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 10: Rethinking veil piercing

Stephen M. Bainbridge and M. Todd Henderson

Subjects: law - academic, corporate law and governance


The first nine chapters of this text demonstrated that the standards by which veil piercing is effected are vague, leaving judges great discretion. The result has been uncertainty and lack of predictability, increasing transaction costs for small businesses. At the same time, however, there is no evidence that veil piercing has been rigorously applied to effect socially beneficial policy outcomes. Judges typically seem to be concerned more with the facts and equities of the specific case at bar than with the implications of personal shareholder liability for society at large. Veil piercing thus has costs, but no social pay-off. A standard academic move treats veil piercing as a safety valve: allowing courts to address cases in which the externalities associated with limited liability seem excessive. In doing so, veil piercing is called upon to achieve such lofty goals as leading shareholders to optimally internalize risk, whilst not deterring capital formation and economic growth, while promoting populist notions of economic democracy. The task is untenable. Veil piercing is rare, unprincipled, and arbitrary. Veil piercing should be reformed (if not outright abandoned) by refocusing judicial analysis on the appropriate question; namely, did the defendant-shareholder do anything for which he or she should be held directly liable? So reformed, the doctrine would ask such questions as: Did the shareholder commit fraud, which led a creditor to forego contractual protections? Did the shareholder use fraudulent transfers or insider preferences to siphon funds out of the corporation? By doing so, veil piercing would go to the heart of the matter instead of ephemeral incidentals.

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