What is 'Limited Liability'
Limited liability is a type of liability that does not exceed the amount invested in a partnership or limited liability company. The limited liability feature is one of the biggest advantages of investing in publicly listed companies. While a shareholder can participate wholly in the growth of a company, his or her liability is restricted to the amount of the investment in the company, even if it subsequently goes bankrupt and has remaining debt obligations.
BREAKING DOWN 'Limited Liability'When either an individual or a company functions with limited liability this means that assets attributed to the associated individuals cannot be seized in an effort to repay debt obligations attributed to the company. Funds that were directly invested with the company, such as with the purchase of company stock, are considered assets of the company in question and can be seized in the event of insolvency.
Any other assets deemed to be in the company’s possession, such as real estate, equipment and machinery, investments made in the name of the institution, and any goods that have been produced, but have not been sold, are also subject to seizure and liquidation.
Limited Liability Partnerships
In a partnership, the limited partners have limited liability while the general partner has unlimited liability. The limited liability feature protects the partner's personal assets from the risk of being seized to satisfy creditor claims in the event of the company's or partnership's insolvency while the general partner’s personal property would remain at risk.
Limited Liability in Incorporated Businesses
In the context of a private company, becoming incorporated can provide its owners with limited liability since an incorporated company is treated as a separate and independent legal entity. Limited liability is especially desirable when dealing in industries that can be subject to massive losses, such as insurance.
As an example, consider the misfortune that befell numerous Lloyd's Names, who are private individuals that agree to take on unlimited liabilities related to insurance risk in return for pocketing profits from insurance premiums. In the late 1990s, hundreds of these investors had to declare bankruptcy in the face of catastrophic losses incurred on claims related to asbestosis.
Contrast this with the losses incurred by shareholders in some of the biggest public companies to go bankrupt, such as Enron and Lehman Brothers. Although shareholders in these companies lost all of their investment in them, they were not held liable for the hundreds of billions of dollars owed by these companies to their creditors subsequent to their bankruptcies.