Modern Law Review, Wiley The Modern Law Review

Limited Liability: Large Company Theory and Small Firms
Author(s): Judith Freedman

Source: The Modern Law Review, Vol. 63, No. 3 (May, 2000), pp. 317-354
Published by: Wiley on behalf of the Modern Law Review
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THE
MODERN LAW REVIEW

Volume 63 May 2000 No 3
Limited Liability: Larg

Firms
Judith Freedman*
Current enthusiasm for the 'enterpr

access to limited liability forms of b
itself in the creation of new limited
The UK Company Law Review is exam
of the limited liability company to
the claims made for the 'efficiency'
these claims to small firms. It raises
policy issues beyond economic effici
taking and shifting to be encourage
difficult to find rational methods of
not follow that limited liability shou
It is important to signal the limitatio
Introduction
New limited liability forms of business organisation are in vogue. Limited liabilit
is widely regarded as a mechanism that encourages entrepreneurship and makes
major contribution to the law of business organisations.1 Popular and politic
sentiment proclaim: 'the more limited liability the better'.2 In the USA, the Limit
Liability Partnership (LLP) and the Limited Liability Company (LLC) have
emerged over recent years as frequently used and strongly supported new legal
forms of organisation. The UK is following suit, with its own LLP, original
intended for the regulated professions only, but now to be available to all types o
user.3 The Company Law Review Steering Group in the UK is working on th
*Law Department, London School of Economics. I am grateful to R. Baldwin, P. L. Davies, V. Finc

C. Norberg, J. K. McNulty and the two anonymous referees for their helpful comments.
1 For some examples of this contention see J. Freedman and M. Godwin, 'Incorporating the Micro
Business' in A. Hughes and D.J. Storey (eds), Finance and the Small Firm (London: Routledge, 199
(hereafter Freedman and Godwin (1994)); A. Hicks, 'Corporate Form: Questioning the Unsung Her
[1997] JBL 306.
2 For recent pronouncements and comments to this effect, see ns 17, 38, 132 and text to n 66 belo
3 The Limited Liability Partnerships (LLP) Bill was introduced into the House of Lords in Novembe
1999. See also Department of Trade and Industry (DTI), Limited Liability Partnerships Draf
Regulations: A Consultation Document URN 99/1025 (London: DTI, 1999); Trade and Industr
Committee, Fourth Report Draft Limited Liability Partnership Bill HC 59 (1999) para 38; J
Freedman and V. Finch, 'Limited Liability Partnerships: Have Accountants Sewn up the "Dee
Pockets" Debate?' 422 [1997] JBL 387; A. Griffiths, 'Professional Firms and Limited Liability: A
? The Modem Law Review Limited 2000 (MLR 63:3, May). Published by Blackwell Publishers,
108 Cowley Road, Oxford OX4 1JF and 350 Main Street, Malden, MA 02148, USA. 3
The Modern Law Review [Vol. 63
premise that access to limited liabil

business owners.4
The objective of this article is to question the notion that easy availability of
limited liability for small firms is necessarily a desirable feature of a system of
business organisations. The purpose here is purely to examine the theoretical
arguments on limited liability and their application to small, owner managed firms.
The empirical evidence, as well as other aspects of the legal needs of small firms,
are reviewed elsewhere.5 This article does not consider whether internal
governance needs might justify the introduction of specialist limited liability
forms for small firms. This is an important question, but the preliminary
dealt with here, is to consider the importance of making limited liability w
available to small, closely held firms.6
The first part of this article poses some broad questions about the tests t
applied in assessing the value of limited liability for small firms and suggest
economic efficiency must be weighed in the balance with other factors. The s
part discusses the trend towards extension of limited liability through new
vehicles or deregulation of existing legal forms. It introduces the USA deba
LLCs in order to provide context for the later theoretical discussion, which is
in part on literature arising from the surge of interest in the applicability of lim
liability to small firms in the USA inspired by the LLC. The current UK po
on limited liability for small firms is also outlined. The third part of the a
discusses the debate on limited liability for firms in general. It shows that
economic advantages of limited liability are now being questioned in
contexts and are, in any event, unconvincing when applied to small, closely
companies. This part goes on to describe the difficulties encountered in restr
access to limited liability to those firms for which such a regime does appear
suitable.
The fourth part of this article considers the application of economic efficiency
tests to LLCs. It questions whether the legislative popularity of the LLC in the
USA can be attributed to the characteristic of limited liability rather than other
factors. It argues that the development and rapid uptake of the LLC in the USA is
not in itself an indication that limited liability is efficient for small firms, either for
the owners or the community more generally. In part five it is concluded that
limited liability is not desirable in all circumstances, whether judged by economic
or non-economic tests. It is difficult to find a rational method of restricting access
to limited liability forms of business organisation, but it does not follow that
Analysis of the Proposed Limited Liability Partnership' [1998] CfiLR 157; A. Griffiths, 'Structuring
the Law of Private Limited Companies Through the Next Millennium' in D. Milman (ed), Regulating
Enterprise (Oxford: Hart Publishing, 1999).
4 The Company Law Review Steering Group, Modern Company Law for a Competitive Economy: The
Strategic Framework, (London: DTI, 1999) (hereafter The Strategic Framework) para 5.2.10 and
question 10 and see text to n 66 below.
5 DTI Company Law Review: The Law Applicable to Private Companies URN 94/529 (London: DTI,
1994); J. Freedman 'Small Business and the Corporate Form: Burden or Privilege?' (1994) 57 MLR
555 (hereafter Freedman (1994)); Freedman and Godwin (1994), n 1 above; Andrew Hicks, Robert
Drury and Jeff Smallcombe, Alternative Company Structures for the Small Business (London:
Chartered Association of Certified Accountants, 1995) (hereafter ACCA Report) and contributions
from a number of authors in Barry A. K. Rider and Mads Andenas (eds.), Developments in European
Company Law, Vol 2/1997: The Quest for an Ideal Legal Form for Small Businesses (London: Kluwer
Law International, 1999); The Strategic Framework, ibid.
6 The term 'closely held firms' is used here to mean firms which are owner managed with few or no
outside investors. Further work is under way on the internal governance issues as part of the Company
Law Review - see The Strategic Framework, ibid.
318 ? The Modern Law Review Limited 2000
May 2000] Limited Liability and Small Firms
limited liability should be positively encouraged for

of new limited liability vehicles, or attempts to fur
limited liability forms by small firms, may encourag
run as sole traderships and general partnerships to
liability. Such developments could mislead busine
limited liability for themselves as well as sending out
undermine the importance of personal responsibility
in transfers of risk to those least able to bear them.
Limited liability: economic analysis and alternative tests
Much of the literature discussed below evaluates limited liability on the basis of
economic analysis. This approach measures limited liability in terms of economic
efficiency,' posing three central questions. First, does limited liability allocate risk
to those most capable of bearing it? Secondly, does it result in optimal levels of
risk taking, ensuring that ventures with a net positive value to society, but not
others, are undertaken? Thirdly, does it reduce transaction and monitoring costs? In
this literature, these measures of 'efficiency' operate within an overall framework
of profit maximisation. All forms of satisfaction can be incorporated into this
concept, but they must be given a value in monetary terms. This may lead to many
interests and values being hidden or cancelled out simply in order to produce a
workable model.8 Economic analysis assumes that a society with greater wealth,
measured in terms of profit maximisation, is necessarily better off than a society
with less.9 Self-interest remains the guiding force in this world: all is explained
through this medium.10 In broad terms the test of efficiency used by these analysts
(the Kaldor-Hicks test) is whether the aggregate benefits of the system exceed the
costs to such an extent that the winners could compensate the losers.11
As will be seen below, even accepting the measures and approach of economic
analysis, there are strong arguments in support of the view that limited liability is
not efficient for the smallest firms. In addition, it is argued here that efficiency is
not the only test to be applied. Other values must also be weighed in the balance.12
These other values should be seen as moderating the efficiency test, not simply
contributing to it, although they are sometimes explained away in terms of
efficiency by the economic analysts.13 These underlying considerations, reflecting
society's values, need to be exposed and discussed in order to ensure that legal
policy does properly reflect moral and political criteria. The danger is that they will
be lost under an all subsuming cloak of 'efficiency'. There may come a point at
7 For the different types of efficiency and generally an excellent discussion of the relevance of
economic analysis to company law see S. Deakin and A. Hughes, 'Economics and company law
reform: a fruitful partnership?' (1999) 20 Company Lawyer 212 (hereafter Deakin and Hughes). See
also S. Deakin and A. Hughes, 'Economic Efficiency and the Procedularisation of Company Law'
[1999] CfiLR 169; C.W.Maughan and S.F.Copp, 'Company law reform and economic methodology
revisited' (2000) 21 Company Lawyer 14.
8 G Lawson, 'Efficiency and Individualism' (1992) Duke Law Journal 42:1 53.
9 R. Dworkin A Matter of Principle (Oxford: Clarendon Press, 1986) 237.
10 R. Posner, Economic Analysis of Law (New York: Aspen Law and Business, 5th ed, 1998) 3.
11 Note that there does not need to be actual compensation. Kaldor-Hicks efficiency is easier to achieve
than Pareto efficiency, which would require someone to be better off and no-one to be worse off: see
Jules L Coleman, Markets, Morals and the Law, (Cambridge: CUP, 1988) chapter 2; Brian R.
Cheffins, Company Law: Theory, Structure, and Operation (Oxford: Clarendon Press, 1997) 14-16.
12 Deakin and Hughes, n 7 above, 217.
13 Deakin and Hughes in CfiLR, n 7 above, 171.
C The Modern Law Review Limited 2000 319
which we are prepared to choose

above profit maximisation: 'Effici
policy maker is concerned not onl
also with the appropriate distribu
political criteria. . .'.14
In the context of limited liability
on efficiency may mask the conseq
are the losers at the expense of oth
efficiency, it would be possible to
liability in some circumstances wa
because it breached principles of in
views might be taken upon the ext
has been argued that 'liability limi
real life effects of the enterpris
acknowledged personal responsibil
encouraging 'a culture of enterprise
wishes to encourage risk taking, b
irresponsible risk taking. Where t
efficiency but also of social values
Small firms are seen as an engine
limited liability to enable them to
for entrepreneurship is that it ca
sector, which contains many fi
employment beyond that for thei
not a matter for criticism, since th
users.18 Yet it is important to note
very small,19 and do not wish to exp
14 A. Ogus, 'Economics, Liberty and the
Teachers of Law 42. See also N. Duxbury,
Press, 1995) 394-419.
15 Robert Flannigan, 'The Economic Structu
16 T. Gabaldon, 'The Lemonade Stand: Fe
Corporate Shareholders' (1992) Vanderb
from Silence: The Future of Feminist An
Law Journal 149.
17 See, for example, DTI White Paper, Our Competitive Future: Building the Knowledge Driven
Economy Cm 4176 (1998) para 2.7 'The Government's aim is to create a broadly-based
entrepreneurial culture, in which more people of all ages and backgrounds start their own business';
Budget Statement 9 March 1999, [1999] STI 381.
18 For an elaboration of this argument see J. Freedman 'The Quest for an Ideal Form for Small
Businesses - A Misconceived Enterprise?' in Barry A. K. Rider and Mads Andenas (eds), n 5 above
(hereafter Freedman (1999)), 11.
19 There were 1.32 million companies on the Companies Register at the end of 1997/98 but only around
12,000 were public limited companies and only about 2,450 had their shares listed on the Stock
Exchange: The Strategic Framework n 4 above, Annex D. Of course this is the majority only by
number. By other measures such as turnover and employment the balance is different. Only about
740,000 of the companies on the register are actively trading. Of these, around 506,000 have fewer
than five employees but they provide only 5.8 per cent of all employment provided by companies
The 3,380 companies with 500 or more employees provide 54 per cent of employment with
companies - SME Statistics Unit, SME Statistics for the United Kingdom 1998 (London: DTI, 1999).
Nevertheless the weight of numbers of small private companies is overwhelming. It also seems that
the majority of trading companies have only one or two shareholders (ICC Company Shareholders
Database Breakdown prepared for the Company Law Review, 1999 <http://www.dti.gov.uk/cld/
review.htm>).
20 C. Hakim, 'Identifying Fast Growth Small Firms' (1989) Employment Gazette 29; C. Gray, 'Growth-
Orientation and the Small Firm' in K.Caley et al (eds) Small Enterprise Development Policy and
Practice in Action (London: Paul Chapman Publishing Ltd., 1992).
320 C The Modem Law Review Limited 2000
the UK have unlimited liability and no employees.2

fact providing only services or labour and could
entrepreneurship under most definitions of that wor
The political rhetoric surrounding small busin
emphasis on limited liability because this will be of
a result, the importance of catering for the non-gr
and growth may be highlighted at the expense of o
protect third parties (including other small bu
enthusiasm for limited liability as a mechanism for
which does not always take into account the facts
sector. This is an enthusiasm that is clearly presen
business organisations.
Extending limited liability: LLCS, LLPS

