A New Understanding of the History of Limited Liability:

An Invitation for Theoretical Reframing

RON HARRIS 1

Kalman Lubowsky Chair of Law and History at Tel Aviv University School of Law

In this paper, I will investigate the historical development of limited liability – widely considered

the cornerstone of the business corporation. I challenge the common, linear narratives about how

limited liability evolved, and argue that corporations, the stock markets, and the corporate

economy enjoyed a long and prosperous history well before limited liability in its modern sense

became established. 2 This radically different historical understanding calls for the economic theory

of limited liability to be revisited. It also opens up a new set of conceptual, empirical, and

theoretical research questions, and points to new possibilities for viable liability regimes in the

future.

1
I wish to thank David Gindis, David Ciepley, and participants in the TAU corporate law forum for comments. My
thanks also to Mais Abdallah for the research assistance on this paper and Amanda Dale for her editing.
2
A business corporation has the attribute of “limited liability in the modern sense” when: it has both equity investors
and creditors; it can be liquidated when insolvent; and, in such event, creditors have priority over equity investors in
collecting based on corporate assets, but they cannot access the private assets of shareholders. The liability of
shareholders is limited to their initial investment in the shares they purchased (in primary or secondary market or
private placement). Creditors can collect only from the corporate pool of assets and not from the personal pools of
assets of the shareholders. This attribute is confined to organizational law, to corporation law. Even under a limited
liability regime, shareholders can be made liable toward corporate creditors by assuming personal liability or providing
personal guaranty or security to corporate debts in the realms of contract or property law (a common practice in
closely-held corporations).

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 1. Introduction

Limited liability is viewed by many eminent corporation law scholars, including Clark (1986, 7)

and Armour, Hansmann, and Kraakman (2009, 9–10) as a defining attribute of the business

corporation. 3 Nicholas Murray Butler, who served for 43 years as President of Columbia
2F

University, in a famous, oft-cited, and much-echoed 1911 speech at the Chamber of Commerce of

the State of New York, said: 4 “I weigh my words, when I say that in my judgment the limited
3F

liability corporation is the greatest single discovery of modern times… Even steam and electricity

are far less important than the limited liability corporation, and they would be reduced to

comparative impotence without it. Charles William Eliot, the longest-serving President of

Harvard, made a comparable proclamation just a few years later. 5 In 1926, The Economist made a
4F

similar sweeping assertion: “The economic historian of the future may assign to the nameless

inventor of the principle of limited liability, as applied to trading corporations, a place of honour

with Watt and Stephenson, and other pioneers of the Industrial Revolution. 6 5F

Such statements about the historic importance of limited liability as a game-changing

invention were theoretically substantiated with the emergence of economic analysts of corporation

law in the 1960s and beyond. Henry Manne (1967) argued that the modern corporation, whose

shares are held by numerous passive shareholders, could not exist without the attribute of limited

3
On the doctrinal level, the limitation of shareholders’ liability for corporate debts to corporate property was the
fifth of six characteristics defined under the United States (US) “Kintner regulations” in the period 1960–1997.
These were applied to determine whether an entity would be taxed as a corporation (taxable entity) or as a
partnership (pass-through entity). United States v. Kintner (1954). 26 I.R.C § 7701 (1986), (a)(2), (3).
4
Butler was also a Republican presidential candidate, and became a Nobel Peace Laureate. Here, it was neither the
corporate entity, nor joint stock capital, nor delegated management that he was celebrating, but rather the limited
liability of shareholders.
5
Eliot said: “The principle of limited liability is by far the most effective legal invention for business purposes made
in the nineteenth century . . . the fundamental advantage of a corporation, the advantage which enables it to mass and
direct capital, is the privilege of limited liability.” Quoted in Cook (1921).
6
The Economist, December 18, 1926 quoted in Halpern et al. (1980).

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liability. If shareholders holding small stakes were subjected to unlimited liability to corporate

debts, then investors with personal wealth would be reluctant to invest in public corporations, 7

because every single share would place all their personal assets at risk. To guard against this,

without the protection of limited liability risk-averse investors would be forced to concentrate their

investment in a single firm, in which they had access to information via employment or a

management position, or in which they could justify the high costs of monitoring. Only the

invention of the limited liability corporation, argued Manne, would allow the investor to spread of

risks by holding a diversified corporate stock investment portfolio.

Halpern, Trebilcock, and Turnbull (1980, 117) added a further dimension to the theoretical

importance of limited liability, noting that it is essential for stock markets to operate efficiently:

without it, shares would not be priced uniformly and efficiently. Shares held by deeper pockets

allow the company to borrow more cheaply and to be more profitable. The personal wealth of

shareholders and their holdings in other corporations affect the value of the corporation in which

they buy or sell shares. Thus, the price of shares in the same corporation will be affected by the

personal wealth of the buyer and seller of those shares.

Taken together, the contributions of Manne (1967) and Halpern et al. (1980) provide the

theoretical support for the claim that limited liability was pivotal for the emergence – or at least

for the efficient functioning of – the corporate economy, in which the larger firms are organized

as corporations with numerous shareholders and tradable shares. 8 But when was limited liability

7
This insight was first made a century earlier – albeit without any theoretical elaboration or empirical support – by
the British political economist Walter Bagehot in The Economist. Bagehot (1862) asserted that only persons of modest
means would be willing to become shareholders in unlimited companies and particularly unlimited banks.
8
In a later contribution, Easterbrook and Fischel (1985, 89) listed six economic advantages of limited liability:
lowering monitoring costs on other shareholders and the corporation itself; promoting share transfer; making share
prices homogenous; allowing diversification; and facilitation of optimal investment decisions. In economic terms, the
advantages are a combination of reduction in agency monitoring and transaction costs with risk diversification and
efficient prices. They admitted that, while limited liability has clear benefits, it also means the costs of engaging in

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“discovered,” to use Butler’s term, or “invented,” in The Economist’s terms? Surprisingly,

historians, economists, and jurists have paid little attention to this question; their (limited) analysis

has not been rigorous; and they have not been unequivocal in their interpretations.

