Legally, one of the most important features of a company is that it has a personality distinct from its shareholders. A company, as a separate person from the shareholders, conducts the business, owns the property, enters into contracts, it can sue and get sued, and most importantly incurs debts. (Mayson, French, Ryan, 2011) The fact that the shareholders do not owe any of the company’s debts is also related to the concept of limited liability. Since the company is a separate legal person from its members, and since the shareholders have limited liability, they cannot be held liable for the debts of the company. So in case of insolvency, or in case the company owes compensation to tort victims, (as the current legislation and case law suggests) shareholders do not risk anything, and the company is held responsible and has to pay for the recovery of damages. In case of big corporates, that have subsidiaries worldwide, the parent will delegate liability to the subsidiary, stating the rule laid down in Salomon’s case. Limited liability means that the shareholders’ liability is limited to the sum that they initially invested in the company. This means that if the company becomes insolvent, or is liable for any debts or torts, then the shareholders will only pay for the value of their share in that company, and nothing else. If the company gets sued, the plaintiffs will be suing only the company and not the shareholders (because of the separate legal personality). In other words the shareholders are protected from potential claims against the company in which they invested. Limited liability has had an enormous impact on the business world. It was thought that the introduction of limited liability would encourage investments, and generally help the shareholders to handle claims brought by creditors. But, history has shown that there have been many cases where shareholders have abused with their limited liability and the concept of separate legal personality, to avoid their liabilities. They justify their wrongful actions with the privileges they earn from limited liability. As stated in the introduction, the events of the last 40 years, environmental abuses, mass torts etc have led to many authors believing that the doctrine of limited liability is not completely accurate.”[In 18th and 19th century,] incorporation did create an entity which was distinguishable from the people composing it, but there was no suggestion that this entity was completely separate from its members” (Ireland, Spann & Kelly, 1987). An incorporated company was ” its” members. The legal system gradually restricted to facilitate joint-stock companies, a process culminating in the limited liability legislation in the mid 1850s and later the Companies Act 1862 (Ireland, Spann & Kelly, 1987). This new legislation was immediately implemented in cases of the time: Salomon v A Salomon and Co Ltd (1897), ” Ashbury Railway Carriage and Iron Co Ltd v Riche (1875) and In Re Wiltshire Iron Co (1868)”. Salomon’s case is one of the most controversial cases in company law. Mr. Salomon was the sole proprietor of a shoe business. Since at the time, the law required that a corporation should have at least seven members, and since his son was willing to start engaging in the business, Mr. Salomon decided to incorporate a new limited liability company, where all his family members would be involved. But when the company went insolvent and the creditors sued to recover debts, Salomon claimed that he and his family members were not personally liable for the debts, the corporation was, because, the shareholders were a separate entity from the corporation. The Court of Appeal objected Mr. Salomon’s claims, by arguing that his limited company was just a sham, it was Mr Salomon, but with another name. Surprisingly, the House of Lords, supported Mr. Salomon’s claims by arguing that he had taken advantage of the statutes, but there was nothing wrong with that, because he didn’t breach any of the laws. The decision in favour of Mr. Salomon, constituted a huge revolution in company law, considering that separate legal personality and limited liability had never been used in such a way as to succeed in escaping responsibility. In this way, a veil was drawn between the limited liability company and its members. This also meant that the parent company wouldn’t be any more liable for the actions of its subsidiary, because now they were considered two separate entities with two different legal personalities. Salomon’s case showed that that anyone could incorporate a company which would have a separate legal personality and the shareholders. the privileges of limited liability. By some people, Salomon’s case was even considered a scandal at the time, because they thought that, by referring to this case, people would take advantage of separate legal personality and limited liability, and this would encourage the incorporation of fraudulent activities. After Salomon’s case, as expected, the abuses started to appear. It was realized that there was the need to somehow limit the powers that limited liability provided. The courts introduced the concept, known as, ” piercing the corporate veil”. But even with the introduction of piercing the corporate veil, some issues weren’t clarified. For example, there was no mention of tort creditors. There was a huge debate about many ambiguities on the consequences of the permitting of limited liability. There were three groups of authors. The first group criticised limited liability regime with the argument that it encouraged wrongful behaviour. They argued that because shareholders have limited liability, they are not risking any of their assets besides those firstly invested in the company, so they remain somehow ” comfortable” and don’t worry about the negative consequences of their actions. And also because there is room left for the incorporation of fraudulent activities, just like in Salomon’s case, which according to them, was a pure abuse of the limited liability of shareholders, and just a sham, a fraud, to avoid liabilities. Another reason that limited liability should not be applied, according to this group of authors, is that the doctrine privileged one category of creditors, over another, respectively, those voluntary over involuntary ones. For the