In the USA, the issue of limited liability for small f
to the development of new legal forms of organisa
LLP. This has produced a surge of interest and much
limited liability in small firms. This part of this art
of the LLC was driven by a combination of tax
competition. Nevertheless, there are some who arg
supports the notion that limited liability is efficient fo
too there are strong proponents of the view that limite
smallest firms.
The name of the USA limited liability company or LLC is confusing for UK
readers, since this vehicle is not a corporation, although it has a legal entity distinct
from its members. Great claims have been made about the theoretical basis of the
LLC as a new form of business organisation for small firms wishing to combine
limited liability with a partnership style of internal governance.23 In fact, however, it
seems to have been largely modelled on existing USA vehicles and tax driven in its
origins.24 Moreover, it was originally introduced at the behest of a large business.25
There is no limit on the number of members in an LLC, nor any other size cap.26
21 Twenty per cent of UK firms are companies, 61 per cent sole proprietorships and 19 per cent
partnerships. Of the 3.7 million businesses in the UK in 1998, over 2.3 million were 'size class zero'
businesses (sole traders or partners without employees). SME Statistics 1999, n 19 above. The US
statistics also seem to show that large numbers of the self-employed act in a 'routinized service
capacity' see Gabaldon, n 16 above, fn 1433.
22 On entrepreneurship see P. Moran 'Personality Characteristics and Growth-orientation of the Small
Business Owner-manager' (1998) 16 (63) International Small Business Journal 17.
23 A number of different models are claimed for the LLC, from the Panamanian limitadas to the German
Gesellschaft mit besechrankter Haftung (GmbH): Richard A. Booth, 'The Limited Liability Company
and the Search for a Bright Line Between Corporations and Partnerships' (1997) 32 Wake Forest Law
Review 79; Ernest A. Seemann, 'The Florida Limited Liability Company: An Update' (1990) 14
Nova Law Review 900; CCH, Guide to Limited Liability Companies (Chicago: CCH, 4th ed, 1997)
(hereafter CCH Guide).
24 William J. Carney, 'Limited Liability Companies: Origins and Antecedents' (1995) 66 University of
Colorado Law Review 855.
25 The Hamilton Brothers Oil Company approached Wyoming to create legislation permitting
vehicle: Carney, ibid 857.
26 The rapid increase in LLCs therefore probably represents conversions from limited partnersh
corporate form as well as from general partnerships and sole tradership: Larry E. Ribstein 'Statu
Forms for Closely Held Firms: Theories and Evidence from LLCs' (1995) 73 WULQ 369 (herea
Ribstein (1995)).
C The Modem Law Review Limited 2000 321
In the US, corporations are subjec

and shareholder level,27 so ther
unincorporated firm.28 The LLC i
advantages of partnership with th
treatment was achieved by ensurin
characteristics under a 'corporate
same time its designers tried to
possible.30 Once the Internal Reven
LLC could attain the tax transparen
became the driving force behind th
now available in every state o
harmonisation by virtue of the
(ULLCA),34 variations remain.
Initially, not all LLCs met the IR
depended on their precise drafting
the IRS and the taxpayer. Eventua
introduced.35 Under these provisi
created by state and federal statu
other entities may choose their de
classification factors less importan
27 Boris I. Bittker and James S. Eustice, F

(Boston: Warren, Gorham & Lamont, 5
Corporations satisfying certain condition
Sub-chapter S of the Inland Revenue Code.
first introduced- see John K. McNulty,
Foundation Press, 1992) although they we
(PL 104-188).
28 Charles E. McLure, Must Corporate Income be Taxed Twice? (Washington DC: The Brookings
Institution, 1979); Alvin Warren, 'The Relation and Integration of Individual and Corporate Income
Taxes' (1981) 94 Harv L Rev 719; David G. Davies, United States Taxes and Tax Policy,
(Cambridge, Cambridge University Press, 1986); United States Treasury Department, Integration of
the Individual and Corporate Tax Systems - Taxing Business Once (Washington: US Treasury, 1992);
John K. McNulty, 'Corporate Income Tax Reform in the United States: Proposals for Integration and
Individual Income Taxes and International Aspects' (1994) 12 International Tax & Business Lawyer
161.
29 The four fundamental corporate characteristics were continuity of life, centralised management,
limited liability and free transferability of interests: Morrissey v Commissioner 296 US 344 (1935);
IRC ? 7701 and Treas. Regulations promulgated thereunder (?301.7701 as it then was): see John K.
McNulty, 'A Tax Experiment in the United States Federal System: Limited Liability Companies as an
Escape from the Unintegrated Corporate Income Tax', in Joachim Lang (ed), Die Steuerrechts-
Ordnung in der Diskussion - Festchrift for Klaus Tipke (Otto Schmidt: Koln, 1995).
30 Robert B. Thompson 'The Limits of Liability in the New Limited Liability Entities' (1997) 32 Wake
Forest Law Review 1, 32.
31 Rev. Rul. 88-76
32 Ribstein (1995), n 26 above.
33 CCH Guide, n 23 above.
34 National Conference of Commissioners on Uniform State Laws, Uniform Limited Liability Company
Act (1995) adopted by the American Bar Association in 1996. Subsequent amendments have been
made to accommodate changes in the tax rules (CCH Guide, ibid 5).
35 T.D. 8697. Treas. Regs. ? ? 301.7701-1 to -3, Simplification of Entity Classification Rules, 61 Fed.
Reg. 66,584 (1996). CCH Guide, n 23 above, 76; Roger F. Pillow, John G. Schmalz and Samuel P.
Starr, 'Simplified Entity Classification Under the Final Check-the Box Regulations' (1997) Journal of
Taxation 197; Larry E. Ribstein and Mark A. Sargent (eds) 'Check the Box and Beyond: The Future
of Limited Liability Entities' (1997) 52 The Business Lawyer 605 (hereafter Ribstein and Sargent);
CCH, 'Tax Focus - "Check - the Box" Regs Simplify Entity Classification' (1997) 84 Standard
Federal Tax Report No. 11, Issue 13.
36 Thompson, n 30 above.
Nevertheless, the influence of the original tax requir

the tax status of the LLC continues to be a basic attraction.
Despite being tax driven initially, the spread of the LLC in the USA has led to
claims about the efficiency and value of this new vehicle. These claims go to the
heart of the more general debate discussed in this article about the role of limited
liability for owner-controlled, private companies ('closely-held' firms or close
corporations). The proponents of extended limited liability in the USA argue that
the arrival of the LLC, together with the registered LLP, may mark the end of
general partnerships and the close corporation, or, at least, much diminished use of
those forms.37 One of this group, Larry Ribstein, even argues for the limited
liability sole proprietorship (LISP).38 He argues that increased access to limited
liability is welcome since this is an efficient default rule even for small
businesses.39
Ribstein argues that the partnership form held an attraction for many firms on the
margin only because of the regulatory costs of limited liability, including double
corporate taxation, and limitations on organisational form.40 These are costs that
are reduced or dispensed with in the LLC. The tax problem is eliminated. The LLC
is flexible in terms of its internal governance regime, which is usually left almost
entirely to an operating agreement that does not have to be publicly disclosed,41
although the statutes of most states and the ULLCA provide default provisions.42
Like the UK partnership agreement, the operating agreement is of great
importance, yet not normally mandatory. The LLC has no minimum capital
requirement and may now be formed by one member in many states. Members
normally have the right to manage and control the LLC, subject to contrary
agreement.43
37 For example, Larry E. Ribstein 'The Deregulation of Limited Liability and the Death of Partnership'
(1992) 70 WULQ 417 (hereafter Ribstein (1992)); Ribstein (1995), n 26 above; S. J. Orsi, 'The
Limited Liability Company: An Organizational Alternative for Small Business' (1991) 70 Nebraska
Law Review 150; Bernard Black in Ribstein and Sargent, n 35 above, 611.
38 Larry E. Ribstein in Ribstein and Sargent, ibid 638. This is not very far removed from the LLC in any
event. See now in the UK the tentative proposals to limit the liability of bankrupt unincorporated
traders by allowing them to retain up to ?20,000 pound for pound matching their investment in their
business: DTI Press Release, Byers Outlines Details of Bankruptcy Study P/99/575 2 July 1999.
39 Larry E. Ribstein, 'Limited Liability and Theories of the Corporation' (1991) 50 Maryland Law
Review 80 (hereafter Ribstein (1991)); Ribstein (1992), n 37 above, although later writings by the
same author make less firm claims for limited liability in relation to small firms see Ribstein (1995), n
26 above and R. Hillman ' Limited Liability and Externalization of Risk: A Comment on the Death of
Partnership' (1992) 70 WULQ 477; Jonathan R. Macey, 'The Limited Liability Company: Lessons
for Corporate Law' (1995) 73 WULQ 433.
40 Ribstein (1992), n 37 above, 417.
41 To form an LLC, articles of association must be filed with the chosen state but operations are
generally governed by an operating agreement The articles usually include minimal information such
as the name and registered office of the LLC and details about management and date of dissolution.
They do not define the powers of the LLC. If the purposes have to be set out then this is in general
terms only. Annual filing provisions are also minimal and, in particular, do not include the filing of
accounts, although tax returns normally have to be kept by the LLC, available for inspection by
members: CCH Guide, n 23 above, chapter 3.
42 The USA literature also discusses in detail the efficiency of the standard form defaults provided by
the LLC statutes: see especially Ribstein (1995), n 26 above and Dennis S. Karjala, 'Planning
Problems in the Limited Liability Company' (1995) 73 WULQ 455 (hereafter Karjala (1995)). This
question is referred to where relevant but not discussed exhaustively in this article.
43 In the ULLCA 1995 the parties' choice on whether to be member-managed or manager managed
controls questions of authority, fiduciary duties and dissolution characteristics, for example: see
prefatory note to the Act. Most states provide for at-will or fixed term dissolution and for member
management in their LLC statutes. These clauses stem from the original tax requirements that the
entity should not have continuity of life or centralised management and both are now usually subject
to contrary agreement, following the tax changes described above. The ULLCA default allows owners
These supposed advantages of the

limited liability, lead some to argu
for formations of LLCs between th
efficient alternative statutory standa
the LLC as 'more an unfortunate pr
expanding innovation'.45 On this
'provides nothing (besides uncertai
corporation statutes'.46 LLCs have
about how the courts will apply th
the judicial treatment of single
suggesting that courts are more lik
there are fewer than two members.47 This leads to the conclusion that taxation must
be the main reason why the LLC is flourishing where special close corporation
legislation designed for small firms failed.48
Much is left to the operating agreement, which increases flexibility but is also
very costly to the extent that it needs to be tailor made.49 Commercial standard
forms will be provided for LLCs and the courts will develop rules, but this will
take time. Some practitioners are therefore wary of the LLC as there is little
precedent to guide them.50 The critics of LLCs argue that there are now too many
choices to be made between different types of entity and that the result could be
confusion - a case of 'hyperlexis'.51 The popularity of the LLC should not be
exaggerated, therefore, and its rapid spread across legislatures, far from proving its
efficiency, may 'suggest to some that [it] fails to strike an appropriate balance
between private gain and social benefit'.52
Between these two camps are the agnostics holding the middle ground. They do
not accept that the explosive growth of LLCs necessarily means that they are
efficient for society overall: there are other explanations for their establishment
and there are problems with the arguments justifying limited liability for closely
held firms.53 Nevertheless, they argue that the fact that LLCs were born as a result
to demand payment of the fair value of their interests at any time in order to exit. If this right is
excluded by agreement, an owner may apply for a judicial dissolution.
44 See n 198 below and text thereto.
45 Saul Levmore, 'Partnership, Limited Liability Companies, and Taxes: A Comment on the Survival o
Organizational Forms' (1992) 70 WULQ 489, 492; Hillman n 39 above; R. Hamilton and L. Ribstein
(a debate) 'Limited Liability and the Real World' (1997) 54 Washington and Lee Law Review 687;
Mark J. Roe, 'Chaos and Evolution in Law and Economics' (1996) 109 Harvard Law Review 641.
On interest group theories see also Macey, n 39 above, W. Bratton and J. McCahery 'An Inquiry into
the Efficiency of the Limited Liability Company: Of Theory of the Firm and Regulatory Competition
[1997] 54 Washington and Lee Law Review 629. For a more general discussion of interest group
theories see R. Baldwin and M. Cave, Understanding Regulation (Oxford: OUP, 1999) chapter 3 an
works cited there.
46 Karjala (1995), n 42 above, argues that similar internal structural freedom could already be achieved
under modern corporation statutes.
47 CCH Guide, n 23 above,18; Ribstein and Sargent, n 35 above 637. A few states spell out the position
in their LLC enabling statute - CCH Guide, n 23 above, 44.
48 See Dennis S. Karjala, 'A Second Look at Special Close Corporation Legislation', (1981) 58 Tex L
Rev. 1207; Ian Ayres 'Judging the Close Corporation in the Age of Statutes' (1992) 70 WULQ 353.
49 CCH Guide, n 23 above 18; Michael Bamberger in Ribstein and Sargent, n 35 above, 626.
50 Karjala (1995), n 42 above; Ribstein and Sargent ibid.
51 Walter D. Schwidetzky in Ribstein and Sargent ibid 617. Schwidetzky ascribes the term 'hyperlexis',
meaning 'pathological condition caused by an over-active law-making gland' to Bayless Manning.
52 Allan W. Vestal, '"Assume a Rather Large Boat": The Mess We Have Made of Partnership Law'
(1997) 54 Wash & Lee L Rev. 487 (hereafter Vestal) 516.
53 Bratton and McCahery, n 45 above. Note that their discussion is purely in terms of economic
efficiency.
324 ( The Modem Law Review Limited 2000
of the combination of tax and regulatory issues and

