Original sins: limited liability
Untangling the limits of responsibility and irresponsibility
Liable: mid-15c., "bound or obliged by law," from Old French lier, liier "to bind, tie up, fasten, tether; bind by obligation" (12c.), from Latin ligare "to bind, to tie" - https://www.etymonline.com
Limited Liability: “means that the business owner or owners are only responsible for business debts up to the value of their financial investment in the business.” BBC Bitesize Business studies revision guide
Last week, Mark explored the idea of incorporation - the process of setting up a legally separate “corporate body” to act on behalf of a group of people. Over the years, the attribute of “limited liability” has become seen as one of the key characteristics of the corporate body. Today we’re going to delve into what limited liability is, what benefits and challenges it creates, and think a little about what alternatives might exist.
So, what does it actually mean?
In essence, as BBC Bitesize points out, when you own (or hold shares in) a limited company, your responsibility for the debts of that company is limited to the amount you put in in the first place. This only really comes into play when a company is being dissolved, or has gone insolvent - you as an individual owner or shareholder can only be pursued by people your company owes money to up to the amount of your initial investment. You can only lose what you put in1.
In the case of not-for-private profit organisations like charitable companies, community interest companies or charitable incorporated organisations, the same principle applies: but because these corporate bodies don’t have shareholders their constitutions often say that members will put in a nominal amount (usually £1) on the winding up of the company to pay any debts.
On the other hand if you are a sole trader, or in an unincorporated partnership, trust or association, and you go bust owing people money, they will be able to pursue you and the rest of your wealth to recover what you owe. You don’t have the shield of a corporate body to protect you. I would always advise a community organisation that is about to do anything with even the tiniest bit of risk (employing people, entering into contracts, anything to do with buildings or land), to incorporate for this reason.
Incorporating in order to limit your liability therefore obviously has huge benefits for people who want to start businesses or projects. It allows you to take risks that you couldn’t (or most people with average amounts of money couldn’t) as an individual.
Much mainstream wisdom paints limited liability as an absolutely fundamental part of company law, both in the UK and globally, summed up nicely in 1911 by future winner of the Nobel Peace Prize (and Nazi sympathiser 😬), Nicholas Murray Butler:
‘I weigh my words, when I say that in my judgment the limited liability corporation is the greatest single discovery of modern times … Even steam and electricity are far less important than the limited liability corporation, and they would be reduced to comparative impotence without it’2
But we wouldn’t be looking at this if it wasn’t also a part of the weirdness of most organisations - and potentially a contributor to some of the large scale systemic fuckedness that we are all facing.
On an organisational level, limited liability allows the founders of a company to displace risk - both onto their future creditors (people they owe money to) but also onto the staff of an organisation and the people it serves. Those with power to make decisions - the board - in theory also hold the responsibility for the organisation but in practice are to a large degree protected from the financial consequences of their actions. If they mismanage their funds it tends not to be their livelihoods at risk. This core of power imbalance creates a kernel of weirdness at the heart of many organisations (and has been interestingly explored by Dark Matter Labs here).
On a systemic level, the legal acceptance that corporations are people (which Mark will delve further into next week!) means that limited liability extends to companies that own other companies. This can create fractal nests of “corporate irresponsibility” where companies can escape liability for debts their subsidiaries have incurred3.
But despite all of these challenges, isn’t limited liability too important to mess with? Given the interlocking challenges we face, we need institutions that enable us to act collectively, and sometimes those institutions will need to take risks. Isn’t it right - and necessary - to protect the people taking the risks?
There is unsurprisingly a wealth of academic literature on this, and we might get to dig further into some of the nuances of these arguments as Corporate Bodies develops. But it does seem (and is interestingly argued by Ron Harris in this article) that limited liability in the modern sense was maybe not as crucial to economic development as we might have thought. Paddy Ireland also points to other models such as the 19th Century French société en commandite where passive investors benefited from limited liability but active managers had unlimited liability.
I find this all quite exciting. What are the spectrums of liability that we might need to grapple with the challenges we face? There’s a grown up conversation to be have about risk, responsibility and the balance of liability holding that we need in the future. Any thinking about the future of the company has to include being willing to unpick our assumptions about the role and importance of limited liability. We can’t have an honest conversation about power and control without it.
If you have experience of the oddness of limited liability - or any other organisational weirdness - you’d like us to include in our forthcoming podcast, please drop us a voicenote here. We’d love to hear from you!
obviously if you are being actively criminal or fraudulent (and you are caught), then criminal proceedings might confiscate more of your wealth…
quoted in Ron Harris’s 2020 article “A new understanding of the history of limited liability: an invitation for theoretical reframing” - accessible here
In the same article, Ron Harris wonders whether the change in the investment banking sector from partnerships with liability to debts to a full limited liability model in the 1970s-1990s might have been a contributing factor to the 2008 financial crisis - this stuff has real life implications!