption” rights and by company legislation that seeks to protect the interests of minority investors. The process of lending to a company is also easier than with other business forms. The lending bank may be able to secure its loan against certain assets of the business (a “floating charge”) or against the business as a whole (“fixed charge”.

Better Pension Schemes

Approved company pension schemes usually provide better benefits than those paid under contracts to self-employed sole trading businesses.

Taxation

Sole traders and partnerships pay income tax. Companies pay Corporation tax on their taxable profits. There is a wider range of allowances and tax-deductible costs that can be offset against a company’s profits. In addition, the current level of Corporation Tax is lower than income tax rates. [2]

Economic advantages to shareholders

The commercial significance of limited liability cannot be overstated: In Re London and Globe Finance Corporation Ltd, Buckley J declared ‘’The statutes relating to limited liability have probably done more than any legislation in the last fifty years to further the commercial prosperity of the country. They have, to the advantage as well as of the investor as of the public, allowed and encouraged the aggregation of small or comparatively small sums into large capitals which have employed in undertakings of great public utility, largely increasing the wealth of the country’’. [3]

The main advantage is often limited liability company to shareholders or investors can be economically beneficial with less risk involved can be explained in greater detail on the principal of economic efficiency.

In LLC there is a less requirement for the shareholders to monitor the activities and acts of the managers and directors of the companies. The main part of them is to invest into the company because there are limited financial consequences of company failure.

The permission of efficient diversification by shareholders is provided in limited liability. This diversification in turn allows shareholders to reduce their personal risk. If a principle of unlimited liability applied and the shareholder could lose his or her entire wealth by reason of the failure of one company, shareholders would have an incentive to minimize the no. Of shares held in different companies and insist on a higher return from their investment because of the higher risk they face. Consequently, limited liability not only allows diversification but permits companies to raise capital at lower costs because of the reduced risk faced by shareholders. This diversification acts as insurance policy to shareholders as all the risk are undertaken by the third parties or creditors.

Limited shareholder liability may facilitate cost-effective diversification. In a truly unlimited liability regime, diversification may increase rather than reduce investor risk, since a single investment could result in the loss of all of an investor’s assets. [4]

Limited liability facilitates optimal investment decisions by managers and directors. As we have seen, limited liability provides incentives for shareholders to hold diversified portfolios.

Disadvantage of a limited liability company

Limited Liability has certain disadvantage but these don’t have huge impact on the investors. The advantages overweigh the disadvantages. A Limited Liability Company should have at least two members. However, there are some states that allow a single member Limited Liability Company, although the company is not allowed to elect partnership classification for the purpose of federal tax.

Earnings from a Limited Liability Company are subject to self-employment tax.

It is quite possible the state law might limit the duration of the Limited Liability Company.

If the company allocated more than 35% of the losses to non-managers, it may lose its cash accounting method.

Some states across the U.S. do not tax partnerships but end up taxing Limited Liability Companies.

A Limited Liability Company gets lower minority discounts for estate planning when compared to a corporation. Invariably, the minority discount is around 15 percent while corporations get between 25 percent and 40 percent.

If 50 percent or more of the capital and profit interests are sold within a period of 12 months, the Limited Liability Company is terminated for the purpose of federal tax. This is in the case of partnership.

A Limited Liability Company cannot offer incentive stock options.

There is no uniformity in the statutes governing Limited Liability Companies across the U.S. This means that if a company operates in more than one state, it could be treated differently in different states.

If you convert your existing business to a Limited Liability Company, you could incur taxes on the appreciated assets. [5]

Lifting Corporate Veil

Lifting the corporate veil means where the court has authority to pierce or lift the veil in the light of justice. To provide rational encouragement to business initiative which has taken by its investors or shareholders? The main purpose of the lifting is to sue the company in its own name because its being used for other purpose rather than doing business in the right manner. The purpose is fulfilled by the courts who do have the authority. Thats the only remedy to shareholders and creditors after the company being liquidated or goes into administration due to heavy losses it suffered. The circumstances in which courts can lift the veil of incorporation are discussed below.

Fraud

The courts have been more that prepared to pierce the corporate veil when it fells that fraud is or could be perpetrated behind the veil. The courts will not allow the Solomon principal to be used as an engine of fraud. The two classic cases of the fraud exception are Gilford motor company ltd v. Horne and Jones v. Lipman .

In the first case, Mr. Horne was an ex-employee of The Gilford motor company and his employment contract provided that he could not solicit the customers of the company. In order to defeat this he incorporated a limited company in his wife’s name and solicited the customers of the company. The company brought an action against him. The Court of appeal was of the view that “the company was formed as a device, a stratagem, in order to mask the effective carrying on of business of Mr. Horne” in this case it was clear that the main purpose of incorporating the new company was to perpetrate fraud. Thus the court of appeal regarded it as a mere sham to cloak his wrongdoings

Agency

In the case of Bodrip v. Solomon Justice Vaughan Williams expressed that the company was nothing but an agent of Solomon ” That this business was Mr. Solomon’s business and no one else’s; that he chose to employ as agent a limited company; that he is bound to indemnify that agent the company and that this agent, the company has lien on the assets………” however on appeal to the house of lords it was held that a company did not automatically become an agent of the shareholder even if it was a one man company and they other shareholders were dummies.