does not necessarily mean that they are inefficient;
business organisations. In the view of some aut
necessitate intervention by the courts to take into acco
had no say in the original lobbying process.54
The LLC is not the only limited liability legal v
USA to accommodate firms which require a par
regime coupled with limited liability. For example, t
is now also available in most states.55 Sometimes, as
professional partnerships, but elsewhere, as in
partnerships.56 The USA LLP raises many issues sim
in connection with LLCs.57
In the UK, the position is not entirely comparable with that in the USA. There is
already very easy access to limited liability for small firms through the ordinary
limited liability company. The UK system of corporate taxation attempts to
integrate the corporate and personal tax systems so that double taxation is
avoided.58 The incentive to avoid incorporation for tax reasons is therefore much
less than in the USA and there may even be tax advantages to incorporation in
some circumstances.59 The UK private limited liability company has no minimum
capital requirement and flexible internal governance rules. External regulation, in
particular accounting requirements such as the statutory audit,60 has also been
reduced over recent years. There is, however, continued pressure for simplification
of the legal rules for small companies in the interests of entrepreneurship.61
The UK Company Law Review Steering Group62 does not support the introduction
of a new free standing limited liability legal form for small firms,63 although it
describes various free-standing legal vehicles for small business.64 The Strategic
54 Macey, n 39 above; Thompson, n 30 above.

55 Born in Texas in 1991: see R Hamilton, 'Registered Limited Liability Partnerships: Present at the
Birth (Nearly)' (1995) 66 U Colorado Law Review 1065. The level of protection bestowed by the
limited liability rules for LLPs vary from state to state and may well not be as comprehensive as for
LLCs.
56 CCH Guide, n 23 above, 72.
57 For reasons of space these are not discussed further in this article.
58 See John Tiley and David Collison, Tiley & Collison's UK Tax Guide 1999-2000 (London:
Butterworths, 1998), chapter 23, although the logic of this so called 'imputation system' has been
broken down by recent tax reforms: see Finance (No. 2) Act 1997 and Finance Act 1998.
59 There are tax advantages and disadvantages of incorporation under the UK tax system which does not
achieve complete neutrality: Graham Buckell, 'Incorporation Tactics' (1998) Taxation 278. Changes
in the 1999 Finance Act further tip the balance in favour of incorporation since a new 10 per cent tax
rate is to be introduced for companies with low profits from April 2000 but the effect is relatively
small. National Insurance considerations make incorporation costly for large partnerships, which is
one reason why the UK pressure for LLPs has come from large professional partnerships.
60 See Companies Act 1985, ss 249A-249E as amended; Freedman (1999), n 18 above, 29.
61 Freedman (1999), ibid.
62 The Strategic Framework, n 4 above. The author was an adviser on the Working Groups on the needs
of small and closely held firms both prior to and subsequent to publication of The Strategic
Framework but her views do not necessarily represent those of those Working Groups nor of the
Steering Group.
63 It calls for flexibility and options for such companies within a broad framework. See also Freedman
(1994), n 5 above and Freedman (1999), n 18 above.
64 The Strategic Framework, n 4 above. Consultees responding to the DTI's initial consultative paper,
Modem Company Law for a Competitive Economy, March 1998 suggested LLCs as an option for the
UK - for example Graham Mather, A Company Law Fit for the Millennium (London: European Policy
Forum, 1998) and the response of Professor P. Willoughby, 'Offshore Trusts and Companies: A
Consumer's Guide' (copy kindly supplied by author).
Framework recognises that unlim

suitable for some types of business, b
limited liability vehicles. The thru
liability company should be made
possible for the small business. Th
'Is it agreed that it is not desirable to
majority of respondents agreed wi
Confederation of British Industry, f
innovation'. The Institute of Director
role in creating a dynamic private se
open to all those who wish to set
however, this support for limited
obligations to be imposed on those
proper creditor protection.
Although the Company Law Re
totally new limited liability legal f
proposed LLP is to be available to a
adapted for small businesses. As it
designed to be particularly user fr
required to make it so.68 There are
regulated or even to large firms.
developed to encourage firms,
partnerships, to obtain limited lia
only if there will be benefit to the
context is very different, the limite
of LLPs for small firms and the d
companies are similar to those dis
In both the USA and the UK ther
about the efficiency and desirability
the USA, the development of th
theoretical arguments on this area
further in the following parts of th
The limited liability debate

firms
The virtues of limited liability hav

The dominant, though not unoppo
65 The Strategic Framework, 68, ibid ques

66 These responses are available in the DTI
67 See n 3 above and DTI's Response to the
<http://www.parliament.the-stationery-off
et seq. It was argued, logically, by consulte
professions the advantages of a partnership
liability. This might give regulated firms a
68 For example it provides no standard form
HL Deb vol 610 col 846 et seq 6 March 2
partnership bill: a good deal for small bu
69 To the extent that firms would otherwise
proposals could be preferable from the po
would bestow would be less complete than
invention central to the creation of a modem capit

law and economics analysis supporting the value
widely accepted for around the last three decades, b
begun to question this. There have always been thos
liability is too freely available to small firms.71 Th
small firms to incorporate with limited liability ma
both for business owners and those to whom they tran
consider any curtailment of access to limited lia
enterprise and even suggest that more sole trade
encouraged to incorporate.73 It has been remarked u
proliferation of the LLC statutes, which give easie
small firms, has coincided with developments in t
which raise questions about the value of limited liab
To investigate these conflicting views further, thi
examining the general arguments in the law and econ
limited liability, and then proceeds to consider the a
small firms. It evaluates the law and economics argume
leaving consideration of the alternative values outlin
General advantages and disadvantages of lim

the 'efficiency' test
A contractarian analysis provides the now orthodox law and economics
explanation of the value of limiting shareholder liability. This economic theory
of the firm explains the company as a nexus of contracts joining inputs to produce
output.75 Equity investment is just one of those inputs. It is against the background
70 See P. Halpern, M. Trebilcock and S. Turnbull 'An Economic Analysis of Limited Liability in
Corporation Law' (1980) 30 University of Toronto Law Journal 117 (hereafter, Halpern et al) citing
The Times of 1824 opposing limited liability and The Economist, December 18, 1926 which put this
'invention' on a par with the work of Watt and Stephenson. Acceptance of the principle was slower in
the UK than in the USA: Kevin Forbes, 'Limited Liability and the Development of the Business
Corporation' (1986) 2 Journal of Law, Economics and Organization 163. For a flavour of the early
debates see Bramwell, 'The Law of Limited Liability' (1888) 9 J. Inst. Bankers 373; C.A. Cooke,
Corporation, Trust and Company (Manchester: Manchester University Press, 1950).
71 See the historical discussion in J. Freedman (1994), n 5 above and, for example, Otto Kahn-Freund,
'Some Reflections on Company Law Reform' (1944) MLR 54; Jacob S. Ziegel 'Is incorporation (with
limited liability) too easily available?' (1990) 31 Les Cahiers de Droit 1075; Andrew Hicks, 'Limiting
the Rise of Limited Liability' in R. Baldwin (ed) Law and Uncertainty (London: Kluwer, 1997);
Vestal, n 54 above; Lawrence E. Mitchell, 'Close Corporations Reconsidered' (1989) 63 Tulane Law
Review 1143.
72 See Vestal, 'New and Revised American Laws for Unincorporated Firms Create Significant Traps fo
the Unwary' in Patfield (ed) Perspectives in Company Law: II (London: Kluwer, 1997); Henry
Hansmann & Reinier Kraakman 'Toward Unlimited Shareholder Liability for Corporate Torts' (1991
100 Yale LJ 1879 (hereafter Hansmann and Kraakman).
73 For example, Institute of Directors, Deregulation for Small Private Companies (London: IOD, 1986
Mather, n 64 above; J.J. Henning, 'Close Corporations and Private Business Corporations - Th
Southern African Solution', in Rider and Andenas (eds), n 5 above; John Lowry, 'In Defence o
Salomon: Promoting the Corporate Veil' in Rider and Andenas (eds), n 5 above; Ribstein (1991), n 3
above; Ribstein (1995), n 26 above; Macey, n 39 above. B. Pettet in 'Limited Liability - A Principl
for the 21st Century?' in Freeman and Halson (eds) (1995) 48 Current Legal Problems Part 2, 148
argues that abolition of limited liability would create problems but urges the use of insurance to
protect tort creditors. See also n 68 above and text thereto.
74 Bratton and McCahery, n 45 above.
75 The classic articles include M. Jensen and W. Meckling, 'Theory of the Firm: Managerial Behavior
Agency Costs and Ownership Structure' (1976) 3 J Fin Econ 305 and E. Fama and M. Jensen, 'Agency
Problems and Residual Claims' (1983) 26 J L & Econ 327. For a general critique see W. Bratton, 'Th
"Nexus of Contracts" Corporation: A Critical Appraisal' (1989) 74 Cornell Law Review 407.
0 The Modem Law Review Limited 2000 327
of this model that the virtues of lim

terms of efficiency.76
The theory of the firm argum
summarised briefly as follows. Firs
agents.77 The less risk the shareh
agent. With a quantified risk, the sh
at a certain level would exceed t
limited liability also have less need
of those others is irrelevant. Thir
shares. Shares with limited liability
of the identity of seller or purcha
negotiation needed on the part of
(managers) through the market p
facilitates diversification of portf
reduce their risk through diversif
diversification increases risk becaus
failure of any one firm. Diversific
enter into risky ventures without ri
therefore, increases the capital a
efficient provided those project
beneficial uses of capital.
The above summary represen
contribution made by limited lia
view is that since the parties can c
liability regime, the liability regim
to this is that the cost of contrac
regime is chosen,79 and that ris
shareholders alone.80 The writing
about the efficiency of limited liab
company.
Recent work on the theory of the firm threatens to disturb some of the
underlying assumptions behind the standard analysis of the value of limited
liability.82 The 'orthodox' economic analysis of law has absorbed theory of the
76 H. Manne, 'Our Two Corporation Systems: Law and Economics' (1967) 53 Va. L. Rev 259; Halpern
et al n 70 above; F. Easterbrook and D. Fischel, 'Limited Liability and the Corporation' (1985) 52
University of Chicago Law Review 89; R. Posner, n 10 above, chapter 14; Cheffins, n 11 above.
77 This, and the summary of the arguments which follows, are taken mainly from Frank H. Easterbrook and
Daniel R. Fischel, The Economic Structure of Corporate Law (Cambridge, Massachusetts: Harvard
University Press, 1991) (hereafter Easterbrook and Fischel), Posner n 10 above and Manne, ibid.
78 R. J. Mofsky and R. Tollinson 'Piercing the Veil of Limited Liability' (1979) 4 Delaware Journal of
Corporate Law 351 also contend that limited liability does not arbitrarily impose unwarranted costs
on involuntary creditors because the cost to consumers will reflect where the tort risk falls.
79 Kevin F. Forbes, 'Limited Liability and the Development of the Business Corporation' (1986) 2
Journal of Law, Economics and Organisation 163; Halpern et al, n 70 above.
80 Easterbrook and Fischel, n 77 above, 45, discussed further below.
81 Hansmann and Kraakman, n 72 above. But see Grundfest, 'The Limited Future of Unlimited Liability:
A Capital Markets Perspective' (1992) 102 Yale L J 387; H. Hansmann and R. Kraakman, 'Do the
Capital Markets Compel Limited Liability? A Response to Professor Grundfest' (1992) 102 Yale LJ
427; D. Leebron, 'Limited Liability, Tort Victims and Creditors' (1991) 91 Colum L Rev 1565.
82 Bratton and McCahery, n 45 above, 640 et seq who show, for example, that this literature questions
the assumption of the 'first generation agency theory' of Jensen and Meckling and others that a single
optimal capital and ownership structure for the firm exists as a theoretical proposition. They cite
Joseph T. Williams, 'Perquisites, Risk and Capital Structure' (1987) 42 J Fin 29; Oliver Hart, Firms,
Contracts and Financial Structure (New York: Clarendon Press, 1995) .
firm but not its subsequent development. Brat

