It is the day of the year when, at least with regard to political economy, almost nothing seems to have happened. I am aware of others news, but that is for others to comment on. I will stick to political economy, and that's on its summer holiday.
In that case let me do what politicians will not, and discuss an idea that could result in action.
The idea is limited liability, in the form of the limited liability company.
The suggestion is that this idea is being widely abused.
The action required is to prevent that abuse.
Let's be clear what limited liability is. It is the protection provided by law to the shareholders or members of a company that means that so long as they have paid all that they owe for their share then they have no further liability for the debts of the company that they own if it is unable to meet its obligations to pay.
To be clear, a company does not have limited liability: it has full responsibility for its debt. It is its members who enjoy limited liability.
But the consequence is that the company does have limited liability because if it cannot pay it can be liquidated without recourse to its members, and usually its directors (unless they can be shown to have traded recklessly or whilst knowingly insolvent), and the creditors of the company will suffer the loss that the company has incurred. The result is that a moral hazard is created, with the cost of trading or other losses being transferred to those who did not create them.
The risk of this happening (because its possibility was always understood to exist) was meant to be mitigated in several ways:
- By reason of the company being required to have sufficient share capital to ensure that a buffer existed to prevent losses being passed on to creditors.
- By requiring the provision of up to date accounting information on the company to Companies House for it to place that data on public record so that those supplying credit to the company might know the risk that they were taking.
- The requirement that details of all shareholders and directors of the company be placed on public record so that the identity of those with whom the creditor is really trading is known, as companies do not have their own personalities.
- Rules on protecting creditors were put in place, meaning that this was supposedly the primary task of the directors of the company and that they must not trade if those creditors were at risk of loss.
These days all of these protections have been abandoned.
The vast majority of companies have share capital of less than £10. Larger companies are mainly reliant on debt for their funding and not capital. The essential idea that capital should be at risk in limited liability companies has disappeared.
Well over 90 per cent of all companies now qualify to file micro or small company accounts - which deliver effectively meaningless data to those who search this information on public record. Attempts to change this are moving pitifully slowly.
And when it comes to large companies, it is quite explicitly stated by accounting standards setters that the data supplied is only for the purposes of credit appraisal and that no data for any other purpose is within the scope of those standards - meaning that these companies can very often deliberately omit vital data on key issues of concern.
Meanwhile, shareholder and director details have disappeared from or been obscured on public record, the former most especially since 2016.
And, the idea of protection of creditors has become meaningless when hundreds of thousands of companies are struck from the Register of Companies each year without any investigation or attempt being made to secure protection for any creditor of any sort.
In other words, every protection for society from abuse by those owning limited companies has been removed whilst simultaneously the scale of those companies in terms of size, number and impact on society has grown out of all proportion to that which any Victorian who first enacted legislation to permit their widespread use could have imagined.
Worse, the right to limited liability without disclosing details of the ownership of an entity now appears to be considered a human right in some countries, including within the EU - which is utterly absurd. This is ownership without obligation being passed into law.
So what can and should be done about this? A number of obvious suggestions follow:
1) Companies must have a capital commensurate to their level of trading and those not doing so should be able to call on their shareholders to make good the deficiency in the event of an insolvency. Shareholding cannot be seen to be a risk free activity when it clearly is not.
2) All company accounts should be available on public record, in full, and accounting standards should ensure that they are designed to meet all shareholder needs.
3) Companies failing to file accounts on time should lose the benefit of limited liability until they do so.
4) Details of all directors and shareholders should be on public record. Those companies not filing correct data should lose their limited liability.
5) All companies must be required to file tax returns annually (most do not at present). Those that do not should have personal liability imposed on the directors for tax owing.
6) No company should be struck from the Register of Companies without filing accounts, including creditor lists, if insolvent. Anyone missed from the list should have a personal claim against the directors of the company.
7) Banks must be required to share with Companies House and HMRC annually the details that they should on the company, its trading addresses, the shareholders and directors and must supply a figurine for sums deposited in all bank accounts that they holds for it. In the absence of company supplied data this information should be placed on company record in place of company supplied data.