above reasons, they were calling for unlimited liability. The second group argued that unlimited liability discouraged investments and therefore was inefficient. They argued that, if shareholders had unlimited liability, then they would be risking all their assets in case the company becomes insolvent, or if the company has to compensate involuntary creditors for liability in tort. Of course shareholders would prefer to be safe with limited liability, rather than risk with unlimited liability. But, on the other hand, what about the involuntary creditors? They too want to feel safe. Good working conditions should be provided, the company must meet all health and safety requirements, and compensation schemes should be prepared in case of corporate torts. And the third group, argues that limited liability should be applied, but not in case of corporate torts. As corporate torts constitute a ” substantial” kind of harm, because they include severe physical harm and no compensation for the victims, there should be an exception for this case, to apply unlimited liability to shareholders. Clearly, the ambiguity lied in the lack of a clear answer to the question if limited liability applied to tort law. At first limited liability (Limited Liability Act passed by English Parliament, 1855) only applied to corporate contract liability, ” but, the courts seem to have drifted towards the assumption that limited liability also applied to torts” (Pettet, 1995). But, an assumption is not at all a sufficient base to apply limited liability for corporate torts. There has to be a legal basis, or an interpretation from courts regarding this issue, to make this application valid. This is why involuntary creditors are very disfavoured compared to voluntary creditors. Even though, I think that the process of this transition, was not very natural, as there should have been a law for the courts to be based on, before allowing shareholders to use limited liability even in tort, I do think that it should have been expected. Before enacting the Limited Liability Act, all issues should have been clarified, including that of the liability in tort. After, the introduction of the concept of limited liability, and then the lack of a legal basis to regulate liability in tort, the courts somehow shifted limited liability to liability in tort. ” While history of general limited liability is well documented, that of the transition of the application of the doctrine on corporate torts remains somehow a mystery and to date no comprehensive treatment of the subject exist.” (Kahan, p. 1087-1088, 2009).
2) Relation between limited liability and corporate torts
” Voluntary creditors, such as banks that lend money to companies based on a contract signed by both parties, can apply protections ex ante. These kinds of protections assure that in case the other party doesn’t comply with the terms, the creditor will be compensated” (Kahan, p. 1090-1091, 2009). In contrast, involuntary creditors don’t have this opportunity because they cannot predict the injuries and therefore cannot be guaranteed sufficient compensation. By the very definition of tort, tort victims are hit by an event for which they in principle could not negotiate in advance. They did not voluntarily choose the company as their debtor in tort. Involuntary creditors are not in a position to choose and to protect themselves against short-comings. It is impossible for involuntary creditors to sue company members of an insolvent company. Another disadvantage is the compensation process. Involuntary creditors always risk not receiving compensation, because there is the risk that the company will not have sufficient funds to pay for the compensation and the shareholders will only pay up to the value they first invested in the company, which means the value of their shares. But even if they do have sufficient funds to pay for the compensation of the tort they caused, parents and subsidiaries will try to delegate liabilities to one another. Which means that, if an involuntary creditor is suing the parent company, then the parent will probably claim that it doesn’t have control over the subsidiary and it is a separate entity from the subsidiary. So the parent can claim, that it is not the one who should take responsibility, therefore should not even be sued. Which basically means, that they’re using the rule laid down in Salomon v Salomon. And if an involuntary creditor is suing the subsidiary, the subsidiary will probably claim, that it was acting under the total control of the parent, which means that the subsidiary was just taking orders from the parent, and none of its actions, were actually ” its” actions. So, the subsidiary can claim that it shouldn’t take responsibility for the actions that it actually didn’t do by itself. Which means that the veil should be lifted, justifying it with one of the legal circumstances that allow the courts to lift the veil. So the parent should be liable. This whole confusing structuring of the corporates makes it even more difficult to seek compensation. Many large corporations are using the doctrine of limited liability to deny fair compensation for harm caused to innocent people, which is very unjust. The principles of vicarious liability are not applicable to establish liability in tort for claims against other companies in the group. Thus, tort victims are at the most disadvantageous position. In practice, there are many cases when there is nothing left for unsecured creditors. ” While many victims of tort committed by companies in the UK are fully covered as a result of compulsory insurance requirements, for instance persons injured in road accidents and in the workplace, others such as persons affected by defective products or hazardous industries, might not be” (Keay, p. 332, 2007). Although some protection is provided in statutes, (Bankrupty Act, Consumers protection Act, Compensation Act 2006) this isn’t sufficient. The problems stated above cannot be solved only by referring to these codes. The variety of cases makes it impossible for any test, or any law to include all the cases. Every day, new cases arise, which haven’t been issued before. Even if we try to make the law more specific, or try to move towards an objective test, the chances to facilitate the system are a few.
