Evolution of Entities Henry Hansmann Yale Law school Owner shielding and entity shielding • Limited liability (owner shielding) protects owners’ assets from entity creditors • Entity shielding protects entity assets from owners’ creditors • The two have necessarily evolved together – Limited liability would not be viable without locking in entity assets or entity creditors – And vice versa • California proves the rule The great arc of entity evolution • From contract to law to contract • Starts in late Middle Ages: – Unlimited liability entities dominate – Allocation of control and earnings were completely contractable – But, vis-à-vis third parties, control brought personal liability as a mandatory rule By the late 19th century • Limited liability entities were well- developed • In particular, persons exercising control could have limited liability easily entity creditors, unlike the Middle Ages • But contractual freedom to allocate earnings and control internally was highly restricted – at least in the U.S. By the year 2000 • Restrictions on contract have been progressively eliminated • The Delaware statutory trust is virtually an empty shell with only asset partitioning – And the LLC is close behind • So limited liability entities have the contractual freedom that unlimited liability entities had half a millennium earlier This leaves two questions • First, why the 19th century restrictions? • A tempting answer: – Contracting and enforcement were inadequate to the greater scope for opportunism created by limited liability and capital lock-in – Judges then became better at administering standards – Parties became better at contracting and monitoring – Contractual technology – disclosure, communications, computation, etc. – improved too But Europe is a problem here • Had highly flexible private company forms very early • England’s public company form was also originally quite contractual, though it retreated. • Was there a different contracting environment than in the US? Second question: where will we go? • Business trust has been used to unimaginatively so far – Mutual funds and asset securitization • The flexibility of the LLC has perhaps been used a bit more • Will we see yet more? • Are we creating a continuum between entities and security interests?
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