example, that some of the more recent literature
shareholdings is not necessarily desirable. Concent
better way to deal with the monitoring problem, si
incentive to monitor without others free-riding o
consistent with real developments such as the con
the hands of the institutions, although it is not entire
are eager to play an active monitoring role.84 Thes
literature give grounds, then, for questioning the
enhances productivity by discouraging concentration and encouraging
diversification and suggest that limited liability cannot be assumed to be the
optimum arrangement for business organisations in all circumstances. Other work
on the theory of the firm may result in further questioning of the assumptions
about ownership structure which underlie the efficiency theory applied by the law
and economics analysts.85
Even the current 'mainstream' law and economics literature raises arguments
against limited liability in some circumstances. The primary argument against
limited liability is that it shifts the risk of failure onto creditors from shareholders,
creating potential moral hazard.86 In response to this, Easterbrook and Fischel reply
that, when a limited liability firm fails, the loss is 'swallowed' rather than shifted.87
Due to the legal rules governing priorities, they argue, the shareholder of a failing
company loses his investment before the creditor. Each investor in fact has a cap
on the loss he will bear. Posner, on the other hand, does describe limited liability as
a means of risk shifting.88 The ability of the shareholder to limit his risk must have
some effect on the risk to others, although it is true that this may not create any
greater moral hazard than would arise if an investor in an unlimited regime had
insufficient resources to cover his liabilities. Once these resources run out, the risk
will be borne by creditors in an unlimited liability system also.89
Whether this effect is described as risk shifting or risk sharing, it is argued by
proponents of limited liability to be a more efficient arrangement than one in which
shareholders bear all the risk. For one thing, creditors, such as banks, will often
have specialist knowledge and skills, so that they will be better equipped than
shareholders to monitor managers. Voluntary creditors can build the risk of
83 Bengt Holmstrom, 'Moral Hazard in Teams' (1982) 13 Bell J Econ 324 discussed in Bratton and
McCahery, ibid, 649.
84 On institutional shareholders and corporate governance see Paul L. Davies 'Institutional Investors in
the United Kingdom' in D. Prentice (ed) Contemporary Issues in Corporate Governance (Oxford:
OUP, 1993); Paul L. Davies 'The United Kingdom' in T. Baums and E. Wymeersch (eds)
Shareholder Voting Rights and Practices in Europe and the United States (London: Kluwer Law
International, 1999); V. Finch 'Company Directors: Who Cares about Skill and Care? (1992) 55 MLR
179; Committee on Corporate Governance, The Combined Code June 1998. A Committee of Inquiry
into UK Vote Execution has recommended that 'regular, considered voting should be regarded as a
fiduciary responsibility' for institutional investors: National Association of Pension Funds Press
Release, 5 July 1999.
85 For example see Andrew Winton, 'Limitation of Liability and the Ownership Structure of the Firm'
(1993) 48 J Fin 487. He considers that increased shareholder liability could have productivity benefits
and is interconnected with the efficient choice of ownership structure (discussed in Bratton and
McCahery, n 45 above, 651).
86 Particularly in relation to private, undercapitalised companies and groups: Halpern et al, n 70 above,
discussed further below; Jonathan M. Landers, 'A Unified Approach to Parent, Subsidiary, and
Affiliate Questions in Bankruptcy' (1975) 42 U Chi L Rev 589.
87 Easterbrook and Fischel, n 77 above, 44.
88 Posner, n 10 above, 432.
insolvency into the interest they c

collateral, minimum capitalisatio
attached costs but these will be lo
changing body of shareholders th
regime.90
There are two major problems
convincing for trade creditors tha
Arguably shareholders are superio
latter. One issue is whether these d
appropriate weightings in the e
argument cannot justify the cons
creditors for whom there is no op
this, Hansmann and Kraakman argu
torts would be a plausible alternat
liability would avoid the problem
shareholder. They are not persuad
liability for torts would discourag
be in the case of firms which impo
invest would be a good thing. In th
by the lowering of share prices to re
again a good thing.
Hansmann and Kraakman conclud
justified, despite the practical, a
operating a regime of pro rata unl
however, that they lack the stat
needed to decide policy finally and
mainstream.93 The criticisms of th
of corporations with liquid, activel
that modem financial markets wou
such a way as to undermine its effec
corporate veil should be lifted in fav
difficulties this would create in
shareholders in a system in whi
corporations, the arguments in fav
seem to have more credibility.96
So, standard efficiency theory of
of corporate torts. In addition, t
consider in detail the effect of lim
90 Posner, n 10 above, ch 14.

91 It would be possible for economic analysis to take into account the trade creditor's lack of information
and weak bargaining position through concepts such as that of asymmetric information and barriers to
contractual cooperation but some of the literature on limited liability seems to assume a model
without these complications: see Deakin and Hughes, CfiLR, n 7 above, 171.
92 Hansmann and Kraakman, n 72 above, 1933.
93 Posner, n 10 above; Grundfest and Leebron, n 81 above. Ribstein has remarked that the tort system
may also not get the balance of liabilities right - Ribstein and Sargent, n 35 above, 643.
94 See the exchange between Grundfest and Hansmann and Kraakman, n 81 above.
95 Posner, n 10 above, 448. He also rejects insurance as a satisfactory alternative since the managers
might fail to take out adequate insurance and there might be reasons why the insurance company
would not cover or pay up on a particular tort. See too Bratton and McCahery, n 45 above, 655, who
question whether the insurance market could handle the increased levels of risk and demand which
they believe would follow a shift to an unlimited liability regime.
96 Bratton and McCahery, ibid 639.
330 C The Modern Law Review Limited 2000
have the bargaining power or resources to protect

Current orthodox thinking is that the benefits of lim
despite the above objections. There is a danger, how
far permeate our thinking that we will not stop t
situations.
Limited liability, efficiency and close corporations

The LLC makes formation with limited liability more flexible and tax efficient for
small firms - how far is a move in this direction justified on grounds of economic
efficiency? To what extent should the UK attempt to make incorporation with
limited liability for small firms even more attractive and simple than it is already?
The arguments of mainstream law and economics analysis in favour of limited
liability are based on the use of incorporation to raise capital from outsiders. It is
therefore worth questioning what, if anything, this analysis has to tell us about
limited liability for shareholders of small, private, closely held firms.
Contractarian economic analysis has been explicit in distinguishing closely
held, or owner-managed, corporations from public, quoted corporations.97 The
tendency has been towards a simplified model, however: one in which these two
types of firm are quite distinct and easily categorised.98 In practice, it is clear that
firms need to be described in terms not of a dichotomy (large or small, public or
private) but as dynamic entities along a continuum, often with hybrid
characteristics or in stages of transition.99 In addition, the law and economics
analysts are concerned primarily with public quoted corporations, precisely
because their theories are designed to explain that phenomenon. By definition,
their theories lead to the subordination of the needs of closely held corporations
to those of the public corporation. The result is that the close corporation is seen
as something of an irritant, a problem for the theorists or an exception to a
general rule rather than a widespread phenomenon in its own right which appears
in numerous forms.
It is widely accepted that many small close corporations and those dealing with
them do not benefit from the advantages of limited liability identified by the
standard analysis.100 The first of these, it will be recalled, is the reduction of the
need to monitor 'agents' - the managers. In close corporations, owners and
managers may be an identical group, perhaps even a single person. If there is no
separation of ownership and control, this supposed benefit of limited liability falls
away. Monitoring costs would be low without limited liability, because few people
are involved. Secondly, because the number of shareholders is small the
shareholders are often in a position to monitor each other. Thirdly, the shares are
not marketed and are usually not freely marketable, so there is no control of agents
97 For example, Manne, n 76 above; Fama and Jensen, n 75 above; Easterbrook and Fischel, n 76 above;
Frank H. Easterbrook and Daniel R. Fischel 'Close Corporations and Agency Costs' (1986) 38 Stan L
Rev 271 (hereafter Easterbrook and Fischel 1986); Halpern et al, n 70 above.
98 These analysts do not purport to be describing the 'real world' but argue that a lack of realism is a
precondition of theory. An attempt to reproduce the complexity of the empirical world would be a
description and not a theory see Posner, n 10 above, 18. The value of the theory may be questionable
if the models are too far removed from reality, however and it may be better to produce a less clear
but also less misleading analysis: - see Deakin and Hughes, n 7 above, 215.
99 Freedman (1994), n 5 above; T. O'Neill, 'Toward a New Theory of the Closely-Held Firm' (1993)
Seton Hall Law Review 603.
100 See Easterbrook and Fischel, n 77 above, 56; Easterbrook and Fischel 1986, n 97 above and Halp
et al, n 70 above for discussions of the arguments summarised here.
through the market price of the sh

that investors and managers are a
Fourthly, diversification is less o
those where ownership and manag
regime, the owners of an owner m
entire wealth in the firm, thereb
whereas in an unlimited liability re
In practice, however, they may
guarantees. Security of this type is li
marketable shares, has no addition
funds. The facility for diversif
circumstances. Moreover, as the
investing their own human capita
diversify the risk of business failu
Fifthly, and perhaps most signific
by limited liability in close cor
incentive to attempt to invest ins
undertake than do those who are
managers. Where the direct invest
negligible, as is often the case in a
all, but shifted to others. To preven
relationship of importance will of
resulting transaction costs.103 Such
on to the shareholders, who may t
one venture. Trade creditors with
will not be in a position to shift b
Limited liability with partial reve
allocation of risk to those most ca
firm believe they have a measure
investing more and more of their p
guarantees, especially if it gets int
from this regime. Nor does the risk
least able to monitor and assess ris
fact pick up any remaining losses.
bargaining power who seems to ga
101 Easterbrook and Fischel, n 76 above, 1

diversification is c more important in close
shareholders in such companies are requir
precise size and type of company under d
102 Survey evidence supports the impression
in terms of formal and informal capital:
Report, n 5 above, 13-15.
103 If the loan is small, even banks will not f
Cressey, 'Overdraft Lending and Busines
Chittenden, M. Robertson and D. Watkins
Chapman Publishing Ltd, 1993). Where th
charges. A range of devices is available to
Risk: Who Pays the Price?' (1999) 62 ML
104 See Freedman and Godwin (1994), n 1
business owners to understand the conse
regime. UK banks and other lenders may h
by taking personal guarantees than in o
Businesses and their banks in the year
Enterprise: The Future of the Small Busi
332 0 The Modem Law Review Limited 2000
The law intervenes in the UK to protect creditors

trading by directors can be proved.105 This, though
enforcement can be costly and uncertain even if th
be satisfied. Not every case where risk is shifted by
wrongful or fraudulent trading. Even where ther
always funds to bring such actions, which may mea
still not be as well protected as banks and major t
covered themselves through a range of security d
bearing the greatest risk may be those least able to
is difficult to see that the disadvantage of creating
any benefits, either to the owners or to others.
Thus limited liability for close corporations m
claimed for it in open corporations and a number of
create a moral hazard for third parties, but it may
parties who seek to contract around this regim
themselves. Some economic analysts assume that w
liability or no true separation of ownership and co
not be incurred. Fama and Jensen have commen
where ownership and control are not separated, ag
so are 'costly mechanisms for separating the m
decisions'.107 Unfortunately, this is an over-simpl
business organisation recognises the possibility
separating, those mechanisms may need to be in p
organisation used is designed to give limited liabilit
may end up paying for a layer of regulation design
the effects of limited liability (such as disclosure re
main benefits of such a regime. At the same t
insufficient to provide for those third parties due to t
to enter into risky transactions for which they nee
Despite these apparent disadvantages, many owner-ma
companies, sometimes through lack of information, in
to limit their liability more effectively than they actu
perceived benefits which may have very little to
economic analysts. Empirical work has shown that
example, are high on the list of reasons for in
company.108 Irrational though they may seem, the
105 Insolvency Act 1986, ss 213 and 214. See Paul L. Davies, G
Law (London: Sweet and Maxwell, 6th ed, 1997), 151-155 a
Farrar's Company Law (London: Butterworths, 4th ed, 1998) 7
case law. Also V. Finch 'Directors' Duties: Insolvency and the
Current Issues in Insolvency Law (London: Stevens, 1991).
106 See S. Wheeler, 'Swelling the Assets for Distribution in Corpo
'Wrongful Trading - Has it been a failure?' (1993) Insolvency Law a
are recovered under sections 213 or 214, it seems they are available
of a charge - see for example Re Oasis Merchandising Services L
(CA) cited by Farrar and Hannigan, ibid in support of this point
Smoke without Fire?' (1995) Palmer's In Company (September
Insolvency' [1998] CfiLR 121 who argues that the attitude shown
provides some cause for optimism that innovative funding mechan
107 Fama and Jensen, n 75 above.
108 In the author's survey 66 per cent gave limited liability as a r
prestige and credibility: Freedman (1994), n 5 above. See also
Business School, Your Business Legal Structure (Manchester:
result in a situation in which the vas

private companies which do not appea
are extolled by the theorists.109 Econo
this factual information into their
example, state that the principal i
advantages, perpetual existence and o
recognises the mismatch between rea
Probably the greatest single mystery in
small corporations in existence, the st
exclusively with the problems of the la
the existing corporate system were not
was overlooked. With hindsight, we c
small corporations were logically pred
Manne refers to historical evidenc

extension of the availability of lim
firms.11" Those who support limit
being necessary for the functionin
that the reasoning does not apply t
Not only do small private firms w
fact do so, but it is also very diffi
and exclude firms for which such
not. It might also be perceived a
limited liability despite the fact t
them that they expect.112
The moral hazard argument and th
contract round limited liability, le
limited liability, to form an 'emp
liability regime is the most effici
They acknowledge difficulties, ho
distinguish large and small firms
different sized firms. Halpern et
some perverse and wasteful incent
structures to ensure compliance wit
This tension between the theoretic
work of other writers also. Vari
alleviating the problem of access to li
most efficient liability regime and y
109 For the statistics, see n 19 above.

