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Sean Gabb’s Thoughts on Limited Liability

Sean Gabb’s Thoughts on Limited Liability

A previous post, In Defense of the Corporation, discussed whether “limited liability” of modern corporations is compatible with libertarian principles. This topic was also discussed on Kevin Carson’s “mutualist” [socialist? neo-Marxist?] blog; see the excellent comments there by “iceberg.” Carson also recently promoted some anti-corporate comments by the eloquent libertarian Sean Gabb. I wrote Gabb about this, and he responded to some of my questions in Thoughts on Limited Liability. He quoted most of my substantive comments in his piece, so I won’t reprint them here. My response to his piece follows: 

Very reasonable and thoughtful comments, Sean, and a profitable way to pursue this. I do not disagree strongly with much of what you write. I will elaborate more on this later after your post becomes linkable or emailed.

The main differences here would probably be this—first, if you want to show a link between ownership of shares, and liability for acts done by any employee of the enterprise that uses property of the company, then I simply think more needs to be shown. You have provided a sketch of a possible theory that might show a sufficient connection, and I would not be hostile to seeing if it plays out. I am not so confident this can be done from one’s armchair. It seems to me the application of the general principles might need to be left open.

In other words, it seems to me the default libertarian position is that an individual is responsible for torts he commits. If you want to hold others liable for this too, you need to show some kind of causal connection between something done by the third person, and the tort committed by the direct tortfeasor. You seem to assume that this connection is present in the case of a shareholder because he is the “true” or “natural” owner of the company’s assets. This I think is what troubles me the most—it seems too much of an assertion to me. I do not see its basis. And as I alluded earlier, it seems to rest on the notion of respondeat superior. Maybe this legal principle could be justified but I have never been quite sure exactly how or why it is justified under libertarian principles. It seems to me the idea is that the principle of respondeat superior simply is the presumption or finding that the employment relationship necessarily is a sufficient causal connection to hold the employer responsible for torts of his agent-employee. I am not hostile to this conclusion but am not quite sure the case has been made. Maybe there is a presumption, maybe in many or most cases the employer is causally responsible, but I am not sure it is necessarily the case (I have always loved the idea that if the employee goes off on a “frolic“ then there is no respondeat superior liability; so you have cases examining whether the employee who deviates from his assigned duties is on a “frolic” or not—ha!). But consider: the basis for respondeat superior (and I bring this up b/c it seems to me something along the lines of this principle must be employed to hold the shareholder liable for acts of employees) has to do with the employer’s practical right or ability to control or direct the actions of the employee (this principle probably underlies the “frolic” exception too). Can we assume that this control is present when we move further back the chain of causation? Say, to the directors, who appoint the managers? Or to the shareholders, who elect the directors? And if practical control is one of the main relevant features that determines whether there is liability, again, why couldn’t lenders, employees, suppliers, customers, etc. at least potentially be held liable? In some cases they exert more control and give more “aid and comfort” or “aid and abet” in more visible and substantial ways than a mere shareholder.

This highlights that you still seem to draw some kind of bright line between the position of a lender and a shareholder. Something about this troubles me—it seems too artificial; too reliant on the state’s own positive legal distinctions. In my view, the general question is one of causation. I cannot say from my armchair that lenders necessarily are radically less responsible for the actions of company employees than are shareholders. It seems to me one needs to say this, however, in order to draw the bright line distinctions you do. In economic or financial terms, for example, it is common to classify shareholders and lenders/creditors on a spectrum, based on who gets paid first: if a company is going bankrupt, say, then out of its remaining assets: first, you pay secured lenders; then unsecured lenders; then, say, preferred shareholders; then finally, common shareholders. Sure, for legal purposes you classify some as shareholders and some as lenders; but financially, in a sense, this is just a way of specifying priority of payout and relative risk of capital. And there is nothing inconceivable about a lender agreeing (for some reason) to be paid only after shareholders receive a certain liquidation preference amount... all kinds of mixtures are conceivable. This would muddy the waters about who is the “natural” owner, it seems to me. The point, to me, is that this shows the limitations of relying on “natural ownership” as a key principle here.

Also I would say that if you had your way, I could see creative commercial lawyers and businessmen thinking of different investment vehicles that are economically similar to the joint stock company (as you even intimate in your comments about bonds being another way to finance endeavors and the “naturally” limited liability of bondholders). You conceive of a shareholder as the “natural” owner of the enterprise. I am skeptical of relying on the conceptual classifications imposed by positive law. To me a shareholder’s nature or identify depends on what rights it has. What are the basic rights of a shareholder? What is he “buying” when he buys the “share”? Well, he has the right to vote—to elect directors, basically. He has the right to attend shareholder meetings. He has the right to a certain share of the net remaining assets of the company in the event it winds up or dissolves, after it pays off creditors etc. He has the right to receive a certain share of dividends paid IF the company decides to pay dividends—that is, he has a right to be treated on some kind of equal footing with other shareholders—he has no absolute right to get a dividend (even if the company has profits), but only a conditional, relative one. He has (usually) the right to sell his shares to someone else. Why assume this bundle of rights is tantamount to “natural ownership”—of what? Of the company’s assets? But he has no right to (directly) control the assets. He has no right to use the corporate jet or even enter the company’s facilities, without permission of the management. Surely the right to attend meetings is not all that relevant. Nor the right to receive part of the company’s assets upon winding up or upon payment of dividends—this could be characterized as the right a type of lender or creditor has.

The main shareholder right that could be latched on is the right to elect directors. This the only “real” factor I see of genuine relevance. That is why I say that the alleged causal connection between the shareholder and the employee has to rest on the shareholder’s control. Which really rests on his right to vote for and elect directors. That is all. So the question is: is this degree of or level of control (due to the right to vote for directors) sufficient to make the shareholder causally responsible for the actions of agents of the enterprise? Again, I do not see how one can maintain there is automatically or necessarily liability here, without opening up a huge can of worms: because, as I noted, it is not only shareholders who exert “control” over which directors are elected, or which managers are appointed, or which employees hired, or which policies or directives are issued by the managers. There are many others—employees, unions/coops, customers, vendors, creditors, landlords.... I am not in principle against holding any of these types of actors responsible for torts of the corporation—if the causal connection can be shown. It has to be demonstrated, in each case, based on the facts and context. I just see no reason why this is not also true of the case of shareholders.

Finally, it seems to me the chief aspect of limited liability that is objected to by the detractors of modern corporations is not the immunity from tort liability, but rather the contractual limited liability aspect (which you accept). It seems to me that a company that is sufficiently capitalized can simply purchase insurance that would effectively immunize shareholders for tort liability—then we’d be back to where we are now (except maybe there would be a greater incentive to have such “shareholder insurance”).


Incidentally, for a real-world example of a limited liability provision, see the recently enacted Texas Business Organizations Code, in particular § 21.223, as well as other provisions such as §§ 21.106, 21.107, 21.224, 21.225.

Update: Roger Pilon’s Corporations and Rights: On Treating Corporate People Justly also has some very good stuff on why limited liability does not give any special privilege to shareholders. See also my post Legitimizing the Corporation and Other Posts.

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