It is clear that limited liability was a concession by the state to enable companies to attract investors without the risk of these investors being liable for the company’s debts should the business venture fail or other liabilities arise. However, the doctrine of limited liability was adopted at a time when companies consisted of individual shareholders who were natural persons. As shown above legislators in the United States of America only allowed companies to hold shares in other companies in the 1880s and the judiciary also refused to recognise companies as shareholders unless their memoranda of association allowed this. Furthermore it should be borne in mind that after the Industrial Revolution
196 Chapter 6, paras 6.4 and 6.5 below.
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and the advent of companies, companies were small consisting of only a few investors.
With the advancement in technology and growing economies it would only be natural to assume that companies would grow from businesses with a small number of investors to larger entities with more complex structures to deal with the expansion of their enterprises. An example is provided by the evolution of corporate structures to finance the building of railroads in the United States. Companies grew from being part of
“atomic capitalism” to a system where groups of companies became the face of the economy.197 When the doctrine of limited liability was adopted, the growth and sophistication of corporate business activities could not have been foreseen. This argument is strengthened by the fact that shareholding in companies was initially restricted in the United States to natural persons. The legislature had to intervene to enable shareholding by companies in other companies. Even when corporate shareholding was allowed the judiciary set strict requirements before a company could hold shares in another. Parallel to shareholding by a shareholder is the privilege of limited liability, namely that he will not be held liable for the debts of the company of which he is a shareholder. A conclusion which could reasonably be drawn from the above is that limited liability cannot be treated the same where a natural person is a shareholder in a company compared to the position of another company being a shareholder, since limited liability became the norm before companies could hold shares in other companies.
Limited liability was merely an existing tool in company law which the judiciary and the legislature inadvertently extended to companies as shareholders without taking into account the context in which limited liability was adopted.
Limited liability evokes much discussion, as shown above. Its origins and the reasons for its existence differ from scholar to scholar. It is however clear from the historical perspective that it came about through a concession by the legislature and not by private contractual means. Companies were in existence long before limited liability was considered to be important for incorporators. Company groups were also not possible or even under consideration when the legislators in the United States granted limited liability to companies with natural person shareholders as shareholders. It is therefore an
197 Antunes Liability of Corporate Groups 21-22.
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open question whether the doctrine of limited liability provides adequate justification for not imposing some form of liability on holding companies in the light of the historical fact that holding companies and subsidiaries were not in existence or possible when the doctrine was introduced.
Interestingly, limited liability has not evoked much discussion in South African law and it is seemingly accepted as a logical consequence of the principle of a company being a separate juristic person.198 Limited liability of shareholders is, however, not necessarily a logical consequence of separate juristic personality. Although a partnership is not a separate juristic person, the partners do enjoy limited liability to an extent during its existence in respect of partnership debts. Any claim which a creditor has, has to be instituted against the partners jointly and not against an individual partner. Any claim has to be first satisfied from the partnership estate and only if this is insufficient can the balance be recovered from the estates of the individual partners.199 Only upon dissolution of the partnership do the partners become jointly and severally liable for the debts of the partnership.200
Limited liability was also not specifically mentioned as an automatic consequence of incorporation in previous companies law legislation. The 1926 Companies Act merely provided that upon registration of the memorandum of association and articles the members of the company form a body corporate with perpetual succession, which can exercise all the functions of an incorporated company.201 Nathan202 writes that this meant that the company became an entity distinct from its members and that the members enjoyed limited liability by referring, among others, to the Salomon203 case. Limited liability, in terms of the 1926 Companies Act, however, has to be understood within the context of the 1926 Act. The basic form of company in the 1926 Act was the unlimited
198 See Blackman, Jooste & Everingham Commentary on the Companies Act 1 (2002) 4-116; De Wet & Van Wyk De Wet en Yeats Die Suid-Afrikaanse Kontraktereg en Handelsreg 4ed (1978) 528-530; Cilliers & Benade Korporatiewe Reg 3ed (2001) 10.
199 Rule 14(5)(h) of the Uniform Court rules.
200 Lee v Maraisdrif (Edms) Bpk 1976 2 SA 536 (A).
201 Section 18(2) of the Companies Act 1926.
202 Nathan Company Law of South Africa 3ed (1939) 87.
203 [1897] A.C. 22 [H.L].
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company.204 Nathan’s referral to the Salomon case is therefore only in respect of a limited company.
Although unlimited companies ceased to be the basic form,205 the 1973 Companies Act206 (“the 1973 Act”) contains virtually similar wording to the 1926 Companies Act.207 The new Companies Act differs from its predecessors. It specifically provides that the shareholders, incorporators and directors generally are not liable for the company’s debts,208 as a consequence of its incorporation with a separate juristic personality.
From an economic perspective it would also appear that most of the reasons which are advanced in respect of the benefits or justification of limited liability are in respect of the shareholders of the company being natural persons and not other companies. The monitoring costs of shareholders, who are natural persons, simply cannot be compared to the monitoring costs for a juristic person, especially one that controls another company.
The juristic person furthermore can effectively appoint the managers of the subsidiary which further reduces any monitoring costs for the holding company. The same may be so in the case of an individual who dominates a company, but generally speaking monitoring costs do not play as an important role where groups of companies are involved compared to a company directly controlled by natural persons.209
In conclusion it would therefore appear that historically the principle of limited liability was not related to the existence of company groups. The fact that companies in the United States and England were prohibited from holding shares in other companies until later in the nineteenth century precludes an interpretation that one should look at the principle behind limited liability, namely shareholder protection for the existence of limited liability where groups of companies are involved. If the purpose of the principle
204 S 5 read with s 18(1).
205 Under the 1973 Companies Act, new unlimited companies could not be formed, and s 25 provided for the conversion of existing unlimited companies.
206 61 of 1973.
207 Section 65(1).
208 Section 19(2).
209 See also Blumberg “Limited liability and corporate groups” (1985-1986) Journal of Corporate Law 11 573 623-626.
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of limited liability was to protect a shareholder, why would there be a distinction in respect of the nature of the shareholder? No logical reason exists for the prohibition on the holding of shares by one company in another. The principle of limited liability can therefore not be accepted to apply to companies holding shares in another as it does in respect of natural person shareholders without more. Had there been no distinction between the two forms of a shareholder in a company, there would not have been a prohibition or restriction on companies holding shares in other companies when companies and therefore by implication, limited liability, were introduced by the English and United States’ legislatures.
From an economic perspective it would also appear that limited liability is efficient in the context of a natural person as shareholder of the company. Although the same reasons could be advanced in the case of companies as shareholders this construction would appear to be a more forced one and make less sense than limited liability where a natural person is the shareholder.
It would appear that limited liability was a convenient, available principle with the advent of company groups. The law could merely take an existing principle and utilise it in a situation which at first blush seems much the same as the position of a natural person as shareholder but there are also important differences between the two situations.
2.7 Exception to the principle of limited liability: The doctrine of the piercing of the