Sean Gabb on Limited Liability


http://www.seangabb.co.uk/flcomm/flc152.htm

Free Life Commentary,
an independent journal of comment
published on the Internet
Issue Number 152
26th September 2006
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Thoughts on Limited Liability
by Sean Gabb

I was approached yesterday—Monday the 25th Deptember 2006—by an American friend who had just read a piece I wrote in 2005 against limited liability (Free Life Commentary, issue 135: http://tinyurl.co.uk/rfav). Because his enquiry was private, I will not give his name. But I feel it would be useful to make my reply public.

I will begin with an edited publication of his enquiry:

“Sean, I read some of your passionate remarks on joint stock companies. I See you were endorsed by Kevin Carson (http://tinyurl.co.uk/ccnc)

“…I agree with much of what you say but am on the other side of the issue on whether aspects of limited liability could be formed on the free market by means of contracts�.

“I am curious why you say shareholders should be liable in tort—presumably automatically, or necessarily.

“Of course the concept of ownership just means the right to control, and in a corporation the right to control is divided in complex ways. Just as it can be in any business or in other situations.

“We Austrian libertarians ought of course to realize that just because The law draws a bright line of ownership and non-ownership (and relegates various property rights or interests to definitions other than “ownership”) does not necessarily make a difference morally or praxeologically.

“For example, suppose you start a business, and you take a loan from a bank. Does the bank not contribute money to your endeavor (like a shareholder)? Does the bank not impose conditions on what you may do with the property you Use in the business (covenants, warrants), and exert practical influence Over your business (if they insist on  something you might listen—want to re-do the loan later, or not have them call it now). What about employees, and contractors? They are economically supportive of the business. Why are they not responsible too?

“My point is that libertarians seem to jump to some kind of  black-and-white strict liability type rule, that they want to apply from their armchairs. I am all for attributing liability and responsibility to the causally responsible actor. But I am not sure why you assume that a shareholder is necessarily causally responsible for torts committed by employees of a company in which they own shares.

“This rule has to assume respondeat superior, first; it has to assume some kind of strict liability; it has to assume some kind of necessary causal responsibility on the part of shareholders for the actions committed by employees (despite the fact that the shareholder might not even have given money to the company—he might have bought the shares from a previous shareholders; despite the fact that the control of directors, and managers, and employees, is in the chain of causation between shareholder and employee; despite the fact that the shareholder may never have voted and even if he did, his vote may be minuscule, or he may have voted against the managers who allowed the tort to occur); it has to assume shareholders are for some reason more causally responsible than the umpteen other economic types of actors who interact with and have an influence on and give assistance to the company (employees, creditors, suppliers, customers, contractors).

“I write not to attack but out of curiosity if you have addressed these issues or think there is a good response to them.”

Bearing in mind the eminence of the person making this enquiry, I feel some embarrassment at the shortness of the reply that I shall make. But it is better to make some response than none. And I feel it useful to make the response in public so that others may also have the chance to bring to my attention defects in my approach to an issue that I have come to regard as one of key importance.

I will begin by stating an approach that is probably common to many other libertarians whose works I have not read or have forgotten, but which I picked up from the Roman lawyers. This is to ask whether any particular institution could exist without a state to uphold it.

Now, I am not a committed anarchist. But I do regard the likely shape of a stateless society as a partial basis for judging the legitimacy of actually existing institutions. If something could not exist without a government, that is not necessarily a reason for it not to exist. There must, though, be a presumption against its existence. Nothing can be desirable that involves a violation the rights of individuals to life and property acquired by consent. It may be necessary for the prevention of greater evils. But it must, to be accepted, have its case for existing made out on at least the balance of convenience�and perhaps even beyond reasonable doubt.

Marriage, family life, common politeness, most property rights, and so forth � these could exist without a state. They might exist with greater security. They would certainly be different in several important respects. But they would exist. As such, they can be regarded as legitimate institutions. Any laws regulating them can, therefore, be judged on the extent to which they give just protection.

Where limited liability is concerned, I am not so sure. I can imagine a contractual limitation of liability. I might, for example, rent a shop that I own to Boots plc, on the understanding that I am dealing with a joint stock corporation with which ultimate liability rests. I shall have accepted that Boots exists as an artificial person. If Boots is then unable to pay the rent, I shall have no just right to expect any other person to pay the rent.

But suppose you rent a neighbouring shop to Boots, and supposing some negligence of Boots causes damage to my property. Suppose then that Boots is unable to pay whatever damages may be awarded by a court. I see no reason why I or any court should respect an agreement private between you and Boots. The owners of Boots are those who own shares in the company. They appoint the directors. They receive the profits of the company. They must be regarded as ultimately responsible for the torts of the company.

