Doctrine of Limited Liability: Everything You Need to Know
The Doctrine of Limited Liability states that the liability of the shipowner is restricted to only the shipowner's interest in the vessel.3 min read
The Doctrine of Limited Liability, also known as the "no vessel, no liability doctrine," states that the liability of the shipowner is restricted to only the shipowner's interest in the vessel. In the case of a total loss, the liability of the shipowner ends. In the case of the vessel's total destruction, all maritime liens also end.
Limited liability is put in place as a way to protect the personal interests of an investor from any wrongdoing of a corporation. However, it is possible for the investor to lose what they have invested in the corporation. Limited liability for a shipowner extends to the following:
- Insurance proceeds.
Advantages and Disadvantages of Limited Liability
Limited liability is a legal precedent that was pivotal to the modern corporation and stock markets. By instituting limited liability, entrepreneurs were given the ability to use small investments from a large pool of corporate shareholders, rather than just a few wealthy partners.
In partnerships, the partners are each responsible for any wrongdoing. This is removed with limited liability. Shareholders have the confidence to invest knowing they will only lose what they put in, nothing more. With the introduction of limited liability, the economy boomed from a new way to source investment capital.
A major disadvantage of limited liability is the problem of who is deemed responsible in the case of wrongdoing. When limited liability is in place, the blame is hard to place based on the corporate structure. This is especially true when corporate subsidiaries are not held to the highest standards and perform risky tasks like oil drilling. Parent corporations use lawyers to legally protect themselves and the assets of their subsidiaries.
Exceptions to the Doctrine of Limited Liability
Typically, the shipowner's liability is limited to what they are entitled to abandon the vessel. This includes all equipment and freight that was collected on the trip. If the freight was lost, this can be sufficient for the shipowner's discharge. However, there are exceptions to consider when reviewing the doctrine of limited liability:
- Repairs and provisioning of the vessel that took place before losing the vessel.
- Any insurance proceeds. Any proceeds will go to the claimant if the vessel is insured.
Piercing the Corporate Veil
Limited liability is achieved by creating a corporation to protect the shareholders. The corporation separates the owners as a different legal entity and makes the corporation responsible for all debts and obligations. By using this corporate structure, the shareholders are protected under what is referred to as the "corporate veil." However, it is possible to remove the corporate veil or pierce it when it is shown that the corporation has been improperly run. This principle can also be applied to other business entities, including limited liability companies and limited partnerships.
To prove that a corporation has acted improperly, some states apply a test. This two-prong test examines formalities and fairness:
- The formalities prong asks if there is enough proof to show that the ownership and corporation is too intertwined to be considered separate. In other words, can the corporation stand on its own and still have the funds to operate?
- The fairness prong asks if it would be unfair, or inequitable, to pierce the corporate veil.
There are other factors that can justify piercing the corporate veil. These factors include the following:
- Failure to follow corporate legal formalities like holding board meetings and shareholder meetings.
- Failure to pay dividends to shareholders.
- Insolvency of the debtor corporation.
- Loss or absence of corporate records.
- Corporate funds being siphoned by the dominant stockholder.
- Officers and directors that do not complete their responsibilities.
It should be noted that successfully piercing the corporate veil is the exception, not the rule, according to the courts. It is only in extreme cases that the protection of limited liability can be removed. However, just filing as a corporation will not guarantee protection. Businesses of all sizes should follow all legal requirements of their specific business entity type. Some requirements that should be followed include these:
- Follow all state formalities.
- Keep proper corporate records include meeting minutes.
- Keep personal finances separate from business finances.
- Register in any state where corporate activities take place.
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