Limited liability: why we should want more of it

On my previous post on corporate personhood I intended to also deal with the matter of limited liability–hence the URL of the post. However, I couldn’t do that in that post, so here it goes.

Limited liability is a privilege conferred by the state, without which much of the progress capitalism has achieved would have been unthinkable. The risks necessary to carry forward large-scale industrial operations would exceed any person’s capacity to plan for and mitigate. If every failed enterprise led to destitution, there would soon be few people crazy enough to start new ones.

The normal functioning of civil law, which inherits a lot of its assumptions and infrastructure from the Roman legal tradition, is that persons are fully responsible for their debts. In Roman law, responsibility for debts was demanded, at first, through the use of the legal action of manus iniectio–or laying on of hands. The debtor was taken in hand by the creditor and dragged to the prætor, where a formula was pronounced which placed him at the creditor’s mercy. He could be kept in chains for a period, sold as a slave beyond the river Tiber, and ultimately killed. In cases where the debtor owed several creditors, the law established a gruesome partition of the corpse amongst them. Liability has never since been quite as unlimited.

Even in Roman times, this treatment of debtors became culturally unacceptable. The forms of the ancient actions of the law were annulled, and new mechanisms appeared to substitute the Roman notion of personal liability. Still, our juridical tradition carries this history with it. The very word obligation, refers to the way in which a debtor could be bound by his creditors.

That debts must be paid is common sense: that is, it is part of the uncontested and largely unexamined assumptions of the prevailing ideology. Legal aphorisms such as pacta sunt servanda — deals must be kept — stand as witnesses to this outlook. The very notion of justice we inherit from Rome, is to give each person what is theirs. Ulpian, one of the most successful Roman jurists, defines justice as honeste vivere, alterum non laedere, suum cuique tribuere–to live honestly, not to harm others, and to give each their due. Due is, of course, derived from the Latin word debere–to owe.

Much has been made of the etymological similarity in Germanic languages between debt and blame, or flaw. As an attempt to explain the conduct of the German state regarding the current crisis in the Eurozone, it appears to be grossly exaggerated (we’d have to look into material forces to explain that), but as a means to highlight certain cultural outlooks regarding credit, it may be somewhat enlightening.

When considering why a debt should be paid, which is already difficult to consider (it seems a tautology), we can use different justifications. A very traditional one lay on the subjection of one person to one’s own given word: if you promise you will pay 300 sestertii to such and such a person at such and such a date, that is that. In many societies, such promises were enhanced by appealing to the gods. So the traditional view is debts must be paid because one has committed oneself to paying them, and it is fitting that society should enforce such a bond. Many explanations have been layered over this idea, including that of improving public trust and facilitate economic traffic, or more metaphysical Kantian notions on how the development of one’s personality requires consistency between actions and words.

Of course, in order to begin talking about debt, it’s necessary to talk about property, or at least, about some form of right of exclusion in the use of things. This right was largely taken for granted by ancient jurists, as natural, but we can’t so easily dispose of the matter. Money represents a certain amount of value, in the form of the call on a particular aliquot part of social surplus. Whatever one may think about the exact means whereby values transform into bourgeois prices–or even whether they do–it seems clear that money acts as a sort of proxy for crystalised labour, which is to say, labour already carried out. Under bourgeois law, I am free to exchange my labour for a consideration, which underpins the whole wage system. The keystone of bourgeois law is that of equal exchange: my labour trades at its value on the market, for its due wages. Likewise with crystalised labour: money has its own cost of production–and I’m not referring to the cost of the specie, but to the economic cost of making a certain amount of money–and can therefore be exchanged for a different quantity of money in the future.

Subjectively, we speak of net-present value of money to justify interest: money now is better than money later, since the future is uncertain: we may no longer be alive, the debt may not be paid, and the amount of social product which that money calls may have shrunk. More objectively, given the m-c-m’ cycle, a certain amount of money today can be reproduced at an assumed prevailing rate of profit, and derive a higher amount of money in a year’s time. Hence, equal exchange will require an interest rate. Of course, the person actually investing the money in commodity production is bearing with certain risks, but, then, so is the person lending it.

Given this justification for paying one’s debts, why does bourgeois law, invariably, develop the notion of limited liability? It would appear to be some form of distortion, but only if we take the liberal discourse at face value. Capitalism may blush when exploiting unequal exchange, such as it arises from rents, imperialist relations, or fictitious capital, but such are invisible blushes, which never stay its invisible hand. Likewise with limited liability.

The explanation for the existence of limited liability for companies seems reasonable. Starting up a new enterprise is risky, and society needs to assume a part of that risk, by giving investors the opportunity to limit their potential losses to their investment in a given firm. This explanation, however, ignores a few relevant issues:

  • Limited liability is a privilege of all firms, not just new ones.
  • Firms, new or old, can also be creditors, and limited liability can increase their chances of failure.
  • Some creditors can secure their credit through real guarantees (mortgages, liens…) and these will be paid in full.
  • If it’s a social burden to encourage new investment, why isn’t it socialised instead of falling on the shoulders of unsecured creditors alone?

At this point it’s necessary to think of limited liability as it currently exists as if it were a tax. As a tax, it is not one which falls equally on the population, but it is limited to unsecured creditors. Who are these unsecured creditors? It depends on local legislation, but, largely, banks issuing lines of credit, suppliers, customers–regarding undelivered goods–, and workers. Who benefits from such a tax? Broadly, investors: shareholders. So capital has decreed a tax to benefit itself, but, it would seem, largely at one’s own expense. True, workers and clients aren’t capitalists, as a rule, but banks and suppliers definitely are.

