Can there be Limited Liability in a Free Market?

[presence]

Corporations Are Not Free Market

Here are some brainstorming ideas. I'd be interested in knowing what you think. The purpose of this page is to have a discussion that prompts participants to think more clearly about exactly what is involved with a government's chartering of a corporation, providing limited liability to the corporation's shareholders (and, possibly, employees, directors, and officers, when acting on behalf of the corporation). I don't mean to say either that LimitedLiabilityIsaGoodThing? or that LimitedLiabilityIsaBadThing?, only that a government's charter of limited liability is entirely interventionist and the extreme opposite of a free market.

Contracts between individuals, without the government being involved, could be used to obtain three out of four features of corporations:

1. Freely transferable ownership interest;
2. Centralized management;
3. Continuity of existence.

The only thing a government can add is the fourth characteristic of a corporation:


4. Limited liability.


Limited liability means
that the executive branch
orders the judicial branch
to not enter any judgement against corporate owners
beyond the extent of the capital owners risked.

As BuckminsterFuller pointed out, the corporate structure was developed to further the European AgeOfExploration? by allowing investors and ship owners to have their risk of loss limited to the capital they contributed to exploratory voyages; while the sailors, some of whom were conscripted against their will, had unlimited liability as they could lose their lives on the voyage. In effect,

a corporate charter is an insurance policy
issued by the executive branch:
in exchange for the premium
(corporate filing fees, taxes paid by corporations, legislative oversight,
and other alleged benefits to society as a whole),
the executive branch assumes all risk to society of the corporation's activities
when the cost of those activities exceeds the capital contributed by owners.

In a completely free market (as in TheMoonIsaHarshMistress),
courts would be decentralized and ad-hoc,
so it would be impossible for anyone to issue a grant of limited liability.

A world of CorporateGovernment is certainly NOT the Nth degree of a free market;
it is the Nth degree of a government
in which the executive has greatly limited the ability of the judiciary
to hold individual people responsible for actions they undertook
as a part of, or on behalf of, a group chartered by the state.

See also the TheoryOfSecondBest for why corporations and the free market and society don't mix.

 

[helmuth_hubener]

As to limited liability, the most important aspect of limited liability is that it is the investors whose liability is limited (to the amount of their investment). That means that limited liability applies to you and me, the small-change investors whose 401k retirement accounts are invested in a diversified assortment of stocks and other securities. We need this insulation from corporate liabilities to take any advantage of technology and the division of labor.

The alternative is unthinkable: imagine getting a letter in the mail telling you that, by virtue of your day-trading investment in $500 worth of stock of some oil company, you must fork over $5,000 to help pay for the latest oil spill. Not one of us would voluntarily risk such liability...

How can I be confident corporate limited liability and aggregation of small investments into big piles of money would be possible without the state? Because contracts are possible without the state...

How would these contracts work to insulate passive investors from lawsuits against corporations? The contractual mechanisms necessary are already well known in business drafting. There are indemnification clauses, whereby one party agrees to hold the other harmless and reimburse the other for expenses incurred in certain legal actions. Examples include warranty deeds in real-estate contracting, and guaranty agreements in lending: when Joe sells his little incorporated business, and Joe has personally guaranteed payment on loans associated with that business, the buyer of Joe's business will agree to indemnify Joe for anything Joe spends on the debts of that business after the business is sold. Such clauses, whereby the business agrees never to hold its passive shareholders liable nor allow them to be sued without covering for them, would be relevant to tort creditors of the business — people who do not contract with the business voluntarily (e.g., someone who slips on a banana peel in the grocery store in which you own a few shares of stock).

Equally simple, and already in use in various types of contracting, are clauses that limit recourse of one party to the other party, used to protect passive investors from contract shareholders (lenders and vendors): when you or a business signs a contract with Corporation X, the contract will include a clause by which you agree to hold Corporation X, and only Corporation X and its officers and directors (and not those of its shareholders who do not participate in the daily management of the business) liable for any debts or contract breaches. Such conditions are already assumed when people contract with corporations, LLCs, and limited partnerships today.

