• Video

What Is Limited Liability?

Who does limited liability protect and why was it developed in the first place? Professor J.W. Verret explains that limited liability is the key to large scale development. Small investors could take a chance on a business opportunity without the risk that they would be held personally responsible for accidents or problems. These people might lose the money they invested, but they would not be pursued for larger debts that the company could incur on its own. https://youtube.com/watch?v=bjzOKLJPeHg


Limited liability is one of the key attributes of corporations and other business entities like LLCs. Limited liability means that the shareholders are not liable for the obligations of the business entity. Creditors, tort creditors or contractual creditors of the corporation can sue the corporation to be made whole, but they cannot sue the owners of the corporation. Limited liability is key to the development of large scale enterprise. Enterprises can't finance themselves solely with debt. To get to the scale of enterprise and the level of risk in enterprise that we see today in large scale enterprises, but you see throughout the industrial era, through the expansion into the Western world, in which corporations were used to finance expeditions, you have to have some element of equity investment, of people who are taking a chance, they don't have the protections of a creditor. They're taking a chance on the enterprise and hoping to see profit from its success. That's only possible if the shareholders don't also experience liability for the enterprise's obligations. In part, because they're entrusting the management of that to the managers of the enterprise. So if you imagine, let's go back in time to 1890, beginning of the industrial era - factories are being developed across New England, for say, the production of textiles on a mass scale. You're sitting with potential investors and you're saying, "I'd love to get a thousand dollars investment from you and your family." And the investor says, "Will I be liable if the factory sets on fire and sets the town on fire?" If the answer is yes, then you're not going to get that investment. If the answer is no, then you can see how families can start to finance and greater groups of people can start to finance these large scale enterprises in New England. And that is a foundational element to large scale production. It's a similar concept to even the ancient Romans who first recognized the importance of limited liability for business entities. Let's say you have a trade expedition and you're going to ship grain from Egypt to Rome, a very expensive and very risky enterprise. A lot of those ships don't make it to Rome. So you have to think about all the families of the sailors that are going to be on there. How are you going to finance that expedition if the financiers of that expedition feel like their Roman families could be potentially bankrupted by the expedition. You won't. But Rome needs lots of ships to bring that grain over. Limited liability is what protects these Roman families and their assets as they're investing in these ships, bringing grain from Egypt to Rome. So limited liability protected the assets of the Roman families. They could invest in the enterprise and enjoy profits if the enterprise works out. But they don't have to fear for liability for the enterprise's obligations. This also allowed for large scale creation of projects like the aqueducts, where groups of farms could come together and finance aqueducts that could bring water. But if there's some disaster in the building of the aqueducts, the farms don't feel like they're going to be personally liable for this investment. That large scale investment is essential to our economic prosperity. It's an unavoidable attribute of any developed economy.

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