Section C: Illustrating the problems
The problem with involuntary creditors – Asbestos Case
The Asbestos case is a leading case on limited liability for corporate torts. According to the International Labour Organisation (ILO), asbestos-related illnesses have contributed to the deaths of more than 100, 000 people worldwide in the late nineteenth century. Even though today, asbestos which causes asbestosis and cancer, is considered the most dangerous mineral of the world, and its manufacturing is banned in most countries, during most of the last century it was considered a life saver. The severe harm that asbestos brought to people has been extreme. This severe harm includes: injuries and even deaths to innocent employees, abuse with fundamental human rights, and non-compliance with health and safety requirements. Not only did Asbestos harm the people working with asbestos, in the factories, but also the people who never worked there, but lived around the area. ” The Asbestos was a global industry with mines in South Africa, Canada, and factories in America, Europe, and Far East” (G. Tweedale & L. Flynn, 2007). Some of the largest companies and subsidiaries selling and manufacturing Asbestos were: Cape Asbestos, Johns & Manville, Turner & Newall, North American Asbestos Corporation (NAAC), Union Asbestos & Rubber Company (UNARCO) etc. The Asbestos case is one of the most controversial and complex cases in company law. What makes it so controversial and complex is first, the particularity of the case. As we know, the law has always been vague, when it comes to issues such as lifting the corporate veil. And common law courts very rarely lift the veil. Common law judicial system is a system based on case and statutory law. Case law, which includes the solutions coming from similar cases in the past, is the main basis where judges rely to decide upon the concrete case (Stare decisis). Since judges decide by binding to stare decisis, the plaintiffs somehow know what they are expecting. But, in Asbestos case it was the first time for the judges to be dealing with limited liability for corporate torts, especially with such a complex structure of a corporate, and such extreme negative consequences. We should take into consideration how difficult this judgement was in common law legal system. The question whether the veil should be lifted in case of corporate torts, was a very unfamiliar matter for the judges. The judgment had to be somehow innovative. Limited liability was a well-known concept in company law, and it was used by shareholders to protect themselves from claims brought by creditors, but it had never been issued or implied anytime or anywhere, that it was legit for shareholders to use limited liability to protect themselves from liability for corporate torts. As we know, common law courts, can in certain circumstances ignore the limited liability rule and make the shareholders personally liable for their actions despite the fact that they have limited liability. These certain circumstances include: fraud, agency, unfairness, group enterprises, and sham or façade. But common law courts don’t lift the veil, even for corporate torts, unless there has been grave abuse of the corporate. But then, what constitutes a grave abuse? Did the Asbestos Companies make a grave abuse? Neither case law, nor the codes, clarifies the real definition of the term. At least a detailed interpretation is needed. In the asbestos case, the asbestos companies continued the business even though they knew all the dangers that working with asbestos caused. The harm was completely foreseeable. It could have been avoided, if the leading companies took some serious measures to stop the manufacturing of mined asbestos or at least warn the employees for its negative effects. The working conditions were very poor too.” The NAAC had known for decades that inhaling asbestos fibers scarred the lungs and caused asbestosis. Gaze, a chemist, testified that since 1961 he had continually discussed health hazards with the Tyler management and that neither Cape, nor the NAAC had ever placed warning labels on asbestos bags. In 1973, in case Borel v Fibreboard a landmark decision involving an Asbestos insulation worker effectively shifted awards from the workmen’s compensation system to the courts. This ruling held manufacturers strictly liable for their failure to warn of an unreasonably dangerous product, thus launching the ” greatest avalanche of tocix-tort litigation in the history of American jurisprudence. In 1982 54 former workers succeeded in suing the cape group on the grounds of strict liability in tort and wilful and wanton misconduct the plaintiffs were awarded $55 m in damages. Part of this total $35 m was punitive damages against Cape (exporting a lethal product without warnings)” (G. Tweedale & L. Flynn, p. 206, 2007). In many other cases, the companies refused to appear in court. Considering the fact that the companies had been aware of the dangers of working with asbestos and never bothered putting warning labels, and that the working conditions were very poor, and the fact that they used every possible way to escape responsibility despite of the severe damage they had caused, one can interpret this conduct as grave abuse. Even a documentary ” described how Cape Industries of London, part of one of the richest corporations in the world, had run away from its responsibilities to the sick and dying families of a small town in America.” (G. Tweedale & L. Flynn, p. 280, 2007). But how did the companies manage to escape responsibility and not give the huge compensations to the harmed employees of the asbestos companies? The complexity of the structure of the corporate has helped in this aspect. This is another factor which has made this case one of the most controversial cases in the history of company law. It’s quite clear that as complex as the structure of the corporate is, as easy it will be for the shareholders to escape liability, and as difficult for tort victims to seek compensation. Large companies often have their subsidiaries, which are often spread worldwide, and each country has its own judicial jurisdiction. If a creditor tried to sue a subsidiary, then the subsidiaries would probably try to escape responsibility by arguing that the parent must be liable, because the parent has control of the subsidiary. And if the creditor tried to sue the parent, then the parent would probably try to