The Role Of Limited Liability Companies In Encouraging Or Discouraging Excessive Risk-Taking

Role of Reporting and Scrutiny

Question:

Discuss about the Business for American Journal of Comparative Law.

A limited liability company or LLC is referred as a corporation in which the members are responsible for its debts up to the amount of capital that they invest. In other words, members cannot be held personally liable for debts or liabilities the company (Tricker, 2011). This essay will provide arguments against the statement that the ability to create an LLC leads to excessive risk taking which negatively affects the society. In this context, excessive risk-taking means members of the company are more likely to take business risks that are not safe for the corporation or society in order to get substantial returns. The negative impact on society includes factors such as high risk of fraud by the members, high chance of loss suffered by shareholders, members are more likely to take rash business decisions, risk of unethical behaviour of members, and others (Ireland, 2010). Society includes different stakeholders that are directly affected by the actions of an LLC such as public, shareholders, employees, government, creditors, investors, and others. The ability to create an LLC did not encourage its members to take excessive risks that negatively affect society because various laws and moral values bind them. This essay will discuss the role of the doctrine of piercing the corporate veil, moral values, stringent reporting, transparency, accounting requirements and others to argue why the ability to create an LLC did not encourage members to take excessive risks.

A limited liability company is required to comply with a strict reporting system which enforces its members to continuously submit company’s reports to government authorities which reduces the risk of excessive risk-taking. In limited liability companies, members did not have unlimited powers to do anything that they want in the firm. They are continuously under pressure to submit different reports of the enterprise to various parties such as shareholders, government, and public which assist them in reviewing their work (Luchs, et al., 2010). For example, the key document of LLC includes its annual report which includes crucial data regarding the organisation. The annual report includes tax report, management report, directors’ report, franchise tax report, and others. It includes the statement of overall revenue and operating expenditure of the enterprise that assists shareholders, government and public in evaluating the company’s annual performance (Lehavy, Li and Merkley, 2011). The director report includes statements from the directors regarding the performance of the enterprise and the actions taken by them. Other than the annual report, LLCs submit various other reports to its shareholders and government as well for ensuring that it complies with necessary legal requirements. These reports enable shareholders, government and public to review the work of members, and they can hold them accountable for their action. Therefore, due to the continuous scrutiny of their work, members did not take excessive risks that might negatively affect the society.

The Doctrine of Piercing the Corporate Veil

The doctrine of “piercing of the corporate veil” enables the court to avoid the provision of the separate legal entity and hold the company’s directors liable for their actions which ensure that they did not take excessive risk-taking that can negatively affect the society. The piercing of the corporate veil is referred as a situation in which the court set aside the principle of the separate legal entity. The provision was given in Salomon v A Salomon & Co Ltd case in which the court provided that a person operating a company cannot be held personally liable for its liabilities (Lawson, 2015). The corporate veil protects members in an LLC, but the court uses doctrine of piercing the corporate veil to hold company’s members personally responsible for firm’s debts or liabilities (Macey and Mitts, 2014). Generally, courts have a strong presumption against the use of the doctrine of piercing of corporate veil and it is only applied in case of serious misconduct. The provision of veil piercing was introduced because directors misuse their power to take excessive risk in the company that negatively affect the interest of shareholders, creditors and society. Directors often misuse their position since to take excessive or absurd risks in the organisation that negatively affects the interest of creditors. In case of LLCs, the provision of limited liability can encourage directors to take extreme risks for smaller returns that adversely affect the interest of creditors (Huang, 2012). In such case, the court can pierce the corporate veil and hold directors personally liable for their actions. The court pierces a corporate veil in various cases, for example, when there is no separation between the firms and its owners, wrongful or fraudulent actions by directors, or in case creditors suffer unfair loss.

The income of an LLC is taxed as the personal income of its members; therefore, members are not encouraged to take excessive risks as it negatively affects their income as well. An LLC’s owners are known as members, and they are taxed as sole proprietors which mean that the income generated by the LLC passes through to its members’ personal income. This provision removes the risk of double taxation and allows the members to pay tax on company’s income (Jelsma and Nollkamper, 2017). Members of an LLC are required to comply with a number of regulations in order to ensure smooth working of the enterprise. For example, in the United States, the regulations relating to limited liability companies differ based on states. The government implemented strict policies for limited liability companies in order to ensure that the members did not misuse their position and take excessive risks that lead to negatively affecting the actions of the society. Taking uncalculated risk negatively affects the income of an LLC’s members as well which discourage them from making a rash business decision (Djelic and Bothello, 2013). The members also face the risk of losing their capital which they invest in the firm in case they take excessively risking decisions. Therefore, they are less likely to take risky business decisions which might result in negatively affecting the interest of society.