In places where registers of shareholders are inaccurate, or where the shareholders are collectively without sufficient assets to pay damages, this may be a worthless claim in practice. But it was the practice, I think, followed by English courts in the railway bankruptcies of the 1840s. It would also be the practice followed by the courts of an anarcho-libertarian society.

Thus, while a kind of limited liability might arise in contractual arrangements, it would not be recognised in tort.

My correspondent raises doubts about the effective control that shareholders have over their companies, and wonders if they should not rather be placed in the same category as employees or lenders or contractors.

My answer is to assert that they are the natural owners of their companies. They have not lent money to them. They are not providing paid services. They are the owners.

And this is regardless of how much actual control any one shareholder may have. I own shares in various banks. I never ask myself what those banks are doing on my behalf. I never attend the annual general meetings. If I fill out a proxy form, I never give the matter more than the most casual attention. If I did attend a meeting and try to impose my will, the institutional shareholders would flatten me when it came to voting. But that is my choice.

Now, I am thinking at the moment of buying shares in Sainsbury, the supermarket chain. This is so that I can at least attend the annual general meeting and ask awkward questions. But if I do buy shares, I shall not have provided capital to Sainsbury plc. And my correspondent asks if that ought to give me any reasonable liability for the torts of Sainsbury in a world without government. My answer again is yes. I may not be providing fresh capital to the company. But I am stepping ultimately into the shoes of someone who did. I am taking on that person�s rights. I must also be regarded as taking on his responsibilities.

As said, just because it could not exist without a state, an institution does not become absolutely illegitimate. I am not convinced, for example, by arguments that defence of an extended territory could happen without the compulsory taxation of its inhabitants, or that unexpected natural disasters could be handled. The State is legitimate so far � and only so far � as it provides necessaries that will not be otherwise provided.

So, is limited liability one of these necessaries? It may not be a necessary in the strict sense I have laid down. But an argument can be made on the grounds of its convenience, and this may approach to a necessary.

Could railways and motorways be built without a large corporation to mobilise the necessary capital, and to provide the necessary term of existence for the capital to provide a return? Possibly not. Could these corporations raise capital without being able to sell shares to the public? Again, possibly not. Would anyone buy shares in such corporations if he knew he would have no immediate control over the use of his investment, but might be held personally responsible for its use? Probably not. Do you know enough about the transportation market, and about the competence of the Directors, to risk what may be all your possessions in buying shares in Eurotunnel? I hope not.

It may then be convenient, if we want large infrastructure projects and large scale manufacturing, to cap the liability of shareholders to the value of their shares.

I grant it may not be convenient. I am told that such ventures could by financed by the sale of bonds, in which case the providers of capital would be lenders with a liability naturally limited to the value of their bonds. Otherwise, I am told that things like telecommunications networks could be provided by subcontracting and franchising and other free contractual arrangements between sole traders and partnerships.

I have also read the claims by Kevin Carson, among others, that such ventures would not without a state be profitable. Mr Carson says, for example, that the relevant economies of scale are much overstated, and can generally be achieved only by coerced externalisation of many costs. The result, he says, is a “capitalism” that may be a net consumer of capital, and that has little in common with patterns of activity that would emerge in a truly free market.

I will not develop these points. I do not accept all of them in an absolute sense. I have much respect for Mr Carson. But I do not follow him in his rehabilitation of a semi-Marxist economics. I also believe that large corporations do produce things that people want to buy, and may do so better than smaller organisations.

What I will say now about the utility of limited liability laws is that, even if not to the point of consuming capital, they do distort economic activity. And, perhaps more importantly, they are morally corrupting.

They are morally corrupting because they allow the emergence of a ruling class in which political and economic power is as impersonal and as interlocked as in the despotisms of the ancient world. Unlike in early modern English � a place for which Mr Carson has no time � the political wings of these elites have no roots among those whom they govern. Their economic wings enrich themselves by the creation and manipulation of controls that cartellise activity and externalise costs to the systematic disadvantage of outsiders.

The majority of ordinary people find themselves gently conscripted into large organisations that strip them of autonomy and suppress any natural desire for self-direction. They also find themselves locked into patterns of immorality that they would never dare choose for themselves.