escape responsibility by arguing that the parent is a separate entity from the subsidiary. As mentioned above, group enterprises constitute one of the circumstances when the court can lift the veil, in order to look closely at each entity itself and decide which must be responsible for the tort. In Adams v Cape, the Court of Appeal, followed the rule laid down in Salomon’s case, which means that the veil was not lifted and each subsidiary was held liable for its own actions. The Court of Appeal said:”…we do not accept as a matter of law that the court is entitled to lift the corporate veil as against a defendant company which is the member of a corporate group merely because the corporate structure has been used so as to ensure that the legal liability (if any) in respect of particular future activities of the group (and correspondingly the risk of enforcement of that liability) will fall on another member of the group rather than the defendant company. Whether or not this is desirable, the right to use a corporate structure in this manner is inherent in our corporate law.” (Mayson, French & Ryan on Company law, p. 147, 2011)As stated above, the Court of Appeal saw nothing wrong with such usage of the corporate structure, since it is compatible with the corporate law. I think that even though there might not be a clear breach of the corporate law in principal, there should be a detailed observation of the true intentions of such usage of the corporate structure. If the courts were to only take into consideration the fact that there was no breach of law, (same happened in Salomon’s case, where it was held that Mr. Salomon was completely entitled to transfer the liabilities to the company, since there was no breach of law), then this would mean that the veil should never be lifted. Let’s take for example, two of the most famous cases regarding the lifting of the corporate veil in cases of fraud. In both cases, Gilfor Motor Ltd v Horne, and Jones v Lipman, the companies were considered from the court, a fraud/sham to cover for the true owner of the business. But if the courts didn’t seek the true intention of the incorporation of these companies, then it would be very easy for these owners to escape liability. Instead, the courts should examine all factors that led to the owner to the incorporation of the new company. Despite the fact that the courts recognise certain circumstances when the veil can be lifted (one of them includes group enterprises), the Court of Appeal in Adams v Cape dismissed these exceptions and decided that there was no breach of corporate law, even though, as the court stated, the corporate structure was being used to transfer liability to another member of the group. Because of this judgement, it’s very easy for other companies to refer to this as an example to justify their fraudulent actions. And that’s where the problem with involuntary creditors lies I think. The fact that the courts are not looking at the true intentions of such conduct, and interpretation of law (using corporate structure and limited liability to escape liability in tort), but only checking if the law in principle has been breached. But, surprisingly, this was not the case in Chandler v Cape. Here, for the first time, the court ignored the principle of the separate legal personality laid down in Salomon v Salomon, lifted the corporate veil and it was held that the parent was liable for the actions of the subsidiary, because the parent owed a duty of care to the employees of the subsidiary, even though the subsidiary no longer existed. But why did the court this time take into consideration the fact that the parent owed a duty of care to the employee of the subsidiary even though they are two separate legal entities and even thought the subsidiary no longer existed? The Court of Appeal identified parallel duties of care between the parent company and subsidiary employees and the subsidiary company and its employees. This was because: (i) the parent company and subsidiary had relatively similar businesses; (ii) the parent company knew (or ought to have known) that the subsidiary’s system of work was unsafe; and (iii) the parent company knew (or ought to have foreseen) that the subsidiary or its employees would rely on its using that superior knowledge the employee’s protection (Linklaters, 2012). I find the arguments of the court very accurate and I think the same judgement should have been given for most of asbestos cases. In these two cases, the courts held two opposite decisions despite the fact that they were very similar, and in the same context, that of asbestos cases. This proves the fact the there is a lot of confusion and ambiguity when it comes to deciding upon issues regarding the large corporations which benefit from their complex corporate structures to transfer liability to subsidiaries, leaving this way innocent employees harmed, and with no possibility of fair compensation. Clearly, such way of the functioning of the system is not effective. Of course it’s difficult to make precise rules to be implemented in each case. But the doctrine of limited liability needs to be completed, or changed in such a way as to include at least most of issues that can arise regarding limited liability. ” Most of leading asbestos companies have retreated into bankruptcy or adopted various strategies to limit billions of dollars in liabilities. Cape Asbestos had 24 subsidiaries. The asbestos companies in England were linked with the South African Business Empire – Anglo American Corporation. The Oppenheimers, its majority shareholder, was so complex that it was never recognised as a single entity. The Anglo-American Corporation had developed a decentralised structure that was a maze of interlocking directorships, mutual agreements, restrictive arrangements, and monopolistic business practices. The structure was said to facilitate and stimulate business, but it also made it difficult to trace the group’s financial connections. Turner & Newall had implemented a complex reorganization of its Canadian holding company that involved the setting up of ” buffer” companies to distance its assets from claimants. The result was a near empty shell for Asbestos claimants and a tax free exit with the assets for the stockholders.” (G. Tweedale & L. Flynn, pp. 273-274, 2007). This was the result for most of the asbestos cases. What made the decisions in the asbestos case, even more impossible to