Saturday April 19, 2014
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View all articles by Bob Murphy.
Limited Liability Corporations in a Free Society*

Most of my work (e.g. ) on private law (i.e. law outside the State) has been critical of the a priori approach. I normally get very suspicious when people sit back in their armchairs and tell me that a legal system "obviously" must be structured such-and-so, and that if it doesnít conform to the theoristís vision, then the system must be objectively immoral. Usually, I remain very agnostic about what form a private legal system "ought" to take, and I always defer to the customs and legal procedures that would gradually evolve in a truly voluntary, market setting.

However, when it comes to limited liability corporations, I tend to side with the crotchety writers who flatly reject fictitious "legal persons" as complete balderdash. The way I see it, individuals in a free society with private property rights would have the option of pooling their funds into a joint entity called a "corporation," and they would even have the option of issuing (limited liability) stocks and bonds to raise capital, but such actions would in no way limit the ethical and legal obligations of the founding members.

Letís use a concrete example to make my meaning clearer. Suppose that Joe Blow and Bill Smith live in a free society of the type that most libertarians have in mind. (I remain agnostic as to the exact nature of their legal system, whether it be Rothbardian natural law or Friedmanite utilitarian in its foundation. I think my analysis works for both.) Suppose that Joe Blow and Bill Smith believe they can earn a profit in the trucking industry.

Now, from a libertarian point of view, the actions of Joe and Bill do not suddenly change when the men engage in "business activity" rather than "personal activity." In their relations with others, everything is a simple matter of the voluntary exchange of property titles and the fulfillment of contractual obligations. In particular, if Joe owns a truck, he can certainly use it in his "business" to transport cargo for customers, rather than moving his family around. From the libertarian point of view, it doesnít really concern us about the higher context of the operation; all that matters is that Joe has to pay for his gasoline, pay tolls on the private roads, maintain adequate car insurance if road owners insist on this as a condition of entry, etc.

Now the question arises: Suppose that Joe injures someone while operating his truck. What are his obligations to the injured person?

Well, it would certainly depend on the specific case. If Joe is fiddling with his radio and swerves off the road, then under almost any legal regime we would expect that Joe would be held liable for the damages. (Of course, Joe might have "no-fault" insurance to cover this, but thatís a separate point. We are here concerned with the determination of legal liability for the damages.)

On the other hand, if itís late at night and some drunk frat kids lie down in the road (after watching a movie featuring such foolishness), then itís plausible that Joe would be absolved from any legal obligations for the injuries to those hit by the truck.

The issue of liability after a tort is one of the things that any legal system (including a private one) must solve. Some libertarians who favor "strict liability" think they can avoid the issue, but theyíre wrong: Even if you think someone should be fully liable for the damage he causes, regardless of his intentions or ability to pay, that still begs the question of how to determine who "causes" (from a legal standpoint) the accident. After all (as any student of the Coase theorem knows) there are a whole host of people who could be said to have "caused" an accident, including the biological parents of the victim.

At this point I have not really said too much; I have just pointed out that different types of situations would probably be handled differently. Libertarian legal theorists will certainly differ on their recommendations for the assessment of liability in various cases. However, I think one thing we can all agree on is that, in a free society, the private courts would never rule that the truck itself was liable for the damage. No judge would ever declare, "The Ford Ranger owes the victim $10,000 in medical expenses and $5,000 for pain and suffering."

Notice that this is true even if an accident is "caused" by a mechanical failure. Suppose the brakes suddenly go out and this "causes" Joe Blow to hit someone with his truck. Now, the courts might rule that Joe is liable as the owner/operator, or they might rule perhaps that the mechanic who approved the brakes in his last inspection is liable. But clearly the courts would never decide that the brakes were legally responsible and hence liable for the damages.

Why is this? I think the reason is that, except in Stephen King novels, motor vehicles are not acting agents. Rather, the law recognizes the owner(s) as the responsible agent(s) for damage physically "caused" by a piece of property. Therefore, when property damage occurs (and this includes bodily harm, since a personís body may be considered his property), the purpose of the legal system is to determine the person(s) to bear the damage. If the law finds that someone other than the immediate victim should do so, then the lawís designated person must compensate ("make whole") the victim.

Finally, how does this relate to limited liability corporations? I think my reasoning shows that it is completely incompatible with libertarian theory (as well as common sense) to say that, e.g., an oil spill is "caused by" the Exxon Corporation, and that plaintiffs are therefore only entitled to the assets of Exxon. To me, this is as nonsensical as saying that a traffic accident is "caused by" a particular truck, and that the plaintiffs may only seize the truck, but no other assets of the truckís owner.

Now, if the founders of a corporation feel that they can raise more capital by issuing limited liability shares of stock, that is perfectly fine. For example, Joe Blow and Bill Smith can sell shares in the Acme Trucking Company, and use the money to buy a fleet of trucks and to hire drivers. The drivers can sign contracts with Acme, in which the "corporation" pledges to assume full liability for any damages caused by the drivers while operating a truck on the job. Therefore, if the drivers hit someone while driving an Acme truck, the victims can sue Acme (rather than the individual driver).

Here is the crucial point: When a plaintiff "sues Acme," that is just a shorthand for saying "sues the owners of Acme corporation." In my view, a person canít really bring charges against an abstract thing like a "corporation," just like a person canít sue "racism" or "hatred."

Now then, if a plaintiff sues Acme and wins, then he is entitled to restitution out of Acmeís assets, i.e. the assets held jointly by the shareholders and devoted to the operation of the company.

And finally, we come to the controversial part: If Acmeís assets are insufficient to pay the claims of the plaintiff, then I am arguing that there must exist at least one individual whose personal property the plaintiff can seize. This is because, even though subsequent investors may have purchased stock with an agreement that "Acme Corporation" would assume any legal liabilities above and beyond the initial contribution, the original creators of Acme Corporation certainly canít use the same trick.

To put it differently: After an accident, the truckers can say to a plaintiff, "Donít take my house; go talk to my boss." The boss can say, "Hey, itís not my fault; talk to the manager." The management can say, "Hey, weíre just agents of the shareholders; talk to them." Even individual shareholders can say, "Hey, we had a contract with Acme when we first bought in; weíre not liable; talk to the founder."

But when the plaintiff finally reaches the founder of the corporation, he cannot say, "Hey, itís not my fault; the accident was caused by Acme Corporation." This would be as nonsensical and perverse as an assassin first forming a corporation, naming himself CEO, and then shooting someone. When the family sues, the assassin couldnít say, "Hey, I didnít kill anybody acting as a private individual; I was acting as an agent of the corporation."

In conclusion, limited liability corporations are compatible with standard libertarian legal theory, only if the original founders (or subsequent individuals who buy the company and assume full responsibility) maintain full liability for damages caused by agents of the corporation. Individuals cannot evade responsibility for actions by hiding behind the legal fiction of a corporate "person."




* This article was inspired by a fruitful discussion with Matus Petrik, while we were both Summer Fellows at the Ludwig von Mises Institute. Petrik would not necessarily endorse the arguments above.

Bob Murphy has a Ph.D. in economics from New York University. He teaches economics at Hillsdale College.

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