Look at the Virgin Group, which is one of the smaller and less horrible of these organisations. I cannot believe its railway and air franchises were gained by wholly non-political means. Its workers are encouraged into a cult of personality of Richard Branson that must strike any person of individuality as unhealthy. And, as said, the Virgin Group is by no means the worst corporation. Look at those corporations that police the actions of their employees both on and off the job. Look at those increasingly common variations of contract that tell workers not to smoke at home or not to engage in dissident politics.

Or, turning to those patterns of immorality, look at the rapacity and corruption of oil companies and other large corporations in poor and barbarous regions of the world. I would never for myself build factories in places like black Africa that sprayed poison in all directions. Nor would I look the other way when politicians I had funded silenced anyone brave enough to object to my actions. But I probably own shares in such corporations. I probably know people who work in them.

Anyone who works for any length of time in one of these big corporations tends to become just another “human resource” � all his important life decisions made for him by others, encouraged into political and cultural passivity. He is essentially a bureaucrat. He knows nothing of how real business is transacted. He cares nothing about laws and taxes that stop others from transacting real business, and so consents to the further expansion of an already bad system.

The British and American peoples, who together have created the world�s only real attempt at a liberal civilisation, have been turned by a century of corporatism into nations of sheep. We have different prejudices. The decay of our national characters has not been uniform in all respects. But we are by the standards of our ancestors almost equally degenerate. It is surely less remarkable that our rulers have gone as far as they have in abolishing our freedoms, than that they have shown such forbearance as they have. We are so corrupt as nations that our rulers are still heaping less misgovernment on our heads than most of us would be happy to accept.

This is largely the effect of a corporatisation of economic activity that would have been impossible without limited liability laws.

I accept that, in a world without limited liability, certain desirable things might not happen. On the other hand, I do not believe there would be no extended patterns of commerce. As said, there is the financing of ventures by bonds, or their organisation through the voluntary clustering of small businesses. And there is the known tendency of individuals to bring wholly unexpected and elegant solutions to problems when they are free to associate as they please.

At the same time, many undesirable things would not happen.

In conclusion, I am against limited liability because it could not exist without a state � and because its actual existence it attended by at best doubtful benefits and by undeniable evils.

That leaves the further question of what is to be done today about it. Parliament should never have passed the first Companies Act. But that was in the 1850s. What should be done now?

I know I should stay with my first conclusion and leave further discussion to another essay. But I will give a brief answer.

Let us suppose I were to come to power as the front man for a military coup in this country. What would I do about the big corporations? Just pulling the plug on them. By giving full liability to the shareholders, would not be an option. Those corporations would be delighted if I were wicked enough to build giant concentration camps up and down the country and fill them with my opponents. They would probably fall over themselves to sell me the necessary cattle prods and barbed wire. But they would soon shut my revolution down if I overtly tried to shut them down.

The answer is that I would keep on a vast mass of intrusive regulation of limited companies—and even increase the burden of corporation tax, and continue the present trend to thinning the corporate veil where certain torts and crimes were concerned � while exempting unincorporated businesses from all such regulation. It was the growing attractiveness of that veil that encouraged small businesses to incorporate in large numbers after about 1880. It must be a growing unattractiveness that will encourage modern business to unincorporate.

But this is a matter to which I have given little thought, and that really does take me beyond the limited answer that I promised to my correspondent.  

NB—Sean Gabb’s novel The Column of Phocas (£8.99)is ready for dispatch. Buy your copy now from http://tinyurl.co.uk/z31v or via Amazon: http://tinyurl.co.uk/2cnw
You can download the first three chapters free of charge from: http://tinyurl.co.uk/kkl4
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3 responses to “Sean Gabb on Limited Liability

  1. Interesting. I do regard myself as a “mutualist” though am not as well equipped to explain or defend that position as someone like Carson. However for a while now I have been interested in the possibilities thrown up by the Limited Liability Partnerships law of 2000. In its origin it was a consummate piece of protectionist legislation – designed to stop the large accountancy and legal partnerships from incorporating, and so being taxed, offshore, in response to the ever growing claims (culminating of course fter that in Enron and Andersen’s downfall) against them in which the partners of course had unlimited liability.

    However since a friend introduced them to me we have looked at LLPs as a potential way of breaking this capitalist concept of “ownership” by the owner of the shares and of creating a pretty mutualist corporate structure in which all the players in a business play a part in ownership and control, whether they be the providers of capital, employees, suppliers or users or customers.

    He calls it “Open Capital“. It is not actually the limited liability that is crucial, I suppose, but the idea that someone other than the shareholders/financiers can be full partners, recognizing their equally essential inputs to the undertaking. Should you own and control the undertaking merely because you’ve thought it a good investment for your money if it’s equally important to the success of that undertaking that impecunious me has brought the idea for the product and the labour to achieve it? Should I have unlimited liability given I’ve put no cash into it, just my brilliant idea?

