Abstract
The many legal forms for business organisations that first appeared in the United States during the last thirty years — the limited liability company (LLC), the limited liability partnership (LLP), the limited liability limited partnership (LLLP) and the statutory business trust — all combine the pattern of creditors’ rights, or asset partitioning, that is traditional to the business organisation with the freedom of contract among investors and managers that is traditional to the partnership. To view these new entities as partnership-like is to treat the degree of freedom of contract as the essential difference between the traditional corporation and partnership forms; to view them as corporation-like is to treat the pattern of creditors’ rights as the essential difference. While recent scholarship often takes the former view, the latter seems more accurate. History shows that much of the contractual inflexibility in the traditional corporation served merely to buttress its pattern of creditors’ rights and that this inflexibility fell away upon the development of substitute sources of investor protection. The new forms are thus better understood as part of the continuing development of the corporate form rather than as entities more akin to the traditional partnership, which has in fact been evolving in a different direction. This article first develops this argument in terms of the trade-off between contractual freedom and the form of asset partitioning that to date has received the most scholarly attention, that is, limited liability. It then explores the evolution of the new forms from a less familiar perspective, focusing on the entity shielding component of asset partitioning.
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H. Hansmann and R. Kraakman, ‘The Essential Role of Organizational Law’, 110 Yale L. J. (2000) p. 393.
We draw here heavily upon our working paper, H. Hansmann, R. Kraakman and R. Squire, ‘Law and the Rise of the Firm’, 119 Harv. L. Rev. (2006) p. 1333, which explores these themes, and the relevant history, in substantially greater depth and detail.
See J.H. Chopper, et al., Cases and Materials on Corporations, 5th edn. (New York, Aspen Publishers 2000) pp. 18–22, 712; L.M. Friedman, A History of American Law, 2nd edn. (New York, Touchstone 1985) pp. 511–525; G.D. Hornstein, ‘Judicial Tolerance of the Incorporated Partnership’, 18 Law & Contemp. Probs. (1953) p. 435 at pp. 439–448.
See Chopper, op. cit. n. 3, at p. 712.
Del. Code Ann. tit. 12, §§ 3801–3862 (2001). For a thoughtful study of the development and character of the statutory business trust, see R. Sitkoff, ‘Trust As Incorporation: A Research Agenda’, U. Ill. L. Rev. (2005) p. 31.
H. Hansmann and U. Mattei, ‘The Functions of Trust Law: A Comparative Legal and Economic Analysis’, 73 N.Y.U. L. Rev. (1998) p. 434 at pp. 474–475.
This is not to say that most limited partnership statutes do not retain this rule. See, e. g., Cal. Corp. Code § 15632 (St. Paul, West 1991 & Supp. 2005); N.Y. Partnership Law § 121–303 (McKinney Supp. 2005). But, practically speaking, if one wants to have limited liability and also exercise all the control powers typical of a partner, one can simply form one’s business as an LLP, LLLP or statutory business trust.
Exporte Crowder, 21 Eng. Rep. 870 (Ch. 1715).
The change was a result of the Bankruptcy Act of 1978. See 11 U.S.C. § 723 (2000). It has also become a substantive rule of partnership law in those States adopting the Revised Uniform Partnership Act. See generally W. Allen and R. Kraakman, Commentaries and Cases on the Law of Business Organization (New York, Aspen 2003) pp. 56–58. The 1715 rule remains in effect in England.
Craven v. Knight, 21 Eng. Rep. 664 (Ch. 1682–83).
See J. Treillard, ‘The Close Corporation in French and Continental Law’, 18 Law & Contemp. Probs. (1953) p. 546 at pp. 553–554.
R. Kraakman, et al., The Anatomy of Corporate Law (Oxford, Oxford University Press 2004) pp. 97–99.
Hansmann and Kraakman, loc cit. n. 1, at p. 393.
This terminology, and the concepts of weak and strong entity shielding described immediately below, are taken from Hansmann, Kraakman and Squire, loc cit. n. 2.
See F.H. Easterbrook and D.R. Fischel, ‘Limited Liability and the Corporation’, 52 U. Chi. L. Rev. (1985) p. 89 at p. 92. In fact, unlimited liability is compatible with tradable shares so long as the liability is pro rata rather than joint and several. See H. Hansmann and R. Kraakman, ‘Toward Unlimited Shareholder Liability for Corporate Torts’, 100 Yale L.J. (1991) p. 1879 at pp. 1903–1904.
Another important reason why limited liability requires strong entity shielding is that without it firm creditors would be exposed to excessive opportunism by the firm’s owners.
In the Uniform Limited Liability Company Act of 1996 (ULLCA), the default regime for member withdrawal is the same as under the Revised Uniform Partnership Act: a member may withdraw, rightfully or wrongfully, at any time; if the company is at will he must be bought out immediately, but if the company is for a term then buyout need not occur until the term’s expiration. Unif. Ltd. Liab. Co. Act §§ 602(a), 701(a), 6A U.L.A. 610, 614 (2003). ULLCA expressly provides, however, that most of its rules may be altered in the company’s operating agreement, including those respecting a member’s withdrawal voluntarily or due to his bankruptcy. Ibid., §§ 103 and 601(1), (7), at 567–568, 608–609. Moreover, ULLCA explicitly provides that the rules for determining whether a member’s withdrawal is wrongful apply only ‘[i]f the operating agreement has not eliminated a member’s power to dissociate.’ Ibid., § 602(b), at 610. Members of an LLC thus may contract for strong-form entity shielding and full liquidation protection in perpetuity with respect to themselves and their personal creditors. The only exception is that companies must retain procedures for dissolution or the expulsion of members upon a judicial finding of persistent misconduct or that the purpose of the company has been frustrated. Ibid., § 103 (5), (6), at 568.
See Unif. P’ship Act §§ 701(h), 801(2) (1997), 6 U.L.A. (pt. I) 189 (2001).
See Del. Code Ann. tit. 12, § 3808(a)–(b) (1999 & Supp. 2004).
See H. Hansmann, ‘Corporation and Contract’ 8 Amer. L Econ Rev. (2006) p. 1.
This is not to say that the new forms have not been the subject of thoughtful analysis. Their emergence has elicited insightful commentary by, in particular, Larry Ribstein, whose extensive writings on these forms provide our most substantial source of wisdom concerning them. See, e. g., L. Ribstein, ‘Why Corporations?’, 1 Berkeley Bus L.J. (2004) p. 183.
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Hansmann, H., Kraakman, R. & Squire, R. The New Business Entities in Evolutionary Perspective. Eur Bus Org Law Rev 8, 59–69 (2007). https://doi.org/10.1017/S1566752907000596
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DOI: https://doi.org/10.1017/S1566752907000596