Tuesday, September 27, 2005

Unlimiting Corporate Liability

I read a really interesting article this morning regarding corporate liability that got me thinking. The premise of this article, and others I have read making the same argument, is that a free society makes everyone responsible for the consequences of their own conduct, and that should include corporations and their shareholders. In other words, you personally could not escape liability for dumping toxic waste in your neighbor's swimming pool, so why should you be permitted to legally do so through a corporation.

As is stands currently, corporations have the big government protection of limited liability. This means that if a corporation puts a dangerous product on the market and someone gets hurt, the victims have recourse against the corporation itself and corporate assets. The shareholders of the corporation, however, are shielded from liability behind what is commonly referred to as the "corporate veil." There are instances where the veil can be pierced, but I will not bore you with legal mumbo jumbo here.

Conceptually, it is hard to imagine holding the thousands of shareholders of a huge public company liable for wrongs committed by the company, so let's discuss the point in the context of a smaller private corporation. I make great widgets and decide to make it a business venture. I start a company and choose the corporate form (as opposed to a partnership) for my business structure. The corporation starts with my money and, ultimately, I get money from some friends and the business takes off. Along the way, we discover that there is a flaw in the widget design and every 100th user of the widget is going to lose a hand. There are so many widgets out there, however, that we would go out of business trying to recall them so we decide not to disturb the status quo and we hope for the best.

Here is where the legal considerations kick in. Under current law, I am not personally liable to the people who will lose a hand. Indeed, if there are enough lawsuits and the company's financial health is threatened, we can file bankruptcy and start over. There is no legal incentive for me to fix the problems since the law allows me to file bankruptcy, walk away with my bonuses, etc. and start a new corporation tomorrow that goes on manufacturing widgets.

What if the law was different? What if I was personally liable to the people who lost a hand? As between the one-handed person and me, fairness seems to dictate that I should accept the liability since it was my company and the accident was caused by an error in the product I created or funded. If someone drives my car and gets in an accident, I can be held liable even if I wasn't there. So that is an incentive to make sure you don't let your drunk friend take your car. If I had personal liability, wouldn't there be greater incentive to run to the top of the mountain to tell people to stop using the widgets? To correct the design flaw and replace the old ones?

Now extrapolate this scenario to the big, publicly held corporation. Everyone voluntarily chooses to invest their money in a corporation with the faith that the leaders of that corporation know what they are doing and will make the shareholder some money. The laziness begins with that faith. Because of limited liability laws, shareholders aren't concerned if you cut costs by paying female employees a fraction of what male employees are paid; they aren't concerned if you dumped mercury in the pond as the cheaper alternative to legal disposal; and they aren't concerned if the success of your business necessarily depends on war and strife throughout the world. Most sane people want peace, but if a person is invested in defense stocks, they certainly aren't rushing to see the Iraqi resistance defeated. The longer the fight, the more money they make.

My account looks great, so why should I care if there are increased cases of cancer from my investment? My portfolio doubled last year, so it's not my problem if the company is hiring drunk captains for ships. This is America today. I don't care, I don't want to know, I don't want to think and damn you for trying to make me. I will look the other way with no sense of responsibility to see what a company is doing with my money because I don't have to answer for it. Donors to Islamic charities are supposed to research where every penny of their donations go to make sure they don't end up in the hands of "terrorists" and face the threat of prosecution for not doing so. Why not the same individual responsibility for shareholders?

Republicans constantly complain about people not taking responsibility for their actions. This would be a pretty good start. What do you think?

22 Comments:

At 2:29 PM, September 27, 2005 , Blogger Free Agency Rules said...

ii,

There is a little phrase in the free market called "Buyer beware" that needs consideration.

It reminds me of when my uncle was living in the L.A. area and his neighbor was sued because a passer by slipped on a bananna peal on the public sidewalk in front of his house....and the injured party won... :(

It is sad that we have to find things out the hard way..."bad word of mouth", but that is the way it is supposed to work.

What happens now is we don't have enough small businesses becasue too many people want to file law suits to get rich on someone else's (the small business) money.

It is a two edge sword.


FAR.

 
At 3:51 PM, September 27, 2005 , Blogger Intellectual Insurgent said...

It is a double-edged sword. So many things in society are a product of attempting to resolve competing interests of differing groups. How do we resolve the corporate question of limited v. unlimited liability?

Out of morbid lawyer curiosity, did the injured party win at trial or did the insurance company settle to make it go away?

 
At 11:18 AM, September 28, 2005 , Anonymous sctrojan95 said...

II:

I don't think what you have described is an entirely fair or accurate represention. One of the principal tenets for the creation of the limited liability entity is to promote innovation and enterprise. If you knew that you would be held personally liable if you manufactured and sold a widget that, unbeknownst to you, happened to have a certain defect that could cause an injury, by what percentage is your likelihood of proceeding to develop, manufacture and sell that widget going to decrease? We want to encourage the creation of ideas, goods, etc. that will improve the quality of life.

It's not entirely accurate to say that the shareholders of a company have no personal liability. Shareholders are going to be personally liable to the extent of their investment in the company. While it's true that money that an owner has taken out of the business may no longer be reachable by creditors of the corporation, bankruptcy rules do empower the judge to consider whether certain distributions are fraudulent, or if made within a certain period of time prior to bankruptcy, are preferences that are also subject to reclamation.
I think what you are talking about here is what has been termed as "Corporate Social Responsibility". To avoid going on and on needlessly and soiling your blog with my incomplete blather, I recommend that you read Professor Greenfield's articles and publications. He is now probably the leading "expert" in this area.

