Legal Foundations in Business and the Discovery of Limited Liability Company - Assignment Example

? Legal foundations in business and the discovery of Limited Liability Company College Lecturer Introduction ‘The limitedLiability Corporation is the greatest single discovery in modern time. Even steam and electricity are less important than the limited liability company’, (Bernard 1998, p.473). These were the words of Nicholas Murray Butler way back in 1911 in his proclamation of the legal innovation in corporate law with respect to business operations of the 20th century. This statement has remained an icon of knowledge and a common philosophy in the development of limited liability companies otherwise referred to as the LLC business entity. As such, the concept of LLC has since prompted several states and countries to adopt legal provisions and control statues that would pave way for active business investments in otherwise risky ventures that individuals could not ordinarily undertake single handed. The main focus of this discovery revolves around the ideals of protection accorded to members of the LLC in their corporate investment endeavours, especially with borrowed capital. With that in mind, this paper examines the significance of the aforesaid quote of Nicholas Murray with reference to relevant case law and legislative provisions. In particular, the paper looks at how private law exerts legal control on business entities. Besides, the essay examines a variety of legal structures that LLCs adopt in reality to support their business interest in pursuit of profitable ventures that are typically risky and capital intensive. The paper concludes with an epigrammatic analysis of the extent of liability that the LLC or its members may owe indirect investors like banks, other creditors and customers and victims of tortuous acts of the LLC members. Limited Liability Company According to Grossman (1995, p.63), a limited liability company commonly denoted as LLC refers to a legally incorporated business entity with an infinite number of members enjoying protection of liability to the extent of their investment contribution in the business. Technically, an LLC is not a corporate entity per se but a type of unincorporated association that enjoys limited liability. In practice and legal context, LLC has a definite lifetime upon which the business must dissolve on expiry of the stipulated period (Dmitry & Plekhanov 2008, p.18). In terms of structural formation, a limited liability company may also be defined as a business entity that replicates certain features of a company and partnership. As a corporation, the LLC is characterised by limited liability. Whereas the business is more flexible than a typical corporation, a limited liability company possess that the partnership component of pass-through income taxation modalities as reiterated by Hannigan (2003, p.79). Although all its members enjoy limited liability, an individual member of a limited liability company may personally be held responsible for tortuous acts committed by him or by agents specifically under his direct supervision (Lobban 1996, p.401). Of course, this provision is only applicable for torts committed in the normal course of duty and for activities directly related to the business of the LLC. If follows therefore that the law shall protect other members from the liabilities of the responsible individual member or members, whichever is applicable. In even that significant liability has arisen in lieu of the LLC activities, the entity may be subjected to the theory of piercing the corporate veil (Keatinge et al. 1992, p.377). This is however less common when dealing with LLC as opposed to classic corporations due to the fact that limited liability companies do not have several complex formalities to observe. Nevertheless, an LLC may not circumvent the doctrine of piercing the corporate veil when its members had initially commingled their capital in the risky venture for which liability has risen (Halpern et al. 1980, p.122). Depending on the context of its operating agreement, the charging order mechanism applied in the liabilities of an LLC shall not confer any management rights on the company creditors whatsoever. According to Hannigan (2003), the idea provides a safety buffer and protection for the limited liability company to the extent that a creditor would be limited exclusively to the share of debtor’s contribution in the business. Such liability shall not extent to personal asset of the LLC members unless where a member is held personally liable for the specific tort committed by his office or under his direct supervision (Grossman 1995, p.69). The fundamental elements of a typical limited liability company include an article of organization and an operating agreement as stated by Lobban (1996, p.398). These documented instruments are recognized in corporate law as they define the scope and operational parameters of any LLC. They also outline the nature of membership, channels of arbitration, management modalities and share of distribution (Grundfest 1992, p.406). Unless otherwise provided by state law, the management of any limited liability company is clearly enchanted in the operating