reach, was another aspect, that of the problem of the judicial jurisdiction. There was a conflict of laws between the English and the American laws. Cape was mostly considered as a London based company which collaborated with its subsidiaries for asbestos mining in South Africa. These subsidiaries shipped the mined asbestos to Texas, where NAAC (North American Asbestos Corporation) then supplied another company in Texas with these asbestos. But after the employees of the Texas Company got ill and sued Cape, a question arose: even though Cape was a London based company, ” was it subject to Texas jurisdiction or was it present in the US through the NAAC? ” (The Court decided that the parent was not liable. The decision of the Court of Appeal wasn’t as easy as it looks, but I don’t think that the decision needs further analysing since I’m focusing on the problem of involuntary creditors. The conflict of laws seems like an irrelevant issue, even though it remains on the context of the asbestos case. The above paragraph was just another aspect that indicated the complexity of the case.)The judgements in Adams v Cape, and Chandler v Cape, and the severe harm that resulted from the actions of the leading asbestos companies made the asbestos cases probably the most famous and controversial cases in history. G. Tweedale and L. Flynn in their article Piercing the Corporate Veil: Cape Industries and Multinational Corporate Liability for a Toxic Hazard, 1950-2004 draw the following conclusion from asbestos cases.”[The asbestos case] demonstrates that the corporate veil can allow MNEs to escape responsibility and leave victims of corporate actions with no recourse. It provides a striking illustration of how limited liability can act as a bar to recovery for corporate injuries even when a firm has been found guilty. Over the past twenty-five years tort law has arguably been the uniquely effective and indispensable means of exposing and defeating the asbestos conspiracy, providing compensation to victims, and deterring future malfeasance. Yet in Bloomington and Tyler and in many other American locations, hundreds (indeed thousands) of asbestos victims were denied the opportunity to claim damages from Cape Industries because of the legal doctrines supporting the corporate veil” (Tweedale & Flynn, p. 292, 2007).
The big debate on the limited liability for corporate torts
As discussed in section B, when the doctrine of limited liability was first introduced, it had never even been discussed the possibility of using limited liability to protect shareholders from liability in tort. ” Despite of that, the courts seem to have drifted towards the assumption that limited liability applied also to torts” (Pettet, 1995). Clearly, since then, the doctrine had many ambiguities and this caused debates amongst academics and lawmakers. The debate was strongly revived after Asbestos Case, where from 3000 claimants, only a few managed to recover the damages. These events have led to many authors believing that the doctrine of limited liability is not completely accurate and the need for reforms is essential. Two famous critics who call for unlimited liability for corporate torts are Hansmann and Kraakman. In their Article in the 1991 Yale Law Journal they emphasise that ” in certain circumstances limited liability encourages overinvestment in hazardous industries, for since costs are externalised a corporation engaged in highly risky activities can be an attractive investment for its shareholder and yet its net value to society as a whole is negative; to put it simply, the company’s tort victims are subsidising it” (Pettet, 1995). I agree with the arguments of Hansmaan and Kraakman regarding the abolishment of limited liability for corporate torts. Case law has proved that often, because of limited liability, big corporations tend to engage in hazardous industries. Anther author, Bergkamp, also calls for unlimited liability for corporates torts and expands the rationale of Hansmann and Kraakman.” Because neither corporations nor their shareholders have to worry about claims to the extent they exceed the corporation’s assets, they do not have a social incentive to take the full social cost of their activities into account when making decisions on what activities to conduct, how to conduct them and what level. The rationale for abolishing limited liability thus, is that putting the shareholders’ personal assets at risk, will cause them to take these risks into account at least up to the value of the corporation’s assets plus their own assets; the additional exposure would translate into the share price of publicly traded corporations, and the price mechanism would lead to an efficient outcome. Some form of unlimited liability accordingly, would prevent corporations from engaging in unduly risky activities and would cause corporate activities to tend towards the social optimum” (Bergkamp, pp. 234-235, 2001)Lopucki argues that regardless of the arguments against honouring the corporate veil with parent-subsidiary corporations, changing basic liability rules in any society would require such radical changes as to make them highly unlikely (1997). It would be hard to tell if Lopucki is only referring to the principle of limited liability as a general term, or to the rules of the application of limited liability in tort, when he says that the changing of the very basic liability rules is not a good idea. But the argument seems very subjective in both cases. It seems like the only problem according to Lopucki, is not the fact that innocent people can get harmed, just because of the application of these wrong basic principles of the limited liability, but the impact that such a radical change would have. I don’t think that this should be the priority. If we assume the changing of the rules of limited liability in general, the impact of such change would certainly be huge. But if we take into consideration the purpose of the changing of the rules of the application of limited liability in corporate tort, the result would probably be very positive, which means the changing of rules in such a way, as to make sure that involuntary creditors always get their full compensation in case of torts caused by companies. Hansmann, H. & Kraakman, R.. (1991) in their article Toward a single model of corporate law, discuss the disadvantages of limited liability on transaction costs. They argue that: ” In certain circumstances limited