Limited Liability and Competing Interests

[Qwertz]

I have an issue I'm trying to resolve, and would appreciate any help anyone can give me in sorting out my understanding. The ideas are sort of spilled out here in the order in which I've thought about them, and as such may still be a bit disorganized...

Assuming a general principle that if you hurt someone, you should pay for it, what happens when you aren't able to compensate the wronged party for his loss? First, I think the system recognizes that it is not always (ever?) possible to fully compensate someone for a wrong or injury, but instead the system will make available to the wronged party an amount of money (which often is substituted for whatever value was lost, as against replacing the lost value precisely) that approaches, but infrequently reaches, the approximate monetary value of the lost ... value. So victims of torts, for example, are not ever really compensated entirely for their losses. They cannot be made perfectly whole, because the values lost are often so unique as to be irreplaceable (i.e. a leg), even though they may be valuable in terms of (in the case of a leg, large numbers of) dollars. The tortfeasor pays that sum, in a best effort to right the wrong. There may be punitives involved, and there may be criminal charges involved. (In cases of breach of contract, it is perhaps easier to approach a perfect compensation, because contract breach often injures the wronged party in terms of dollars, and we consider money perfectly fungible, and enforcement costs can sometimes also be recovered. In some cases, the only unrecoverable value may be the lost time.) Given that it is never possible to fully compensate the injured party, what is the proper principle for determining whether a particular partial compensation is just?

My thinking is that, because justice is the law of causation applied to men, both parties should be treated in accordance with their actions. With respect to the injured party (assuming no contribution to his own loss), it seems that, having taken no action to cause his injury, he may, depending on circumstances, be entitled to perfect compensation. But given that such compensation is rarely possible, he may be entitled to the best possible approximation of perfect compensation. Likewise, the wrongdoer ought not be required to give up more than this amount. Here's where my question comes in to play. Assuming the foregoing is correct, to what extent is the 'best possible approximation' determined by the wrongdoer's ability to make compensation? Say a court determines that $500,000 is the best possible approximation of perfect compensation for my injury, but the wrongdoer only has $10,000 in assets. Now, justice appears to insist that the wrongdoer assumed complete liability by virtue of his wrong act, and so he incurs a moral obligation to pay the whole adjudicated amount. But as he only has $10,000, he can only pay that much. Ought the law insist on the best possible compensation, and require him to pay now to the extent that he has assets, i.e. require him to pay out all the money he can right now, and then to accept a debt on the balance? What if paying out all his assets would do greater harm to him than the value of the compensation that I will receive? Say that, by being forced to pay out all of his assets, the wrongdoer starves to death. Perhaps this is an extreme example. A better one might be that he incurs an even greater financial liability because he had to take out loans, which bore interest, in order to have food to eat. There seems to be no just solution, which leads me to believe that I've either left something out, or have gotten something wrong.

On the one hand, the wrongdoer should be made to accept the full liability, even if some or all of it must be in the form of a debt to be paid when assets become available to satisfy it. But proper compensation to the wronged party seems to require that the debt be paid back immediately as assets become available. Do wrongdoers have a protected interest in retaining judgment-proof assets sufficient to maintain a certain standard of living? If so, does this actually interfere with the wronged party's interest in rapid compensation? Because the wrongdoer is in the best position to protect against the liability he incurs by virtue of his bad acts (either by avoiding bad acts or by insuring against potential liability), it seems he should eat the risk and be made, not only to accept the full liability regardless of his ability to pay, but to satisfy the judgment as quickly as assets become available. This sounds a little like slavery to me; the wrongdoer would not necessarily be required to work, but if he does, all of his earnings would go to satisfy the judgment.

Hence bankruptcy, whereby many such liabilities can be extinguished. Where two parties have competing interests in the same, limited assets, how does the law justify resolving the conflict by division of the assets without resorting to the old "no system is perfect" excuse? In other words, what is the moral justification (if any) of limiting personal liability, either at the judgment stage (by taking into account the liable party's ability to pay) or at a later stage (i.e. bankruptcy or other ways of absolving a party of a liability)?

(My initial thinking suggests that bankruptcy has no place in a free economy, at least not in its present form, because it constitutes unwarranted mucking around in the economy by the state.)

