Concept of liability is important in corporate form of business organizations and their

operation: Discussion and Implication

Aashma Thapa Magar

Kathmandu University School of Management

Abstract:
The formation of a corporate business organization enables an individual, partners, a group of people,
a corporation, a group of corporations, or any combination thereof to operate through an entity
constituting a separate legal entity. The organization will be subject to the laws and regulations that
apply to it, depending upon the type of company, and will enable its owners to achieve common goals.
When one or more people or corporations want to conduct business activity, the first step is to form a
registered company. The law prescribes either forming a company in which the shareholders’ liability
for the company’s debts is limited (a limited liability company). The second is forming a company in
which the shareholders’ liability is not limited. The first alternative is the most common and accepted
in the business activity. In Corporate form of business organization there might be the situation where
a shareholder is held liable for its corporation’s debts despite the rule of limited liability and/or separate
personality. The veil doctrine is invoked when shareholders blur the distinction between the corporation
and the shareholders.

Introduction:
Based on liabilities, there are three types of companies. Those are the unlimited company, a company
limited by shares and companies limited by guarantee. The unlimited companies or corporations are
those in which the liability of the members is unlimited, similar to that of a partnership firm. If the assets
of the company are not sufficient for satisfying the claims of the creditors, the shareholders are liable
to pay more than the face or nominal value of shares held by them, even if it is paid from their estate. It
may be any percentage of the held shares in the business. The Company limited by shares is that by
which the provisions of the Company Act with a specific amount of share capital divided into a definite
number of shares. The liability of shareholders is limited to the extent of the face value of the shares
held by them. The rule of limited liability means that the investors in the corporation are not liable for
more than the amount they invest. A person who pays $100 for stock risks that $100, but no more. A
person who buys a bond for $100 or sells goods to the firm for $100 on credit risks $100, but no more.
The managers and the other workers are not vicariously liable for the firm’s deeds. No one risks more
than he invests. This type of company is quite common at present. The Company limited by guarantee,
under which each shareholder promises to pay a specific sum as a guarantee at the time of winding up
of a company, is called a company limited by guarantee. The Memorandum of Association of the
Company specifies such guarantees. The amount of such a guarantee may differ from member to
member.

When a corporation assumes for acts committed by the organization’s employees or agents acting on
its behalf is considered to be a legal responsibility which alias as liability. The determination of the
extent to which the organization is liable for the actions of its employees is considered by corporate
liability. To hold a corporation liable, the offense must be committed by an employee (or third-party
agent) of the organization while they are working within the scope of their role and the intent of the
action was to benefit the corporation. If these two criteria are met, the organization could be held liable
instead of the individual who committed the crime. In cases where the acts were committed in
negligence or due to a lack of management oversight, the corporation can still be held liable. However,
if the employee strays from their duties and commits a crime in the process, the law will examine the
extent of the deviation to determine liability. If the employee was not acting within the scope of their
role, it is considered a “frolic” but if the infraction is minor then it will be considered a “detour”. The
courts take many factors into consideration to determine which category the actions fall under, but if
the actions are found to be a “frolic” then the corporation will not be held liable.

Significance:
Corporate liability is important because it helps to define what party will be legally responsible in a
wide range of cases. These liabilities can range from debt-related obligations to contractual obligations
to liabilities related to personnel. Some importance is listed below:

➢ It helps corporations better prepare to mitigate the risks associated with doing business.
Compliance programs can assess corporate liability risks and implement policies or training
that educate employees and third parties on how to ethically and legally succeed in their roles.
➢ It protects the directors, business owners and senior management of a company against any
errors or omissions which could land them with legal problems or disputes.
➢ It protects the individual from fines, penalties, compensation and defense costs, as long as the
Director or Officer has not acted criminally or intentionally.
➢ It facilitates optimal investment decisions.
➢ It allows corporations in some circumstances to externalize the costs of engaging in risky
activities.
➢ It protects the assets of the firm’s owners from the claims of the firm’s creditors.

Implications of liability concept linking with the terms, acts and policies that operates corporate
business organization:

1. Doctrine of Indoor Management:

Doctrine of Indoor Managements states that outsider person has no responsibility to have the
knowledge about the internal affairs of the company. The outsider person cannot be bound by the duty
to review the internal functioning or the internal managerial proceedings of the company. So, the
outsider person shall not be made liable for the irregularities in the internal proceedings of the company.
The company cannot transfer its liability on the outsider person of its own irregular internal actions.
This principle is called the Doctrine of the Indoor Management.

2. Lifting of Corporate veil:

It refers to the situation where a shareholder is held liable for its corporation’s debts despite
the rule of limited liability and/or separate personality. The veil doctrine is invoked when shareholders
blur the distinction between the corporation and the shareholders. A company or corporation can only
act through human agents that compose it.

3. Contracts concluded on the basis of misleading statements are voidable and can be declared
void if the conduct of the seller constitutes fraud or deceit. However, this can be difficult to
prove in practice in transactions between sophisticated parties. Advisers of the seller involved
 in pre-contractual misrepresentation, misleading statements, or non-disclosure of material
information can also be liable for fraudulent misrepresentation.

4. Under the Environment Protection Act 2019, the polluter (person or entity) is liable for causing
pollution and environmental damage through its activities. A person or entity suffering any loss
or damage due to any polluting activities can claim compensation from the polluter. The buyer
can inherit liability when purchasing the shares of a polluting company or polluting assets. The
law does not specify the circumstances in which a buyer inherits environmental liability.
However, in a share sale, the buyer will usually inherit the target's liabilities on transfer of the
shares. In an asset sale, the buyer will only be liable for environmental damage caused by a
purchased asset that occurred before the sale if the buyer specifically assumed liability.