liability encourages overinvestment in hazardous industries, for since costs are externalised a corporation engaged in highly risky activities can be an attractive investment for its shareholder and yet its net value to society as a whole is negative; to put it simply, the company’s tort victims are subsidising it. Their approach is focused on efficiency. They discuss the possible use of minimum capitalisation and insurance requirements in certain circumstances, although they regard such solutions as inflexible. Adequate capitalisation rules would be exceedingly difficult to operate and would produce relatively little benefit for tort victims. A company hit by huge mass tort claims will probably be insolvent whether it was adequately capitalised or not. They say that neither markets nor politics work well to represent the interests of the persons who bear the direct costs of the rule, namely tort victims. Since, by definition, torts involve injuries to third parties, the parties affected by the rule, corporations and their potential tort victims, cannot contract around the rule to capture and share the gains from its alteration”. (Hansmann, Kraakman, 1991)Only a few authors have talked about the effect of the effect of unlimited liability on deterrence of catastrophic torts. Schwartz, on his article on Products Liability, Corporate Structure, and Bankruptcy: Toxic Substances and the Remote Risk Relationship, argues that ” a mix of unlimited liability in tort and strict liability has no deterrent value. If this is so, the arguments in favour of unlimited liability in tort, are thrown back on risk-spreading ability, where the evidence is thus far inconclusive. Where class action claims involve relatively small amounts per claimant and joint and several liability runs the risk of imposing most of the liability on a few wealthy shareholders, it may well be that leaving liability with the injured class places it with the group best able to bear it.” (Schwartz, 1985) I agree partly with the argument of Schwartz. I do think that unlimited liability in tort has no deterrent value, but I think that, the deterrence of catastrophic torts has mostly to do with health and safety requirements imposed by the companies itself rather than the rules of the doctrine of limited liability. First, companies have to comply with the health and safety rules imposed by the labour law and then implement other regulations to prevent such torts. That includes putting warning labels where needed, providing good work conditions etc. How companies meet these requirements and how they take other measures to provide a safe working environment, is companies’ responsibility. What the judicial system can do in this aspect on the other hand, is to handle fairly and effectively the consequences of the failure of companies to comply with these requirements, which means to prepare compensation schemes for the injured and make sure everyone gets the right amount of compensation, unlike the asbestos cases, where many innocent employees were left injured, even dead, and with no compensation. While the above mentioned authors disagree with the application of limited liability in tort, there are also many authors who have expressed their views regarding the benefits of limited liability in tort. One of these authors, is Bainbridge, talks about the transaction costs and says that limited liability actually reduces transaction costs for involuntary creditors, because by making them seek compensation not from shareholders, but by the company’s assets. (Bainbridge, 1993). It is true that separate legal personality can save legal costs. Case law (for example Taylor 1993, and Re Bank of Credit and Commerce International SA 1993) has shown that courts often tend not to follow the rule in Solomon, and not lift the veil, only to reduce costs. I do agree that the transaction costs are an important issue, and of course attempts should be made to reduce them, but in case of liability in tort, transaction costs should not become the major issue. Liability in tort is a much more delicate issue. Innocent people are harmed, so their full compensation should be the priority. If limited liability is applied to corporate torts, then we can’t even be sure if the tort claimants will be able to collect their compensations at all. What is important in case of corporate torts I think, should not be the saving of transaction costs, but the full compensation of tort victims. If the collection will be made from the firm assets, or from the shareholders, is a secondary issue. Ben Pettet in his article Limited liability: A principle for the 21st century, suggests that ” the abolition of limited liability for tort debts would result in a level of damage to the financing of business enterprise which would sooner or later be seen as unacceptable, therefore some other solution must be found.” (Pettet, 1995)It has been well established that one of the negative consequences that an unlimited liability regime would bring, is the fact that it would discourage investments. Because shareholders have unlimited liability it means that, in case of insolvency, or compensation claims, they won’t only have to pay to the extent of the value of the share they own in the company, but even from their personal assets outside the company. The fear of this risk, certainly makes shareholders think twice before investing in a company. I think that in order to decide which regime should be applied for liability in tort, what needs to be done, is to compare the level of ” damage” that would bring each of the situations. As mentioned above the biggest harm that an unlimited liability regime in tort would bring, is to discourage investments, and the biggest harm that a limited liability in tort would bring, is the repetition of the asbestos cases. I think that a repetition of asbestos cases, which means leaving innocent people harmed, with no chance of compensation just because the doctrine is made in such a way as to favour one category of creditors over another, does more ” damage” than a discouragement of investments. Firstly, because when innocent people are involved, the harm is much more severe. And secondly, because the discouragement of investments, is more of an economical, rather than a judicial issue. Law’s responsibility on the other hand, is to provide equity and justice to everyone, which cannot be achieved using the current doctrine of limited liability.