For many corporate law scholars, history is irrelevant for understanding the present and

dealing with the future (Harris, 2003). Among those for whom history does matter, it has been

argued that the critical issue is the history of entity-shielding – not shareholder-shielding, or limited

liability – because the former required statutory intervention whereas the latter could, to a great

extent, be achieved contractually (Hansmann et al., 2005). One of the most common historical

narratives simply assumes that limited liability was born with the very first business corporations,

in around 1600. But this claim fails to offer hard evidence (Bainbridge and Henderson, 2016). A

notable exception to this narrative is the work of Dari-Mattiacci et al. (2017), which studied the

Dutch East India Company and argued that it acquired limited liability in the modern sense early

in its history. However, I will show that neither the Dutch nor the English East India Company

enjoyed limited liability in the modern sense, and that this characteristic was not conceptualized

until two centuries after these enterprises were established.

Another very popular historical narrative holds that this attribute coincided with the

enactment of general limited liability; indeed, many specifically view Britain’s 1855 General

Limited Liability Act as the watershed. Robert Lowe, a liberal MP and the Vice President of the

Board of Trade (1855–58), presented the two bills that introduced limited liability before the House

of Commons. For this, he has been credited as being “the father of modern company law”

(Micklethwait and Wooldridge: 2003, 51). Those who focus on the US or France offer different

years, based on the dates of the first limited liability legislation of these jurisdictions. Details aside,

risky activities are externalised. For another contribution made in the same year that emphasizes the lowering of
information and transaction costs, see Woodward (1985).

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every version of this narrative in fact refers to the point at which limited liability became

contractually available. But this is not synonymous with the timeframe in which limited liability

was formed, nor the year in which the limited liability of our modern understanding was widely

adopted and became universal. Furthermore, what all such accounts have in common is that they

portray the birth of limited liability as a before-and-after event – virtually an overnight invention.

My argument, in contrast, is that the history of limited liability should be understood as a complex

and gradual process.

I conceptualize this process as divided into three definable periods, linked by two critical

transition phases. In Period I – the nascent corporate economy featuring the first joint-stock

corporations in 1550–1600, until around 1800 – there was no notion of the attribute of limited

liability and no actual manifestation of it as such. Next, in the first transition phase, there were

small but significant technical steps toward forming the attribute of liability and distinguishing it

from personhood. By Period II, from around 1800 until around 1930, the concept had been

moulded, and diverse types and levels of limitation of liability experimented-with. The second

transition phase, leading into to Period III (from around 1900 until the mid-20th century), was

characterized by a gradual convergence into a single, universal model – the model I term here

limited liability in the modern sense. Amid the convergence process, public intellectuals celebrated

the “invention of limited liability”, and in the post-convergence phase (Period III) legal-economic

theoreticians laid out the theoretical arguments supporting the proclamation that, without limited

liability, the entire corporate economy could not have developed. For the sake of brevity, the

present paper focuses primarily on the first period, the explanation for the transition to the second

period, and Period II itself.

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 The entire corpus of corporate finance that has developed since the 1950s is based on the

assumption that publicly-traded corporations are limited liability corporations in the modern sense,

whose shareholders bear no personal liability. The new historical understanding offered here

narrows the conditions in which the theories of limited liability actually apply. It also suggests that

various liability regimes that were widely used in Period II – and were weeded-out by the historical

convergence in the transition to Period III – can inspire the discussion of alternatives to our present-

day limited liability regime. Full joint and several liability is not among them, but I believe other

past regimes should be considered at least with respect to some sectors and some types of liability.

2. Period I: Before the Conceptualization of Limited Liability, 1600–1800

By the late Middle Ages, jurists viewed the corporation as having several distinct traits. Most

importantly, it had a legal identity separate from that of its members (Harris, 2000, ch 1). The

corporation was not a “pass-through” entity with no legal liabilities. Individuals who acted as

agents on its behalf (in their capacity as mayors, abbots, deans, or masters) typically assumed no

individual legal liability as long as they acted exclusively in that personal capacity. Nor did they

create individual personal liability among the members of the corporation, be they guild members,

university doctors, or monks. Rather, they placed liability with the corporations they governed.

This is the effect of the legal personality that was conceptualized as a major attribute of these early

corporations. It has nothing to do with the future attribute of limited liability in its modern sense.

Indeed, these jurists could not even conceptualize limited liability in its modern sense as

one of the attributes of corporations, as these were not-for-profit entities and had no equity

investors. Nor was limited liability a relevant privilege for early corporations, because they held

most of their assets in immovable land, their tort liabilities were not expected to be considerable,

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they did not transact commercially or have joint-stock capital, and they were unlikely to be deeply

in debt.

The early business corporations: The East India Companies

The first large-scale and long-lasting joint stock business corporations were the English East India

Company (EIC), established in 1600, and the Dutch East India Company (VOC), established in

1602. Both engaged in long-distance oceanic trade with Asia around the Cape of Good Hope, and

both combined the legal concept of a corporate legal entity with the financial scheme of joint-stock

investment. The EIC’s most distinctive attribute, as evident in its charter, was its incorporation as

"one body corporate and politic” – a separate legal entity. It had a full set of legal capacities and

privileges: to own land, litigate in court, and hold franchises such as monopoly.

The EIC’s first charter in 1600 made no mention of joint-stock finance or of limiting the

liability of its members (Harris, 2019). For the limited liability attribute to have become an issue

in the early history of the EIC, it would have had to be financed by both equity and debt. However,

debt was initially only a marginal source of corporate finance, 9 due to the high level of uncertainty

in the early stages of trade, the high level of on-going risk, the absence of tangible collaterals, and

the non-existence of commercial banks or bond markets of the magnitude that could provide long-

distance finance. The company was financed almost exclusively by equity, while credit was used

only on a small scale, as an integral part of commodity transactions. Thus, there was no significant

conflict between shareholders and creditors, and no need to define the liability of shareholders for

corporate debt. Some degree of asset-partitioning was evident from the fact that the company was

a separate legal entity, but this should not be confused with limited liability in the modern sense.

