Yves here. While this Richard Murphy post correctly fingers the considerable cost of the limited liability regime, omnipresent in modern commerce, he doesn’t suggest a way out. And that’s because the existence of very large enterprises depends on it. No one would be the CEO or sit on the board of an entity of any size if they might be personally liable, particularly since those with the deepest pockets would be cleaned out every bit as much as say a community leader with little net worth. This is why, even with limited liability to shield corporate big wigs, companies of any size also buy directors and officers insurance to further protect those nominally in charge from the consequences of their bad actions or negligence.
Murphy suggests a teardown. This is simply na ga happen. But there are a couple of things that are not totally impossible, just vanishingly unlikely, that could do a lot to make corporate managers and boards more accountable and reduce the dangers and unfairness of our current “heads I win, tails you lose” legal regime.
When I was in Oz (early 2000s) and I believe that standard also applied then in the UK, board members were personally liable if a company was found to be “trading insolvent” as in incurring expenses or other expected liabilities it could not pay. This at a minimum led board members to watch company books, costs, and commitments pretty carefully. And they would put a company into bankruptcy pronto if they thought it was about to stray into “trading insolvent” terrain.
Having said that, it seems just about certain that Big Cos even under a “trading insolvent” stricture buy directors’ and officers’ insurance to shield the higher ups, so this by itself is not much of a remedy.
Second would be to implement a regime suggested, by of all people, former New York Fed president and Goldman Sachs partner to give top executives what Taleb would call skin in the game by making them retain bonuses (which would be defined as anything over a not-all-that-high base pay level), other incentive comp, and deferred pay in the company, for say at least five years. That is the time frame Warren Buffett has long used for executives in his reinsurance business. Buffett does that to make sure any problems with the policies his top team has written have shown up and been charged off before he gives them their profit participation pay. Otherwise he would be at risk of rewarding execs for income not actually earned.
The XX version of this scheme would be for this pool to serve as subordinated equity. It would pay out first in the event of a major litigation loss or insolvency.
An additional approach would be to end the limits on secondary liability. In the US, astonishingly, shareholders and creditors can’t sue lawyers and accountants who gave bad advice that led to a company failing or suffering large losses. Only their client, as in the board or executives, can. As we wrote in ECONNED:
Legislators also need to restore secondary liability. Attentive readers may recall that a Supreme Court decision in 1994 disallowed suits against advisors like accountants and lawyers for aiding and abetting frauds. In other words, a plaintiff could only file a claim against the party that had fleeced him; he could not seek recourse against those who had made the fraud possible, say, accounting firms that prepared misleading financial statements. That 1994 decision flew in the face of sixty years of court decisions, practices in criminal law (the guy who drives the car for a bank robber is an accessory), and common sense. Reinstituting secondary liability would make it more difficult to engage in shoddy practices.
Now to the main event.
By Richard Murphy, part-time Professor of Accounting Practice at Sheffield University Management School, director of the Corporate Accountability Network, member of Finance for the Future LLP, and director of Tax Research LLP. Originally published at Fund the Future
Post summary
Limited liability is a privilege that protects directors and shareholders from personal consequences when their companies incur debts. Historically this has facilitated economic growth by enabling capital accumulation, but is it now fair when it might be overly exploited, particularly by small companies?
In this morning’s video I note that we’ve had limited liability companies in their current form for about 170 years now, but no one back then imagined we’d have more than five million of them. So, are we really doing the right thing giving limited liability to anyone who asks for it now, or should we be more circumspect?
The audio version of this video is here:
The transcript is:
Limited liability is a privilege.
It’s one I’ve enjoyed on many occasions throughout my career because I’ve been a director of quite a lot of companies over the last 40-plus years. They were put in place to undertake an economic activity and we were protected as directors, as shareholders – and I’ve been both – from the consequences of our actions by the existence of limited liability.
Limited liability was a creation that was first known about in the Elizabethan era, but in its modern form, it was created in a way that is readily available to everyone from about the 1850s onwards, when in the UK, companies were first allowed to be registered with limited liability by the prospective shareholders getting together, signing a document to declare that they wished to be a company, applying to have limited liability, and being granted it by a registrar.
