By Janet Morgan, Contributor
WE all are familiar with the concept that the shareholders of a company are limited in their individual liability to contribute to the assets of a company to the extent of the amount unpaid (if any) on their shares. Put simply, shareholders are not obliged to contribute more than they are contractually obliged to, no matter what the extent of the debt of the company.
We are also familiar with the concept that a company has a separate legal personality from that of its shareholders called its separate corporate personality which it assumes when it is incorporated. Under our Companies Act, on incorporation a company becomes "forthwith capable of exercising all the functions of an incorporated company". In Barbados and Trinidad, under their respective companies legislation, a company has the capacity of exercising all the "rights, powers and privileges of an individual".
The separateness of the corporate personality of a company from the limited liability of its individual members defines the legal divide between the two. There have been statutory and judge-made rules that have provided opportunities in the law for claimants to reach behind that corporate protective shield to make shareholders liable beyond the limit of their obligations to contribute. Equally, shareholders may agree with creditors or investors to give personal guarantees to underwrite the liability of a company. But we are not looking at those exceptions today. Today, we take a look at some of the reasons why corporate entities with 'limited liability'- which itself should be an inhibiting characteristic in modern commerce have not only survived but thrived as the principal vehicle of modern commerce in the accumulation and growth of wealth for the past 100 years and more.
The principle of limited liability received celebrated judicial recognition in the late 19th century in Salomon v. A. Salomon & Co. Limited, a case which has been described as the cornerstone of company law in which the House of Lords unanimously held that a company is a separate legal person from its members. Therefore, its members are not liable for its debts. One may reasonably argue that this artificial person called a limited liability company should have 'died' long ago. But it has not.
One of the often cited and immediately obvious reasons for its acceptance is that it limits the personal liability of shareholders to a fixed amount (in the absence of agreements to the contrary or statutory provisions).
In this way it encourages persons to become shareholders of companies because they do not run the risk of personal bankruptcy, particularly where they have left the management of the company in the hands of directors. Shareholders are content to leave the day to day control and management of the business to those who are expected to know better how to manage, in exchange for limited powers over them and the company exercisable at the general meeting, held usually only once a year.
Limited liability promotes a certain measure of certainty in the business world for creditors who deal with companies. Trading for cash only, or within the proven limits of a company's ability to meet debts, would halt modern commerce as we know it today. Creditors manage the risk of limited liability through a range of contractual and other techniques including directors' guarantees, charges on the assets of the company (debentures) and insurance coverage. Trading creditors may also price the product sold to a limited liability company by the terms of credit based partly on the risk of the irrecoverability of its receivable and on the general risk of bad debts in the market place. Modern commerce has, therefore, responded to the concept of limited liabilities companies in those and other imaginative ways.
The protection of limited liability encourages the accumulation of capital, especially in public companies, because each shareholder is secure that beyond his individual contribution there is no recourse to him personally. The accumulation of the pool of capital contributed by people from diverse backgrounds, impelled to invest for various reasons, finances the growth of companies for the promise of returns called, dividends. As well, shareholders are comfortable in giving a free hand to directors to manage the business because their liability is limited.
Shares are transferable and each represents a unit in the share capital of the company. However, a shareholder is not entitled to direct proprietary rights in the company's assets. Shareholders may transfer their shares in a public company without restriction, and with restrictions in a private company. Shares may also be mortgaged or charged to secure loans and are often accepted by lenders as security from shareholders. Further, a company may issue a charge to creditors over particular assets which are used in the ordinary course of its business, called a floating charge, to finance its business activities something an individual cannot do.
Other equally important characteristics of a limited liability company which have influenced its popularity are that members of family businesses, private entrepreneurs and unincorporated associations may become registered as a limited liability companies and enjoy:
Perpetual existence because although its members may die, the company need not perish with them; and
The ability to sue or be sued in its own name, isolating its members from exposure to liability to a judgement.
The challenge is for the process of company law reform to meet the demanding changes of a more discerning and sophisticated market place of investors, creditors and shareholders as we pursue company law review.
Janet Morgan is an attorney-at-law at the DunnCox Firm, 48 Duke Street, Kingston.