9
See the discussion of contemporary usury laws in Malynes (1622).

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 The EIC started using long-term debt finance only during its challenging years before the

Glorious Revolution. The 1685 balance sheet recorded debt of £783,890 (some of it short-term)

and equity of £1,703,422 (Chaudhuri, 1978: 424). But after the Revolution, the company became

a financial intermediary issuing bonds to the investing public and a lender to the government. At

this stage, in theory, it could have become insolvent, and the question of the relative priority of

bondholders over shareholders – and related questions of how to limit the personal liability of its

shareholders to company debts – could have become an issue. But they didn’t. The EIC’s

relationship with the government may have made to company “too big to fail”.

The VOC was chartered two years after the EIC, in 1602, by the States-General, the Federal

Assembly of the Dutch Republic. The charter positioned the company as an entity separated from

the state and separated from persons. The VOC could own property, transact, and hold privileges

(such as a monopoly or franchise) issued by the state. 10 Unlike the EIC, the VOC’s charter also
9F

addressed the financial scheme. 11 It contained permission to issue a public offering of shares,
10F

granted all residents of the Netherlands the right to subscribe to them, and locked-in the capital

thus raised (6,424,588 guilders) for ten years.

Was the liability of VOC shareholders limited in the modern sense? Gelderblom, de Jong,

and Jonker (2013), prominent economic historians of the company, have argued that, by 1623, the

VOC was a limited liability corporation. 12 When, in 1611, the Middelburg Chamber postponed

paying import duties, the Zeeland tax collectors did not seize the VOC property but threatened the

directors with imprisonment for debt instead. From this, these authors concluded that the directors

10
The question of whether the incorporation also entailed limitation of liability is debated among scholars. See, for
example, de Jongh (2011).
11
For a view that the VOC was a property corporation whose locus was its joint stock, whereas the EIC was a
members’ corporation, in which the joint stock did not fit well, see Ciepley (this volume).
12
See also: Dari-Mattiacci, Gelderblom, Jonker, and Perotti (2017).

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bore personal liability for company debt and may have inferred that passive shareholders

(participanten) enjoyed limited liability. In 1623, it was resolved that the text of bonds would be

rewritten to explicitly exclude creditors’ recourse to the signatories’ person or property. 13

I think this conclusion is misjudged. The VOC liability regime is confusing because, unlike

the EIC, it had two classes of shareholders: the aforementioned passive participanten and the

active bewindhebbers. The passive shareholders were entitled only to a share in the profits. The

VOC also had two levels of governance, six city Chambers, and a united company. 14 The active

shareholders served by their status as governors of their respective city Chambers and could be

appointed as the united company’s directors (members of the Herren XVII). The liability of the

passive shareholders of the VOC was not defined in the charter or anywhere else (de Jongh, 2011).

Clause 42 of the VOC Charter specifically exempted directors, who were also the active

shareholders, from salary debts. The charter does not refer to the event of insolvency and

dissolution.

The VOC was initially financed exclusively by equity investment. When resorting to debt

finance, each VOC City Chamber borrowed according to its needs and at the discretion of its

directors (active bewindhebbers). The survey of VOC bonds by Gelderblom et al. (2013) shows

that City Chamber directors contracted loans on their personal account, pledging their person and

goods. This personal borrowing may have resulted from the fact that each of the chambers, unlike

the VOC itself, was not viewed as a separate legal entity. The question of whether the passive

shareholders had limited liability was muted by the fact that the active shareholders assumed

personal liability. In 1617, the directors centralized borrowing and resolved that henceforth they –

13
See also Gepken-Jager (2005).
14
This dual class structure emerged out of earlier organizational history in the Dutch Republic. The VOC was a merger
of previous city-based precompanies. The precompanies, in turn, were based on the commenda model, which had
passive investing partners and active traveling partners.

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and not the City Chambers – would make any decisions to borrow. In 1622, bonds were no longer

issued and signed by the directors, but by the bookkeepers, and they no longer carried the

signatories’ customary guarantee of person and goods. But this happened because the VOC was a

legal personality and the directors ceased borrowing personally, acting instead as VOC agents

borrowing on its behalf. There is no evidence that the liability regime applying to passive

shareholders in the event of insolvency and dissolution was defined in 1602, in 1623, or at any

later stage, or that the liability attribute of the VOC was separated from the legal personality

attribute and conceptualized as a limited liability attribute in the modern sense.

Over the following years, the VOC’s resort to longer-term debt finance increased, as –

unlike the EIC – it did not raise additional equity investment beyond the initial public offering of

1602. However, the mid-life VOC was backed by the state and was never under real risk of

insolvency. When the VOC became insolvent in 1799, the Dutch government revoked its charter

and nationalized the company’s territorial possessions in Asia, plus its assets and debts (Sinninghe

and van de Vrugt, 2005). Limitation of liability, as we understand it today, was irrelevant

throughout its entire history.

In short, the two largest corporations of the 17th and 18th centuries, the EIC and the VOC,

had thousands of shareholders each. Their paid-up capital was in the millions and their shares were

traded successfully in high volumes on the Amsterdam and London Stock Exchanges – and all of

this without limited liability being one of their key features.

The corporate economy begins to expand

The Bank of England was formed in 1694 by an Act of Parliament and a Charter. Neither defined

the Bank as having limited shareholder liability, yet this did not prevent the company from opening

10

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public subscriptions for a capital of £1,200,000. The offering was fully subscribed, with 1,520

shareholders contributing from £25 to £10,000 each (Bank of England, 2018).

Late in the 17th century, Lloyds of London began to develop as a marketplace for marine

insurance. Individual underwriters, who formed syndicates for insuring ships, were not limited in

their liability. On the contrary, the fact that underwriters were fully liable for their share in the

ships’ insurance in the event of sinking backed this commitment, together with their personal

assets. In 1720, two new marine insurance corporations were formed, the London Assurance

Company and the Royal Exchange Assurance Corporation. The two were fully incorporated, but

their shareholders did not have limited liability. From the 1760s, further insurance companies were

established in the fire and life insurance subsectors. These were unincorporated and their

shareholders were not shielded with limitation of their liability.

