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Limiting limited liability

February 4th, 2004

Via Lawrence Solum, I found this interesting post from Professor Bainbridge arguing that corporations should not be compelled to pay reparations for past wrongdoing (in this case, complicity in slavery). He says

Punish the wrongdoers, you say? Sorry, but the corporation’s legal personhood is a mere legal fiction. A corporation is not a moral actor. Edward, First Baron Thurlow, put it best: “Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and nobody to be kicked?” The corporation is simply a nexus of contracts between factors of production. As such, there is no moral basis for applying retributive justice to a corporation – there is nothing there to be punished.

So who do we punish when we force the corporation to pay reparations? Since the payment comes out of the corporation’s treasury, it reduces the value of the residual claim on the corporation’s assets and earnings. In other words, the shareholders pay. Not the directors and officers who actually committed the alleged wrongdoing (who in most of these cases are long dead anyway), but modern shareholders who did nothing wrong.

This seems plausible. On the other hand, the obvious implication (one that was clearly implicit in Thurlow’s original point) is that the principle of limited liability is untenable, at least in relation to civil and criminal penalties for corporate wrongdoing. The wrongdoers are, as Bainbridge says, the officers and shareholders at the time the wrong is committed, and they should be held personally liable. The law has moved a bit in this direction in recent years, but Bainbridge’s argument implies that it should go a long way further, restricting the principle of limited liability to the case of voluntarily contracted debts.

I doubt that the Professor would want to go that far, but I think it’s hard to make his general case without doing so (there are, of course, more specific defences that might be used in relation to reparations for slavery).

There are a number of counterarguments that might be offered. If you accept strong versions of the efficient markets hypothesis, the share price should discount the expected penalty associated with wrongdoing when it takes place, so that the penalty falls on contemporary shareholders. Since I don’t accept the efficient markets hypothesis (except in the very weak form that information about the past history of share prices alone can’t be used to predict future prices) I won’t push this any further.

A second, more practical, argument is that the collective nature of corporate activity makes it hard to prove individual wrongdoing even when the fact of corporate malfeasance is clear – the current crop of corporate trials is making this point pretty clearly. The options for punishing such malfeasance are therefore rather unattractive. They include extending the law of conspiracy (which has frequently been misused) and expanding the scope of special-purpose provisions such as the US RICO laws (ditto). If there’s no easy way of punishing guilty individuals, it seems preferable to hit the corporation in the only place it hurts – the bottom line.

It’s good that we seem to be getting away from the silly idea that limited liability and the corporate veil represent some sort of fundamental human (or maybe legal-fictional-human) rights. They are 19th century pieces of government intervention, widely disputed at the time by economic liberals, and justified (to the extent they are justified) on the same kinds of pragmatic grounds as social security systems. But it’s still probably best, except in cases of egregious personal wrongdoing to treat corporations as if they were individuals, responsible for their own actions, past and present.

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  1. rdb
    February 4th, 2004 at 22:46 | #1

    Should corporations providing utilities or other services that the government will step in to provide

    have limited liability? Isn’t this a moral hazard?

    Maybe at least the officers and directors should accrue something like a HECS debt in that case.

  2. observa
    February 5th, 2004 at 09:35 | #2

    The other problem is like the question- On what day of what year was it obvious to all that asbestos(smoking) causes cancer? Interestingly enough, our Govts have only just outlawed the only residual use of asbestos, in automotive brake pads, as of Jan 1 this year. They have allowed a known toxin to be distributed widely around our road sytem for years, safe in the knowledge that no individual could prove a direct cancer link to this.

  3. February 6th, 2004 at 08:35 | #3

    This was the point of licensing systems, like licensed public houses or taxi drivers. You made sure that there was a responsible individual before the activity was allowed in the first place. The quid pro quo for the licensees was that they got a barrier to entry, and the cost to running the system – policing it – fell on them, since it was up to them to point out interlopers.

    Nowadays the system has degenerated in at least two ways:-

    - Firms have accurately pointed out that it is an inconvenience to them, and arranged to have whole firms licensed with nominees that they can switch around as man-on-the-spot. This of course undercuts the raison d’etre, since there is no one person who has been made “you’re it, and I don’t care if someone else actually did it, you took on the job of supervision and control”.

    - The other problem is that bureaucracies have mistaken the purpose of the barrier to entry, as a quid pro quo to eliminate the need to resource the policing. Instead, they try to charge for licences, the licensees treat licences as transferrable assets rather than crystallisations of obligation reminiscent of feudalism, and licensees and bureucrats together see it as the role of the state to police the activity. Yet the only reason for using a licensing system is when there are practical problems with being on the spot – when you really do need a man-on-the-spot to do the job efficiently, since his overheads are covered (again, reminiscent of feudalism).

    Of course, feudalism itself came about when it wasn’t practical to have separate state authority and it was necessary first to devise expedients and then systematise them.

  4. Charlie Bell
    February 6th, 2004 at 12:35 | #4

    There are two reasons for applying penalties for wrongdoings. The concept of punishment has been the topic of this thread, but there is also the concept of prevention of future wrongdoings.

    Presumably the thought of having to face shareholders who have just carried the financial lost of a corporate fine, helps some directors to try to avoid corporate wrongdoings.

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