Limited Liability

Limited Liability

A Legal and Economic Analysis

Stephen M. Bainbridge and M. Todd Henderson

The modern corporation has become central to our society. The key feature of the corporation that makes it such an attractive form of human collaboration is its limited liability. This book explores how, by allowing those who form the corporation to limit their downside risk and personal liability to only the amount they invest, there is the opportunity for more risks taken at a lower cost.

Chapter 2: History of limited liability

Stephen M. Bainbridge and M. Todd Henderson

Subjects: law - academic, corporate law and governance

Abstract

In this Chapter, we provide a brief history of limited liability. We trace its origins back to Roman times, when the idea of corporate separateness was first used as we know it today. Although ancient in origin, the modern concept of limited liability did not appear until the early 19th Century. We thus show how limited liability is not inherent to the corporate form, but rather depends on the ends to which that form is applied. At times, whether in ancient Rome or modern America, that application demands the isolation of liabilities in the corporate entity, while at other times, the concept of shareholder liability for the corporation’s creditors is a more sensible one. We document how limited liability arose initially out of the concept of sovereign immunity – the state outsourced its functions, such as building a road, to a private entity, and gave this entity the immunity the state would have had had it done the work. But even early on there were contracts, such as the Roman peculium and the Middle Ages commenda, that permitted investors of capital in large and remote projects, such as sea voyages to achieve limited liability. Liability tends to follow control, then and now.We trace the scope of limited liability in continental Europe, the United Kingdom, and colonial America, but find that corporations were rare and limited liability still tied closely to the idea of state power. The big change came with an 1811 New York statute that liberalized incorporation and limited liability. This statute provided the model for other states and, several decades later, European countries, to expand the concept of limited liability to permit the specialization and fundraising necessary to fuel the industrial revolution. Finally, we describe limited liability today, which bears little resemblance to much of its history. We also discuss some relatively modern alternatives to limited liability, such as those used in California through the early part of the 20th Century, pointing out why they failed to provide a viable alternative to limited liability as we know it.

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