But the fastest-growing corporate sector of 18th-century Britain was canals. In 1766, bills

were introduced in Parliament for two schemes, the Trent and Mersey Canal and the Staffordshire

and Worcestershire Canal. Both were conceived as joint-stock corporations (Harris, 2000: 95–

100). In the following decades, no fewer than 122 acts were passed for the incorporation of joint-

stock companies for the construction of canals, and more than £17 million was raised by canal

companies in the period before 1814. The Grand Junction Canal, the largest of all, required

eighteen times more capital than the Staffordshire and Worcestershire (£1,800,000 and. £100,000,

respectively) (Ward, 1974: 29–30, 43–6). 15 The financial model relied on equity investment,

initially from local investors, provincial financial markets, and exchanges, and over time, the

national market and the London Stock Exchange.

15
33 Geo. III c.80 (1793).

11

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 The main instrument for raising additional capital downstream, which was often needed as

the projects came in over budget, was by additional calls on the original shares. For this purpose,

the nominal value of canal shares was high, while the initially called-up capital could be as little

as 10% of the nominal capital. Bank loans were rare. Some of the companies borrowed from public

investors by issuing bonds, sometimes convertible into stock and usually secured by the future toll

income. Hence, under most scenarios, the shareholders bore the risks of loss of investment. When

debt finance was used, this was often when completion was in sight and repayment secured by

tolls. Thus, once again, limited liability in the modern sense did not feature here. Even if debt

finance had been used extensively, in the event of insolvency creditors could have collected the

uncalled capital from shareholders, which was often much greater than the called-up capital.

The number of joint-stock companies in the United Kingdom (UK) grew from 24 in 1740

to 61 in 1811, and 216 in 1834. The total nominal capital of these companies grew from £20 million

in 1760, to £90 million in 1810, rising to £240 million in 1844. They expanded into growth sectors

such as gas lighting, mining, and railroads, and by 1840 more than 35% of the British economy in

the sectors relevant for incorporation was incorporated in joint-stock companies (Harris, 2000:

193–98, 219, 297–300). The circle of investors presumably widened correspondingly, as

particularly evident in ownership of railway companies, while shares in unlimited companies

traded regularly on quite a liquid market, as evident in bank shares (Acheson and Turner, 2008;

Acheson et al., 2017; Rutterford et al., 2011; Thomas, 2013).

Jurists, courts, and legal discourse around corporations

On the level of legal discourse and legal doctrine, historians have offered three indications that a

doctrine of limited liability already existed in the late-18th century (DuBois, 1938). First,

12

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shareholders could not, in practice, be arrested for the debts of the company in which they held

shares, thus they could not be forced to pay its debts. Second, an Act of 1662 confirmed the

exemption of shareholders of certain trade corporations from bankruptcy procedures by holding

that they were not traders. 16 Third, it can be inferred from a judgment of 1671 that, when a

corporation was not authorized to make further calls upon its members, the debts of the corporation

could not be collected from them. 17 My interpretation of these three doctrinal pieces is that it was

the legal personality attribute of the corporation that provided the rationale for them – that is, they

did not emerge out of a modern limited liability concept.

The first general statute of Parliament that dealt with joint stock companies was the famous

Bubble Act of 1720. This statute was enacted amid the wild days of the South Sea Bubble, in

which numerous joint-stock companies were floated and speculative trade in company shares

reached an all-time peak. This Act prohibited the formation of undertakings that pretended to act

as joint-stock business corporations without obtaining a Charter or Act of Incorporation:

All undertakings . . . presuming to act as a corporate body . . . raising . . .

transferable stock . . . transferring . . . shares in such stock . . . without legal

authority, either by Act of Parliament, or by any Charter from the Crown, . . .

and acting . . . under any charter . . . for raising a capital stock . . . not intended .

16
13 and 14 Car. II c.24 (1662). Following a judgment in King’s Bench in the case of Andrews v. Woolward (1653),
in which a knight who was a shareholder of the EIC was found liable for a commission of bankrupts, the above act
was passed in Parliament. It exempted shareholders of the EIC, the Guiney Company, and the Royal Fishing Trade
from bankruptcy procedures, and rendered the above-mentioned judgment of King’s Bench void.
17
Salmon v. Hamborough Company (1671). In this particular case, the charter of incorporation gave the company the
power to levy on its members; and, on occasion, it used that power. In view of this arrangement, judgment was given
in favour of the debtor of the corporation. However, when such a power was not in the charter, no further calls could
be made and a degree of limitation of liability existed.

13

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 . . by such Charter . . . and all acting . . . under any obsolete Charter . . . for ever

be deemed to be illegal and void. 18

Note that it prohibited companies from pretending to have corporate entity, joint stock, or

transferable shares. But there is no mention of pretending to have limited liability for shareholders.

One can infer that the companies that bypassed state incorporation and turned directly to investors

in the market did not view limited liability as a lucrative attribute that could attract investors to

their companies. 19 I take this striking absence as further support for my claim that, in 1720, limited

liability had not yet come into being.

William Blackstone provided a comprehensive and authoritative digest of mid-18th-century

law applying to corporations in England. He wrote:

After a corporation is so formed and named, it acquires many powers . . . Some of

these are necessarily and inseparably incident to every corporation . . . The five

core attributes: to have perpetual succession, to sue and be sued by its corporate

name, to purchase lands, and hold them, to have a common seal and to make by-

laws. (1765: 462)

Limited liability is not mentioned in Blackstone’s chapter on the corporation –

either by this name or even as an idea. It is also entirely absent from the most significant

English corporation law book of the 18th century, Stewart Kyd’s Treatise on the Law of

Corporations (1793: 12). Indeed, no scenarios of insolvency of corporation or claims of

18
6 Geo I, c. 18 (1720).
19
See Harris (1994, 610–27).

14

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creditors are even discussed, so the absence is not just of the term or the concept, but of

the entire circumstances in which equity holders and creditors are in conflict and the

liability of shareholders can be defined.