The whole reason I'm working on this subject is this: corporations. As they exist today, corporations are distinguished from partnerships (which can normally be created through private contract) and sole proprietorships by virtue of the special feature of limited liability. Investors (in the form of shareholders) are insulated against personal liability (in excess of their investment) for corporate wrongdoing. But this limitation on liability is a special legal status, bestowed by the state, on a voluntary association of individuals (which is visualized by the law as a fictitious, separate legal entity, as if it were its own individual, distinct from any of the individuals that actually make up the corporation). I found myself thinking that the corporation appeared to be a collectivist entity, because it seemed to be characterized by the assignment of a special right (limited liability) on a group of individuals, but which the individuals themselves did not have. So I wonder about whether there is an individual right that leads to the concept of limited liability, and if so, how the (apparent) conflict between limited liability and the interest of the wronged party in compensation should be resolved.

Help?

-Q

[Capitalism Forever]

There can be a corporation owned and run by a single individual, so I don't think it's a product of collectivism.

In a free society, parties to a contract have the right to limit their liabilities towards each other. You are free to say: "I will provide you with product or service X, but only if you accept that my liability towards you shall not exceed $xxxx." Corporation law allows such limitation to be made implicitly, by means of giving your business a name that ends in the word "Corporation," "Incorporated," or something similar. That's all--I don't think anyone should be able to limit his liability towards third parties who don't agree to such limitation.

[John McVey]

I'll have to leave the determination of what is appropriate compensation to another as I have no knowledge of how to do that. As to corporations, I do see that you're confusing economic limited liability with political limited liability, which is itself a mistake that the law makes with the Separate Entity theory.

As they exist today, corporations are distinguished from partnerships (which can normally be created through private contract) and sole proprietorships by virtue of the special feature of limited liability. Investors (in the form of shareholders) are insulated against personal liability (in excess of their investment) for corporate wrongdoing.

In law today, all that is based on Separate Entity theory, the idea that the corporation is treated as a legal person distinct from its owners. It can be shown that corporations and LL are legitimate, and in the process show that the present law is unjust. Part of that injustice is the very injury compensation issues you raise, which the courts have often dealt with by resorting to a legal procedure called "piercing the veil" and placing personal liability on the corporate officers and other key individuals connected with the corporation. A rational corporations law would retain LL in its proper format and deal with those compensation issues without using a principle that is wide open to "social policy" distortions.

But this limitation on liability is a special legal status, bestowed by the state, ... I found myself thinking that the corporation appeared to be a collectivist entity...

I believe that is historically correct. The first corporations were townships and cities, operated by the leading merchants and guildmasters (burghers, hence bourgeoisie in French), and had their status granted by the Crown to exempt them from feudal dues to and control by nearby lords. A little later after that came the use of the mechanism for specific business ventures, and corporate charters were individually granted by the government because there was no general corporations law. Both of these are also linked with historical monopolies over trade in particular commodities. Only in the 19th century did the concept of the corporation turn into a normal business practice and hence a corporate law arise, thereby creating the modern corporation.

I think that limited liability started before the corporation, though. If memory serves me, the Romans employed the concept to investment in mining ventures. People said they wanted to explore for minerals, got loans from money lenders, but had their liability to the lenders limited just to some amount of collateral they put up.

That's almost as much as I know history-wise, but neither history is relevant to how the concepts can be applied to practice in principled justice.

So I wonder about whether there is an individual right that leads to the concept of limited liability,

Limited liability is a legitimate concept, and if done right a legitimate practice. The issue is delimiting that use, which in turn must come from seeing what is legitimate about the corporation as opposed to a partnership. The origin is just plain freedom of contract. The basic idea is that limited liability is limited primarily to commercial matters. All that limited liability is in commerce is where a group of people say, via the corporate officers who are their agents, that they will only sign a contract where the counterparty recognises that in commerce the most they will be financially accountable for is some limited amount. The counterparties either accepts those conditions or they don't sign, and commercial bargaining power does not mean that the counterparty is being coerced. If the contract is signed and acted upon in good faith then the courts are obliged to uphold it under general justice as it applies to contracts. Developing this along with other details then leads to other legitimate features of the world of banking and finance.

and if so, how the (apparent) conflict between limited liability and the interest of the wronged party in compensation should be resolved.