    It seems to me that this could create a new, mutualist, sort of enterprise. Your problem with me destroying your shop because of something I do next door of course would remain, so maybe limited liability is still a problem, but it seems a less toxic and more consensual way of building a business in which the voluntary inputs of all types of participants are better respected and rewarded.

  2. It’s nice to see this excellent piece back up again.

    I should mention, just passing, that I have attempted to rehabilitate Marxist ideas in the same way that I have used Austrian and other marginalist ideas: to the extent that they can be broken down and incorporated into a Tuckerite framework. Joseph Stromberg has, in a similar manner, built on the affinity between neo-Marxist theories of overaccumulation and imperialism, and Rothbardian ideas of regulatory cartelization and malinvestment (see “State Monopoly Capitalism and Imperialism”).

    It’s interesting that some of the Austrians who normally have the strongest affinity for Mises’ “entrepreneurial corporation,” and treat the corporation as an absolute contractual expression of the shareholders’ property rights, are forced for tactical reasons to retreat from this absolute position when defending shareholders from liability. Stephan Kinsella, for example, who started by parroting Hessen on the purely contractual nature of the corporation as a form of private property, was soon forced to retreat to an argument that those who control the corporation–senior management–are the real owners, and that shareholders are just another class of contractual claimant akin to creditors. Followers of Mises, who himself angrily repudiated Berle’s and Means’ theory of the managerial corporation, are in the end forced to reinvent Berle and Means.

    Since I began studying the corporate form, the more I am convinced that the status of shareholders as “natural owners” really is largely a legitimizing myth. Hostile takeovers become significant only in widely separated waves, like those of the ’80s, and quickly subside as management uses its insider control to rig the rules against outside takeovers. The corporation is in fact hardly dependent on outside finance at all, since most corporations generally rely on retained earnings for new capital investment, and limit capital projects to those items on their priority list that can be financed by retained earnings. Directors, who in theory represent shareholders, in reality participate in a log-rolling game with senior managers, in which they back each other up against outside interference and recommend each other for high salaries and perks.

    The legal privileges of the corporate form are evil not so much because they impede the natural ownership responsibilities of shareholders, as because they only selectively apply the implications of the shareholder ownership myth. They provide the benefits of ownership to shareholders, at the same time as they protect them against the responsibilities. In effect it is a vehicle for plausible deniability, in which shareholder capital flight creates pressure for short-term profit maximization “by any means necessary,” while shareholders can deliberately avoid any knowledge or blame for the means adopted by management. “Who will rid me of this turbulent priest,” etc.

    I agree that the solution is to remove the legal fictions that enable this neither-fish-nor-fowl status. Once corporate management is recognized as a self-perpetuaing oligarcy, as so many mini-Gosplans, we have every reason to remove the legal protections that enable them to hide behind the corporate veil. It also makes it much more reasonable to consider such vehicles as the stakeholder cooperative or the community development corporation as the normal vehicles for mobilizing large amounts of capital when it is really necessary.

  3. Hi, Kevin,

    Good to see you here. Chris Tame rated your work very highly, as do I.

    I was going to post a response to the suggestion that your work was ‘semi-Marxist.’ Of course, Marx believed he was describing a theory of inexorable social evolution, whereby the bigger capitalists absorbed the smaller capitalists until there was something like “One Big Company”, by which time the infrastructure would have been built for vast over-capacity, with production limited by the hunger for profit. The “Revolution” would be a mild matter of expropriating a few people, then using the existing infrastructure to relieve poverty by “simple” managerial instructions to increase production.

    Strictly speaking, the Marxist may welcome the Revolution, as he might welcome the sunrise, but it will happen regardless.

    Whereas yours and Tucker’s approach (and mine) is to build the new and better society within the shell of the old, using real free markets to optimize the economic allocation of resources.

    Voluntary co-operatives a la Mondragon are twice as profitable as “Capitalist” corporations, so that their success in a free and open marketplace will be plain for all to see. $10 billion in annual sales; 8% audited return on capital; and greatly increased growth.

    I’m sure it’s the wish of many libertarians to be self-employed rather than crony-capitalist chattel serfs that brings them to libertarian ideas. In real cooperatives, everyone is self-employed in free association with others.

    Hasten the day!

    BTW: The British “Conservative” Party has just climbed on board the ASI’s imported “Workfare” horrors. Methinks a second “Poll Tax” debacle is in the offing… >:-}

    Regards,

    Tony