One of the truly powerful ideas that has helped business and Western economies grow has been something related to bankruptcy: limited liability. Once people were able to invest without risk of their entire fortune, people who had assets became more willing to invest in risky ventures, not just lend money to those willing to take a risk. That's good, we need to have a wide range of investors willing to invest equity, debt alone discourages growth.
What doesn't encourage growth, or responsible decisionmaking on the part of corporate managers is limited liability for subsidiaries. It's time to get rid of it.
Unlike owners or investors, managers are not personally responsible for debts incurred by a company, but they still choose to incorporate their subsidiaries separately to allow them to take advantage of limited liability, often allowing the parent to force the risk of loss onto third parties. How can this be done? Say your corporation owns a hundred cabs in NYC. You don't want to pay for any more insurance than you absolutely have to, but you don't want to lose the company to a large judgement, either, so you incorporate, say 50 separate corporations that each own two cabs, buy the medallions, on secured credit from the parent corporation, and buy the minimum required insurance for each.
If the cab crashes and the insurance liability goes beyond the insurance, the subsidiary goes into bankruptcy and, as the secured party, you get the medallions back. The victim gets little more than the value of the inadequate insurance and maybe the low value of the vehicles. Is that the intent of limited liability?
Say you are a developer who tends to push the limit. Each development is separately incorporated, but owned by the developer's corporation. The developer's corporation collects the fees associated with the development, leaving the developer with little or no capital invested in the business. If the development fails, the developer has all of the profits he expected. The risk falls on others.
Now, as I said, limited liability is a great idea, but it was developed to protect people from unlimited liability. I don't see any reason for an organization that has already protected investors from added liability to be able to be protected by limited liability statutes as well in their investments.
While part of the reason for limited liability is to encourage investors to invest in more risky propositions, that does not mean that managers of these companies should also be encouraged to engage in additional risk by being able to create undercapitalized subsidiaries that take on the risk and disappear at little or no cost to the parent if things go bad, but reward the parent handsomely if things go well.
The reform is simple. All limited liability organizations (Corporation, LLC, LP, etc) will be fully exposed to liability to the extent of their share of the business they have invested in as long as the investment is less than 80% of the subsidiary. If a corporation owns 80% or more of a subsidiary, it will be responsible for 100% of the debts. No more hiding your asbestos liability in a subsidiary. No more high risk trading in a subsidiary with no assets.