The inexistence of the concept of limited liability in contemporary writings is further

echoed if we search for the term across the entire (digitized) corpus using Google resources (Figure

1).

Figure 1: Use of the Term “Limited Liability” in Google Database

Source: Google Books Ngram Viewer

The Google Books Ngram of “limited Liability” shows that the term first appeared in books

in the 1770s, but really picked up only in the 1830s. It appears only in the transition from our

Period I to Period II and, is used extensively only in Period II.

Limited liability in the modern sense kicks-in only when the corporation is not

only insolvent but is also being dissolved because of this. In 16th-century British law, the

15

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Crown could create a corporation at will (through a charter) and could also revoke a

charter at will, terminating the corporation. But, by the 17th century, the Crown could no

longer arbitrarily dissolve corporations; and misuse of charters had to be reviewed by the

court through the writs of quo warranto or scire facias before a charter could be

rescinded. By the 18th century, the main means of liquidating a corporation was through

special act of Parliament (Blackstone, 1765; Kyd, 1793). Kyd states:

The effect of the dissolution of a corporation is, that all its lands revert to the

donor; its privileges and franchises are extinguished; and the members can neither

recover debts which were due to the corporation, nor be charged with debts

contracted by it, in their natural capacities. (1793: 516)

This statement comes nowhere close to reflecting limited liability. Insolvency is not

mentioned as grounds for dissolution; the dissolution is not viewed as a collection measure on

behalf of creditors; and the rationale for the extinguishing of the debts is the death of the corporate

legal entity. Indeed, until the 19th century, bankruptcy procedures, both in Britain and the US, did

not apply to corporations, only to individuals. Insolvent corporations could only be dealt-with by

Parliament. The affairs of the York Buildings Corporation exemplify the impossibility of swiftly

dissolving an insolvent corporation. This entity was first incorporated by a letter patent issued by

King Charles II in 1665, and was reincorporated after the Glorious Revolution in 1690. During the

South Sea Bubble of 1720, it became involved in high-risk speculations, including lottery schemes.

From then on, its financial state was shaky, at best; and its creditors, sensing it was insolvent,

attempted to collect on their debts. But despite numerous litigations, it took an Act of Parliament

16

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to dissolve the company in 1829, over a century after the signs of financial insolvency (Cummings,

1980; Murray, 1883). At no stage during these century-long proceedings could the issue of

personal liability of shareholders be discussed, because the corporation was not dissolved and its

inability to pay its debts in full was not ascertained.

Legal personality is not limited liability

As I have demonstrated, the period 1600–1800 predated the emergence of the attribute of limited

liability in the modern sense. One should not read my argument as claiming the attribute of limited

liability existed but was not yet conceptualized in this period: pre-1800 business corporations

simply predated the relevance of limited liability. Corporations then were not unlimited but they

were not limited either – hence, the question of limited vs. unlimited liability had not yet been

formulated. What may have misled some scholars are the manifestations of the separate legal

personality of the corporation. The implication of the legal personality attribute of the corporation

was that the corporation was not a pass-through enterprise but a liability-bearing entity. But

without debt finance, without a procedure for dissolving insolvent corporations, without the legal

ability to determine whether shareholders would bear liability in insolvency, limited liability in the

modern sense could not yet exist.

The corporation went through a fundamental organizational transformation around 1600.

It became a for-profit entity with joint-stock capital and transferable shares, but no parallel

invention of the limited liability attribute. Within a few decades after 1600, business corporations

with thousands of shareholders and an active market for corporate shares were thriving, despite

predictions to the contrary under the theory of limited liability. This organizational revolution, in

which limited liability did not feature in the publicly-traded corporation – a scenario theoretically

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inconceivable to some academics – had far-reaching economic consequences in the form of the

rise to dominance of business corporations in long-distance Eurasian trade. The two largest and

longest-lasting joint-stock business corporations of the 17th and 18th centuries did not need – and

hence did not develop – the notion of limitation on shareholders’ liability. Nor did the Bank of

England and the several insurance corporations established during the post-1688 financial

revolution. This was also the case with the transport revolution of the 18th century. For the first

two centuries of its history, the business corporation did just fine without any help from limited

liability.

3. The Transition to Period II: The Emergence of Limited Liability 1780–1855

It was somewhere between 1780 and 1830, I claim here, that shareholder liability evolved distinct

from the attribute of legal personality. The transition from what I term Period I to Period II is a

turn from a world in which liabilities were determined by the legal personality, to one in which the

liability dimension became detached and formed a distinct attribute of the corporation. I will

substantiate this argument by calling attention to important developments that the literature

hitherto overlooked or failed to connect to the emergence of the attribute of limited liability.

Unincorporated and unlimited

The unincorporated company was a new organizational form created in Britain in the second half

of the 18th century. This form was a bypass created out of necessity, due to the reluctance of the

Crown and Parliament (and the opposition of vested interests) to incorporate new business

corporations in the aftermath of the 1720 South Sea Bubble (Harris, 2000). Unincorporated

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companies were formed by shrewd lawyers at the service of businesspersons in the realm of private

law. These lawyers used legal devices such as private contracts, the common law partnership, and

particularly the trust to hold assets in a single pool, turning the company’s directors into trustees

that governed these assets (DuBois, 1938: 94–104). These companies acquired the financial

attributes of joint-stock capital and transferable shares, but they could not enjoy the status of a

separate legal personality (which at the time could only be provided by the State in the realm of

public law).

Because their shareholders were not shielded by the separate legal personality of the entity,

unincorporated insurance companies often limited the liability of shareholders toward insured

persons by means of clauses in the insurance policies. But shareholders were fully exposed to tort

liabilities and contractual liabilities that were not explicitly limited in written contracts. Thus,

shareholders in unincorporated companies were liable for the company’s debts in so far as these

were not limited in contracts with third parties. By the late-18th–early-19th century,

unincorporated companies were at a considerable disadvantage relative to the business

corporation. But it became evident that a joint stock company could be formed with (corporation)

or without (unincorporated) limited liability, with no supporting legislation. Entrepreneurs could

consider whether to invest the effort and money required to apply for full incorporation, or settle

for the unincorporated form. Limited liability had taken its first step toward being a separate and

desirable attribute.