agreement and its article of organization. Corporate Law and LLC The general rule of corporate law with respect to LLC is that the investors in limited liability companies are not liable for any debts, liabilities or obligations of either the restricted liability corporation or other associates of the firm (Halpern et al. 1980, p.119). As such, the law on one hand treats limited liability companies more or less like limited partnerships. Contrary to the case of limited partnerships however, LLCs are not obliged to have a single general partner with exposure to unrestricted personal or company liability as reiterated by Hannigan (2003, p.81). With regard to the huge protections given in opposition to third party liability, the LLCs closely bear a resemblance to the Subchapter S Corporations. The basic difference is that limited liability companies cannot be formed in perpetuity without forfeiture of their pass-through income taxation status as noted by Dmitry & Plekhanov (2008, p.31). This limitation is mainly because corporate law stipulates that LLCs must limit their duration of existence to substantiate the lack of perpetual life as a non-corporate characteristic. Otherwise, the limited liability company would be subjected to full legal obligations as in the case of typical Subchapter S Corporations. To that end, corporate law impose legal statutes that compels limited liability companies to demonstrate lack continuity of life with a clear understanding that the business must dissolve at the expiration of a fixed period (Macey 1995, p.435). There are a number of important perspectives that legal and economic scholars agree upon in asserting that the discovery of limited liability company concept is the greatest single innovation of the modern time. Primarily, limited liability companies under corporate law enjoy unbounded freedom with respect to the type and number of investors commonly known as members as argued by Halpern et al. (1980, p.120). In addition, LLCs are not restricted by corporate law on the ability of its members to create income deductions and allocations from the firm provided that such actions are not inconsistent with the operating agreement or in breach of the law (Bernard 1998, p.478). Whereas limited liability companies have no maximum limit on membership, the business can explore more than one class of stock in addition to having several subsidiaries as the members may deem fit. On the other hand, private law allows limited liability companies to determine the amount of distributions it can make to its members (Macey 1995, p.437). This is contrary to the case of Subchapter S corporations that are restricted by law in terms of the dividends that may advance to their shareholders as reiterated by Creighton (2013). The third component of limited liability companies that makes it’s a legendary of the modern time is that of maintaining capital account. According to Keatinge et al. (1992, p.380), limited liability companies are not compelled by law to maintain certain capital account or that they must be managed by a board of director. Provided that its operating agreement is not inconsistent with the state law on corporate governance, the LLC can manage its accounts and business in the best way deemed appropriate by members. To that end, the debate as to what constitutes legal management of an LLC remains a eccentric in modern corporate law as illustrated in Lee v Lee Air Farming [1961] AC. 12 (Bernard 1998, p.481). Another area of concern of softening in modern corporate law is that of hybrid aspect of limited liability companies. Ideally, limited liability companies are unincorporated business associations that are privately held (Lobban 1996, p.398). Private law allows LLCs to combine corporate benefits of centralized management and limited liability with the characteristic advantage of partnership perpetuated in the pass-through taxation arrangement and organization suppleness. In any case, these legal provisions technically permit the creation of corporate personality even in a one-man limited liability company as illustrated in Salomon v. Salomon & Co., Ltd. [1897] AC 22 (Macey 1995, p.447). It was held that Salomon & Co. Ltd was a separate entity from its controlling shareholder Salomon. As such, Salomon enjoyed limited liability form the debts obligations of Salomon & Co. Ltd. In dealing with the discovery of LLC, states are keen not to lose revenues while taking considerable measures to protect potential investors from potential third party loses which may be incurred in the course of business. Due to the increased volatility of the global marketplace and the uncertainties of pursuing risky ventures, proactive investors have always preferred limited liability to unlimited liability (Grundfest 1992, p.387). In addition to reducing exposure to loss, the limited liability derived from investing in an LLC reduces that cost of insurance. It also increases investment incentives for engaging in risk but potentially profitable ventures (Hannigan 2003). Despite the fact that investors of LLC benefit from limited liability, some costs implications may arise in the form of additional capital borrowing costs from external creditors