Section D: Possible solutions
Proposed solutions from authors
Ben Pettet in his article about limited liability, has summarised various suggestions that have been made as to how the position of tort creditors could be improved. Leebron has argued that ‘financial’ creditors should be deferred to tort claimants in liquidation. Hansmann and Kraakman of course wish to abolish limited liability for tort claims anyway, but do discuss the possible use of minimum capitalisation and insurance requirements in certain circumstances, although they regard such solutions as inflexible. ” Deferring financial creditors in a liquidation, will provide only a very partial solution. Adequate capitalisation rules would be exceedingly difficult to operate and would produce relatively little benefit for tort victims. A company hit by huge mass tort claims will probably be insolvent whether it was adequately capitalised or not”. (Pettet, 1995)P Halpern, M. Trebilcock and Turnbull, in their article An economic analysis of limited liability in corporation law, specify their solutions depending on the type of the corporation. ” First, they argue, in the case of large, widely held companies, a limited liability regime, as a general rule, is the most efficient regime. By sewing the distribution of business risks amongst different shareholders, an unlimited liability regime would create a significant measure of uncertainty in the valuation of securities and threaten the existence of organised securities market, thus including costly attempts by creditors and owners to transact around the regime” (p. 150, 1980). I agree with the fact that an unlimited liability regime would create uncertainty and put shareholders in risk, but it would also put creditors in risk. By sewing the distribution of business risks amongst different shareholders, it will be much more difficult for the creditors to realize which one should be sued, and at the same time wonder if any of them will take responsibility since the shareholders have limited liability, and the corporate has a separate legal personality from its members, and if it has subsidiaries, the subsidiaries have a separate legal personality from the parent. ” Second, they argue, in the case of small, tightly held companies, a limited liability regime will in many cases create incentives for owners to exploit a moral hazard and transfer uncompensated business risks to creditors, thus including costly attempts by creditors to reduce the risks. An unlimited liability regime for this class of enterprise would seem to be the most efficient regime.” (P. Halpern, M. Trebilcock and Turnbull, p. 150, 1980) I agree with the first part, that an application of a limited liability regime for small companies would probably not be effective. But even an unlimited liability regime would not be the best solution. Small companies do not have the ” power” that big corporates have. Therefore, if shareholders of a small company, that have unlimited liability, were to be held liable for tort, then the company would immediately become insolvent and the shareholders would probably get into debt. Another solution has to be found.” Third, they argue, in cases where a general rule, a limited liability regime is the most efficient regime, there is a case for a limited number of exceptions to the regime where some form of unlimited liability seems desirable. These exceptions might embrace the following classes of case: misrepresentation, the involuntary creditors and employees”. (p. 149, 1980) Apparently, when Halpern, Turnbull and Trebilcock mention exceptions to the regime of unlimited liability, they are actually referring to the exceptions made, to lift the corporate veil. But they do not suggest the exceptions set out by case law on the corporate veil. Instead, they have an innovative approach, and add involuntary creditors and misrepresentation as two additional cases, as to when shareholders should be held liable. (even though both misrepresentation and involuntary creditors, according to the abovementioned authors, constitute exceptions to the limited liability rule, I am going to keep focusing on the case of involuntary creditors) They even give a full explanation of the advantages of the application of unlimited liability for corporate torts, on transaction costs. ” Regarding involuntary creditors they argue that in cases such as Walkovsky v Carlton, transaction costs are such that a firm can transfer uncompensated business risks to this class of creditors. It can be argued that directors of the company should be personally liable to this class of creditor. In the large, widely held companies where this exception would apply, such a rule would minimize the information costs that owners would face in monitoring each other’s wealth, would reduce creditors’ transaction costs in enforcing claims, and would focus incentives to adapt cost justified avoidance precautions on that body of persons (directors) in such a class of corporation best able to respond to those incentives. In this way they say, involuntary creditors and employees, under these proposals would receive special protection and other creditors, prejudiced by intra-group transactions induced by moral hazard considerations, would have to rely on the misrepresentation exception” (p. 149, 1980)Another author that has proposed a solution to the problem, is Paddy Ireland in his article Limited liability, shareholder rights and the problem of corporate irresponsibility. Ireland refers to corporate harmful behaviour (torts) as corporate irresponsibility. ” The no-obligation, no-responsibility, no-liability nature of corporate shares, permits their owners—or their institutional representatives—to enjoy income rights without needing to worry about how the dividends are generated. They are not legally responsible for corporate malfeasance, and in the event of failure, only their initial investments are at risk” (Ireland, p. 845, 2008) Regarding this issue, another author, Glasbeek says that ” the shareholders in corporations have little financial incentive to ensure that the managers involved behave legally, ethnically or decently because in law they are