These measures will be seen as tough, and there will be howls of protest from ‘free marketeers'. But why? Limited liability, as Adam Smith knew and did not like, creates the chance for free riding, moral hazard and straightforward abuse that undermines all theories of market competition. So, such protest cannot actually be about free markets. It would, more like, be a defence of free-loading, because that is what limited liability has become, and what it will remain as unless action to end abuse is taken.
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Good to see somebody at last addressing one of the elephants in the room that has played such a major role in the Last Days Of The Roman Empire re-enactment society that has passed for governance since 1979.
Twenty years ago a friend of mine decided to change his tax status from an employee working on contracts that lasted only as long as it took to complete a project to instead working on projects as a sub-contracting limited liability company.
After a couple of years he remarked that given all the legal privileges and financial benefits of being a limited company he could not see why anybody would ever feel the need to get into other forms of tax fraud.
S/he was right
One of the very first things I learnt at school about accounting was A=O+L.
What you are saying is that now it seems that the Capital part of the equation has been made redundant by borrowing funds and converting it to capital? That is quite crazy.
Additionally of course, as, I think David Graeber pointed out, although incorporation means to be made into a body, most things with bodies are animals who die in due course. The effect of company incorporation means that most of our large companies need never die – they have no natural lifespan and are potentially immortal.
I wonder whether perhaps, free market hat on 🙂 in order to promote competition, they should be required to shuffle off their corporate coil after say fifty or a hundred years? And then perhaps allowed to reform with different share capital?
Interesting idea.
There have been rules to try to prevent trusts lasting in perpetuity – you are suggesting extending them.
There could be some very important academic work to do on this issue.
I am currently reading Harari’s book ‘Sapiens’ where he discuses that at some point we created ‘legal fictions’ where Peugeot for instance takes on a life of its own – where even if all employees died at once, or all is buildings burned to the ground, or all its products disappeared, this fictional entity still remained, despite not being real in any sense whatsoever.
So it’s interesting to me that you raise this now.
It seems that we allow such fictions to persist all too willingly beyond their usefulness, and they have far too much power (or confer far too much for too few people).
This issue is far too little considered
Richard,
I don’t fundamentally disagree with you but what sort of levels of Shareholders Capital do you suggest?
I gather that Directors Guarantees are often required for Company loans and wonder if there might be other ways round this issue such as rules on lending/credit to Companies?
This would take research but a formula based on turnover and assets to limit risk arising from over trading and from over leveraging would seem to be appropriate.
I would add one other reform. Directors should be required to pass a test before being allowed to take office. Firstly this would allow them to be more easily identified (assuming the licence issued had a number, as driving licences do, and that number is recorded with the information on record in Companies House), and secondly it would stop the vast numbers of people who acquire limited companies with little or no knowledge of the legal responsibilities that entails.
If we can demand a licence to drive a car we can certainly do this.
In the case of utility “companies” maybe there is an argument to be made for them to look a bit more like members of Lloyds – i.e the directors and owners of a utility are liable to the limit of their personal wordly goods.
I am not sure what form such an org would take, but it would certainly focus minds as outraged citizens sue them for every penny they have (e.g. the current rivers as sewage outlets scandal). If such a proposal were enacted, I have every reason to believe that the org plus its assets would be handed back to HMG gratis. Indeed, the principle could apply to any & all orgs providing public services – outsourced NHS services? yep & so on & so forth.
I notice the neo-cons are all in favour of “personal responsibility” – “yer gotta take responsibility for yer actions (& omissions)” – all for it! & I am sure, nay certain, that they would be all in favour of the proposal 🙂
I like the idea for PLCs in particular.
One thing that is happening is China’s market regulators, the Securities Regulatory Commission; “introducing a number of measures aimed at making it easier to trade. These include cuts in the cost of trading, via a reduction in the handling fees charged by brokers, as well as a relaxation of the rules governing share buybacks – making it easier for companies to buy back their shares. The regulator indicated it is also looking into extending trading hours for the country’s stock and bond markets and a possible cut in stamp duty on share trades. The measures follow sharp reverses this month in both stock and bond markets amid a weakening of confidence among investors. (Ian King, Sky News).