whose risks are increased by limited liability (Orhnial 2005, p.58) Fortunately, such higher borrowing costs may be evaded by contract especially if the borrower values less expensive credit at a higher rate than the benefits associated with limited liability. In that way, LLC investors who endeavour to circumvent the additional borrowing costs can easily contract to provide further investment security by way of personal guarantee to the creditors (Bernard 1998, p.479). Members’ Liability to Creditors and Tort Victims In evaluating the options for possible investment, the management and members of a limited liability company are often likely to put into consideration the various marginal costs as well as benefits related to the investments to be internalized. As a result, the profit-minded members of the LLC will pursue business activities that are relatively risky but potentially profitable (Creighton 2013, p.2). To that end, the concept of limited liability as applied in LLC allows investors to undertake exceedingly risky ventures and to profit from the pursuit of the probabilistic theory of win-lose financing strategy. Unfortunately, the costs associated with risky business activities that turn out badly are basically borne by creditors and circumstantial tort victims as argued by Macey (1995, p.439). Whereas the tendency to engage in potentially profitable but risky business projects is common practice in modern economy, many a times the victims of collapsed LLC ventures have counted irredeemable loses due to the protective aspect of LLC. According to Orhnial (2005, p.59), creditors and other victims of LLC torts are left with not further avenues of recompense whenever the LLC or its member that caused the perceived harm lacks the means or resources to compensate injured parties. While this state of affairs predisposes the creditors and other fixed claimants such as employees to substantial lose, it cushions the authors of the loss through limited liability clause. The law is well aware of this challenge but much of the norms maximizes on the grey areas of the prevailing corporate law as illustrated in Buchan v Secretary of State for Trade and Industry [1997] 1 RLR 80 (Bernard 1998, p.497). Like any other human venture, every innovation always produces winners and losers. This assertion is true of the context of business ventures of the limited liability company as argued by Hannigan (2003). In this case, creditors of limited liability company especially the perceived future tort creditors of LLC are typical losers of the single discovery of the limited liability company. The losing idea is clearly eminent especially when the limited liability companies imposing the loss on tort victims would otherwise have been established as normal partnerships (Macey 1995, p.452). Generally, the future tort victims of limited liability companies are anonymous and they lack political force as opposed to the LLC investors whose identities are identifiable and whose financial resources or political connections are unique to the venture. With this realization, it seems perhaps that the concept of creating limited liability companies remain a phenomenal discovery of our time. Capitalists are inspired by the ideals of LLC while socialist argues that the discovery of LLC is an economic suicide that risks the future of partnerships for public good (Grundfest 1992, p.388). On one hand, corporate law on limited liability companies encourages capital intensive engagement in rather risky business activities with defined protection of the investors against third party loses. On the contrary, this philosophy renders the creditors and tort victims perpetual losers in the event that an LLC can not pay its debt obligations resulting of huge loses incurred from a risky venture. The only amount that creditors can recover is limited to the debtor’s contribution and any deficits will be considered lost on grounds of limited liability (Orhnial 2005, p.48). In a tortuous act of the business, a member may be held personally liable in cases of fraud or an unlawful action for which the limited liability company has suffered significant loses (Macey 1995, p.436). Provided that the creditors can prove that such loss occurs as a result of personal negligence of malicious act of specified members, the court will not allow such defendants to deny liability. This reality is well illustrated in Westerville’s Sons v. Regency, Inc., [1948] A. 2d 818 (Bernard1998, p.477). Considering the impact of the aforementioned contentions, it is no longer surprising to note that the political debates surrounding the adoption of LLC enabling statutes in various states have not featured much concern about the extension of limited liability beyond its previous confines. It seems therefore that limited liability frameworks entrenched in the LLC ideology is more of a compromise to encourage investment in business activities that ordinary partnership would rather avoid due to the burden of risk involved. Liability is still limited inasmuch as the burden of proof remains on the shoulders of the injured parties as reiterated by Orhnial (2005, p.63). Piercing the Corporate Veil According to Macey (1995, p.453), the