A company having power to act as an agent may do so as an agent for its parent company or indeed for all or any of the individual members if it or they authorize it to do so. If so the parent company or the members will be bound by the acts of its agent so long as those acts are within actual or apparent scope of the authority. But there is no presumption of any such relationship in the absence of an express agreement between the parties it will be difficult to establish one. In cape attempt to do so failed. Incases where the agency agreement holds good and the parties concerned have expressly agreed to such a agreement them the corporate veil shall be lifted and the principal shall be liable for the a acts of the agent.

Trust

The courts may pierce the corporate veil to look at the characteristics of the shareholders. In the case of Abbey and Planning the court lifted the corporate veil. In this case a school was run life a company but the shares were held by trustees on educational charitable trusts. They pierced the veil in order to look into the terms on which the trustee held the shares.

Tort

Usually the English courts have not lifted the veil on the ground of tort it is a phenomenon not witnessed in most common law jurisdictions apart from Canada

Enemy character-

In times of war the court is prepared to lift the corporate veil and determine the nature of shareholding as it did in the Daimler case where germen shareholders held the shares of an English company during the time of world war 1.

Tax-

At times tax legislations warrant the lifting of the corporate veil. The courts are prepared to disregard the separate legal personality of companies in case of tax evasions or liberal schemes of tax avoidance without any necessary legislative authority.

d) Misdiscription of the company

Section 349(4) of the companies act provides that if any officer of the company or other person acting on its behalf

Signs or authorizes to be signed on behalf of the company any bill of exchange, promissory note, endorsement, cheque or order for money or goods in which the companies name is not mentioned in legible letters..He is liable to a fine and he is personally liable to the holder of such as mentioned above.

e) Premature trading.

Another example of personal liability is section 117 (8). Under this section a public limited company newly incorporated as such must not “do business or exercise any borrowing power” until it has obtained from the registrar of companies a certificate that has complied with the provisions of the act relating to the raising of the prescribed share capital or until it has re-registered as a private company. if it enters into any transaction contrary to this provision not only are the company and it’s officers in default ,liable to pay fines but it the company fails to comply with its obligations in that connection within 21 days of being called upon to do so, the directors of the company are jointly and severally liable to indemnify the other party in respect of any loss or damage suffered by reason of the company’s failure. [6]

Case Study

Fall of Empire Direct Plc.

It was an electrical retail business in U.K. which was formed in 1982. Company had its headquarters in the former Clock Buildings Cinema on Roundhay Road (A58) in Harehills (Harehill’s Corner). Company had 350 employees.

Administration

Company went into administration on 19 January 2009, 158 of the 350 employees were made jobless. KPMG being appointed as administrators.

In a statement issued by KPMG, joint administrator Mark Firmin said, “Empire Direct has been severely affected by the economic downturn and experienced a significant reduction in sales from the middle of last year. In addition, the business really suffered when credit insurers withdrew cover in October. Low stock levels and operating losses mean the business cannot continue to trade in administration.” [7]

Conclusion: It was limited company and due to losses it went into liquidation due to which its employees had to suffer the losses and become jobless whereas no effect seen on the faces of who formed the company. After all in a limited company the loss has to suffered by the shareholders and employees.

Fall of MFI

It was founded in 1964 as Mullard furniture industries by two British men. It became public company in 1971. On nov 2008, the BBC first reported the possibility of MFI going into administration. The furniture retailer had ceased down its business and close down due to which 1400 people become jobless who were employees of MFI. The company went into administration after the business had failed to sell. MFI went into administration in November as the downturn in the housing market took its toll on demand for new kitchens and bedrooms. Sales had fallen in recent years due to competition from rivals such as Ikea. The administrators MCR could not say what redundancy payments would be made to the staff who had lost their jobs. [8]

Conclusion

The Limited liability Company is a venture developed by the members, where an operating agreement is established for the smooth and flexible running of the business. This allows for greater flexibility without the formalities, such as Board of Director meetings, which are imposed on a corporation. The advantage of limited liability if seen in the real sense has provides the aggregation of small or comparatively small sums into large capital by the undertakings of great public utility(formation of limited companies) is largely increasing the wealth of the country. The evolution of limited liability so far indicates that it is a stronger contracting tool and financing device. It can be said that limited liability is also an efficient economic tool. The main aspect or benefit of LLC is that t provides personal liability protection for members as a result of which he faith and confidence in investing grows higher. And yes a lot of LLC have been established and has contributed towards the economic development of the country. Again there is no need to meet the requirements and formalities of a corporation to maintain the business status. In Limited Liability Company every member’s ideas and potential is valued and taken into account where members can draw up their own contract, allowing for flexibility in management and responsibilities. This enables in the establishment of a working and powerful management. At present world where the economic crisis has been a major problem, development of LLC in various field can greatly increase the power to tackle the economic problems.