Taxation

In case of limited liability corporations, members are required to comply with a number of strict legal regulations which ensure that they are performing their duties ethically which discourage them from taking risky business decisions. An LLC has to comply with different legal requirements such as an operating agreement with suppliers, buy-sell agreement, profit distribution structure, changing tax status, and others. Effective compliance with these regulations ensures that members are performing their task ethically, and they are taking calculated risks rather than rash business decisions (Dammann and Schundeln, 2012). Members are accountable to report the performance and actions taken by them that affect shareholders, creditors, employees and public. Although the statutory audit is not mandatory for an LLC, most of the firms conduct them to get taxation and loan benefits. It also assists them in increasing the number of shareholders since investors prefer to invest in the corporations that conduct a regular audit of their accounts (Williams, 2012). Many countries are mandatorily applying the principles of corporate social responsibilities (CSR) over corporations which require its management to think morally while taking a business decision. An effective CSR model ensures that the management of an LLC takes into consideration the interest of each stakeholder while taking a business decision which avoids excessive risk-taking decisions (Hiller, 2013). Therefore, these policies ensure that the members of an LLC did not take excessive risks while operating their business which might negatively affect the society.

Conclusion

In conclusion, members of a limited liability company cannot be held personally liable for its liabilities or debts. The lack of liability did not encourage members of an LLC to take risky decisions because of various factors. Members are required to continuously update stakeholders by issuing different reports of the company which enforces them to take corrective actions. The reports are easily accessible to LLCs’ stakeholders, and members are required to justify their decisions and performance of the company in the report which discourage them from taking risky decisions as their actions are being monitored. The doctrine of piercing of corporate veil also discourages members to misuse their powers and take risky decisions that may negatively affect the society. In this doctrine, the court can pierce the corporate veil and held members personally accountable for company’s liabilities or debts. Taking excessively risky decisions negatively affect the capital of members as well along with the society; therefore, they are less likely to take rash business decisions when their money is at stake. Strict government regulations also discourage members from taking a risky business decision that might negatively affect the society or shareholders of an LLC. Therefore, it is not correct to say that the ability to create an LLC leads to excessive risk taking which negatively affects the society.

References

Dammann, J. and Schündeln, M. (2012) Where Are Limited Liability Companies Formed? An Empirical Analysis. The Journal of Law and Economics, 55(4), pp.741-791.

Djelic, M.L. and Bothello, J. (2013) Limited liability and its moral hazard implications: the systemic inscription of instability in contemporary capitalism. Theory and society, 42(6), pp.589-615.

Hiller, J.S. (2013) The benefit corporation and corporate social responsibility. Journal of Business Ethics, 118(2), pp.287-301.

Huang, H. (2012) Piercing the corporate veil in China: Where is it now and where is it heading?. The American Journal of Comparative Law, 60(3), pp.743-774.

Ireland, P. (2010) Limited liability, shareholder rights and the problem of corporate irresponsibility. Cambridge Journal of Economics, 34(5), pp.837-856.

Jelsma, P.L. and Nollkamper, P.E. (2017) The Limited Liability Company. New York City: LexisNexis.

Lawson, T. (2015) The modern corporation: the site of a mechanism (of global social change) that is out-of-control?. In Generative Mechanisms Transforming the Social Order (pp. 205-230). Springer, Cham.

Lehavy, R., Li, F. and Merkley, K. (2011) The effect of annual report readability on analyst following and the properties of their earnings forecasts. The Accounting Review, 86(3), pp.1087-1115.

Luchs, M.G., Naylor, R.W., Irwin, J.R. and Raghunathan, R. (2010) The sustainability liability: Potential negative effects of ethicality on product preference. Journal of Marketing, 74(5), pp.18-31.

Macey, J. and Mitts, J. (2014) Finding order in the morass: The three real justifications for piercing the corporate veil. Cornell L. Rev., 100, p.99.

Tricker, B. (2011) Re?inventing the Limited Liability Company. Corporate Governance: An International Review, 19(4), pp.384-393.

Williams, R. (2012) Enlightened shareholder value in UK company law. UNSWLJ, 35, p.360.