doctrine of piercing the corporate veil refers to the legal position by which the court in deciding a case may allow the victims of torts to reach personal assets of the members of the LLC held personally liable. It follows therefore that the level of limited liability in the case of LLC can be by-passed by the courts of law in an attempt to correct an imbalance created revenue driven legislatures. This unbiased legal perspective in addressing liability suits in limited liability company cases is constitutionally acknowledged through the independence of the judiciary (Hannigan 2003). Due to the fact that limited liability shields the members of a limited liability company for third part loses, it is apparent that the chances of uncompensated tort victims will increase with increased venture in risky business by LLCs. Similarly, strict adherence to corporate personality at some point may result in inequity or prevent proper compensation for loses suffered by innocent victims of tort in LLC business ventures. The notion hitherto is undeniable and the court will always exercise its jurisprudence mandate by piercing the corporate veil to serve justice and restore balance for public good (Orhnial 2005). The practice is also inevitable where members of a limited liability company had commingled their capital to defeat public convenience or protect potential fraud. By clearly identifying the nature of loss suffered from excessive risk-takings faced by tort claimants of LLCs, courts are in a better place to initiate proper recompense of the victims by allowing the tort claimants to pierce the corporate veil (Macey 1995). Despite the fact that such legal actions of allowing creditors to reach the assets of LLC shareholders are distinctive and carefully applied by the courts, the practice as seeks to balance the benefits of limited liability against its cost of unwarranted risky ventures. This stance is distinguishable in the case of one-man limited liability company as illustrated in Biscayne Realty & Ins. Co. v. Ostend Realty Co. [1933] 109 Fla.1, 148 So.560 (Bernard 1998, p.482). The court granted claimant relief sought on ground that Busch was personally liable for the unpaid promissory notes issued by Busch for the purchase of realty under corporate name in which he was the sole shareholder. In essence, the sentimental perspectives for piercing the corporate veil are basically ideal for purposes of serving justice. In particular, this doctrine holds firm where a group of LLC investors or a members of the limited liability company knowingly commingled funds where the risks are extremely high and the capital financing is low. As a result, the decision could be fraudulent especially where such members immediately files for bankruptcy upon realization of loses incurred prior to any law suits against them by creditors or victims of tort (Orhnial 2005, p.47). It is on such grounds that the court may, upon determination of facts, allow the creditors to reach for the assets of the liable LLC member. Conclusion The coming of a new organizational formation inscribed in the philosophy of Limited Liability Company is indeed a phenomenal discovery of the legislature. This concept of modern day business allows the members of the LLC to pursue risky investment projects at the expense of societal good. From one angle, LLC opens new doors to increased state revenues and potential higher profits for the investors. On the other viewpoint, this discovery renders the creditors and future victims of tort unlikely beneficent of a risky venture. They stand recover nothing more that the debtor’s share of contribution in the insolvent business which might not necessarily construe sufficient compensation for the loss suffered. Even the piercing of corporate veil might be a rare possibility in LLC unless the members commingled funds. References Bernard, CF 1998, ‘Limited liability with one-man companies and subsidiary corporations’, Law and Contemporary Problems, vol.2, no.1, pp.473-504. Creighton, CA 2013, Dominance of limited liability companies will ebb with progress in IT, Accessed April 5, 2013 Dmitry, S & Plekhanov, V 2008, Amendments to the Law on Limited Liability Companies, EPA & Partners, St. Petersburg. Grossman, ZP 1995, ‘Market for shares of companies with unlimited liability: the case of American Express’, Journal of Legal Studies, vol.24, no.1, and pp.63-70. Grundfest, AJ 1992, ‘Limited future of unlimited liability: a capital markets perspective’, Yale Law Journal, vol.102, no.2, pp.387-425. Halpern, P, Trebilcock, M & Turnbull, S 1980 ‘Economic Analysis of Limited Liability in Corporation Law’, University of Toronto Law Journal, vol.30, no.2, pp.117-150. Hannigan, B 2003, Company Law, Oxford University Press, Oxford. Keatinge, K et al. 1992, ‘Limited Liability Company: A Study of the Emerging Entity’, Business Law Review, vol.47, no.3, pp.375-384. Lobban, M 1996, ‘Corporate identity and limited liability in France and England’, Anglo-American Law Review, vol. 25, no.2, pp.397-411. Macey, RJ 1995, Limited Liability Company: Lessons for Corporate Law, Yale School of Law, Boston, MA. Orhnial, T 2005, Limited Liability and the Corporation, Taylor & Francis, London. Read More