Author: Timothy Sandefur
A while back I wrote about the New York Times’ article attacking the rights of corporate shareholders. I’ve had a couple emails in response to that, so I thought I’d share one and my answer to it.
Governments do much more for corporations than simply allow them to sign a form and become a legal entity. Corporations are entitled to sundry favorable laws, usually designed to encourage them to incorporate. The most prominent example takes the form of limited liability: the government excuses the individual shareholders from personal liability for the debts incurred by the corporation. But there is a tradeoff, or at least the NY Times board is arguing there should be: by taking advantage of this most generous benefit, the corporation must be subject to some reasonable state-imposed limitations. If you don’t like those limitations, keep your business privately owned and subject to personal liability.
Here’s my answer:
Limited liability is not a favor given to corporations by the state. There are two reasons this is so.
1) Limited liability is a basic element of free contract. I have the right to contract with you over virtually anything. This means I’m also able to contract with you for limited or liquidated damages provisions. You and I can form a contract where we agree that in the event of some happenstance, you can only recover against me to the amount of X, rather than to the amount of Y. If I can do that, then I can make the same agreement with everyone else I trade with. I can put a sign out front that says “If you trade with me, you do so under the following conditions…” That’s what symbols like “Ltd.” or “Corp.” or “Inc.” do. Limited liability could be equally well created by free contract. Getting it through a government stamp is just a streamlined way of doing the same thing.
2) As far as shareholders are concerned, it’s not limited liability, but respondeat superior that bears the burden of proof. Holding one person liable for the wrongs of another is an injustice, unless it can be shown that the liable party somehow is actually responsible for the wrong that occurred. Thus if I made you do the tort, it’s fair to hold me liable. But if I didn’t make you do it, or had no control over what you did, then it would be unfair to make me pay. Shareholders, of course, have virtually no control over the managers, and absolutely no control over the employees, of a corporation. Holding them liable for those actions would be an injustice. Limited liability is not a favor granted by the state, but a recognition that it is unfair to make me pay the costs of anothers’ wrongdoing.
Imagine a person comes to you and says “You know, Billy Smith, your long distant cousin whom you’ve never met, killed someone in a car accident the other day. So you have to pay damages to the victim’s family.” Ridiculous. But imagine now that the person says “However, I’ve decided to let you off the hook this time…on the condition that you give me ten thousand dollars.” That would obviously be a protection racket. Likewise, for liberals to claim that limited liability is a favor for which corporations must pay someone is nothing more than a extortionist trick.
For more on these issues, I recommend Robert Hessen’s book In Defense of The Corporation, and Roger Pilon’s article Corporations and Rights: On Treating Corporate People Justly, 13 Ga. L. Rev. 1245 (1979).