Drafting incorporation acts

Somewhat similarly, the shift from incorporation by charters to incorporation by private and

special Acts of Parliament created a way of defining limitation of shareholders’ liability separately

from legal personality. In the chartering era, the Crown used a template that included a standard
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legal personality clause (like the “body corporate and politic” clause in the EIC charter) but no

reference to shareholder liability. When incorporation moved to Parliament, drafting was openly

negotiated between entrepreneurs, parliamentary agents, and MPs, meaning that limitation of

liability could be included in incorporation acts. Explicit clauses dealing with shareholder liability

were included in some incorporating statutes, and gradually such clauses became common. 20

Toward the end of the 18th century, limited shareholder liability became a declared motive

of entrepreneurs who petitioned for incorporation, claiming it was essential for the success of their

undertakings. 21 Montefiore, in his Trader’s and Manufacturer’s Compendium of 1804, wrote that

incorporation was indeed sought “principally for the purpose of exempting the shareholders from

any responsibility as partners” (235). Thus, by the early-19th century, the limitation of liability

was on a par with, or even surpassed, the raising of a large joint-stock capital as the leading motive

for incorporation.

The issue then filtered back to charters. In 1825, the Bubble Act of 1720 was repealed. This

statutory repeal legalized (subject to the common law) the formation of unincorporated companies

(Harris, 1997). The second section of the 1825 Act gave the Crown discretion to grant charters

without full limited liability. 22 This, according to Attorney-General Copley, the drafter of the

repeal Act, would make law officers more willing to grant charters, and would encourage

promoters to apply for charters rather than for Parliamentary Acts of incorporation (HC Deb 02

June 1825). We learn in retrospect from the fact that, in 1825, a specific legislative arrangement

20
Such clauses can be found in 4 Geo. III c37 (1764) for the incorporation of the English Linen Company; 26 Geo.
III c 106 (1786) for the incorporation of the British Society for Extending the Fisheries; 31 Geo. III c55 (1791) for the
incorporation of the Sierra Leone Company.
21
See DuBois (1938: 94–98) for cases in the last third of the 18th century, in which limitation of liability was a
declared motive for incorporation. These include the cases of Warmley Company, Albion Mill, Sierra Leone
Company, and British Plate Glass Company. In the case of the Globe Insurance Company, early in the 19th century,
the request for limited liability was the centre of the debate.
22
6 Geo. IV, c91 (1825), sec.2.

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had to be made to legalize the granting of charters without full limited liability: limitation of

liability had not been considered an attribute dealt-with by charters until then.

The General Incorporation Acts

General incorporation legislation created the opportunity (and need) to define the attributes of

corporations, including their liability regime. Here I shift attention to the US, because the first such

acts were drafted and passed there. New York was the first jurisdiction in the world to enact general

incorporation law in 1811, initially only for manufacturing companies (Hilt, 2008). The Act

relative to incorporation for manufacturing purposes of 1811 served as a model for similar acts

enacted in New Jersey (1816) and Connecticut (1837) (Cadman, 1949; Kessler, 1948). The terms

of the Act included a low maximum capitalization of $100,000, a short life of only twenty years,

and a shareholders’ liability provision, Section 7:

. . . all debts which shall be due and owing by the company at the time of its

dissolution, the persons then composing such company shall be individually

responsible to the extent of their respective shares of stock in the said company,

and no further. 23

This Act has been positioned by some historians of US corporations as the first declaration

of general limited liability (for manufacturing companies) (Wright, 2010). But Stanley Howard

(1938) convincingly shows that the case law that interpreted and applied the act did not view it as

creating full limited liability in the modern sense. In the cases of Slee v. Bloom (litigated between

23
An act relative to incorporation for manufacturing purposes, passed March 22, 1811. Sess. 34, Chap. 67.

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1816 and 1823) and Briggs v. Penniman (litigated between 1819 and 1826), the judges were

uncertain how to apply Section 7. Eventually, Judge Woodworth of New York’s Court of Error

held that: “Every stockholder, in a company of this description, incurs the risk of not only losing

the amount of stock subscribed, but is also liable for an equal sum, provided the debts due and

owing at the time of dissolution, are of such magnitude as to require it.” This is what Howard

(1938) justly terms “double liability.” So liability was perceived in the 1811 New York Act as an

attribute separate from legal personality. A mandatory double liability regime was thus set.

In the first half of the 19th century, Massachusetts granted the highest number of corporate

charters of any American state. The charter of the first Massachusetts manufacturing corporation,

granted in 1789, contained no reference to individual liability. This was also the case in a few other

late-18th-century charters, while others provided that, if a judgment against the corporation

remained unresolved for six months after its dissolution, it should be satisfied out of the private

property of the members. Some early-19th-century charters stipulated that, if a judgment could not

be collected from a corporation, individual shareholders were personally liable. Interestingly, in

the early-19th century Massachusetts refused to grant limited liability to any manufacturing

corporation, but it did eventually separate the attribute of shareholders’ liability from that of

separate legal personality. This did not, however, create universal limited liability in the modern

sense.

Corporate liquidation procedures

As we have seen, in the era of incorporation by charters and special Acts of Incorporation,

dissolution could only be realized by a revocation of the charter or repeal of the act. Creditors

could not take an insolvent corporation to court and liquidate it. In the UK, it was not until 1844

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that the first act to establish a procedure for the winding-up of companies was enacted. This

immediately followed the 1844 General Incorporation Act, 24 which made general incorporation

by registration available in the UK, thus rendering a winding-up procedure also necessary. The

1844 United Kingdom Winding-up Act applied a procedure to registered companies that was

similar to the bankruptcy procedure applied to individuals. Now, for the first time, with permission

from the Chancery Court, creditors could dissolve insolvent companies to collect from their

shareholders. This act connects the dissolution of registered companies to the earlier doctrines that

applied to the dissolution of partnerships (Baker, 2007; Getzler and Macnair, 2005).

