Up to the late middle ages, business was pretty steady – one family owned a cow, another some cabbages, there was mutual jealousy and so they swapped. In time, money was used to facilitate more complex exchanges but, all in all, relatively few people were involved and there wasn’t a huge need for capital.
Around the 1600s though, people started exploring the world. Trade followed exploration and trade was very profitable so naturally the great families of the era liked to keep it to themselves. Notwithstanding, there were two major problems:
- firstly, intercontinental explorers were thin on the ground and trade required the wealthy to give some brash upstart a great deal of money and send him to some remote corner of the globe; and
- secondly, trade exploration required tonnes of capital, and given the risks, often more capital than one family was willing to contribute on their own, so there was a need for joint investment from unrelated parties.
A system was needed to record who was trustworthy and who had whose money and because everyone knew they could trust their King, the monarch assumed the right to allow these early joint stock companies to operate.
One of the earlier companies to receive a Royal Charter was the British East India Company. Regrettably, it developed a reputation for oppressing and pillaging India over a few centuries, so they changed their name to the Honourable East India Company and, obviously, that cleared things right up.
Through the colonial period, trade increased Gross Domestic Products which even royal families saw as a good thing, so seizing the opportunity to do less and get more, the regulation of companies was lowered and stock certificates came to be traded amongst progressively more common people.
The industrial revolution increased business size and technicality to unprecedented levels and the essential problems were heightened:
- investors didn’t have the foggiest understanding of Carnegie’s Steel or Rockefeller’s oil, and while they didn’t like these risks, they didn’t want to forgo their profits either; and
- companies had become so big, that they required continual diversified funding from a large number of investors to continue expansion and operation.
Thus emerged the concept of limited liability. To get people to invest it was necessary to create a law that separated the shareholders from the company itself, and limited their liability for the company’s risks up to the amount they had paid for the share capital.
That remains the essence of a limited liability company today and explains why a right to sue a company does not include a right to sue its directors or shareholders. Without the rule, which sometimes seems harsh, our economy could not have developed as it has.
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