Separate Entity theory, at the heart of current law, must be abandonded. Corporations do not act - individual PEOPLE act. Corporations cannot be guilty of a wrong, it is only individuals who can be guilty. Who acts is the corporate officers and their subordinates. It is they who must bear the liability of any actual wrongdoing as it is they who are responsible for how the corporation acts on a day to day basis. It is not the corporation as an entity that breaks a contract in bad faith, or steals, or commits fraud, or in some other way harms another, it is the officers in charge and their subordinates who do these things using other people's property as the means. Precisely because the shareholders have little influence on daily activities, qua shareholders rather than qua as officers themselves, in justice their liability can only extend to the degree they enabled the officers to act, generally meaning the amount of capital they put up in good faith. If I lend my car in good faith to someone else so they can run an entirely moral errand for me, I am not responsible if they instead use it without my permission or even awareness as a getaway vehicle in a robbery, for instance. Maybe my liability is limited to my car, and more likely not even that. So it will generally be for corporations law. I am not enough of an expert to say much more than that, but I do know that it will be traceable back to justice in the realm of principal-and-agent and especially the topic of vicarious liability.

That's a start, anyway. The corporation is a legitimate business vehicle and limited liability is a legitimate practice, both traceable back to justice in laws of contract and principal-and-agent. I'll leave the rest to specialists in philosophy of law as it applies to commerce. I would be very interested in what you learn, too.

JJM

Edited July 4, 2007 by John McVey

[DavidOdden]

There was also a discussion of bankruptcy here, where some relevant issues are discussed.

But given that such compensation is rarely possible, he may be entitled to the best possible approximation of perfect compensation. Likewise, the wrongdoer ought not be required to give up more than this amount.

My only objection here is the word "possible", which is vague in a way that allows improper mixing of concepts. I'd suggest "computable", so that trashing a Stradivarius violin with an appraised value of $2 million creates a particular computed approximation, independent of whether the tortfeasor can pony up such a sum. That anticipates the question:

Assuming the foregoing is correct, to what extent is the 'best possible approximation' determined by the wrongdoer's ability to make compensation?

Not at all. Suppose we make this really transparent, where I set fire to a pile of $100 dollar bills of yours, having the value $500,000, then I owe you $500,000 -- that's what I owe, and should be the size of the debt that I've incurred by my action. The fact that I only have $10,000 does not create the contradiction that $500,000=$10,000. What I owe, in justice, is $500,000.

But as he only has $10,000, he can only pay that much. Ought the law insist on the best possible compensation, and require him to pay now to the extent that he has assets, i.e. require him to pay out all the money he can right now, and then to accept a debt on the balance?

Here's the hook to the bankruptcy thread. The obligation to compensate you to the tune of a half a mill puts you squarely on the bench in the hall outside bankruptcy court, where a plan of payment will be worked out so that over your life, you can continue to exist (you won't starve to death -- and what banker would lend money to a persom with a $490,000 debt whose plan for the money was "I need to eat"?). The crucial thing is limiting the extent of asset liquidation and wage garnishing (some people think the word derives from German gar nichts "absolutely nothing" but it doesn't). The wrongdoer should still be allowed to exist.

Do wrongdoers have a protected interest in retaining judgment-proof assets sufficient to maintain a certain standard of living? If so, does this actually interfere with the wronged party's interest in rapid compensation?

Yes and no, in that order. The wronged party has the greatest interest in total compensation, so that liquidating the man's worktools for an additional $10,000 makes it impossible for the tortfeasor to do his job and continuously compensate the victim. See also Goose & Egg v. Farmer, 4 Aes. 165 for brief discussion. Quick gratification is or should not be the point. The devil is really in the details as far as "certain standard of living" goes. The mindless, non-evaluative sanctity of the home is an example, where you can hide millions of dollars in assets. I think that it is proper to make a wrongdoer sell his lavish house in the course of liquidating assets, and he can live in a cheap hovel (not that any housing is cheap these days). The tortfeasor still has the right to exist, which limits the victim's right to the assets, and the proper involvement of the court in such a case is to determine what the tortfeasor must hand over, and when. Thus the courts should not require the tortfeasor to hand over his liver for a transplant (and strictly speaking, a program of radical liquidation would involve parting out the tortfeasor to transplant hospitals).

I found myself thinking that the corporation appeared to be a collectivist entity, because it seemed to be characterized by the assignment of a special right (limited liability) on a group of individuals, but which the individuals themselves did not have.

I've looked on corporations differently, as a special kind of agent. The corporation bears total and full responsibility for wrongs, and unlike a human, the corporation can even be totally liquidated and vaporized to satisfy the debt. I don't see that there is a special "I can't pay my debt so it's cancelled" principle, rather, I see the corporation as actually creating a new legal being which isn't just the sum of shareholders, where the shareholders are not all principals. The question is whether such as semi-person ought to be tolerated in a free market / Objectivist legal system. It does not seem to me that the current disconnection between the concepts of "agent" and "owner" is a good thing, but I don't have a concrete proposal (esp. the required knowledge) for a functioning alternative.