110 Manne, n 76 above.
111 Manne, ibid 277 on the USA. On the UK see Freedman (1994), n 5 above, P. Ireland 'The Triumph of
the Company Legal Form, 1856-1914' in J. Adams (ed), Essays for Clive Schmitthof (London:
Professional Books, 1983).
112 Gabaldon, n 16 above, 1434. Some firms would benefit from being excluded from limited liability in
the long run but others would lose and the difficulty, once again, is to draw the line between them.
113 Halpern et al, n 70 above.
114 Halpern et al, ibid 148.
115 Some of these writers also consider the need for different governance rules for close corporations, for
example special exit mechanisms for oppressed minorities or removal of the board of directors with
management directly in the hands of the shareholders. These devices might be seen as justifying a
separate legal form for these firms, or a special subset of rules as found in USA Close Corporations
statutes and chapters, but this is for the purpose of internal relationships (as to which see Freedman
(1994), n 5 above: this topic is not discussed further in this article).
main suggestions are a minimum capital requireme

liability, unlimited liability to tort creditors, manda
corporate veil or imposing liability on managers or
way.116 None of these suggestions, however, provides a
between those firms for whom limited liability is effic
not. These issues will be discussed in turn.
Reducing access to limited liability
A minimum capital requirement

One apparently obvious measure to prevent small, undercapitalised firms from
incorporating with limited liability would seem to be the imposition of a minimum
capital requirement. Such a requirement exists in many jurisdictions for private as well
as public companies,117 but is not part of the Anglo-American tradition. This creates a
distinction in approach that is a matter of more than detail: it reflects a deep cultural
divide as regards attitude to limited liability. It is not surprising, then, that we find
Kahn-Freund, who came to the UK from the continental European tradition, arguing
for the introduction of a minimum capital in the UK to make the formation of
companies more difficult and more expensive in order to 'restore the limited company
its original function, and to the partnership its proper place in business life'.118
The minimum capital requirement is still seen by some in continental Europe as
an important barrier to incorporation to protect creditors, although there are critics
of the requirement in those countries also.119 In Sweden, for example, the level of
capital required for private companies has just been raised.120 Denmark raised its
116 Another suggestion which has been made is that directors should not be appointed to limited liability
companies unless they pass an examination or show fitness to run a company in some other way such
as attending a course: see J. Hudson, 'The Limited Liability Company: Success, Failure and Future'
(1989) 161 Royal Bank of Scotland Review 26; Finch, n 84 above; IOD Press Release July 1999, New
Standard for Company Directors (announcing new qualification for directors which would not,
however appear to be suitable for start ups since it requires three years experience). These proposals,
though, do not relate to economic suitability - one may be very aware but still dishonest!
117 Within the European Union only the UK and Ireland do not have a minimum capital requirement for
private companies: the Second Directive on Company Law requires a minimum capital for public
companies. The idea of extending the Second Directive to private companies has been floated but
rejected to date. See Boden de Bandt de Brauw, Jeantet and Uria, Second Directive's Extension to
other Types of Companies (Brussels, 1992); University of Manchester Centre for Law and Business,
Company Law in Europe: Recent Developments, (DTI/University of Manchester, 1999) (hereafter
University of Manchester).
118 Kahn-Freund, n 71 above.
119 See Boden de Bandt de Brauw et al, n 117 above and note the criticisms of the Belgium minimum capital
requirement, for example, as having only an illusory protective role: J. Wouters, 'Towards a European
Private Company? A Belgian Perspective' in H-J De Kluiver and W. Van Gerven (eds) The European
Private Company? (Antwerp: Maklu, 1995) 166. More important, in Belgium, as Wouters notes, is the
requirement that the company's founders must present a business plan to the notary public in which they
justify the amount of capital in the light of the company's projected activities. In addition the founders
are liable in the event of bankruptcy within three years after the formation of the company if the capital
on formation was manifestly insufficient for the normal exercise of the projected activity for a minimum
of two years. Presumably this second provision would be unnecessary if the first was truly effective, but
this does seem to be a significant restriction on limited liability.
120 This decision is, however, the subject of criticism within Sweden. I am grateful to Professors Claes
Norberg and Per Thorell for informing me of this debate. The arguments against the minimum capital
requirement in the Nordic countries appear to be heavily influenced by the law and economics
analysis described here as well as by the practical problems companies are experiencing in doubling
their share capital from 50,000 SEK to 100,000 SEK (?3,750 to ?7,500). The time period for
implementation of the new levels has had to be extended to allow the smallest companies to adapt to
this requirement.
minimum capital requirement for

Trade and Companies Board refused
company, Centros Ltd, which did no
were essentially that this was an
capital rules. Eventually this refusa
Justice, which held that it was cont
This could be construed as giving t
firms actually intending to operate
avoid paying a minimum share cap
capital requirement in 1996 as part
law122 which could be a result of d
this case. Equally, there could be pre
to raise its requirement if other me
as important.
The law and economics writers reject a minimum capital requirement as a
solution, giving theoretical backing to the pragmatic reasoning which can be
found in the UK debates. A minimum capital requirement for private
companies has been considered on various occasions in the UK. The Jenkins
Committee favoured the introduction of such a requirement in principle but
'reluctantly [came] to the conclusion that its purpose would be too easy to
evade' and so did not recommend it.123 The problem they foresaw was that it
would be impossible to prevent the company from returning cash to the
promoters in exchange for assets or by way of loan, for example. Nevertheless,
a White Paper in 1973124 took the view that a minimum paid-up capital of
perhaps ?1,000 would not only help to 'ensure some minimum financial
substance as a proper qualification for the protection of limited liability but it
would also act as a deterrent to frivolous incorporations'. This idea was lost
with the 1974 General Election and has not been revived since. The current
Company Law Review Group has not encouraged commentators to propose
minimum capital requirement. Most respondents have supported barrier f
access to limited liability, but a significant minority have shown support for
minimum capital requirement.125
There are clear theoretical arguments supporting the current UK opposition
the introduction of a minimum capital for private companies. The main problem
are twofold. First, how would the level be set? Secondly, once the minimum capi
had been paid in, could it be retained in the company so as to protect creditors a
if so, at what cost? On the first point, Easterbrook and Fischel argue that there i
danger that the level required will be set too high so as to impede desirable ne
entries and permit existing firms to charge monopoly prices. Hansmann a
Kraakman also reject minimum capitalisation, largely on the practical grounds
the difficulty of setting the level appropriately for different industries and
121 Centros Ltd and Erhvers-og Selskabsstyrelsen Case C-212/97, ECJ. Judgment 9 March 1999 [19
ECR 1-1459.
122 University of Manchester, n 117 above.
123 Company Law Committee Report (chairman Lord Jenkins) Cmnd. 1749 (1962) at para 27.
124 DTI, Company Law Reform White Pape, Cmnd 5391 (1973).
125 The Strategic Framework (1999), n 4 above asks (a)'Is it agreed that it is not desirable to r
access to limited liability? (b) If not, then what constraints should be considered?' (Question 10)
the answers to (a) see text to n 66 above. Where constraints were thought desirable, a min
capital was the most popular approach, supported by the Institute of Chartered Accountan
Scotland, The Association of Chartered Certified Accountants, the Institute of Credit Manag
and the Labour Finance and Industry Group amongst others.
336 O The Modem Law Review Limited 2000
problems of enforcement. 126 Undoubtedly, if one is

as a tool of creditor protection, the level has to be rea
but the appropriate level for a manufacturing comp
too high for a service company, for example. If the le
or too high for a particular group, this could set up
would be costly in social terms. Once again, the prob
between those firms that should, and those that shou
liability. A minimum capital requirement does not so
poses it in a different way.
This analysis does not, however, deal with the som
deterring frivolous incorporations - the justificat
Paper. Those writing from an economic analysis
rational players. This practice may cause them to for
encourages some to incorporate who would not do so
and understanding of the situation. A minimum cap
amount, which would not deter any serious player fr
much to alert a person for whom incorporation is w
seriousness of that course of action.127 It would not
for which other mechanisms are needed, but it migh
misapprehension, especially if used as an opport
implications of forming a company with limited lia
The purpose of such a requirement could be seen as p
liability cannot be obtained without some level of th
assumed by the business owners.128 This requiremen
the existing provisions, legislative and contractual, wh
business has been embarked upon and, particularly,
that, at present, a company may be purchased off t
purporting to have the capacity to bestow limited
opposite signals.
The second problem is whether, the required minim
fenced so as to provide protection. Easterbrook and F
had to hold or ring fence funds to be held in a risk-f
amount of capital tied up in a form that would not yield
for investment in the business. This measure, there
cost. If the capital were not protected in this way, ho
minimum capital requirement would not be effective
the Jenkins Committee regarding evasion. The prob
ones, although they have not prevented the introdu
requirement for public companies in the UK, accom
to preserve capital reserves.129
126 Hansmann and Kraakman, n 72 above: see, however, Grundfe

minimum capitalization is seen as having some virtues, despite th
127 This has been proposed by J. Hudson, n 116 above, 37 and se
above, especially that of the Association of Chartered Certified A
128 It would reduce, to some extent, what presently seems to be
liability for undercapitalised firms even if only symbolically: s
129 Companies Act 1985, s 118 imposes a minimum capital require
The UK capital maintenance provisions were tightened by the
Law. Not all these provisions have been applied to private com
relaxed: see Davies, n 105 above, chapter 11; The Company Law
Formation and Capital Maintenance URN 99/1145 (London: D
Again, though, these anxieties ar

provide funds for creditors. If the ob
does not come without some respon
this aim might be met without ty
initial outlay required which would
not necessarily provide a fund for cr
type would not achieve the end of
firms where there was a solid econ
be a formal reminder that incorp
appropriate. In this way it would
protection method. It would also a
should consider the suitability of t
treating it as a mere formality.
Another objection to a minimum
panies is that unlimited liability bu
ensuring that family assets are no
corporated businesses may them
Easterbrook and Fischel.130 On thi
capital under a limited liability
imposed on all businesses. There
owners of businesses without limit
at risk and act accordingly.131 Sec
requirement is to give a signal abo
liability company, the parity argu
There are arguments, then, for a
fairly low level as a barrier to f
limited liability is unhelpful for th
does not seem that a minimum cap
mechanism for drawing the line
achieve optimal risk allocation and
enthusiasm for an 'enterprise cu
liability make it unlikely that any
the downside of encouraging risk-
seen in terms of tightening up le
after the event, rather than reduc
about its use.132
Contracting around limited liabilit

As discussed in general terms abov
access to limited liability, since con
that, since most creditors can c

131 Freedman and Godwin 1994, n 1 above,
firms considered that capital contributed by
and see n 190 and text thereto, below.
132 See, for example, the approach to risk
Driven Economy, n 17 at para 2.12 'We ar
will create a lasting stigma. Investors are to
try again'. See also DTI Press Release, n 3
innovation and enterprise'.
133 See n 78 above and text thereto.
personal guarantees on the owners, the problem o

method of limiting access to limited liability,
essentially leaves it to the parties to decide which
On this basis, it might seem that the liabilit
inconsequential. In widely held companies, howeve
the owners to contract for limited liability in eve
regime is generally preferred in order to cut trans
that it is less costly for contractual waiver to
companies, where fewer parties are involved. T
liability regime for close companies is not as com
liability for large, widely held companies.134
There are many problems with this analysis, as re
discussion of limited liability. Leaving the ques
parties assumes they are all equally equipped to de
negotiate to achieve this. This self-help approach
creditors and those too small, ill-advised, or lackin
power to enter into such contractual waiver.135 T
involved in contractual waiver is regressive: it weig
players. Where the trade creditor is small, the cost
liability in the case of an every-day transaction wo
his resources. He does not have the facilities to m
yet cannot afford to turn them away if he wishe
seems a small sum to a banker or other large conc
difficulties to a very small trader.
Hansmann and Kraakman136 consider that the
liability in tort do not extend to contract. Their r
the supposed ability of voluntary creditors to waiv
that shareholders do, in practice, waive limited liab
'where this is most efficient (that is, where waiv
contracting)'. They do not go into the details of
measured by the participating parties. Nor do the
small trade creditor raised above.137 They conclud
contract creditors makes sense even for corporati
because of this ability to contract around the rule.
that it makes sense to allow incorporation by a sin
might otherwise seem pointless'. This seems a thin
one person limited liability companies, but may be
these authors' view that the case for limited liabilit
out either for close or public companies.
Contracting around the limited liability of small f
to the moral hazard problem and, worse, creat
business owner under such a regime has every inc
he can to compensate for the fact that he cannot a
keep his large creditors with personal guarante
others.138 Though he may not have shifted suffici
134 Halpern et al, n 70 above, 148.

