Reforming Limited Liability Law

Reforming Limited Liability Law

It’s time to recognize limited liability for what it is: a subsidy for corporations paid by those hurt by malfeasance.

Facebook
Twitter
Email
Flipboard
Pocket

Everyone in America seems to agree on the importance of personal responsibility. We should be accountable for what we do. If we hurt someone or breach a contract, we should pay.

Yet at the core of American business law is a doctrine that makes corporations more likely to behave badly, makes the harms that occur more severe and passes the costs on to others. If we really care about personal—and corporate—responsibility, we should drastically restrict the doctrine of “limited liability.”

Limited liability is the notion that investors in a corporation should not be personally liable for bad things the business does. The investor may lose what’s been invested, but there won’t be personal liability if the company produces SUVs that roll over or if it defaults on its pension obligations.

Historically, limited liability was the most important legal innovation leading to the creation of the modern corporation and stock markets. It allowed entrepreneurs to finance businesses with small investments from a multitude of shareholders rather than a few deep-pocketed partners. With partnerships, each partner was liable if something went wrong. With limited liability, people could buy stock without fearing they would lose more than their investment. Trillions of dollars in investment capital became available, spurring the economy into hyperdrive.

Another rationale for limited liability was fairness: the iconic shareholders (widows, orphans, retirees) don’t have any real control over a corporation’s decisions and should not be required to pay when something goes wrong.

But notice something. These rationales do not apply or make any sense when corporations are themselves the shareholders: for example, when a parent company owns 100 percent of the shares of a subsidiary. Parents are not financing subsidiaries through the stock market, so the promise of limited liability is immaterial in incentivizing small investors to contribute. And in most cases, the parent controls the subsidiary, so it’s hardly unfair to hold the parent accountable. Nevertheless, the rule of limited liability holds.

What are the impacts of this doctrine, now expanded far beyond its original rationales? When someone doesn’t have to pay for bad behavior, it increases the likelihood and severity of bad behavior. Corporate subsidiaries drilling for oil in the Arctic, making shoes in Vietnam or harvesting hardwood in the Amazon will be more likely to spill oil, exploit child labor and destroy virgin jungle.

And who bears the costs of corporate bad behavior? Whoever is unlucky enough to be victimized by the shoddy products, the environmental degradation or the breached contracts brought about by the subsidiaries. Sure, they can sue the subsidiary. But lawyers know how to protect the subsidiary’s assets by funneling them to the parent. And as long as the lawyers and the accountants do their job well, the parent is protected. Lawyers can easily create subsidiaries through which to operate the riskiest of their endeavors, allowing parents to enjoy the upside while hedging against the downside.

Mention the possibility of ending limited liability for parent companies and witness the gnashing of teeth in corporate counsel’s offices. Large multinational corporations would have to care about the behavior of their subsidiaries around the globe, and parents would have to pay for the sins of their corporate children.

The volume and intensity of corporations’ complaints would be a dead giveaway of how much they benefit from limited liability. It would also indicate how much others are being hurt, since the corporate “benefit” is not that injuries don’t occur but simply that corporate parents don’t have to pay.

It’s time to recognize limited liability for what it is: a subsidy for corporations, paid not out of government coffers but from the pockets of those hurt by corporate malfeasance. It’s an avoidance of responsibility.

To redress the worst of these ills, we would not have to do away with limited liability completely. We’d fix most of the abuses merely by refusing to award corporations the protection of limited liability when they are owners or controllers of other corporations. The benefits of limited liability—and they do exist—are supposed to flow to shareholders who are actual people, not corporations manipulating the doctrine to impose costs on the rest of us.

Read the next proposal in the “Reimagining Capitalism” series, “No Free Parking for Monopoly Players: Time to Revive Anti-Trust Law,” by Barry C. Lynn.

Thank you for reading The Nation!

We hope you enjoyed the story you just read. It’s just one of many examples of incisive, deeply-reported journalism we publish—journalism that shifts the needle on important issues, uncovers malfeasance and corruption, and uplifts voices and perspectives that often go unheard in mainstream media. For nearly 160 years, The Nation has spoken truth to power and shone a light on issues that would otherwise be swept under the rug.

In a critical election year as well as a time of media austerity, independent journalism needs your continued support. The best way to do this is with a recurring donation. This month, we are asking readers like you who value truth and democracy to step up and support The Nation with a monthly contribution. We call these monthly donors Sustainers, a small but mighty group of supporters who ensure our team of writers, editors, and fact-checkers have the resources they need to report on breaking news, investigative feature stories that often take weeks or months to report, and much more.

There’s a lot to talk about in the coming months, from the presidential election and Supreme Court battles to the fight for bodily autonomy. We’ll cover all these issues and more, but this is only made possible with support from sustaining donors. Donate today—any amount you can spare each month is appreciated, even just the price of a cup of coffee.

The Nation does not bow to the interests of a corporate owner or advertisers—we answer only to readers like you who make our work possible. Set up a recurring donation today and ensure we can continue to hold the powerful accountable.

Thank you for your generosity.

Ad Policy
x