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The Impact And Abuse Of Limited
Liability
"When limited liability is cheaply and easily accessible it is likely to be abused"
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The client would
like an answer as to when is there abuse and how do courts deal with it
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1750 words
Limited liability is a concept that has developed in tandem with the development of
companies themselves
...
As the opening quotation suggests, however, where it is both cheap
and easily accessible for companies to achieve limited liability, it opens up the potential
for abuse
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The potential for abuse of limited
liability will be identified, and the courts’ response to cases of abuse will be discussed
...
​[1]​ The majority of
corporations and businesses are now incorporated as companies under the main
company law legislation, the Companies Act 1985 (which is about to be overhauled by
the Companies Bill 2006)
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For the purposes of this essay, the three
main types of companies are those limited by shares; and those limited by guarantee
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It
means that the members of the company, or the shareholders, are liable for the
company’s debts in he event of a liquidation
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In other words, if a
shareholder has fully paid for any shares he or she owns, and the company goes into
liquidation, that shareholder will likely lose the investment, but will not have to
supplement this by losing any of their other wealth
...

In other words, there is no limit on the liability of the partners, unless the partnership
chooses the business medium of a limited liability partnership which developed to
counter this problem, but which is beyond the scope of this essay to discuss
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Only a few
companies opt for this type of limited liability
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It means that each member undertakes,
or guarantees, to pay a certain amount if the company is put into liquidation
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These, then, are the two types of limited liability companies
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This is because, as the name suggests, the liability of the members is unlimited,
so, as with a partnership, in the event of liquidation, the members may find themselves
having to contribute the whole of their private wealth to off-set the company’s debts
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How,
then, can this concept be abused?
A concept that is inherently linked to that of limited liability, and which was mentioned
briefly above, is that of a company being a separate legal person
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This concept was established and illustrated in the seminal case of Salomon v A
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What does this mean in effect? As a separate and distinct
legal entity, a company is able to own its own property; it is liable for its debts and
obligations; it can sue its debtors and be sued by its creditors; and it has ‘perpetual
succession’, meaning that the company survives the death or retirement of any of its
members
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The
common law, however, reveals certain instances of the courts, albeit reluctantly,
overlooked the legal fact that a company is a separate legal person
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The occasions where this is done are rare, however,
and the judicial reluctance to do so were revealed in the case of Adams v Cape Industries
(1990)
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In the
case of Jones v Lipman (1962), a company director had contracted with the plaintiff to
sell him some land
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Specific performance orders are unobtainable once third party rights have been
acquired, so the move was a deliberate attempt to avoid such an order
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The case provides an example

of someone abusing the concept of limited liability, and also the court’s willingness to
counter this
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The National Audit Office has pursued a concerted
approach to tackling abuse of limited liability, as is revealed in a 1999 article entitled
‘Director disqualification - the National Audit Office follows up’
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It is not just the common law, however, that has shown itself willing, on rare occasions,
to look beyond the fact that a company is legally a separate person responsible for its
own obligations, where there is a perception of abuse of limited liability
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This is most notable in section 213
of the Insolvency Act 1986, which is concerned with fraudulent trading
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This can be seen to
overrule the concept of limited liability in the instance of individuals using the ‘veil of
incorporation’ for fraudulent purposes
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Similarly, section 214 of the same Act allows for company directors’
personal liability for the debts of the company where wrongful trading can be
established
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The impact of limited liability, and the abuse of this, on groups of companies is most
evident in the area of accounting practices
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Such transactions are often entered into for the purposes of
reducing the group’s tax liabilities by moving assets or balances around the group
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Under section 227 of the Companies Act 1985,
companies that are members of a group must produce group accounts that reflect that
the financial transactions of the subsidiary companies are actually activities of the
holding or parent company
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This again reflects the fact that the abuse of limited liability is envisaged, and
countered by statute
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It
provides an incentive for individuals to invest personal wealth in a company (which
requires this wealth to operate), knowing that they have full control over how much

they invest and thus risk losing
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There is, however,
potential for abuse of the concept of limited liability, usually in order to make personal
gain while shifting the risk onto the company
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BIBLIOGRAPHY
Statutes
Companies Act 1985
Insolvency Act 1986
Cases
Adams v Cape Industries [1990] Ch 433
Jones v Lipman [1962] 1 WLR 832
Salomon v A
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(2002) Introduction to Company Law (Oxford: OUP)
Blumberg, P
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(1999) ‘Director disqualification - the National Audit Office follows up’, Tolley’s
IL & P, 15, 4, 112
Rutledge, T
...
S
...
(2005) Business Law (Oxford: OUP)

Footnotes
[1]​ See, for example, Slorach, J
...
and Ellis, J
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(1999) ‘Director disqualification - the National Audit Office follows up’,

Tolley’s IL & P, 15, 4, 112



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