135 Hamilton and Ribstein, n 45 above, 697.
136 Hansmann and Kraakman, n 72 above.
137 That is the problems of unequal bargaining power, lack of information and expertise and transaction costs.
138 Leebron, n 81 above, agrees that personal guarantees, far from correcting the balance of liability, are a
distortion and an argument for lifting the veil in favour of involuntary creditors.
survive financially in the long run,

with him. Whether this is efficient in
the risk to superior risk bearers (the
small trade and involuntary cred
necessarily protecting the business
Unlimited liability in respect of tor

The contractual waiver arguments are
for whom contracting out of lim
Hansmann and Kraakman in favour
tort have been referred to above. H
shareholders, should be personally l
held companies in certain circumsta
considered unmeritorious.140
As noted above, there would be major practical problems with the introduction
of an unlimited shareholder liability regime in the case of widely held, public,
quoted companies. These difficulties relate mainly to the costs of administering
such a regime in terms of enforcement against a number of parties, additional
monitoring costs and the reduction of efficiency in the capital markets. These
problems would not exist to such an extent in the case of the very smallest close
companies.141 As close companies grew, however, so would these practical
difficulties. Once again we meet the problem of the appropriate boundary for
accessibility to limited liability. Although the argument for an unlimited
shareholder liability regime is more practically defensible in the case of the
smallest, private firms, this distinction does not assist us in drawing a practical line
between the different types of company.142
The proposal of Halpern et al for directors' personal liability is more limited and
more practical in some senses. The circumstances in which this exception to the
general rule on limited liability would apply would need to be defined, however,
and this would be difficult since so much depends on the facts of the individual
case in deciding whether the use of limited liability is justified or not.
Mandatory insurance
Another approach found in the general literature on limited liability is that the
adverse effects of risk shifting might be mitigated by mandatory insurance. Again,
though, this could create barriers, particularly for new, small businesses, since the
cost of insurance may be greater where there is no past record.143 Conversely, if
effective monitoring by insurers was not possible, so that insurance was made
available for a risky enterprise at a price not reflecting the full risk, owners might
be encouraged to undertake risky activities which they would not have attempted
without the insurance.144 Such a development would increase moral hazard rather
than decreasing it. Whilst some firms would be encouraged to take risks which
were not beneficial to society, ultimately the existence of insurance for certain
139 As to whether it passes other tests, see part five of this article, below.
140 n 70 above, 149 and see Hansmann and Kraakman, n 72 above.
141 Bratton and McCahery, n 45 above, 639.
142 D. Goddard, 'Corporate Personality Limited Recourse and its Limits' in R. Grantham & C. Rickett
(eds) Corporate Personality in the 20th Century (Oxford: Hart Publishing, 1998).
144 V. Finch, 'Personal Accountability and Corporate Control: The Role of Directors' and Officers'
Liability Insurance' (1994) 57 MLR 880.
340 ? The Modem Law Review Limited 2000
whole classes of company could be threatened.14

would not necessarily create the optimal level of i
ventures.
If insurance was always available in the market, there would be less need f
limited liability, but there will be risks which insurance companies will not co
In a perfect world, these would be only the risks that would not benefit society
market failure can occur.146 It will be costly for insurers to gather inform
about large numbers of firms: creditors might be in a better position to eva
risk as they may well deal with fewer firms and have a closer relationship w
them. Halpern et al conclude that, in the type of case where creditors curre
contract out of limited liability - that is, small, high risk firms - insurance w
be unlikely to be available. If insurance were mandatory, the inability of such f
to obtain insurance would indeed have the effect of reducing their access to lim
liability, which is the outcome we seek in some circumstances, but would the
be drawn in the optimal place?
Since a level of insurance cover would have to be fixed upon if the mandat
requirement was to be meaningful,147 the insurance solution has all the difficu
of a minimum capital requirement in terms of fixing this level.148 It would al
difficult to police; possibly more so than a minimum capital requirement, w
could more easily be linked with the registration process. In addition, the argu
for mandatory insurance assumes that insurance will be available w
appropriate and that effective monitoring can and will take place. In essence
mandatory insurance route substitutes the judgement of the insurance mark
(which may be non-specialist and not particularly well positioned to monitor r
for that of the legislator or the creditor about the acceptable level of risk.149
Another modification of the insurance argument is put forward by Leebron
He argues that shareholder/managers in close corporations151 should hav
obligation to provide adequate insurance to meet the claims of foreseeable to
victims. Such an obligation would have the advantage of flexibility. It would b
to the shareholder/managers to decide on adequacy of insurance levels, and t
145 Halpern et al, n 70 above, 140.

146 See K. Arrow, Essays in the Theory of Risk-Bearing (1971), 140 cited in Halpern et al, ibid 12
current auditor liability debate is in part premised on the notion that auditors cannot always ob
insurance to cover their risks: see Freedman and Finch, n 3 above.
147 Pettet, n 73 above, 157 suggests that the requirement could be 'to purchase liability insurance ag
tort claims to the extent that the claims overtop their assets' but recognises that such insurance
not be available in some cases. Insurance companies seem unlikely to be keen to provide open-
cover.
148 Gabaldon, n 16 above suggests that a panel of community volunteer

recommendations about adequate insurance levels but admits that this propos
issues'.
149 These arguments against mandatory insurance in general terms may be less strong in relation to
insurance for specific risks such as, for example, injury to employees, which are more easily
quantifiable than general risks and where more obvious policing mechanisms are available. In the UK,
for example, employees who are tort victims are protected by the Employers' Liability (Compulsory
Insurance) Act 1969. Employees may be in a better position than creditors to monitor compliance
with this requirement. This solution also enables employees to claim against the employer's insurance
policy to take priority over other creditors in the event of insolvency. It remains possible that an
employer could have difficulty in obtaining the required cover: see Cheffins, n 11 above, 508 citing
'Insuring the Uninsurable', Financial Times, 2 December 1994.
150 Leebron, n 81 above, 1636.
151 Leebron, ibid argues that in the case of publicly held companies, officers have sufficient incentive to
insure in any event. They get little benefit from failing to do so unlike owner managers who thereby
save costs of greater significance to themselves. In any event, officers of publicly held companies
usually will have few assets compared with the assets of the company and likely claims.
? The Modem Law Review Limited 2000 341
The Modem Law Review [Vol. 63
could be subject to penalty or per

level of cover. Whilst superficiall
many difficulties. The duty would
what was an adequate level of insu
court decisions would normally b
officers would not have had tha
uncertainty about proper levels of
by the cautious, with the reckl
requirement entirely, especially if
considered to be an acceptable
discussed above would continue to
Thus, mandatory insurance may h
reducing the extent to which certa
risks created by business owners.
liability more generally, its effect
monitor and assess risk accurately
of closely held companies. If m
increase, rather than decrease, mo
Imposing liability on managers or

other devices
In practice, the law sometimes deals with the problem of drawing the line between
firms that should and those that should not have the benefits of limited liability by
the device of piercing the corporate veil. This is used at times to hold shareholders
liable and at others to impose liability on managers. The difficulty is that this
strategy is used only after a wrong has been committed and usually only in extreme
cases. There is uncertainty about the circumstances in which it will be used
because cases are dealt with on a fact basis, case by case. This approach may blunt
the deterrent effect of this strategy and prevents it from drawing a clear dividing
line between types of company.
Judicial veil-piercing is present in both the USA and the UK, but is more
developed in the former jurisdiction. Easterbrook and Fischel analyse the USA
veil-piercing cases as an attempt by the courts 'to balance the benefits of limited
liability against its costs'.152 They see this as a means of controlling 'socially
excessive levels of risk taking'. Indeed it has been argued that the conceptual
'distinction between "liberalized veil-piercing" and "unlimited liability" is
largely rhetorical.'153 In some states of the USA, the courts do indeed lift the
corporate veil explicitly on the basis of undercapitalisation of close corporations,
so that this view has some credibility.154 The position of the courts on lifting the
corporate veil in the UK is much less straightforward and more uncertain.155 They
are generally reluctant to look through the corporate veil other than in the most

153 Hansmann and Kraakman, n 72 above, 1932.
154 R. Thompson, 'Piercing the Corporate Veil: An Empirical Study' (1991) 76 Cornell L Rev 1036;
Larry E. Ribstein, Business Associations, (New York: Matthew Bender, 1990), 69. See especially
Minton v Cavaney 56 Cal.2d.576 (1961).
155 Whincup 'Inequitable Incorporation' (1981) 2 Co Law 158; Davies, n 105 above, chapter 8; S.
Wheeler (ed), A Reader on The Law of the Business Enterprise (Oxford: OUP, 1994) 13; C. Mitchell,
'Lifting the Corporate Veil in the English Courts: An Empirical Study' [1999] CfiLR 15. The
rationale for lifting the veil in Australia seems similarly unclear although, as in the USA and UK, the
veil is lifted most often in relation to small proprietary companies - see I. Ramsay, 'Models of
Corporate Regulation: the Mandatory/Enabling Debate' in Grantham and Rickett (eds), n 142 above.
342 O The Modern Law Review Limited 2000
extreme circumstances. A recent empirical study ha

the UK courts are less likely to lift the veil where the cl
in contract.156 Judicial statements voice strong suppo
liability, which is seen as a tenet of legal policy tha
wherever possible.157 A similar line of judicial r
reluctance of the UK courts to breach the principle o
managers personally liable through the application o
law.158 The value of judicial mechanisms for look
should not be overestimated, especially if the legisla
wide access to limited liability is desirable.
In addition to attempts to make directors personally
judicial piercing of the veil, there are now relevant s
Directors can be ordered to contribute to the assets o
they can be shown to have been trading wrongfully
actions under these provisions must be brought by
directors of insolvent companies may be disqualified
they are found to have traded wrongfully or fraudulent
their conduct as director of the insolvent compa
concerned in management of a company. 161
Helpful though these provisions might be when th
come into operation to restrict limited liability after
risk may have been shifted and it may be too late t
original positions. The directors may by this tim
course occur also with an unlimited liability enterpri
been given access to limited liability and allowed to a
apparent protection may have affected his behavi
Removing limited liability after insolvency may be b
well be too late. The fraudulent and wrongful
disqualification rules do not control initial access, b
abused this access. These provisions may have some g
those setting up companies are well advised, but equa
the unwary without necessarily giving the necessar
limitations of limited liability.164
156 Mitchell, ibid. Mitchell does not seek to explain this odd result b
were similar, n 154 above, 1058, although Ramsay, ibid found a h
Australia than in any other context. The Australian study was of a
157 Adams v Cape Industries plc [1990] Ch 433; Yukong Lines Ltd
Corporation and Ors [1998] BCC 870.
158 Williams and another v Natural Life Health Foods Ltd and another
and C. Rickett, 'Directors' "Tortious" Liability: Contract, Tort or
159 Within the definitions in Insolvency Act 1986, ss 213 and 214
160 See also n 106 above and text thereto.
161 Company Directors Disqualification Act 1986 ss 4 and 6.
162 See ns 105 and 106 above.
163 The deterrent effect of the disqualification provisions has been argued to be weak due to the
number of directors affected and lack of awareness of the provisions: see A. Hicks, Disqualificati
Directors: No Hiding Place for the Unfit? ACCA Research Report 59 (London: Certified Accoun
Educational Trust, London 1998). Professor Sealy has argued, however, that the law on wrongful tr
has had an effect on business, especially as banks may be implicated and so may exert pressu
companies: L. S. Sealy, 'Directors' Personal Liability: English Perspective' in J. Ziegel (ed) Cur
Developments in International and Comparative Insolvency Law (Oxford: Clarendon Press, 1994) 4
164 Clearly there will be ex ante regulation in individual cases since disqualified directors will not be
to manage new companies for a specified period or may be given leave to act in relation to a spec
company, subject to conditions to protect the public: Re Gibson Davies Ltd. [1995] BCC 11.
The attitude of the judiciary is

