Newly appointed minister of commerce Lianne Dalziel has expressed concern that existing company law protects someone engaged in a business "from facing up to his responsibilities to creditors". She cites the case of small business operators who are "ripped off by a supplier going bust, only to find that supplier starting up in business again a short time later in a new limited liability company". In her view "people should not be able to walk away from huge financial liabilities without exposing themselves to the kind of bankruptcy rules that individuals faced."

From a legal perspective this is incoherent. The minister makes no case that the firms she is referring to have failed to discharge their legal responsibilities.

Business involves risk taking. Everyone running or dealing with a business must be conscious of the possibility that the business might fail. This is an inevitable consequence of competition in a market economy.

In the absence of wrongdoing, there is nothing necessarily shameful about business failure. A competitor may simply have come up with a better mousetrap.

From a wider social point of view, losses are a signal that scarce economic resources are not being put to best use. The community is better off if capital and labour are reallocated to profitable activities.

The limited liability company is a vital business institution. Anyone trading with XYZ Limited knows that those who have put money into it do not have a general legal liability beyond the funds invested. That is what 'limited' means. The directors of the company have a legal and fiduciary duty to its shareholders. Potential creditors are on notice that they must look only to the company's assets for the satisfaction of their claims; its shareholders do not accept unlimited personal liability.

This device for risk-sharing is enormously important for mobilising capital. Without it many business activities would simply be impractical. Potential owners of small and medium-sized businesses would not be willing to expose themselves to financial ruin. Large publicly listed companies would not attract shareholders if their liabilities were unlimited. Consumers would get a poorer deal and workers would end up with fewer or inferior jobs.

Contrary to statements the minister has made, limited liability is not a privilege. It is simply an implicit contractual arrangement and existed under common law before company statutes were created. No one is obligated to deal with a limited liability company, and those doing so can negotiate for other terms of trade (such as pledges of assets or personal guarantees) if they wish. Any such shifting of risk, however, will obviously come at a cost, eg in the form of reduced supply or higher prices.

This freedom of choice allows all parties to do business in a way that suits them best. Although many other types of firm exist – such as partnerships, trusts and cooperatives – the dominance of the limited liability company indicates its utility to investors, creditors and consumers alike.

Insolvency law raises a host of detailed issues. In considering them, however, we should not lose sight of the vital importance of law that facilitates risk-taking, risk-sharing and entrepreneurship. People should be legally able to contract to protect themselves against open-ended losses, and those who have failed honestly should not be unreasonably debarred from trading again.

The minister has stated that the review of insolvency law is her top priority in her new portfolio. What alternatives to current arrangements she has in mind has not been made clear.

Business is the wealth-creating institution of society. Only a flourishing business sector can generate increases in living standards.

The government's aim of achieving much faster economic growth requires a business-friendly environment. As a rule, governments should not override the assignments of risk that emerge from competition and choice. Any review of insolvency law should proceed with care.

For more information, contact:

David Young
Communications Manager
Ph: 04 499 0790
Email: dyoung@nzbr.org.nz

Web: www.nzbr.org.nz