Implications of Limited Liability
Limited liability, law that protects investors, carries both positive and negative legal implications. Due to the pervasive nature of limited liability laws, their implications do not just affect the partnerships, companies and corporations they apply to. They also impact other stakeholders, even those who are only tangentially involved, and the international economy as a whole. This means that, whether they are positive or negative, a basic understanding of the implications of limited liability is important.
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Limited Liability Explained
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Limited liability, in a nutshell, is a set of laws that protect investors by creating a distinct difference between the investors and the company they invest in. Someone who invests in a limited liability partnership, company or corporation is liable for only the amount of his original investment. This lowers risk and encourages investment.
The process is best explained by way of example. Assume two people invest $1,000 each in a limited liability partnership. This means each controls a half interest in the partnership and can therefore receive half the profits.
Over time, the theoretical partnership grows to be worth $100,000, meaning each partner has made a profit of $49,000. Either partner could sell at any point and walk away with his share.
However, assume that some bad decisions are made and the $100,000 company goes bankrupt, becoming insolvent and unable to pay its debts. Selling off all its assets only clears $50,000, leaving $50,000 more of debt to be paid. Under limited liability law, the original partners are only responsible for $1,000 of this debt each--the amount of their original investment.
Encouraging Investment
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The major positive implication of limited liability laws is the fact that they encourage investment by reducing its risk. Someone is more likely to buy a $1,000 share in a partnership or a $100 stock in a corporation if they know for sure that that amount is all they are going to lose. Stock investments would likely decrease over time if bankrupt corporations' creditors could go after the stockholders' houses, salaries and other investments.
This means that companies can grow faster and get more access to capital, which grows the economy, creates jobs and encourages innovation and risk-taking.
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Deferred Risk
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Though "reduced risk" is mentioned above, that statement needs explication. Risk is like energy: It cannot be destroyed; it can only be transferred. So in the theoretical example in the first paragraph, our two partners are liable for a total of $2,000. This leaves $48,000 remaining, which is transferred over to the suppliers, workers and landlords who are owed money. Since these people have no way of getting their owed money, they are essentially liable.
This is why limited liability companies are required to put "LLC" or "Inc." after their name. It is a means of fair warning to anyone who wants to deal with them of the risk they are undertaking.
This implication is negative because risk is deferred from investors, who made a conscious risk, to workers and suppliers, who did not.
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References
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