[dbc]

Ought the law insist on the best possible compensation, and require him to pay now to the extent that he has assets, i.e. require him to pay out all the money he can right now, and then to accept a debt on the balance?

The law requires exactly that--the judgment debtor has to pay the full amount of the judgment, even if he cannot pay the entire amount the day after the judgment becomes final. There is an important context here: the "law" does not automatically pursue the judgment debtor. As the judgment creditor, you have the obligation to collect on that judgment. As one example, you must obtain the appropriate writ of execution from the court and put it in the hands of a sheriff who can then collect on that judgment. The court system will not chase the judgment debtor for you. If, for some reason, you decide not to collect on your judgment, you do not have to.

What if paying out all his assets would do greater harm to him than the value of the compensation that I will receive? Say that, by being forced to pay out all of his assets, the wrongdoer starves to death. Perhaps this is an extreme example. A better one might be that he incurs an even greater financial liability because he had to take out loans, which bore interest, in orderAs to have food to eat. There seems to be no just solution, which leads me to believe that I've either left something out, or have gotten something wrong.

As you correctly point out, justice is the application of the law of causality to mens' actions. Your question seems to suggest that regarding the judgment creditor--the person who was wronged--as "causing" the wrongdoer to suffer financial hardship by obtaining a judgment against him or by collecting on that judgment. The tortfeasor is bearing the consequences of his actions--instead of the wronged party. If you decide that it would be unjust to collect on your judgment, don't.

Hence bankruptcy, whereby many such liabilities can be extinguished.

Not all debts can be extinguished. To stick with your example, certain torts cannot be discharged in bankruptcy: fraud and breach of fiduciary duty are two examples that immediately come to mind.

I found myself thinking that the corporation appeared to be a collectivist entity, because it seemed to be characterized by the assignment of a special right (limited liability) on a group of individuals, but which the individuals themselves did not have.

You are correct that, under the corporate umbrella, the investors' liability is limited to their individual investment. I do not understand what you mean by "collectivist entity".

Dan

[DavidOdden]

I've been thinking about the corporation issue for the past day from a different angle, and I can't see the justification for the limit on liability, in a free market. But I have a question about "inherited liability". CF's point about limiting liability between contracting parties covers everything except liability arising from fraud or non-contractual violation of rights (for example dumping toxic waste on another person's property), acts which require one or more evil-doers. The question then should be, under what conditions can / should the members of a partnership be held responsible for the willful misdeeds of their partners.

Suppose for example that Frick & Frack have a tanker-truck equal partnership for transporting linquids from point to point, that Frick is the business genius who gets customers, arranges the contracts, and takes care of the financing, and Frack is the mechanical genius who keeps the trucks in working order, is in charge of loading and unloading shipments. Now suppose that Frack is willfully and grossly negligent in his job, doesn't shut the intake valve on the truck (he doesn't feel like exerting himself), so that 10,000 gallons of deadly toxins end up being released as the truck drives through the city, killing thousands of people resulting in trillions of dollars in lawsuits. Frack is responsible because his (in)action caused the deaths, but Frick would, at least as I understand it, also be liable. If Frick constructively contributed to the act, of course liability should extend to him -- but if Frick has no knowledge of the act (and would not be expected to have such knowledge), is there a reason why he should be held liable for his partner's acts? I would especially like to see a spirited defense of the idea that a person should be responsible for the acts of a person operating on his behalf or in him name (to strengthen my grip on the concept "responsibility").

[Black Wolf]

*** merged with an earlier limited-liability thread. - sN ***

The difference between an incorporated business and a non-incorporated business is that incorporated ones pay a double taxation. In exchange for the second taxation, should the business go under, the government will pool the money for the successful corporations to pay for the losses of the first one.

In a society where government plays an invisible hand, would corporations get such protection? Would they survive long without it? Would the ones that don't survive cause a backlash?

Edited October 26, 2009 by softwareNerd

[VECT]

Nope, if an unsuccessful corporation goes under, no one will have to pay for the failure other than those who made a choice in supporting that corporation while it existed. That means the employees, managers..etc. who choose to work there and pays for it by losing their existing job, the creditors who lent out money and pays for their misplaced faith if they weren't able to collect all their debt, and lastly the investors who made a decision in supporting the failed corporation will pay for their wrong decision by losing their investment.

I don't know what kind of backlash are you thinking of, but in a free society/market, everyone is responsible for their own choices. If they screw up, they have no one to blame but themselves.