How do we know that corporations would be provided for, and necessary, without the state? Entrepreneurs have already proven that anything people really need, they will pay for. Even with the presence of city police departments, private home-security firms have arisen and thrived around the nation. Even with a military and a defense budget that dwarfs that of the rest of the world, private providers of military services are arising in the United States. Garbage collection is now private for the majority of American garbage cans.

Did the king invent corporations? You might as well ask whether any kings were wily entrepreneurs who understood the business world better than businessmen. Few things government does were invented by government, and even those things government did invent would still be better provided privately than through forcible government. Remember also that government is made up only of individual human beings, and they are human beings who are employed by government — that is, they do not face the market pressures businessmen face, and as a result are generally less able than businessmen to regulate business activity intelligently.

The next time you encounter economically ignorant claims that corporations are mere creatures of the state, that they could not exist without state coercion and privilege, you know what to reply: no, they're not; yes, they could. Corporate obeisance to and dependence on the state today is a nonargument. Corporations today don't have a choice in the matter.

-- http://mises.org/daily/2816

 

[Acala]

I don't see how you could arrange for perpetual ownership of assets in a free market. In the absence of the corporate business form only mortal human beings can own anything. When they die, the property changes hands. This creates a natural limit on the concentration of resources

 

[angelatc]

I don't see how you could arrange for perpetual ownership of assets in a free market. In the absence of the corporate business form only mortal human beings can own anything. When they die, the property changes hands. This creates a natural limit on the concentration of resources

Oh, here we go. Mortal human beings do own corporations. When I die, my heirs will get the tiny bits of stock I own.

 

[Acala]

As to limited liability, the most important aspect of limited liability is that it is the investors whose liability is limited (to the amount of their investment). That means that limited liability applies to you and me, the small-change investors whose 401k retirement accounts are invested in a diversified assortment of stocks and other securities. We need this insulation from corporate liabilities to take any advantage of technology and the division of labor.

The alternative is unthinkable: imagine getting a letter in the mail telling you that, by virtue of your day-trading investment in $500 worth of stock of some oil company, you must fork over $5,000 to help pay for the latest oil spill. Not one of us would voluntarily risk such liability...

I would argue that the concentration of vast amounts of capital in a few hands with no individual responsibility is exactly the PROBLEM with corporations, not the virtue. Severing the link between profit, management, and responsibility results in recklessness, shortsightedness, fraud, a lack of loyalty to customers, a lack of loyalty to employees, and a lack of concern for the community.

How can I be confident corporate limited liability and aggregation of small investments into big piles of money would be possible without the state? Because contracts are possible without the state...

How would these contracts work to insulate passive investors from lawsuits against corporations? The contractual mechanisms necessary are already well known in business drafting. There are indemnification clauses, whereby one party agrees to hold the other harmless and reimburse the other for expenses incurred in certain legal actions. Examples include warranty deeds in real-estate contracting, and guaranty agreements in lending: when Joe sells his little incorporated business, and Joe has personally guaranteed payment on loans associated with that business, the buyer of Joe's business will agree to indemnify Joe for anything Joe spends on the debts of that business after the business is sold. Such clauses, whereby the business agrees never to hold its passive shareholders liable nor allow them to be sued without covering for them, would be relevant to tort creditors of the business — people who do not contract with the business voluntarily (e.g., someone who slips on a banana peel in the grocery store in which you own a few shares of stock).

Equally simple, and already in use in various types of contracting, are clauses that limit recourse of one party to the other party, used to protect passive investors from contract shareholders (lenders and vendors): when you or a business signs a contract with Corporation X, the contract will include a clause by which you agree to hold Corporation X, and only Corporation X and its officers and directors (and not those of its shareholders who do not participate in the daily management of the business) liable for any debts or contract breaches. Such conditions are already assumed when people contract with corporations, LLCs, and limited partnerships today.

How do we know that corporations would be provided for, and necessary, without the state? Entrepreneurs have already proven that anything people really need, they will pay for. Even with the presence of city police departments, private home-security firms have arisen and thrived around the nation. Even with a military and a defense budget that dwarfs that of the rest of the world, private providers of military services are arising in the United States. Garbage collection is now private for the majority of American garbage cans.

