C2, I’m getting back to you and Tim late. Sorry. Hopefully, in combination with the subsequent post to Tim, the public policy point will be clear such that it is not off-topic to the thread. Then back to lurking…
How many times have you seen corporations take advantage of the limitation?
That’s like asking – “How often do people take advantage of the sun rising.” The answer – every damn day, every moment of their existence. Limited Liability is a function of the form.
In smaller companies, to what extent do banks and other creditors demand personal indemnification as a condition of financing?
Agreed that almost invariably lenders request require personal guarantees from small borrowers, but they do so - by definition – to acquire additional collateral to negate the legal shield of limited liability in Corps, LLCs and other limited liability forms. They don’t have to ask for personal indemnification in sole proprietorships except to the extant of additional collateral relative to the personal BK code. One could argue that the value of the limitation of liability is at least equal to the value of the amount borrowed for smaller borrowers.
To what extent have insurers filled the gap in the limitation?
Apples and Oranges. I was referring to financing (debt) and the extension of credit (Accounts Payable), while your question implies torts, accidents or force majeure. In the insurance context, it doesn’t apply to the limitation of liability because insurers typically have no claim on the assets of the entity or of its owners. They assess the risk of loss on what they are insuring, calculate how much loss they’re willing to indemnify and charge a commensurate rate. (As an aside, as I’m sure you are aware insurance companies are not in business to pay claims, they are in business to collect premiums.) If a corporation, and if there is a claim, and if the insurance doesn’t pay the full value of the claim, the claimants can only go after the assets of the Company and not the asset of the owners
So, if you are running a bunging jumping excursion company, and even assuming you can buy insurance, will you organize it as either LLC or Corporation, or as a sole proprietorship? I think that answer is obvious. Why? That answer is obvious as well.
How much has the limitation been worth, historically? ….
How much is the limitation really worth?
In real estate, pre-bubble, an individual borrowing for a home would typically need 10% equity and pay 2-3 points on top of it. And that is with a perfected first security interest on the collateral. Business terms were more strict in terms of overall firm debt / to equity – but less so in terms of rates charged because businesses have cash flows to fund principal and interest exogenous from the owners' cash flow. Bottom line though is, the willingness of a lender to lend and the rate they’ll lend is all risk related, and collateral mitigates risk. If I – as a lender - can get to the asset base of the owner I have more collateral. The debt risk premium is readily available, demonstrable and measurable.
But rather than trying to quantify it, let ‘s try a little thought experiment. Think about all those, crappy little OTC BB companies that are hyped on SI and other Boards. If creditors could reach down to the equity owner for recovery, would they trade at all – let alone pennies a share? Heck no, they might likely have a negative value and boy would fraud be reduced. What about an Enron, or WorldCom or United Airlines? After filing an 11, and when the market realizes that the secured and unsecureds are getting pennies on the dollar, in any rationale market would the shares continue to trade if pre and post petition creditors would make claim on the equity holder? Its axiomatic, but as an equity investor if creditors can look to you for recovery of the liabilities of the business, you would demand much greater rates of return to compensate for the increased risk. Quantifying the risk premium is the most difficult, qualitative, and largely subjective issue in valuation. But no professional in the field would opine that the limitation of liability has no value or even little value. It never comes up because it is as unarguable as the benefit of double entry accounting.
Thus, if the extender of credit – for example – demands a 3% risk premium – but the equity holder reduces his risk premium by 6% then who has paid the additional 3%? We as a society have. People make the argument that the 3% (or whatever %) is paid back in increase economic efficiency – but we never get it all back because LLC and corporate structures let investors arbitrage the risk premium.
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