That registrar still exists. It’s called the Registrar of Companies in the UK, and they run something called Companies House, which still records all those companies which enjoy this privilege of limited liability which enjoy this privilege of limited liability to this day. There’s over 5 million companies that have that privilege right now.
But I stress this is a privilege. And when you think about it, it is a totally absurd privilege. Just imagine that today somebody came up with this idea that one or two people – and one is enough – can sign a piece of paper and say that they want to be a limited liability company and as a consequence if something goes wrong in the trade that they undertake then, in the vast majority of circumstances, they will not be responsible to the creditors of the company that they have created for the debts that it has incurred, even though those creditors, whether they be employees, or suppliers, or a tax authority, have incurred liabilities with that company in good faith. Everyone would say that this was an abuse of the rights of those employees, those creditors, and that tax authority. And they would be absolutely right to do so, because limited liability is an abuse of the rights of those people.
What it says is that all those people who trade in good faith with the company might be taken for a ride as a consequence, and lose their money, and have very little, and in some cases, no right of recovery whatsoever. And that’s okay. The shareholders can walk away, the loss is suffered by somebody else, and society supposedly benefits.
Well, the truth is that society probably has benefited from the existence of limited liability overall. There is evidence that this capacity to create limited liability companies has permitted the accumulation of capital from a wide range of sources to create undertakings that could otherwise not have existed.
For example, the railways of the UK would not have been built without the existence of limited liability companies, and many other large companies ever since have accumulated capital in this way, and overall, we’ve probably benefited as a result.
But the concept is still used, and well over 95 percent of all companies are tiny, run by one or two people at most these days. Do they need limited liability? Should they be protected from the consequences of their own actions, which only they know about, especially when the accounts that they have to put on public record are very limited in scope and aren’t available until nine months after their year-end, meaning that everyone who is trading with them is at significant risk most of the time.
Is that privilege something that we should still provide to everybody who asks for it? Or should we regulate its availability a lot more tightly?
Should we, for example, make this privilege of limited liability available to people even with regard to their tax liabilities? Why should we do that?
Should we make it available with regard to the obligation that people have to their employees? Why should we do that?
And is it fair to do this with regard to trade creditors as well? People who genuinely supply goods and then lost their money as a consequence.
These are genuine questions that need to be answered because this cost is imposed on society at large. And there’s no real evidence, especially when it comes to smaller companies, that the benefit is significant.
There is ample evidence that the benefit is abused. We do know that there are many companies that are created that never account for what they do.
We do also know that maybe 30 per cent of small companies don’t pay their corporation tax liabilities, and in that case they probably don’t also hand over the VAT that they owe and the PAYE that they also have owing to HM Revenue and Customs in regard to their employees and the deductions that are payable by them.
Do we, therefore, want to do this?
I ask the question in all seriousness because I think the assumption that limited liability is a universal good thing is something that we need to challenge now.
The time has come to question whether we need fundamental reform of the availability of limited liability to make sure that it provides a benefit to society and not a cost.
With regard to business dealings, the marketplace is reasonably efficient in dealing with corporate shenanigans, although the asymmetric lemon problem does distort investment decisions. But the worst (and correctable) problem with limited liability is the popular distortion that extends it to individual managers who command clearly criminal offenses. We need prosecutors who pursue these offenses, and laws that exact extreme financial penalties on corporations that refuse to fully cooperate with investigations of their managers.
Yah, “we” mopes all see how well libertarian-approved “market forces” are “reasonably efficient” at dealing with ever larger and more powerful mega corporations’ “shenanigans.” As if ever larger abuses of the power of concentrated wealth and wholly-owned government institutions that “legitimize” abuses by “enacting” all that “legislation” and “regulation,”drafted by corporate minions, that makes the predators’ behavior “all nice and legal,?see?”
In keeping with the libertarian manifesto, “we” just need enforcers who will jail and fine the individual corporate officers who violate those “corp-controlled laws” that somehow are going to mark all the “clearly criminal behavior” that no longer is proscribed by the Corp-controlled agents of “legitimacy.” Refer to the Powell Memorandum if it’s not clear how it works.