Did the king invent corporations? You might as well ask whether any kings were wily entrepreneurs who understood the business world better than businessmen. Few things government does were invented by government, and even those things government did invent would still be better provided privately than through forcible government. Remember also that government is made up only of individual human beings, and they are human beings who are employed by government — that is, they do not face the market pressures businessmen face, and as a result are generally less able than businessmen to regulate business activity intelligently.

The next time you encounter economically ignorant claims that corporations are mere creatures of the state, that they could not exist without state coercion and privilege, you know what to reply: no, they're not; yes, they could. Corporate obeisance to and dependence on the state today is a nonargument. Corporations today don't have a choice in the matter.

-- http://mises.org/daily/2816

This all answers the easy question and ignores the hard one. Sure you can limit liability with people you contract with by including exculpatory clauses in the contract. But what about people with whom you have not entered a written contract? Do you sign a contract when you go into a bar and buy a beer? There is an implied contract that you will pay for what you order, but certainly no implied exculpatory clause or liability limitation for the shareholders who own the bar if they accidentally poison you.

And what about the situation where your corporate courier runs over a pedestrian? There isn't even an implied contract there. How do you achieve a limit on that liability without government intervention?

How about when your factory dumps poison in the river? Where's the contract that limits liability?

Those who say that a free market can duplicate the limits of government-created corporate liability have not thought it through in detail. I don't see how you get there.

 

[helmuth_hubener]

I don't see how you could arrange for perpetual ownership of assets in a free market. In the absence of the corporate business form only mortal human beings can own anything. When they die, the property changes hands. This creates a natural limit on the concentration of resources

There's nothing special about the corporate form in this regard. Partnerships can be perpetual. They very often are. Many, many partnerships are organized as perpetual partnerships. The partnership goes on forever owning assets (and owing liabilities). Do you oppose such partnerships?

If so, why do you want to limit my ability to enter into whatever kind of contract I wish? In what way is entering a perpetual partnership illegitimate? In what way would I be violating anyone's rights?

 

[Acala]

Oh, here we go. Mortal human beings do own corporations. When I die, my heirs will get the tiny bits of stock I own.

The assets of the corporation don't change hands when the shareholders die. That's why Monsanto still owns property it bought before you were born and will own it after you die.

 

[Acala]

There's nothing special about the corporate form in this regard. Partnerships can be perpetual. They very often are. Many, many partnerships are organized as perpetual partnerships. The partnership goes on forever owning assets (and owing liabilities). Do you oppose such partnerships?

If so, why do you want to limit my ability to enter into whatever kind of contract I wish? In what way is entering a perpetual partnership illegitimate? In what way would I be violating anyone's rights?

Actually that is not true. Partners own the assets of a partnership directly. When a partner dies his share of the assets pass to his heirs. Partnership agreements can specify certain limits on the way the property is disposed of - such as rights of first refusal in sales - but the ownership of assets changes hands and eventually breaks up over the course of time.

Edit: there is an exception to this in the case of limited partnerships in which the general partner is a corporation. But that is just a case of government-granted eternal corporate entitiy again.

 

[Acala]

But really, the question is academic. If you think corporations can exist without government-granted privileges, then you shouldn't care about eliminating those privileges, right? So we are fine.

 

[helmuth_hubener]

And what about the situation where your corporate courier runs over a pedestrian? There isn't even an implied contract there. How do you achieve a limit on that liability without government intervention?

How about when your factory dumps poison in the river? Where's the contract that limits liability?

There is no limit on any of these liabilities in a free market. The corporation is fully, 100% liable and accountable to make things right.

The "limit" in liability is simply on the shareholder. There is a contract between the corporation (or just think of it as a partnership if you wish) and the shareholder. The shareholder enters into a limited agreement. He agrees, "OK, I'm going to buy a tiny piece of the company and become a tiny partner of sorts. I am going to be a certain kind of partner with certain responsibilities. I am not assuming responsibility for anything and everything you guys might do as the company."

Let's say Katie has a lemonade stand. It's doing well. Venture capitalist Vinnie notices her success and thinks he could help her reach the next level. He and Katie work out a deal: he will give Katie $5,000, and in exchange she will give him 25% of the profits. They sign a contract. In the contract, Katie has full control of the company and full accountability for its actions, Vinnie is just a silent investor. Katie can do whatever she wants. Vinnie just gives her money in exchange for a share of profits (if there are any). If Katie gets into debt, she's got to pay it off. She agrees in the contract not to come to Vinnie in such a situation and try to make him pay it off. It's not his debt. It's not his problem. Katie can't go to the bank, take out a $100,000 loan, and then pay it back using Vinnie's house.