personally untouchable” (Ireland, p. 845, 2008, Glassbeek, p. 129, 2002)The solution to the problem, according to Ireland, is decoupling limited liability from control rights. Even in mid19th century he says ” the belief was that the risk of irresponsibility behaviour by firms would be minimized by fixing those in control with unlimited liability and restricting the control rights of those with limited or no personal responsibility for the consequences of the firm’s activities. It was in other words, a legal form which decoupled limited liability from rights of control”. (Ireland, p. 853, 2008)” Where the corporate legal form is being used or manipulated by groups of companies or individuals, the solution to irresponsible corporate behaviour lies not in divesting parent companies of control rights, but in lifting the corporate veil, denying separate corporate personality to subsidiary companies and denying parent companies the protection of limited liability”. (Ireland, p. 853, 2008)
My approach upon the issue
As we may have seen, the problem of the doctrine of limited liability and specifically the problem with involuntary creditors is very complex. History and practice has shown that the doctrine is not very accurate when it comes to involuntary creditors. The privileges of voluntary creditors over involuntary ones, and the abusing with this unfair positioning of creditors (Asbesots case) have confirmed the fact that this system does not provide equity. Asbestos cases prove that even where a severe harm has been caused, even where there has been pure negligence, non-compliance with health and safety requirements, and abuse of fundamental human rights, the doctrine still favours the shareholders, over the victims of such behaviours. Despite of this fact, the arguments on both sides are strong, Therefore they make the debate on reforming the doctrine of limited liability even more difficult and challenging. But, considering the above proposals to the problem, I believe that the best solution would be unlimited liability for corporate torts. The truth is that with the current doctrine, the abusing with limited liability will continue and the ones left uncompensated will be involuntary creditors. Even though unlimited liability is said to discourage investments, I think that that should not be the priority. First, the arguments that support limited liability for corporate torts seem to be very subjective, in the meaning that it seems like their sole preoccupation is to increase shareholder’s wealth by reducing liability and increasing control rights. This formula leads to wrongful behaviour, it is logical and very expected. The system that functions based on this formula is destined to fail. Plus, we can all eventually become involuntary creditors, even shareholders that have invested in a company. That’s why I think that the approaches have to be more objective, and instead of applying limited liability for corporate torts, unlimited liability should be applied. Second, history has shown that when limited liability was first introduced, it was not meant to apply to corporate torts too. The fact that the courts began to apply limited liability for corporate torts without having a specific legal basis is very unnatural. The whole transition of limited liability to corporate torts is very mysterious, which makes the doctrine vague and ambiguous. Instead of making a wrong interpretation of the doctrine, or just ” assuming” that limited liability can be applied to escape liability in tort, at least a statute that regulates the liability for corporate torts is needed, or a clear interpretation of common law courts from case law. The best way to deal with this issue, would be a reformulation or a new codification of the part on the application of limited/unlimited liability for corporate torts. I agree with the arguments of Hansmann and Krakman and Halpern, Trebilcock and Turnbull who support the abolishing of limited liability for corporate torts and the application of unlimited liability. Hansmann and Kraakman, argue that ” In certain circumstances limited liability encourages overinvestment in hazardous industries, for since costs are externalised a corporation engaged in highly risky activities can be an attractive investment for its shareholder and yet its net value to society as a whole is negative; to put it simply, the company’s tort victims are subsidising it. Their approach is focused on efficiency. They discuss the possible use of minimum capitalisation and insurance requirements in certain circumstances, although they regard such solutions as inflexible. Adequate capitalisation rules would be exceedingly difficult to operate and would produce relatively little benefit for tort victims. A company hit by huge mass tort claims will probably be insolvent whether it was adequately capitalised or not. They say that neither markets nor politics work well to represent the interests of the persons who bear the direct costs of the rule, namely tort victims. Since, by definition, torts involve injuries to third parties, the parties affected by the rule, corporations and their potential tort victims, cannot contract around the rule to capture and share the gains from its alteration”. (Hansmann and Kraakman, 1991) I also agree with the arguments of Halpern, Turnbull and Trebilcock, regarding the exceptions to limited liability. They suggest involuntary creditors, as one of the classes, that should have a special protection because they are mostly disfavoured, and as a result an exception to this class of creditors should be made. The debate was strongly revived after Asbestos Case where from 3000 claimants, only a few managed to recover the damages. ” This provides a striking illustration of how limited liability can act as a bar to recovery for corporate injuries even when a firm has been found guilty” (Tweedale & Flynn, p. 292, 2007) History and practice has shown that the doctrine is not completely accurate. The privileges of voluntary creditors over involuntary ones, and the abusing with this unfair positioning of creditors (Asbesots case) have confirmed that fact that this system does not provide equity.