We are used to buy-backs. In contrast to the neoliberal false flag that the energy giants are investing heavily in Green technology; they (BP, Shell) are actually conducting major share buy-back operations. The purpose is to shrink the share capital. Why? Combined with big windfall profits made without doing anything at all, share buyers will be faced with a higher share price (you can see the irony). This means they eat themselves rather than invest, because they think they can make more money by giving it back to shareholders. capitalism, eh? In China the Regulators shake up the market, encouraging it by helping capitalists decapitalise. “Markets”, eh?
The irony is as plain as a pikestaff. Neoliberals of course, can’t see it.
Agreed, John
What further details do you have in mind for directors and shareholders? Companies House did once show all private addresses, but that became a privacy and security issue.
In exceptional cases it is.
But candidly, the threat is massively overstated. And I mean, massively.
I’m sure adequate safeguards could be built in to handle the rare cases where there is a security issue as they are for personal bankruptcy.
Normally personal bankruptcies are published in the Gazette, but I know of a case where a stay of advertisement was granted to someone against whom credible death threats had been made.
Published company accounts, at least in north america, are typically in consolidated form. They can be of limited protection for creditors dealing with subsidiaries who are themselves insolvent even though the parent company is solvent.
Correct
I can see no reason for limited liability within limited liability.
That is a deeply contentious suggestion.
I don’t know if this is applicable to this thread, but I have often wondered why so many MPs set up limited companies and leave them to wither after a couple of years. It’s happened with lots of the new 2019 intake.
To manage the fees they think they will get from outside work now they are famous MPs, or not (in most cases)
You are right that the system is open to abuse.
I am aware of one individual who has set up eight companies in the last seven years and folded seven of them after a year, so no accounts are available and no evidence of any trading reported. I fully expect that his current company will be folded in a few months time just after he sets up a new one to carry out the same services of the others he has folded.
I am not saying that their is any evidence of corruption, but something is not right when he is able to hide behind a different company each year.
Any new system of registering new companies must close this loophole and have the ability to identify what are in truth continuing companies and make it a requirement that the accounts are linked to all previous companies.
Of course that does mean that the issue of what has to be reported in the company accounts also need to strengthen.
What chance is there that any of these paid any tax?
Close to zero, I suspect.
Richard
Sorry to give you more work but what about producing a set of proposals for the future of Limited Liability some of which have been made here and others elsewhere on the blog?
That is an idea….
I will bear it in mind…seriously…
I also see it as a research project
Hi Richard
This whole area is something I feel strongly about – the veil of incorporation appears to have transformed into the vale of incorporation. Could I assist with the research or do you have any pointers of how I might do
Best wishes and keep up the good work
Alex
Alex – might you mail me?
Great you are looking into this Richard.
Please include LLPs under which “Big 4” and most lawyers operate.
Also – do consider impact on small companies bidding for work with much larger companies where they can not dictate terms of engagement and onerous liability clauses are included in the contract. Often a limitation on their liability is the only thing that allows them to undertake the work – Supply a months IT consultancy , Be held liable for a nuclear reactor failing – Directors lose everything they own.
The people I have the greatest sympathy for are the workers ditched at short notice and losing pension pots they have paid into for years. Although some of this loss is covered by a plan to protect pensions it must be devastating to lose savings while those at the top walse off into the sunset with a stack of funds to spend on their lavish lifestyle.
What you propose effectively ends share ownership as a method of saving. The discussion will not extend beyond the hardy souls on this board.
Shareholding is about investing, but saving
Did you not notice that?
A few somewhat random thoughts.
Firstly, if a limited company is failing to fulfill its obligations of being so, then it should lose its status as such (and the rights that come with it), with the directors and shareholders being jointly and severally liable.
Certain debts and obligations – perhaps most significantly, legal penalties for illegal or criminal behavior – should be excluded from limitation of liability.
If a limited liability company is found against in the courts – for whatever reason – this should be included in their annual (or other) reports.
