Incorporating Responsibility

“Limited liability” is the rule that shareholders are not liable for the debts of the corporations they own. Critics of limited liability argue that it encourages corporations to ignore the harms they cause and cuts off recovery for deserving plaintiffs. Defenders of limited liability reply that it helps the economy by reassuring investors that they cannot lose their life savings merely by buying a single corporate share. Both claims are clearly right, so the debate rages on.

This Article proposes a solution to the dilemma of limited liability that gives both sides what they want: recovery for tort victims and safety for investors. The solution is “incorporation responsibility”—the rule that whichever state incorporates a business becomes responsible for that business’s unpaid debts. Thus, if a Delaware corporation commits a tort that it cannot rectify, the State of Delaware would compensate the victims.

This proposed scheme of incorporation responsibility tracks the logic and law of American corporate federalism. The “genius” of American corporate law is that states compete for incorporation fees by offering appealing laws. This process works well for many corporate rules, but it currently malfunctions for limited liability because states are rewarded for expanding limiting liability, even where doing so imposes disproportionate costs on victims. With incorporation responsibility, states will internalize the costs and benefits of limited liability and can be trusted to craft rules that are both just and efficient.