 
At 12:50 PM, September 28, 2005 , Blogger Intellectual Insurgent said...

What up SC Trojan! Long time no talk. :-)

I am not talking about corporate social responsibility actually. I don't think that a corporation has any more of an obligation to "give back" than anyone else does.

The profit motive would still stimulate innovation and investment. The concept of unlimited liability gives the corporation an incentive to be careful and diligent with its products as opposed to following the Ford Pinto model of business.

BTW - did you take the political label test? Where did you fall in the baseball diamond? :-)

 
At 3:20 PM, September 28, 2005 , Anonymous sctrojan95 said...

II:

Been busy, busy, busy.

Corporate social responsibility is more than just about giving back to the community. If you read Greenfield's articles, you'll see that he talks about companies that lie about layoffs, companies that will run cost-benefit analyses to determine whether it's cheaper to save the $0.20 safety item that oculd produce a $80 million class action, etc.

On that political label test, I was exactly two squares directly below you. Very interesting, huh? I think that's just a function of having lived in L.A. for a period of time ... I bet I'd be farther right if I had never lived there at all.

 
At 4:12 PM, September 28, 2005 , Blogger Intellectual Insurgent said...

Did that make you a Libertarian?
:-)

Do you have a link to Greenfield's articles for us?

 
At 4:22 PM, September 28, 2005 , Blogger jj said...

II great post. You make great points about greed in this country. It is unfortunate that "good Christians" are looking the other way while their portfolio grows from war profits although I honestly do not know I would do any different.
But then again I am not good or intelligent so:)


For labels (which I do not believe in) however here it is

LIBERTARIAN but very close to a

LIBERAL
LIBERTARIAN

 
At 5:21 PM, September 28, 2005 , Blogger Intellectual Insurgent said...

JJ -
I've read your comments on RC's blog and I've read some of your blog. I don't know if you are good, but you are definitely intelligent. :-)

 
At 6:45 PM, September 28, 2005 , Blogger Stalin the Shark said...

Hello all,

I'd swim in with a practical point. Given that liability is tied to due diligence, I'm not sure how it would be possible for the person who holds a few shares to be aware of all wrongdoing in a multinational corporation, nor to take positive action in terms of a remedy.

That having been said, if there were a middle ground - such as more stringent reporting rules and a limited liability that attaches to a share - say, up to ten times the face value - I think you'd see a revolution in corporate governance and transparency.

Meanwhile, can I turn FAR's quotes into a Democratic campaign spot? Caveat emptor; it's funny how they never tell the people at polls about how they plan to screw them.

:-), StS

 
At 7:22 PM, September 28, 2005 , Blogger Free Agency Rules said...

First, I am wondering how corporations pay out hundreds of millions or even billions and yet we still call it "limited" liability? Does that mean we leave them a pittance?

If my understanding is correct, the main basis of the legal system justice is founded upon "intent."

Intent is the difference between 1st Degree Murder, 2nd Degree Murder, Accidental Homicide, and Self Defense, etc.

Accidents are accidents and we usually don't hold people responsible unless there is gross incompetence or negligence.

Having said that, I think that same critera should be applied to Corporate Responsibility and Limited Liability.

If the Corporate Management is accidentally negligent, one outcome, if the managers purposefully concel and mislead, another outcome, (perhaps loss of 50% of their salary for an extended periord of time comensurate with the grievousness of the infraction.)

This way the existing assets of the managers are protected, but yet their future earnings are affected. Also make it so they can not do an "end run" and have the corporation pay the salary to them in another way. A lot of bad things happen because of no accountability on the part of the managers. Now if stocks are involved, then they can still go to jail...Enron....etc.

JMHO.


FAR.

 
At 8:00 PM, September 28, 2005 , Blogger Intellectual Insurgent said...

FAR -

The main basis of the overall legal system is not intent. Intent is a defining feature of criminal law. In tort law, the ultimate issue is compensating those who have been harmed, even if they are harmed by a mere accident, i.e. negligence. In contract law, the issue is making business happen as efficiently as possible. Thus, there are no penalties such as punitive damages in the area of contract law because it would inhibit business.

If we put all the suggestions from these comments together, we might just revolutionize corporate law. :-)

 
At 8:58 PM, September 28, 2005 , Blogger Free Agency Rules said...

Ah,

Thanks to you some of my "Business Law 101" is coming back to me.

I remember "tort."

Thanks for the refresher on Criminal vs Tort and the update on Contract Law.

I love to stimulate the old grey matter, but problem is the older I get the shorter my retention.


FAR.

 
At 10:22 AM, September 29, 2005 , Anonymous sctrojan95 said...

II:

Sorry, I don't have the time right now to locate links to the text of the actual articles, but this link: http://www.bc.edu/schools/law/fac-staff/deans-faculty/greenfieldk/ will at least take you to a list of some of his published articles and links to article abstracts.

.... and yes, I guess I did fall within the libertarian "label", apparently slightly more in favor of a larger government than you though.

 
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