When a limited liability company is involved in a court action, should there be a requirement for a director (or ?) to be in court?
If (when) a limited company goes bust, should top priority for being paid go to individuals (and non-limited undertakings)? And if they cannot be fully paid, should they get a credit for the balance that can be used (wholly or partially? in what circumstances?) in payment of a debt being demanded by another limited company.
Good questions
What you have said needs to be said and it is true.
I’ve used companies house many times over the years only to find that the people it lists and whom we are trying to work with are not the organisations they say they are. Most of the ones we’ve worked with on partnerships are close to calamity behind the scenes and in dire straits and have affected the viability of many a project.
I mean, where can you go to get a decent objective appraisal about a potential private sector partner? Where are you supposed to go?
Company’s House beggars belief.
Well said.
Companies House + accounting standards = failure to supply reliable data
This is little doubt these measures would be beneficial – indeed more might be required. Such as:
1. The existence of Shadow / De Facto Directors should mean no limited liability for such companies making use of those categories of Company Officer.
2. Imposing the weight of fiduciary duty on Company Directors via removal of limited liability for any transaction that reduces a company’s distributable reserves (ie. a payment) when there has been a failure to keep a full and proper contemporaneous entry in the books that both records and evidences the purpose of the said transaction.
3. As I mentioned in a blog post yesterday “Funding Gap For Liquidation Investigations” here: https://www.oliverelliot.co.uk/2023/08/20/funding-gap-for-liquidation-investigations/, there should be a stern and effective Court system enabling robust enforcement by Insolvency Service investigators and Liquidators, looking to both unscramble an insolvent / dissolved company’s affairs and pursue recoveries actions in respect of transactions to the benefit of Directors/Members but made at the expense of creditors.
4. The existence of contingent liabilities should mean dividends are prohibited without full provision made for them, as opposed to the current system in which there appears a worrying level of protection, somewhat reliant on the nebulous concept of the ‘Creditor Duty’. Furthermore, there is also the potentially inadequate provisioning provided when assessing the likelihood of liabilities crystallising using concepts like the ‘probable’ or ‘possible’ – instead again, full provision should replace that.
Interesting points
Thank you
[…] Cross-posted from Richard Murphy’s blog ‘Funding the Future’ […]
I would think that this needs to be accompanied by a revolution at Companies House. It is far too easy and cheap to register a company with imaginary directors.
There should be an appropriate fee structure which would enable Companies House to actually effectively police companies.
Agreed
I think plc status (as amended along the above lines) should be awarded in exchange for strict corporate management changes including having stakeholder (not jut employee) representation on the board – full recognition of the need for people who are subject to any of the externalities. What companies do effects us all, we therefore have a right and duty to exercise some control.
I then think state aid, outsource contract awards, and other privileges should be restricted to companies that have accepted this – i.e. have accepted their social responsibilities. There is a case for outsourcing to social enterprisers, and other types of organisation, so this would need working through.
Also need to consider takeover laws. Acceptance of (amended) plc status being a given or subject to review. And is there any way in which one could stop debts incurred to make the purchase price being added to the accounts of the acquired company? I know household parallels don’t work for economics but I couldn’t add my mortgage debt to the house. I doesn’t seem to make any sense. Could it just be banned?
An accounting friend of mine (now sadly deceased) said that maximisation of profit is written into the accounting code…is this true? If so it needs changing, profit should be the by-product of doing something of value/use to society (a right livelihood as Schumacher would have put it) not an end in itself.
I am not sure your first two suggestions would really work – and would make it nigh on impossible for smaller companies to grow.
I do believe that the pratctice of adding debt for acquisitipn should not be payable by the acquired company.
And, profit maximisation is not in any way built into accountancy. Most accountants have not a clue what profit is and would have even less idea how to influence it, apart from by sacking people (their answer to everything).
Hi Richard, I saw no mention of Graham Barrow’s identification of thousands of bogus companies created at Companies House for criminal activity. This seems to be more of a priority than anything else. Would you agree? What should be done about this enabling of crime?
I see them all as one issue