That's how limited liability could work on the free market. If Katie poisons the lemonade, she's on the hook. She punches a customer, she's on the hook. Limited liability doesn't limit her liability in any way. What it does is contractually take Vinnie's assets out of the equation. Vinnie is contractually keeping an arm's length distance from the lemonade stand enterprise. Doing so is perfectly, perfectly legitimate in a free society.

 

[presence]

I would argue that the concentration of vast amounts of capital in a few hands with no individual responsibility is exactly the PROBLEM with corporations, not the virtue.

Buttery.

 

[Acala]

There is no limit on any of these liabilities in a free market. The corporation is fully, 100% liable and accountable to make things right.

The "limit" in liability is simply on the shareholder. There is a contract between the corporation (or just think of it as a partnership if you wish) and the shareholder. The shareholder enters into a limited agreement. He agrees, "OK, I'm going to buy a tiny piece of the company and become a tiny partner of sorts. I am going to be a certain kind of partner with certain responsibilities. I am not assuming responsibility for anything and everything you guys might do as the company."

Let's say Katie has a lemonade stand. It's doing well. Venture capitalist Vinnie notices her success and thinks he could help her reach the next level. He and Katie work out a deal: he will give Katie $5,000, and in exchange she will give him 25% of the profits. They sign a contract. In the contract, Katie has full control of the company and full accountability for its actions, Vinnie is just a silent investor. Katie can do whatever she wants. Vinnie just gives her money in exchange for a share of profits (if there are any). If Katie gets into debt, she's got to pay it off. She agrees in the contract not to come to Vinnie in such a situation and try to make him pay it off. It's not his debt. It's not his problem. Katie can't go to the bank, take out a $100,000 loan, and then pay it back using Vinnie's house.

That's how limited liability could work on the free market. If Katie poisons the lemonade, she's on the hook. She punches a customer, she's on the hook. Limited liability doesn't limit her liability in any way. What it does is contractually take Vinnie's assets out of the equation. Vinnie is contractually keeping an arm's length distance from the lemonade stand enterprise. Doing so is perfectly, perfectly legitimate in a free society.

Shareholders in government-created corporations OWN the business. They also indirectly CONTROL the business. I am not aware of any way in a free market you can OWN a business or CONTROL a business and not be liable for what it does. But if you can figure it out, great! Then you don't need government-created corporations.

The corporate entity was created by government precisely to shield investors from liability in a manner that could not be easily done with known free-market mechanisms. That is the whole reason the corporation exists.

 

[Acala]

Another problem with the corporate business form is that because shares in the government-created entity can be created out of thin air by the corporate Board and because the government makes them fungible by imposing on the public a set of laws relating to the corporate entity, corporations can use shares of stock like money to buy and accumulate assets. It is rather like a pyramid scheme in which corporations issue stock and use the stock to pay for the purchase of another company. The assets of the purchased company then become part of the corporation. The corporation can then print MORE stock and buy MORE assets using the stock. This is one way in which the mega-corporations of today were formed.

 

[thoughtomator]

Can there be Limited Liability in a Free Market?

No. The other half of freedom is responsibility - the former cannot exist in the absence of the other.

 

[presence]

Any way a mod can drop a YES / NO poll into this thread? I forgot to when I posted.

thx

 

[Acala]

Any way a mod can drop a YES / NO poll into this thread? I forgot to when I posted.

thx

If so, you should refine the question. There is no doubt that you can have SOME limits on liability in a free market. The question (IMHO) is can you contractually eliminate ALL liability for the owner of a business in a free market?

 

[helmuth_hubener]

Shareholders in government-created corporations OWN the business. They also indirectly CONTROL the business. I am not aware of any way in a free market you can OWN a business or CONTROL a business and not be liable for what it does.

Did you read about Katie and Vinnie? Do you think Vinnie violated anyone's rights? Acted in any unlibertarian way? Is their contract invalid?

