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 5: What law applies?

Stephen M. Bainbridge and M. Todd Henderson

Subjects: law - academic, corporate law and governance

Extract

In the US’s federal system, most corporations are formed under state rather than national law. Accordingly, as the US Supreme Court has explained, “except where federal law expressly requires certain responsibilities of directors with respect to stockholders, state law will govern the internal affairs of the corporation.” As to which state’s law governs a given case, the choice of law rule known as the internal affairs doctrine mandates “that only one State should have the authority to regulate a corporation's internal affairs—matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders—because otherwise a corporation could be faced with conflicting demands.” The internal affairs doctrine further vests the state of incorporation with that sole authority and, as a result, requires that the law of the state of incorporation govern disputes arising out of a corporation’s internal affairs. Although most states follow the general corporate law choice of law rule with respect to corporate veil-piercing claims, a handful decline to apply the internal affairs doctrine to such claims. The choice of law question is further complicated because a growing number of veil-piercing cases involve underlying claims based on federal law. In such cases, courts must determine whether to apply state or federal law and, if the former, which state’s law to apply.

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