undermining the principle of limi
although they are prepared to ma
where they have not been dishone
Contractors Ltd166 the judge stated t
of company law or the concept of
I do not think that they deliberately tra
personal liability. However, I do not
manner in which they did, they ought
These directors were made pers

procedures surrounding incorporat
responsibilities or to mark out the
is a very real practical distinction b
veil-piercing in this situation.
One more arbitrary but certain m
suggested recently in the UK.167
'micro' companies at ?50,000. Ab
liability. Naturally, though, this re
problems that would entail. A mini
be needed for companies that were
would entertain use of this new
definitional difficulties discussed above.
Reliance on ex post court decisions seems a haphazard and costly way of dealing
with the problem that making limited liability available has created. If lifting the
veil is justified in certain circumstances, arguably limited liability should never
have been available in these circumstances, and an ex ante barrier would be
preferable. In practical terms, though, lifting the veil or making directors
personally liable after the event has the advantage of not imposing arbitrary
barriers and not requiring the legislature or others to decide ex ante on an
appropriate size or other classification for access to limited liability. If these
devices are to be relied upon, it may seem important for a clear and reasonably
consistent body of case law to be built up in order to provide guidance and for
principles drawn from this case law to be communicated to business owners prior
to incorporation. Such reliance, however, presupposes a highly rational system of
deterrence in which directors show a high level of understanding of detailed legal
information. In practice, general deterrence effects will be cruder than this model
suggests. Ex ante monitoring does not need to rely upon high levels of information
and rational response in the same way.
Theory and practicality

It has been shown that strict economic theory points in the direction of making
limited liability more difficult to attain for very small firms. Most law and
165 See, for example, Harman J in Re Douglas Construction Services Ltd v Anor [1988] 4 BCC 553, 'It is
of vital importance that the court, in operating this very important jurisdiction created by Parliament
for the protection of the public should be careful that it does not so act as to stultify all enterprise. The
purpose and the great value of the invention in 1862 of the limited liability company was to enable
entrepreneurs to take risks without bankrupting themselves'.
166 [1990] BCC 903.
167 See Recommendations of a Joint Institute of Chartered Accountants of Scotland (ICAS) and Institute
of Chartered Accountants in England and Wales (ICAEW) Small Companies Working Party, Getting
Into Shape (London: ICAS/ICAEW, 1999).
economics writers, however, recognise the diffic

between those for whom this regime is efficient, or m
and those for whom it is not. Therefore, most do not
limited liability, preferring to concentrate on prote
suffer from incorporation by undercapitalised firms
very small firms should have limited liability, these w
for a suitable governance regime for small or close c
from that for public companies.168 This approach m
vehicle, analogous with partnerships in terms of righ
restrictions on share transfers and protections for m
there is no escape via the market. Those writers who
radical deviations from standard corporation law
discussion on internal governance with the question o
liability.169 Since they are seeking to replicate
partnership within a limited liability form, they ar
reality that closely held firms will continue to use limit
freely available to them. They do not discuss any ab
liability as part of this more suitable regime. It does
that because it is difficult to restrict access to limite
more attractive by creating special limited liability v
relieving small firms within a general limited liabil
which applies to others. It may be preferable to acc
regime with certain requirements and characteri
implications of that regime and the responsibilities
owners.
The LLC: proof of the efficiency of limited liabil

corporations?
Despite the arguments against limited liability for small firms

the second part of this article, developments in the UK have
direction of making limited liability regimes more attractive fo
USA also, as seen in relation to LLCs, limited liability is becom
than less, attractive for small firms.170 In the USA the creat
given rise to a renewed debate on limited liability for small f
examines these arguments.
Applying the limited liability efficiency arguments

In the context of advocating the LLC regime, Ribstein, its fo
attempts to argue that limited liability is the most efficie
corporations by an application of the reasoning found in the
168 For example, Manne, n 76 above, Posner, n 10 above, 399. See however, Ea
77 above, 237 who argue that the importance of special close corporat
exaggerated since the same result can be achieved by contract.
169 Contrast Hicks n 1 above, who proposes a new unlimited liability regime f
reformed partnership - see Freedman (1999), n 18 above and Freedman (1994),
discussion of internal governance issues.
170 And see Grundfest, n 81 above, 420 who points out the general pressure
Lloyd's names, accountants and lawyers as well as trading firms.
? The Modem Law Review Limited 2000 345
companies. He agrees that his theo

burden of proof is on those who a
regime. In this, he goes further t
limited liability cannot be denied t
He positively espouses the benefits
One problem with Ribstein's an
characteristics of the type of firm
might apply to closely held corpo
majority of firms are very small.
arguments are less than convincing,
justification for limited liability is
chosen full incorporation if th
whether the LLC is efficient for t
trade as a sole trader or general p
identity between owners and mana
discussion). Even if we accept th
liability for public quoted corporat
with adaptations, rather than star
breaking point. 174
Diversification, ownership and con

Ribstein and Macey argue that, ev
reduce owners' monitoring costs a
ownership and control.175 Ribstein
not usually an important considera
managers invest their assets in a si
factor where there are passive inv
micro-firms, as defined above.
Since the LLC regime is specifical
control are in the same hands, fac
also has, by definition, no relevan
may be a desirable economic objec
governance regime will then need
firm's life cycle there might be a
might think limited liability is
expansion without a barrier. This i
limited liability for micro-firms, on
out those which will remain micro
The role of limited liability in red
important where owners and ma
access to information if they are
other's activities in any event. The
171 Ribstein (1991), n 39 above; Ribstein (1

172 See Hillman n 39 above, 479. This takes u
they were a homogeneous grouping; see
173 For the UK figures see n 19 above and
the USA. The LLC tax regime is most suit
174 See Bratton and McCahery, n 45 above
175 Ribstein (1991), n 39 above, 101 et se
176 See n 101 above.
177 Hillman, n 39 above, 484.
unlimited liability regime each partner will need to m

partners because potentially each will be liable for th
firm. This may be a reason for choosing limited liabi
partners and all are engaged in management.178 In m
persons involved, however, and they may well be sp
Such monitoring normally will not be costly. The com
that would be imposed on creditors if the firm had li
creditors might bear the cost of excessive risk taki
monitor the firm closely to avoid this.179
Creditors, insurance and capitalisation

Ribstein attempts to demonstrate that, even if the ad
closely held firms are small, its costs to closely held
credit may be even smaller.180 He picks up the familiar
protect themselves by contracting around limited liab
very much prejudiced by it. The firm can choose
reduce its cost of credit, where the amounts concerne
He then takes this further by suggesting that large
defined personal guarantees to general partnership lia
consider the risk of dealing with the limited liability
because it has sufficient assets. Yet other creditors
credit charges under limited and unlimited liability
too small to incur the investigation and collection c
credit charges for unlimited liability. Also the chan
owners under an unlimited regime might not be muc
liability regime, for example if all the owners' wealth
a case the partners of the unlimited liability firm w
unlimited liability to all creditors without benefitin
credit charges. In sum, Ribstein contends that li
guarantees offers a better opportunity for firms to
than does unlimited liability, so benefiting from lo
large debts without any great cost in the case of sm
limited liability is a superior default rule for small f
There are potential losers here, of course. The abil
creditors is not necessarily desirable. Personal g
lenders precisely because they give the secured cr
unsecured. For the reasons described above, the sma
in a position to assess the risk being passed to h
accordingly. The sum concerned may be small in eac
being passed to those who can least afford it. As Hi
178 66.4 per cent of limited liability company owner respondents to

limited liability was an important reason for incorporation. 16.8 p
to other shareholders was important as compared with around 46
liability to suppliers banks and financiers was important: Free
245.
179 Macey, n 39 above, 449.
180 Ribstein (1992), n 37 above, 428.
181 This may well be the case as the former gives them priority, w
182 Hillman, n 39 above, 487. His question is posed mainly in resp
although these arguments apply equally to LLCs. See the sim
Bratton, n 45 above, 686.
on the issue of limited liability fo

employees, and the like?'
Ribstein does not believe that con
justify restricting the developmen
controlled companies have an ince
limited liability regime. In his v
liability and also will want to prot
insurance. In addition, Ribstein co
provide pressure on small firm
consequence of all these likely a
creditors not in a position to contr
This reasoning is less than convin
above, personal liability for tort
managers can be shown to have
assumption of personal liability
micro-companies than others, it w
incorporation for many of these o
and the UK courts consider this to
breached only in exceptional circ
company owners will often have so
limited in scope: very wide cover
The micro-firms which give greate
those that are undercapitalised. Th
to protect their investment in the fi
few assets.186 They may have insu
directors,187 but since the circum
liable as having breached their d
liability, will be rare, this insurance
If pressure to capitalise and insur
argues, this would be from banks
employees are unlikely to have th
exert such pressure. But these la
concerned about their own risk an
inclined to take personal guarantee
Such measures will reduce rathe
creditors.
183 Ribstein (1992), n 37 above, 439.

184 Hillman, n 39 above, 479 notes that
themselves from the tort liabilities of thei
185 60 per cent of the limited liability res
insurance for goods or services provided
respondents. The difference is not statistic
being used widely used as an insurance subs
of insurance cover available to and taken
Legal Form, Tax and the Micro Business
Paper, 1991) 1991). The ACCA Research R
cover in some areas but only 38 per cent of
186 Hillman, n 39 above, 482.
187 Finch, n 144 above.
188 Empirical evidence suggests a high degree of dependence on collateral (a capital gearing approach)
rather than an income gearing or prospects based approach in UK bank lending to small businesses
see, for example, M. Binks and C. Ennew, 'The Relationship Between UK Banks and their Small
Business Customers' (1997) 9 Small Business Economics 167.
A further argument of Ribstein's in favour of limi

is that unlimited liability firm owners can seek met
such as transferring funds to other family members. T
is not unique to those using limited liability regime
of course, if the business owner is sufficiently far-s
to legislative restrictions.189 The author's empirical
unlimited liability owners of small trading firms
having more at stake than their limited liability counte
will give them a greater incentive to take care and
small partnerships will consist of arrangements be
that it will not be practical to transfer property as
cases. Concern about the matrimonial home is often
incorporate their business in order, as they see it,
would be most unlikely to want to transfer their home
were sophisticated enough to be aware of this po
regime was not so readily accessible, this concern
could be reflected in aversion to risky ventures fo
obtained and thus protect society from projects th
from undue risk-shifting.192
Positive benefit or controllable inevitability?

To the extent that the creation and development of
otherwise would have organised as general partners
opportunities for business owners to externalise th
support this as a positive development on the grou
uneasy application to small, closely held firms of re
larger, and in particular public, firms. Positive support
quoted firms, and particularly micro-firms, on ef
those firms will grow and that the owners will wish to
and transfer shares as well as separating ownership
assumes that micro-firms will cease to be micro
liability in these firms must also consider that risk
creditors is an effective way of increasing general w
available for ventures within those micro-firms. Th
189 For example, in the UK, certain transactions are vulner

administrators under Insolvency Act 1986 ss 238, 239, 244 an
above, 728-735.
190 See Freedman and Godwin (1994), n 1I above, 259. 70.5 per cent of unincorporated respondents stated
that owner's capital was an important source of finance at start up and 15.8 per cent that long-term
loans were important. Of incorporated firms, 21.6 per cent stated that share capital was an important
source of finance on incorporation, 19.2 per cent stated that long term loans were important and 10.4
per cent that debentures were important (these were overlapping groups). There was little difference
in the importance of bank borrowing between the incorporated and unincorporated firms.
191 In fact they will often lose that protection through personal guarantees, Freedman and Godwin (1994),
n I above.
192 It might also dry up funds for business enterprise. If the aim is to protect the home it might be b
do this through homesteading legislation to provide specific protection up to a limit rather th
through general limited liability: this is discussed further in J. Freedman and M. Godwin, 'L
Form, Tax and the Micro-Business' in K. Caley et al (eds), Small Enterprise Development (Lond
Paul Chapman Publishing Ltd, 1992) 127. See also DTI Press Release, n 38 above for some tenta
suggestions for a provision in the UK to protect a limited amount of a bankrupt's assets to cover
deposit for a new home. This is currently being considered as part of an ongoing review of barrier
enterprise.
the creditors to monitor to ensure

assumes that there is little or no e
borne by the shareholders in one o
of the risk is shifted than would
approach seems to take insufficien
position to monitor and of employ
may well include other small busi
small businesses is not necessarily
This approach overestimates the e
littlecapital invested in the firm, wh
acts of the firm, will have an incen
extent to which creditors will take
other than themselves.
Like Ribstein, Macey194 believes that the arguments in favour of the social
benefits of limited liability are stronger than the arguments against it, even for
closely held companies. He is, however, less certain of this view than Ribstein and
explicitly acknowledges that the interests of potential tort victims were not taken
into account at all in the process of developing the LLC. His response to this is that
the necessary balance should be achieved by 'common law judicial craftsmanship';
that is, by lifting the corporate veil. The problems with this 'solution' have been
discussed above. It is both uncertain and cumbersome, and operates only in
extreme cases. It remains to be seen how far the courts will be prepared to apply it
in the case of LLCs.195
If the efficiency arguments for complete freedom of access to limited liability
are unconvincing, it does not follow that access should, or can, be restricted.
Pragmatism may be necessary. As discussed above, the difficulties of
differentiating satisfactorily between firms for which a limited liability regime is
desirable and those for which it is not, may prevent the development of a realistic
scheme for achieving a sensible division. Macey states that 'once it is
acknowledged that limited liability is necessary for the pooling of capital, then it
is impossible to refrain from extending the benefits of limited liability to smaller
firms such as [LLCs] without creating serious economic distortions'.196 This logic
seems to miss a step. If limited liability is not efficient for small firms per se and
can cause both inefficiencies and injustice when applied to them, as argued above,
then ideally it will be curbed. Even if we accept the proposition that it is not
practical to restrict access to limited liability, this is not an argument for extending
it and actually facilitating and encouraging use of a limited liability legal form by
small firms.
Other explanations for the LLC's popularity