So there’s no longer any effective prosecutors to go after any real or legal persons, see, eg, Kamala Harris, and the FBI and DoJ. And “extreme financial penalties” on corps, but only for not cooperating with the investigations that pretty much don’t exist? Cost of doing business, added to the price the mopes pay for their necessities.
A long time ago, corps had to regularly demonstrate that their limited liability was justified by performing a public good. https://reclaimdemocracy.org/corporate-accountability-history-corporations-us/ There was even a death penalty, in rescission of the corporate franchise and charter, for really bad actors. Corps early on figured out how to dodge that, by getting big and rich enough to buy the government.
The notion that “the market efficiently does ANYthing” other than accelerate accumulation of wealth and concomitant power is kind of laughable. As in “Because Markets,” and “Just die.”
Small hope that maybe the Russian formula of public and private inter operation, or the Chinese model, both of which have effective “severe sanctions” for misbehaving oligarchs and corrupt government officials, might spread, and the neoliberal libertarian political economy might die off along with the “liberal Western order.” Small hope, given human nature as demonstrated by our history..,
1. Volunteer boards typically do not have the shield of insurance or other measures due to cost. Trying to be a good community member comes at added risks.
2. Lenders should implement a variation of that Buffett plan, so that their loan officers do not just waltz off with an incentive check and avoid consequences of what turn out to be bad loans with hidden or concealed problems that surface later. Ninja loans got some post-GFC treatment, and other asset lending should too.
Important post.
I agree with the introductory comments, but it’s key to emphasize that Limited Liability prior to the Obama/Holder Doctrine of Too Big to Fail did not shield corporate officers and directors from criminal liability, in particular for fraud. The Obama/Holder Doctrine continues to grant officers and directors complete impunity.
Once upon a time, Limited Liability was only intended to protect shareholders’ personal assets from the failure of a business in which they had invested. The use of the formerly frowned-upon practice of granting stock options as executive compensation twisted the “corporate veil” to protect officers and directors, who have now become the major shareholders of many corporations, against liability for their looting, theft, and fraud.
Of course, part of the appeal of stock as compensation is the unconsionable “special” personal income tax treatment for so-called “capital gains” and the so-called “Carried Interest Rule” that gifts managers of other people’s money the same “special” tax treatment. Special tax treatment for “capital gains” to supposedly lure investment came from ignorance of the first rule of being wealthy: never spend principal.
Given the ascendency of the Powell Memorandum through our Clintonite system of Inverted Totalitarianism it is highly unlikely that the abuse of corporate limited liability will change through any sort of legislation for the foreseeable future. A “tell” about Kamala is the presence of those two craven corporate toadies Eric Holder and Tony West as her top advisers.
All PFAS roads lead to 2 companies. What did they know and when did they know it?
Based on the 3M documents I’ve seen while working on the 3M mitigation project in MN, they knew a lot more and a lot earlier in the game than they’ve admitted.
Seeing that I’m working on this project, that’s all I’m willing to say.
The advantage of limited liability is that it allows for combinations of private capital on a scale which prior to the corporate era would require government. Which means private capital can complete large projects that previously would require the State. If you are not a Stalinist, then presumably there are large projects that you would want done that you believe the government wouldn’t/couldn’t/shouldn’t get involved with.
That being said, if someone is operating in a control position, or someone is an employee, and they are committing criminal offenses “under color of corporate charter”–there is no reason why the law should protect them.
As far as on the small side of things, limited liability is used as creditor protection. Assets in one company, operations out of another, etc. If you get rid of it, people would just put the assets in their spouses names and operate under there name (e.g. easy to loophole). Big question about what kind of protections are afforded debtors as far as policy.
As an aside, I saw an interesting graph on bank failure rates in 19th century America in “progressive” jurisdictions where women could own property, and “regressive” jurisdictions where women could not. Bank presidents who could not put assets in their wives’ names were much less likely to make decisions which led their banks to fail. So incentives matter, its just how do you set up the right ones and prevent loopholes. Its hard to defend the existing corporate governance model.
a cousin runs a construction outfit…just him, and all the folks in his rolodex that he subcontracts out to.
he got an LLC to mitigate child support…which, to be honest, in this case, was egregious and being used as a weapon by his ex.
