Thoughts on Limited Liability
by Sean Gabb
(26th September 2006)
I was approached yesterday—Monday the 25th September 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. [Is is Stephan Kinsella, and you can find further discussion of the issues raised here] 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 onsomething 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 ofblack-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 England – 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.