In the US, the Constitution made bankruptcy a federal issue and incorporation a state law

issue. This fact made the US path to corporate liquidation different from the British one. The short-

lived Bankruptcy Acts enacted by Congress in 1800 and 1841 did not apply to corporate entities,

and there was significant opposition to such application on constitutional grounds. It was argued

that, as corporations were created by states, they should also be liquidated (exclusively) by states.

But the growing interstate nature of railroad corporations weakened this constitutional view.

Corporations were permitted for the first time to take advantage of the 1867 Bankruptcy Act, which

applied not only to merchants but to any individual including corporate persons. Corporate

insolvency became a major issue only in the 1870s, during the wave of railroad companies’

failures. These failures were not dealt with straightforwardly by the Bankruptcy Act, which

provided corporate liquidation procedures via federal and state judiciary using equity receivership

tools, to avoid the liquidation of large concerns mid-way through construction of essential railroad

lines (Skeel, 2001: 48–70). It was only in the late 1860s and 1870s that US corporations could be

24
7 and 8 Vict c110 (1844); 7 and 8 Vict c111 (1844).

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liquidated due to insolvency in a manner that exposed the question of whether shareholders were

subject to liability or to a limited liability regime.

Debt finance

The late creation of corporate insolvency and bankruptcy procedures in Britain and the US can be

explained by the demand for such mechanisms in the corporate economy of Period I. Debt only

gradually became a secondary source for financing the large infrastructure projects of the transport

revolution. The loans for river and turnpike projects were more municipal than private, and were

secured by the tolls. Canals and railroads were financed initially by locally-floated equity

investment. Often, shares in canals and even railways were traded locally on provincial stock

exchanges (Ward, 1974; Evans, 1937; Baskin et al., 1999). Debt finance was only sought when

investment was required from non-locals at an informational disadvantage (such as London

investors for canals in Yorkshire, or for US railroads) (Chandler, 1954). To reduce risks, the debt

was raised after equity had been raised in the region served by the route in question, and the real

estate of the project was offered as a security. The total number of corporate debentures listed in

1860 on the UK Stock Exchanges was just nine, all in railway ventures, and their nominal par

value was just £5.8 million (Coyle and Turner, 2013). The corporate bond market grew slowly,

and by the 1880s was still composed mostly of railway bonds. The real par value of bonds and the

par value of bonds per GDP reached a peak in 1909. This small (compared to equity) and slow-

growing (in real terms and compared to GDP) corporate bond market in such a late period simply

cannot explain the transition from Period I to Period II and the separation of the limited liability

attribute. What we have here is not a story of shareholders calling for a limitation of their liability,

in the face of growing need for debt finance. Situations in which corporate insolvency could open

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up the issue of the liability of shareholders simply did not present themselves in Britain or the US

before the middle of the 19th century.

4. Period II: A Continuum of Liability Regimes, 1800–1930

Proponents of the evolutionary-convergence-to-efficiency hypothesis may view this middle period

of multiplicity of regimes as a brief and unremarkable stage during which inefficient liability

configurations were rejected in favour of the most efficient organizational regime – limited liability

in the modern sense. However, I argue in this section that this century-long period of growing

economies, expanding sectors, and successful enterprises at the height of Western industrialization

cannot be dismissed as a mere hiatus. For more than a century, different configurations of

shareholder liability along a continuum were selected by different jurisdictions, sectors, and

companies in what seems to be a successful manner. We can gain important insights from this

period.

Unlimited liability jurisdictions

As we have seen, the development of the conceptualization of limited shareholder liability as a

distinct attribute emerged out of the conceptualization of unlimited liability. State jurisdictions

realized they could select where to position themselves on the liability continuum, and some opted

for unlimited liability.

Let us start with the US. Massachusetts, unlike New York, opted to position itself at the

unlimited liability end. Did this negatively affect economic development, as theory suggests? The

short answer is “no.” Its chosen unlimited liability regime did not prevent Massachusetts from

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being the most advanced corporate economy in the US in terms of the number of charters issued

to manufacturing firms, rising from 15 charters in the 1800s to 133 in the 1810s, and 146 in the

1820s. Following a wave of business failures in 1829, the 1830 Massachusetts Act Defining the

General Powers and Duties of Manufacturing Corporations was passed. The law imposed a charter

clause that limited the liability of shareholders to the unpaid balance on the shares (Hilt, 2016).

No less an authority on corporation law than E. Merrick Dodd, Professor of Law at Harvard

University, the initiator of Corporate Social Responsibility, Adviser to Restatement of Business

Associations, and one of the most prominent corporate law jurists of the first half of the 20th

century, asserted publicly that neither the absence nor the subsequent introduction of limitation of

liability was relevant for economic growth. Dodd’s research shows how the years before the

introduction of limited liability in Massachusetts in 1830 witnessed the formation of textile

corporations with capital of $500,000–$1,000,000 – large-scale by contemporary standards. The

shares of these corporations were traded on the Boston Stock Exchange. Dodd observed that the

textile industry and manufacturing in New York, a jurisdiction with general limited liability

(double liability) for manufacturing companies since 1811, grew no faster or larger than in

Massachusetts, where it was introduced a full two decades later (Dodd, 1948: 1,366–71). The

leading industry of the time (textiles) in a leading industrial state (Massachusetts) seems not to

have been adversely affected by holding to a regime of unlimited liability during this crucial pre-

1830 industrialization phase.

Therefore, it is not that the introduction of full limited liability in Massachusetts in the 1830

Act unleashed hitherto-constrained demand for the limited liability corporation; in fact, the number

of incorporations followed the same trend as in the previous period. This suggests that limitation

of shareholders’ liability was not a major factor, given the financial structure of the companies and

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the available winding-up procedures. The real jump in the volume of enterprises took place in later

years, but this was thanks to new manufacturing technologies and had nothing to do with the

limited liability alternative.