But if you can figure it out, great! Then you don't need government-created corporations.

Obviously you don't. You don't need that monopoly dispute-resolver called the government at all! But Katie and Vinnie making contracts is perfectly legitimate. Wouldn't you agree? Even if the contract is one that assigns liability away from Vinnie and to Katie instead, that seems fair, nothing untoward about that, right?

The corporate entity was created by government precisely to shield investors from liability in a manner that could not be easily done with known free-market mechanisms. That is the whole reason the corporation exists.

Investors choosing to shield themselves from liability is totally upstanding, moral, and right. It can be done easily on a free market, as I explained above with Katie and Vinnie. It can be done with a corporate form, which is a perfectly legitimate way to organize yourself -- people should be free to organize themselves however they want, so long as it doesn't involve aggressing against others -- and it can be done with in multiple ways with non-corporate partnerships.

If you don't like the straightforward Katie-Vinnie contractual solution, here's another free market way to achieve limited liability. It's simple. It's called a secret partnership. You and one or more people form a partnership secretly. The outside world doesn't know you're operating together. They don't know that "Katie's Lemonade" and "Connor's Cookies" are really just two "doing business as" branches of the same company. And so if you're coming after Katie's Lemonade for some liability -- either a debt or a tort -- you would never think of coming after Connor, too. Because you don't even know about their relationship.

 

[helmuth_hubener]

Another problem with the corporate business form is that because shares in the government-created entity can be created out of thin air by the corporate Board and because the government makes them fungible by imposing on the public a set of laws relating to the corporate entity, corporations can use shares of stock like money to buy and accumulate assets. It is rather like a pyramid scheme in which corporations issue stock and use the stock to pay for the purchase of another company. The assets of the purchased company then become part of the corporation. The corporation can then print MORE stock and buy MORE assets using the stock. This is one way in which the mega-corporations of today were formed.

Oh my goodness, this version of reality is totally wrong. You can NOT just create shares out of thin air! You can only do what your corporate contract says you can do!

You think stockholders would like for their shares to be infinitely dilutable? Get serious.

 

[Acala]

Did you read about Katie and Vinnie? Do you think Vinnie violated anyone's rights? Acted in any unlibertarian way? Is their contract invalid?

Obviously you don't. You don't need that monopoly dispute-resolver called the government at all! But Katie and Vinnie making contracts is perfectly legitimate. Wouldn't you agree? Even if the contract is one that assigns liability away from Vinnie and to Katie instead, that seems fair, nothing untoward about that, right?

Investors choosing to shield themselves from liability is totally upstanding, moral, and right. It can be done easily on a free market, as I explained above with Katie and Vinnie. It can be done with a corporate form, which is a perfectly legitimate way to organize yourself -- people should be free to organize themselves however they want, so long as it doesn't involve aggressing against others -- and it can be done with in multiple ways with non-corporate partnerships.

If you don't like the straightforward Katie-Vinnie contractual solution, here's another free market way to achieve limited liability. It's simple. It's called a secret partnership. You and one or more people form a partnership secretly. The outside world doesn't know you're operating together. They don't know that "Katie's Lemonade" and "Connor's Cookies" are really just two "doing business as" branches of the same company. And so if you're coming after Katie's Lemonade for some liability -- either a debt or a tort -- you would never think of coming after Connor, too. Because you don't even know about their relationship.

If Vinnie is not an owner of any assets and does not control the operations he would not be liable any more than a bank is liable for loaning a business money. But control and ownership bring liability.

 

[Acala]

Oh my goodness, this version of reality is totally wrong. You can NOT just create shares out of thin air! You can only do what your corporate contract says you can do!

You think stockholders would like for their shares to be infinitely dilutable? Get serious.

Sorry, but you don't know what you are talking about. Corporate Boards issue stock on their own vote all the time. Yes, dilution of the equity of existing shareholders is a POLITICAL issue for the Board members in the next election, BUT if they are using the new shares to buy other businesses, the current shareholders don't care.

GM currently has 1.38 BILLION shares of stock outstanding. You think they STARTED with that many shares? They split them and issue new ones all the time.

I don't know what contract you are talking about, but most corporate shareholders never even see a stock certificate let alone sign a contract.