Working Paper No. 08-15:
A Federalism-Based Rationale for Limited Liability

Author(s):

Douglas Smith

Date Posted: March 2008

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Abstract:

 

This article contends that there are strong historical and economic arguments in favor of limited liability for corporate shareholders that arise from the federal structure in the United States. Limited liability is an important tool for minimizing extraterritorial regulation. It allows each state to bar other states from imposing liability on corporations created in their respective states in a manner that deviates from the policy of the state of incorporation. Moreover, it allows states to compete as centers of corporate creation. Certain states have developed particularly stringent doctrines of limited liability and it is arguably no accident that such states are favorites for those seeking to incorporate. Likewise, States with stringent doctrines of limited liability may protect their corporations from the application of relaxed standards of tort liability found in other jurisdictions or procedural standards that threaten to impose significant and arguably unwarranted liability upon the corporate entity. Plaintiffs under such circumstances will find themselves limited to the assets of the corporation even though they may be able to establish entitlement to far greater sums under the laws of their own jurisdictions. This aspect of limited liability has become even more important given the recent increase in forum shopping and the recognition of certain jurisdictions as magnets for claims that would not succeed elsewhere. Moreover, it explains the continuing vitality of limited liability in the context of involuntary tort creditors, which has been the focus of significant academic criticism.