Ribstein has been correct in predicting the spread of the LLC.197 This outcome
could be seen as supporting the limited liability efficiency hypothesis on the basis
that interstate competition is a 'race to the top' which has produced an efficient
194 ibid.
195 CCH Guide, n 23 above, 44; Ribstein and Sargent, n 35 above, 645; Karjala (1995), n 42 above, 463
The ULLCA 1995 6303 provides that failure to observe the usual corporate formalities is not a ground
for imposing personal liability. Thompson at n 30 above concludes that liability protection in LLC
will not be markedly different than that under the corporate form, but some uncertainty remains.
197 Ribstein (1992), n 37 above and Ribstein (1995), n 26 above.
350 c The Modem Law Review Limited 2000
legal form through competition.198 Bratton and McCahe

the spread of the LLC is not the result of a 'classic race
fifty states compete to supply cost-saving business form
amount to a 'race to the bottom'. Instead the story is ba
and demand and interest group causation and, as such,
efficiency or inefficiency pronouncement in favour of
agreed that the LLC is the result of pressure group act
legal form demanded by some business owners and the
initially primarily for tax reasons, but has not taken in
losers from this change: involuntary creditors and othe
powerful lobby group.200 Ribstein agrees that Bar group
to retain business in their states.201 He believes that the
supports the hypothesis that it is efficient, but is force
factors also.202 The spread of the LLC in the USA
efficiency.203 It has occurred for reasons specific to the
a good model for export.
Alternative tests of limited liability
Incorporation with limited liability achieves a degree of

be so easily attained in an unlimited liability regime. To t
risk-shifting more automatic and cost free for the busi
chances that risk will be shifted to the creditors. How fa
a question about efficiency, as discussed above, but also
policy. What signals should the law be sending out abou
responsibility? Does sensible encouragement of entre
subordination of personal responsibility?
We have seen that the efficiency arguments for limited
firms are questionable. Even if we were to accept, contr
current regime was efficient overall because of the supp
we would need to go further. Is society prepared to
Should losers actually be compensated and how? Wha
prepared to bear to devise a system that secures the adv
and avoids the disadvantages, perhaps by setting up bar
liability for certain firms? Leaving these issues to the
'unjust' distributive effect within the business commu
inequalities of information and resources. So, for exam
limited liability may achieve an efficient result for the larg
the business owner to lay off still more of his risk on to
198 Roberta Romano, 'Law as a Product: Some Pieces of the Incorpora

Law, Economics, and Organisation, 225; Easterbrook and Fischel, n 7
'State Law, Shareholder Protection, and the Theory of the Corporatio
Ralph K Winter Jr, 'The "Race for the Top" Revisited' (1989) 89
199 Bratton and McCahery, n 45 above, 633 and 667 et seq.
200 Macey, n 39 above, 452; Levmore, n 45 above, 492. Creation of the
tax revenue initially since some firms would move from corporate for
least they would be kept within the state and so pay some tax, and cr
201 Ribstein 1992, n 37 above 474.
202 Ribstein 1995, n 26 above 406-411.
203 And see Deakin and Hughes, n 7 above, citing Roe, n 45 above and arguing that 'there is no automatic
process of adjustment between the legal system and the external economic environment through
which inefficient rules are 'weeded out'.
such a contractual waiver. The abilit

the business owner that such act
difficulty may he find that he has
creditors, so that he may not have
made personally liable to general cr
signals this offers in terms of guid
of strong direct value. They are cer
requiring a capital contribution fr
The law, in allowing limited liability, n
reducing shareholder liability.., but it e
this sort of risk shifting is desirable. It
artificially distancing themselves from t
and, in the process, it decreases society'
The response to this from an eco

benefits of encouraging risk-taking
leaves the question of deciding how
begin from a principle of personal
efficiency in all cases, it does alter
might argue that the onus is on tho
that its advantages apply in the cas
those who doubt its advantages to sh
this view, efficiency would not be
values to be fostered in the busine
responsibility.205 The practical dif
from limited liability regimes w
encouraging such access and mak
weak, and would be countered b
responsibilities
from the outset in ord
The company law reform process in
Theoretically there is an opportunit
as in the USA, those groups most in
and respond to consultative documen
policy makers.206
Conclusion
It has been shown that the arguments for the efficiency of limited liability
widely, although not universally, accepted for public corporations in respect
contractual creditors (though in the case of tort creditors there is som
disagreement). For small, owner-managed or micro-firms, the efficienc
arguments are much less clear. Returning to the economics based questions po
in the first part of this article, first, within very small firms limited liability does
seem to allocate risk to those most capable of bearing it, but rather favo
sophisticated contractual creditors over smaller and involuntary ones. In the lo
run this must weaken the small business sector as well as others, since other sm
businesses frequently lose when one of their number fails.
204 Hall, n 16 above, 168.

205 For a similar argument see Vestal, n 52 above, 523.
206 J. Freedman, 'Reforming Company Law' in Patfield, n 72 above, 217-219.
Secondly, limited liability for micro-firms does n

levels of risk-taking. In some cases, easy availabili
incentive for small firm owners to try to underta
belief that they are protected and can shift the ris
themselves. In fact they may subsequently discove
possible and that they will have some measur
nevertheless others may lose where they have been
The signals sent out by the law are confused an
optimal levels of risk-taking.
Finally, the role of limited liability in reducing t
is much reduced in micro-firms. In some respects,
liability adds a layer of costs, such as disclosure c
reduce these regulatory burdens207 for firms wh
accompany separation of ownership and contr
regulated, vehicles in such cases, however, enco
liability is not efficient for the first two reasons t
So, the application of the economic efficiency
companies to micro-firms is not convincing. It
company begins to grow and acquire some of th
company. It is, however, very difficult to find me
those firms where limited liability might be effic
firms that might grow and those that will not
therefore, that it is impossible to refrain from ex
liability to smaller firms on grounds of practical
distortion.208
It might seem to follow that if micro-firms can
liability regimes, it should be made easier and more
on grounds of consistency and competition. This
fact that it is hard to restrict access to limited liab
be encouraged if that will result in yet more inef
above, other questions of social policy, such as
personal responsibility, must be considered. Limit
often argued to be essential for the encouragement of
of risk-taking which is to be encouraged, and at
this equation to avoid an 'unjust' distributive
information and resources.
There are real difficulties encountered in, and objections to, making access to
limited liability more difficult for micro-firms. These problems should not prevent
the use of signalling devices, such as a minimum capital requirement set at a low
but not insignificant level, combined with information about the implications of
limited liability. These devices would not set up barriers to genuine enterprise, but
would prevent some incorporation with limited liability that had not been properly
considered. A minimum capital would not stop rogues from attempting to abuse
limited liability. Other measures would still be needed for that. A significant
minimum capital requirement might, however, encourage business owners to take
proper advice on set up. Obtaining such advice would have its own cost but could
also have many beneficial effects, including awareness of statutory measures that
might result in personal liability. Ideally, these developments should be combined
207 Often hand in hand with pressure for internal governance reforms, not discussed here.
208 Macey, n 39 above.
with a more principled and coge

recognising the dangers as well a
together, this group of measures co
to business owners about the balance between risk-taking and personal
responsibility.
Creating a specialist limited liability form for small firms, or a less regulated
version of incorporation, might encourage inappropriate use of the limited liability
regime that could otherwise have been avoided. If such a regime is to be provided,
therefore, it is most important to be aware of the disadvantages of limited liability
in micro-firms so that an attempt can be made to counter them by protecting or
compensating those who must bear the resulting costs. If anything, LLCs and
similar specialist limited liability regimes for micro-firms need to be more, not
less, heavily regulated in relation to third parties than larger corporations since the
potential to exploit moral hazard is greater. The fact that the overall sums involved
are smaller may not prevent losses to small creditors that are of a significant level
for them. If the business owners object to these regulatory protections, they should
be encouraged to adopt unlimited liability legal forms. Appropriate unlimited
liability regimes need to be available, therefore, and prospective business owners
need access to good information about the choices available to them.209
Limited liability is not universally beneficial, either for business owners, or
those who deal with them. The current enthusiasm for limited liability both in the
UK and in the USA and amongst lawyers as well as politicians needs to be
considered carefully both in terms of economic efficiency and from other
perspectives. In the USA the LLC has emerged as a product of a combination of
factors rather than being the result of a clearly articulated consensus of all groups
concerned that limited liability should be extended and made more accessible.210
The UK should not be persuaded that it needs to make opting for limited liability
even easier and more attractive than it already is for small firms merely because of
developments emerging in other jurisdictions. Limited liability has its limits.
209 The Law Commission recommended to the DTI, in 1994, that education and reform of general
partnership law was the way forward: DTI, Company Law Review: The Law Applicable to Private
Companies, n 5 above. See also Freedman (1994), n 5 above, 583-584. A Law Commission report on
partnership law is now awaited.
210 Vestal, n 72 above.

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Limited Liability: Large Company Theory and Small Firms

Author(s): Judith Freedman

MODERN LAW REVIEW

Limited Liability: Larg

Current enthusiasm for the 'enterpr

*Law Department, London School of Economics. I am grateful to R. Baldwin, P. L. Davies, V. Finc

premise that access to limited liabil

318 ? The Modern Law Review Limited 2000

limited liability should be positively encouraged for

Limited liability: economic analysis and alternative tests

C The Modern Law Review Limited 2000 319

which we are prepared to choose

320 C The Modem Law Review Limited 2000

the UK have unlimited liability and no employees.2

Extending limited liability: LLCS, LLPS

C The Modem Law Review Limited 2000 321

In the US, corporations are subjec

27 Boris I. Bittker and James S. Eustice, F

322 C The Modem Law Review Limited 2000

Nevertheless, the influence of the original tax requir

C The Modem Law Review Limited 2000 323

These supposed advantages of the

324 ( The Modem Law Review Limited 2000

of the combination of tax and regulatory issues and

54 Macey, n 39 above; Thompson, n 30 above.

C The Modem Law Review Limited 2000 325

Framework recognises that unlim

The limited liability debate

The virtues of limited liability hav

65 The Strategic Framework, 68, ibid ques

326 ( The Modem Law Review Limited 2000

invention central to the creation of a modem capit

General advantages and disadvantages of lim

0 The Modem Law Review Limited 2000 327

of this model that the virtues of lim

328 C The Modem Law Review Limited 2000

firm but not its subsequent development. Brat

C The Modern Law Review Limited 2000 329

insolvency into the interest they c

90 Posner, n 10 above, ch 14.

330 C The Modern Law Review Limited 2000

have the bargaining power or resources to protect

Limited liability, efficiency and close corporations

C The Modem Law Review Limited 2000 331

through the market price of the sh

101 Easterbrook and Fischel, n 76 above, 1

332 0 The Modem Law Review Limited 2000

The law intervenes in the UK to protect creditors

C The Modern Law Review Limited 2000 333

result in a situation in which the vas

Manne refers to historical evidenc

109 For the statistics, see n 19 above.

334 C The Modem Law Review Limited 2000

main suggestions are a minimum capital requireme

Reducing access to limited liability

A minimum capital requirement

C The Modem Law Review Limited 2000 335

minimum capital requirement for