This article is adapted from Economics, Capitalism, and Corporations: Contradictions of Corporate Law, Economics, and the Theory of the Firm, part of the Routledge series on The Economics of Legal Relationships, ISBN 978-0367895563.
I explained the end of modern corporate law in a previous article, It’s the End of Corporate Law as We Know It (Business Law Today, January 29, 2021). This article serves to recognize the death of modern corporate law, drive nails in its coffin, and bury it..
The first nail in the coffin concerns shareowners’ rights to protection from creditors.
Shareowners are often said to have “limited liability;” i.e., protection against claims of creditors of the corporation.
But for shareowners to have limited liability for corporate debt, shareowners must have some liability, as would be the case if, for example, directors were the agents of shareowners (which I address below). For shareowners to have any liability, limited or otherwise, necessarily means that property that is owned by shareowners can be used to satisfy the claims of the creditors of the corporation; it means that creditors may assert a claim against the property of the shareowners.
In bankruptcy proceedings, the unsecured property of the bankrupt corporation is used to satisfy the claims of unsecured creditors. Therefore, we must ask, what property that is owned by the shareowners can be used to satisfy claims of creditors against the corporation?
Posner, for example, wrote that a “shareholder’s liability for corporate debt is limited to the value of his shares.” If by “the value of his shares” Posner meant the market value, the market value of the shareowners’ shares is determined by the market and absolutely no market value of shareowners’ shares can be used to satisfy corporate creditors. That is, corporate creditors can assert no claim against shareowners for the market value of their shares.
If, however, by “the value of his shares” Posner was referring to the book value of the shares (total corporate equity, i.e., assets minus liabilities, divided by the number of shares outstanding), then that also fails to meet the requirement of liability for corporate creditors. The total assets are owned by the corporation. Therefore, the net assets are also owned by the corporation. But since net assets is the equity, it is the corporation that owns the equity, not the shareowners and thus, the equity that is used to satisfy corporate debts is the corporation’s equity, not the shareowners’.
While shareowners may lose the entire value of their shares when the market price falls to zero, the value of their shares cannot be used to satisfy any claims of creditors because first, the value of their shares is not determined by the value of the corporate equity, and second because corporate creditors can assert no claim against shareowners’ assets. Shareowners’ risk of loss is limited to the market value of their shares, none of which is used to satisfy corporate debt.
There is no such thing as “limited liability” for shareowners unless limited means zero. Shareowners have no liability, limited or otherwise. What “limited liability” really means is “limited risk.” Shareowners have the risk that the value of their shares will fall to zero, but that is unrelated to liability for corporate debt. Therefore, Posner was wrong. Shareowners’ liability for corporate debt is not limited to the value of their shares because shareowners have no liability for corporate debt and the value of their shares cannot be used to pay corporate debt.
In order for shareowners to have any liability to creditors of the corporation, shareowners would have to owe a duty, whether contractual or tortious, to the creditors of the corporation. But on closer inspection we find that by property law and corporate statutory law, shareowners owe no duty to creditors whatsoever.
Delaware General Corporation Law, for example, states: “The aggregate liability of any stockholder of a dissolved corporation for claims against the dissolved corporation shall not exceed the amount distributed to such stockholder in dissolution” (emphasis added). At first glance the law appears to say the shareowners do have a liability for corporate debts, but that is not the case.
Upon dissolution, the net assets which are owned by the corporation are distributed to shareowners. The aggregate liability of any shareowners of a dissolved corporation for claims against the dissolved corporation is merely a claim by creditors of the corporation to recover the net assets that were owned by the corporation and wrongfully distributed to the shareowners. It is thus not the shareowners’ liability since they were never entitled to receive a distribution of the net assets owned by the corporation.
But, perhaps more important is the fact that the law refers to “the aggregate liability of any stockholder of a dissolved corporation for claims against the dissolved corporation.” A dissolved corporation no longer exists.
A second nail in the coffin of modern corporate law concerns shareowners’ right to dividends and distributions. Shareowners’ rights, or rather lack thereof, to dividends is well known but the implication is often ignored. The implication of shareowners’ rights, or lack of rights, to distributions is also often ignored.
Shareowners have no property right in corporate earnings; the earnings belong to the corporation. Thus, shareowners have no right to dividends which are distributed out of corporate earnings. Under Delaware General Corporation Law, “The directors of every corporation, subject to any restrictions contained in its certificate of incorporation, may declare and pay dividends upon the shares of its capital stock…” (emphasis added). New York’s corporate law is similar. The right to receive dividends is merely an expectation and not a right (and certainly not since Dodge v. Ford), which even Berle and Means acknowledged: “[the] shareholder in the modern corporate situation has surrendered a set of definite rights for certain indefinite expectations.”
Shareowners have no property interest in the corporation or its assets. Thus, they have no right to distribution of its net assets, i.e., its equity. Shareowners only have a right to a distribution of net assets of a dissolved corporation, which no longer exists. The corporation owns the equity. The equity is comprised in part of earnings that have not been paid out in dividends (“retained earnings”), reinforcing the principle that neither corporate earnings nor equity is owned by shareowners, but by the corporation.
Another nail in the coffin of modern corporate law concerns shareowners as “residual claimants” which is related to the distribution of net assets. The term “residual claimant” refers to the proposition that shareowners have a claim on net assets, i.e., the equity, after all liabilities are satisfied by corporate assets.
In order to see that shareowners are not residual claimants, we must ask what, exactly, is the claim that “residual owners” have? What are they claiming? Against whom or what? In order to be a claimant, one must have a claim recognizable in a court of law. However, as previously shown, shareowners have no rights or ownership interest in the corporation, its assets, or its earnings.
While shareowners have a right to receive a distribution of the net assets of a dissolved corporation, they have no claim on either the assets or net assets of the corporation the way a creditor has a claim against the assets of the corporation. A creditor may assert a claim against the corporation in a court of law. A shareowner may not assert a claim against the corporation in a court of law. A creditor does not wait for the directors to declare an interest or principal payment. A shareowner must wait for the directors to declare a distribution. Thus, shareowners are not residual claimants because they have no claim that can be asserted in a court of law.
That shareowners are residual claimants is an assumption not supported by either property law or corporate law. Shareowners have no greater claim on the net assets than they do on the total assets. The corporation owns the assets and shareowners have no claim against the total assets. The corporation owns the equity, thus the shareowners have no claim against the equity.
Qui facit per alium facit per se. “He who acts through another acts himself.” This has been the literal basis of agency law for centuries.
I touched on agency law in my previous article. Here, I further explain the legal impossibility of directors being agents of shareowners in order to drive another nail in the coffin of modern corporate law.
If directors are agents of shareowners, then directors are those through whom another (the shareowner) acts. Thus, we must ask, and answer, the question that has been ignored for decades. How, exactly, do shareowners act through directors? The response to that question is found by first answering another question: Are shareowners legally permitted to act through directors? The answer to the second question is no, shareowners are prohibited by corporate statutory law from acting through directors. Thus, the response to the first question is that, in fact, shareowners do not act through directors.
Delaware General Corporation Law states: “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors.” New York and other states have similarly worded statutes. Thus, corporate statutory law prohibits shareowners from acting through directors. If shareowners are prohibited by corporate statutory law from acting through directors, then directors are prohibited by corporate statutory law from being agents of shareowners.
The funeral march is long overdue.. It is time to bury modern corporate law.