The trick lies in the fact that limited liability is a tax, but unlike most other forms of taxation, it’s a tax on the future: it is paid by future creditors, for current investors’ sake. So at any given point in time, it is always preferable for investors to preserve it.

How does capital achieve this alchemy whereby future creditors bear the costs of today’s production cycle? Money being crystalised labour, it’s not possible to use labour in the future to realise production in the present. However, and especially–though not uniquely–after the twilight of commodity money, and with the definite hegemony of money as credit, the exact quantity of money does not and cannot correspond precisely to the labour value yielded by a given society. Much money pools in hoards, thus rendered socially useless, while banks keep creating it and destroying it constantly anew. The interest rates chosen by central banks are, so to speak, an approximate and very coarse control on its rate of increase, and only by the most extraordinary coincidence will they reflect accurately the true state of the productive economy–that which makes goods, and not financial instruments.

As credit money appears in this curious form, it becomes increasingly possible to commit portions of future production to those who fund it in the present. This way, money which would otherwise be kept out of circulation, is placed in the cycle to produce new commodities which willll in turn produce new money. Naturally, the result of such operations isn’t always benign: we’re seeing how, during this crisis of profitability, the past has made pledges of value which we cannot, at present, satisfy. Plenty of present creditors (many banks, but also plenty of workers, construction companies, states, bond-holders, etc) are being right now taxed for past production in the form of unpaid and unrecoverable debts.

Given the clear dangers that limited liability incentivises overproduction, and reduces the slack of the system, why do I say we need more of it?

It’s not always a good idea to take capitalists at their word. When they claim that limited liability was devised to “democratise” investment, we should take this with due scepticism. However, and although the primary reason may have been hustling funds from rentiers into the productive economy, there is a grain of truth here. In the past, entities such as Lloyds, the insurance clearing-house, worked on the basis of personal, unlimited liability. In fact, Lloyds is an anomaly in the financial world, in that, to this day, some so-called Lloyds Names–i.e., those people who back it financially–still are personally liable without a limit. Other joint stock corporations proved their credit-worthiness by having partly paid shares, or as we say in the continent, passive dividends. If shares cost a pound to acquire but represented an investment value of ten pounds, in case of bankrupcy, shareholders would have been obliged to pay up to ten times their initial investment.

Limited liability and wholely paid shares allowed investors of lesser means to participate in the funding of corporations and to benefit from their profits. Today, such an arrangement is the norm, with very few exceptions. Certainly, the cooperative movement would have had real difficulties without such a principle. If every cooperative member – and let’s remember cooperatives begun as an alternative to dodgy merchant practices, so all shoppers would be members – would have to bear a potentially financially crippling loss in case of cooperative default, it’s difficult to imagine many could have succeeded. Finding members would have been extremely difficult, given the way debtors were treated at the time.

Today, there are still some entities which lack the privilege of limited liability. Though these depend on local legislation, it’s often the case for trade unions, political parties, non-profit associations–not foundations or trust, what a coincidence–, and the like. What they have in common is that they’re not strictly speaking mercantile concerns: their object is not profit. Hence they do not benefit from the liability protection offered to capitalists. This can cause difficulties when fines are imposed on such organisations for carrying forward protests which may be deemed illegal, strikes, demonstrations, and so on.

Of course, the other entity which is deprived of limited liability is the natural person. As the Spanish Civil Code states: The debtor responds of the fulfilment of obligations with all his goods, present and future1. This rigorous article causes banks to execute their real guarantees on people’s homes, evicting them and auctioning them, after which the poor unfortunates are still burdened with unbearable debts to cover the difference between the value of sale and the previously existing debt. It’s true that, thanks to the mortgage law, it is possible to reach an agreement whereby the liability is strictly limited to the value of the real estate. It is true in theory, of course, as, in practice, no bank will consent to such terms. Thus, the perfect abstract freedom to bargain is acknowledged by the law, while the banks hold the absolute concrete power of a monosony in credit.

One of the biggest social demands in Spain, which has been taken up across all strata of society, and by many people on the left and on the right, is the so-called datio in solutum, best translated into English as non-recourse debt. The idea is that by giving up the mortgaged property, the debt incurred should be written off. After all, the point of mortgages is supposed to be guaranteeing the creditor their due, and if the creditor has over-exposed themselves by lending too much, whose fault is it?

This notion is nothing more and nothing less than a form of limitation of liability. One which is urgent in the current conditions in Spain if we are to avoid this crisis, already dramatic, from becoming a tragedy. Likewise, a limitation of liability for non-profit associations, political parties, trade unions, and irregular cooperatives is nothing but the realisation in effective terms of the rights to assembly, political action, and, even, enterprise, if they are to mean something more than the right of the rich to do these things. Limited liability has a bad name because it all too often has served to short-change those harmed by corporate malfeassance, but it is not, per se, an enemy. It is the corporate veil, which covers agents, directors and shareholders of corporations from the consequences of their actions, which should be lifted in such instances. Let’s have more of it, where it matters: on our side.

  1. Spanish Civil Code, Article 1911.  

About modulus

Modulus is an unaffiliated Marxist from South Western EU (Spanish state). He studied computer science and law, and is at present preparing for civil service exams for the Spanish administration. An avid IRC user, he enjoys arguments and will occasionally play devil's advocate. He regards himself as orthodox and is concerned about unscientific attitudes on the left on such things as nuclear energy, biotechnology, and so on. His support for the European Union as a platform to unify the class struggle across the continent has earned him plenty of strong opposition, and doubtless will continue to do so; until, that is, his view is vindicated by history.
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