LLC owns stuff…he doesnt.
LLC gets income…he doesnt.
on paper, he’s as poor as i am,lol.
and myself…i finally cajoled mom into getting this place in a trust…takes effect when she kicks off(“ding, dong…”)
similar thing…me and the boys wont technically own anything.
but like my cousin, i’m doin this to protect us from idiotic government things(medicaid clawbacks) and being sued if a guy mowing the lawn steps on a mesquite thorn(cousin and i both have a moral sense to do whatever we can for anybody that gets injured on our watch)….Not, otoh, to avoid legitimate debts(almost no debts, anyway) and obligations.
neither of us made the world we live in…nobody ever asked us,lol…we just live in it.
i’ll happily use the tools of the oppressors to do good…which includes protecting me and mine.
sad little king, on sad little hill, and all…but this was baked into the neolib catechism from the get-go…hyperindividualisation+”theres no such thing as society”+every human an Enterprise+ destruction of all civic institutions, formal and especially informal(bowling alone)=> Hobbes’ “Bellum omnium, contra omnes”.
“We didnt start the fire…”
A couple of anecdotes:
When my father ran his company in Sweden and was about to renew a loan for his limited liability company then the bank asked him to become a personal guarantor of the loan – effectively negating the limited liability. Luckily for him it was a renewal so he could refuse and the bank had to decide whether or not to refuse the renewal and put his company in liquidation and therefore be guaranteed a loss or extend the loan without personal guarantor.
When I worked for a bank more than a decade ago then I did what that bank did to my father – I asked for a personal guarantee and it got signed effectively ending the limited liability.
Trading while insolvent laws/rules seems to only apply to small businesses. From the outside this looked like a case of trading while insolvent:
https://www.theguardian.com/business/2018/jul/09/carillion-collapse-exposed-government-outsourcing-flaws-report
Maybe it was investigated and ruled out, I just know that at the time I thought it looked at least borderline to be a case of trading while insolvent.
As far as I can tell the only benefit of making it easy to set up limited liability companies is for setting up lots of shell companies to facilitate financial shenanigans. Among those financial shenanigans I’d count the examples listed above in the article about not paying taxes. But the powers that be somehow don’t see it that way, they see it as making it easier for the young entrepreneur.
I do like the idea/theory of limited liability but in current practice then I’d say there is a lot that needs to be improved.
Possibly SOX (https://corpgov.law.harvard.edu/2022/08/30/the-important-legacy-of-the-sarbanes-oxley-act/) might do some good but again in practice it doesn’t seem to work that well.
well said, Jesper…i reckon its the “Limited” part that needs work,lol.
cant sue Exxon, or whatever…because theyll bury you in the literal bodies of lawyers,lol…
and TBTF, like Yves pointed out, is an obvious discontinuity in this line of thought.
but i figger thats just more evidence of Dems becoming/having become the liberal wing of the GOP,lol….i remember gop senators, long ago…using “small business” when they really meant McDonalds….because of legal definitions, of course.
so they werent “lying”…ha!
but whatever…us little people are all but screwed in this system…and They aint gonna change it to help us’n’s…so we gotta help ourselves with whatever tools and methods they leave laying around.
this LLC thing is one of those.
i had a nail…they left a worn out ball peen on the side of the road.
As a small environmental consulting business owner, the limited liability allows my small business to exist. Full professional and general liability insurance for working in (literally) drinking water supplies and contaminated sites while responsible for heavy equipment would be 50%+ of my gross revenue. Dropping that to 8-10% to provide minimum coverage and relying on that shield allows my little company to exist, and even then I’ve had projects where the project insurance cost more than I billed.
Large companies enjoy a huge economy of scale for this kind of insurance. The absolute cost gets bigger but the % gets a lot smaller as an engineering/environmental firm gets larger.
limit liability like qualified immunity, is a get out of jail free card that encourages criminal negligence and criminal activity.