5. The Income Tax Act 2002 allows the government to conclude international agreements with
other countries to avoid double taxation. Nepal has concluded agreements with India, Norway,
Thailand, Sri Lanka, Mauritius, Austria, Pakistan, China, South Korea, Qatar, and Bangladesh.
Under these agreements, if a person's income is taxable in both countries, benefits such as
exemptions or lower tax rates are available. Double tax relief is available for gains on a sale of
shares.

6. Company act,2063 (BS):

➢ The liability of a shareholder of a company incorporated under this Act in respect of its
transactions shall be limited on to the maximum value of shares which he has subscribed or
undertaken to subscribe.
➢ The directors who have signed the prospectus shall be liable for the matters mentioned in that
prospectus. If any published prospectus contains false statements made maliciously or
deliberately and any person sustains any loss or damage by reason of his/her subscription of
securities on the faith of that prospectus, the directors who have signed that prospectus shall be
personally liable to pay compensation for the actual loss or damage so sustained. Provided,
however, that a promoter who resigns before the decision made by the company to publish the
prospectus or whom on becoming aware of any false statement in the prospectus, publishes a
notice of that matter to the information of the general public prior to the sale or allotment of
securities or who proves that he/she did not know that the prospectus contained any false
statement shall not be liable to bear such compensation.
➢ Any director who knowingly conceals, hides or holds back the name of any creditor who is
entitled to object to the resolution for reducing capital or knowingly prepares or submits a false
statement on the amount of loan or clam or liability or conceals, hides or holds back such loan
or liability or prepares or causes to prepare a false statement or any officer or employee of the
company who abets to such act shall be liable to punishment under this Act.
➢ The shareholders, directors or officers who were involved in the management of such company
and responsible for giving rise to the situation in cancellation of registration of the company
shall personally bear such remaining loan or liability.
➢ If, on behalf of a company, any director or officer of the company does any act beyond his
jurisdiction, any shareholder of such company may make a petition to the Court to prevent such
act.
 ➢ No member of the company shall be liable for the debts and liabilities of the company except
in the case where any member accepts such liability in writing the liability of the company,
with specification of the limit of such liability; his/her liability shall be limited to the extent of
that limit.

7. The income tax to be paid should be calculated at the applicable rates on the estimated profits
of the entity for the entire year. Advance tax shall be deposited as follows:

Particulars Due Date % Of estimated tax liability

First installment Mid- January 40% of the total estimated tax liability for the year
Second installment Mid- April 70% of the total estimated tax liability for the year
Final installment Mid- July 100% of the total estimated tax liability for the year

8. Labour Act:
➢ The labor provider whose license has been cancelled shall not be considered free from any
financial liability it has towards the government or any worker on the ground that the license
has been cancelled.
➢ Where any main employer hires workers from a person or company operating as labor provider
without taking a license pursuant to this Act or hires workers in violation of the provisions of
this Act, such workers shall be deemed to be the workers of the main employer.
➢ When transferring any worker, an agreement between the enterprise which is transferring and
the enterprise where the worker is being transferred shall be entered into regarding the issue of
taking the liability of adding the service period and employment conditions and benefits for
such period of the worker by the recipient employer.

9. Insolvency act,2063 (BS):

➢ Company has become insolvent where it is proved from any other matter that the liability of
the company exceeds the value of the assets of the company or the company itself admits that
it has become insolvent.
➢ Where the liquidator considers that the sale and disposal of any property or termination of any
contract or liability will render benefits to the company, to sell and dispose of such property
or terminate such contract or liability.
➢ Any claims made in relation to any debt or other liability in a foreign currency under this Act
shall be settled by
calculating the value in the Nepali currency according to the exchange rate fixed by the Nepal
Rastra Bank for the day on which an application is made to the Court for the liquidation,
insolvency of the company or its restructuring.

Liability on the basis of organization's classification in Nepalese Context:

Corporations are quite different from sole proprietorship, partnership and limited liability companies.
Measures (2017) distinguished those sole proprietors, partnerships and limited liability companies in
terms of structure and decision-making methods.
Table 1:

Types Incorporation Status Financial Tax Liabilities

Operation
Sole Proprietor Firm’s registration The identical All financial The owner is
act status between matters regard as responsible for the
owner and personal matters. tax liabilities.
business.
Partnership Partnership deed Decides The partners take Each partner pays
partnership deed their risks as to their taxes
their share in the separately.
business.
Corporation Chartered or Legally exists Financial Imposes taxes in
corporate act and separately from its operation the name of
involves a board owner(s). conducts from the corporations.
of directors name of the
corporation.
Limited Liability Neither Liable either by It protects some Imposes taxes in
Company Partnership nor members or by a liabilities of the the name of
corporation manager. individual assets. company.
Limited Company A separate legal Liability including Operates in the Determines the
entity debts limited up to name of the tax liability in the
the shares. company. name of
companies.

Conclusion:
The liability concept formation ensures sharing the risks of transactions with the firm’s
creditors, in situations in which the latter are in a better position to identify or bear those risks
in relation to the assets shielded by the corporate form. The clear implication can permit
flexibility in the allocation of risk and return between equity-holders and debt-holders which
simplifies the administration of both business and individual bankruptcy. Hence, the effective
discussion and clear implication regarding the provisions underlined for liability in business
corporation should be precisely implied for the better practice and a good business
governance.

Citation:
Easterbrook, F. H., & Fischel, D. R. (1985). Limited Liability and the Corporation. The
University of Chicago Law Review, 52(1), 89–117. https://doi.org/10.2307/1599572
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