Even without limited liability (Amazon’s board of directors probably doesn’t lose sleep over the idea of an Amazon bankruptcy), there are still the many problems of corporate personhood, and the bill of rights applying to corporations. That should be done away with too. “But that would make it impossible for corporations to own property!”. No it wouldn’t. Anything corporations can do would simply be a privilege created by legislation, rather than a right like humans have. By analogy, there is no 2nd amendment in Canada, so there is no automatic right to own a gun, but hunting is popular there and lots of Canadians do own guns, because the elected Canadian parliament has written laws keeping it possible.
“The Corporation” (2003) is a terrific movie. It argues that if corporations were people, they would be diagnosed under DSM-III criteria as psychopaths. It looks to be online: https://www.youtube.com/watch?v=6v8e7dUwq_Q
that was an excellent primer on that subject.
made wife and both boys watch it…prolly need to do it again, now that theyre adults.
Richard Murphy is talking about limited liability in the UK and he seems rather confused.
The key point is that limited liability, in the case of a company limited by shares, limits the liability of a shareholder to creditors of the company to the amount of capital he subscribed. That’s it, nothing more or less.
For completeness, in the UK it is also possible to form a company limited by guarantee, where there is no share capital or shareholders but the liability of the guarantors is limited to their guarantee. Finally, it is still possible in the UK to form an unlimited company (NB Michelin tyres is an unlimited French company, which allows the Michelin families complete secrecy. I believe Hermès may be one too).
Weirdly, Murphy’s complaint is not directed at the too big to fails, which Yves rightly points out will never surrender limited liability despite the global financial crisis highlighting the risk their one way bets, heads I win tails you lose, pose to society. Murphy instead attacks small companies, typically owner-managed companies. He complains that too many of them do not pay their taxes or creditors and he complains that the management hide behind limited liability.
But this is nonsense. Shareholders benefit from limited liability in that they cannot be compelled to subscribe more capital to pay the company’s debts, including taxes. Managers do not have limited liability. As Yves recollects correctly, certain acts by the directors entitle wronged parties to act against the directors personally (“pierce the corporate veil”). Trading while insolvent is one of these matters.
The fault is not law, it is the lack of prosecutorial zeal by HMRC and the Department of Business to bring wrongful trading actions and personal liability claims against directors who cynically “pump and dump” companies. The cost of private litigation is too high for most people – perhaps these agencies could bring suits to compensate all the wronged as a class, if Murphy wants to see justice done?
This bad behaviour is not restricted to SME companies though. It happens with sole traders (unincorporated businesses) and with PLC’s (the Carillion example in comments). Why is Murphy not complaining that big business abuses both limited liability of shares (and limited partnerships) and also the corporate veil over directors’ acts? And why is he not complaining that sole traders, with unlimited liability, still get away with stiffing customers and suppliers because the cost of UK litigation is so eye watering that nobody can afford to sue and then enforce judgment against rogue traders (often men of straw or able to hide themselves and their money with friends and family).
Finally, he complains about lack of financial info but many UK suppliers will not touch small companies without three year trading histories and clean credit records, unless they pay cash. Caveat vendor works well in avoiding rogue traders….
This is one of those articles that shows Richard Murphy has some irrational prejudices and blind spots and does not offer real solutions.
My preference would be to require banking (borrowing and lending) to be conducted from unlimited liability vehicles. That would enable railways etc to form equity capital with limited liability but discourage zero-sum speculation and leverage. Hoares is a UK private bank with unlimited liability.
A softer form of this would be to regulate interest rates chargeable by limited liability vehicles, forcing the usurers into unlimited liability.
I feel the need to mention an old blog post of mine. (2018)
Short version, in the 1800s, changes in marital property laws in the United States resulted in wives being able to own property at different times, which meant that bank presidents, who would be liable in the event of a bank failure, could place items, like houses, jewels, and even cash, in their wife’s name, and so would be less exposed.
The result was more reckless lending and more bank failures.
It’s a neat real world experiment in economics:
So yes, it makes a difference.
Changes to the bankruptcy code, for example allowing creditors to claw back all remuneration in excess of the salary of the President of the United States,($400,000.00) for example for a look-back period of 10 years, would be something that might work.
I would favor hard caps on remuneration instead.