Massachusetts and other New England states gradually adopted and extended limited

liability laws. But there is no evidence, from the current state of research, that they did so because

unlimited liability had retarded their economic growth. Nor is there evidence suggesting that an

evolutionary process weeded-out the unlimited liability regime, which did not fit the economic

needs in, favour of a more efficient limited liability regime better equipped to facilitate economic

growth. Further controlled econometric comparison of the role of endowments and institutions in

the growth of Massachusetts and New York would definitely make a worthwhile contribution to

the extant literature.

General limited liability

Returning to the British case, the 1855 General Limited Liability Act allowed incorporators to

decide how much to personally owe creditors, by determining how much of the nominal capital

was not to be paid up initially. It stated:

If there cannot be found sufficient [property in the company], execution . . . may

be issued against any of the shareholders to the extent of the portions of their

shares respectively in the capital of the company not then paid up, but no

shareholder shall be liable to pay . . . a greater sum than shall be equal the portion

of shares not paid up. 25

25
18 and19 Vict c133 (1855), sec.9.

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 No single liability model derived from this Act. Nor did the subsequent 1862 Companies

Act impose a single mandatory rule:

The Liability of the Members of a Company formed under this Act may, according

to the Memorandum of Association, be limited either to the amount, if any, unpaid

on the Shares respectively held by them, or to such amount as the Members may

respectively undertake by the Memorandum of Association to contribute to the

Assets of the Company in the event of its being wound up. 26

The 1862 Act did not set a default rule that incorporators could opt out of either. The

liability had to be drafted by the incorporators into the Memorandum. This enabled the

incorporators – and later, the directors – to design the desired level of liability by determining the

level of nominal capital and varying the percentage of that capital that was actually paid up. This

drafting also opened the way for the use of reserve liability, to which we will turn later.

Liability for unpaid balance

The common practice of issuing only partly-paid company shares, which began with canals and

railway companies, continued also after the enactment of the two aforementioned 1855 and 1862

Acts. It was initially a response to cash-flow needs in equity investment, but eventually was used

also as security for corporate creditors. Several scholars, studying public companies, suggest that

a significant gap existed between nominal and paid-up capital of companies in the mid-19th

26
25 and 26 Vict c89 (1862), sec. 7.

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century and that the gap narrowed only as the century progressed. Jefferys (1946), in a classic

study, analysed the paid-up capital of listed companies for 1856–85, and found the ratio of paid-

up to nominal capital increased over time. Shannon (1933) argued that the gap between nominal

and paid-up capital in low-denomination shares narrowed considerably between the 1860s and

1880s, but that this was not the case with high-denomination shares. Acheson et al. (2012) found

that, for three sample years (1825, 1845, and 1865), the paid-up–nominal capital ratio was 58.1%,

58.4%, and 67.4%, respectively. In my 2013 study, I concluded (based on a dataset created with

Guinnane, Lamoreaux, and Rosenthal) that, by 1897, 47% of the sample companies had paid-up

capital of 60% or more. The average paid-up capital of the sampled companies (that reported) in

1897 was calculated at 70% (Harris, 2013a: 34–35). Based on these studies, one can conclude that,

as late as the turn of the 20th century, the practice of issuing shares that were not paid in full was

still common in Britain. As long as this practice continued, limited liability in the modern sense

was therefore not yet the dominant practice.

Divergent liability regimes in banking

In Britain, the divergent continuum of liability regimes was manifested in banking more than in

any other sector. Acheson et al. (2010) provide the most comprehensive survey of liability regimes

in the banking sector in England, Scotland, and Ireland. A handful of banks were state-chartered:

Bank of England (est. 1694); Bank of Ireland (1783); and the three Scottish banks – Bank of

Scotland (1695), Royal Bank of Scotland (1727), and British Linen Bank (1746). But these banks

were not explicitly chartered with the limited liability attribute, because their establishment

predated its separation from the personality attribute. Up until the mid-1820s, these banks enjoyed

the privilege of being the only note-issuing banks in England and Ireland to be organized as

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corporations, and other banks were excluded from this organizational form and were not permitted

to have more than six partners. By this, they were also excluded from the unincorporated joint-

stock form.

Parliament permitted the incorporation of unlimited liability joint-stock co-partnership

banks in Ireland by means of the Banking Copartnership Regulation Act (1825), and in England

the Banking Copartnerships Act (1826). The liability of shareholders in such banks was joint and

several. I interpret these Acts as a manifestation of the separation between the personality and

liability attributes of the corporation. They also clarify, I believe, that the older chartered banks, in

fact, also had a shareholders’ liability attribute that was separated from the legal personality

attribute. For example, by 1825 the Bank of England (which, as we have seen, was not established

with limited liability in mind) was understood to have this attribute. Only an 1826 statute legalized

the unlimited joint-stock bank in Scotland. 27

By 1826, unlimited liability joint-stock banking had become available throughout the UK.

Banks were excluded from the initial General Incorporation Act of 1844 and the General Limited

Liability Act of 1855, but by 1858, they were allowed to incorporate by registration with limited

liability. This enabling legislation abolished the distinction between chartered banks and registered

limited-liability banks.

The study conducted by Acheson et al. (2010) illustrates my contention regarding the

divergent liability continuum, by showing that the banking sector in Britain did not converge into

one single liability regime in the 19th century, but rather came to enjoy a choice of four regimes

(see Table 1):

27
Freeman et al. (2007). There is a debate, which is beyond our immediate scope of interest, with respect to the
influence of civil law on the legal status of joint-stock banks in Scotland before 1826.

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 Table 1: Liability Regimes in UK Banking, 1849–1889

Liability regime 1849 1869 1889

ENGLAND and WALES

(1) Limited liability banks (State-charter) 1 1 1

(2) Unlimited liability joint-stock banks 113 73 2

(3) Limited liability joint-stock banks - 41 40

(4) Reserve liability joint-stock banks - - 62

IRELAND

(1) Limited liability banks (State-charter) 1 1 1

(2) Unlimited liability joint-stock banks 10 7 0

(3) Limited liability joint-stock banks - 1 0

(4) Reserve liability joint-stock banks - - 8

SCOTLAND

(1) Limited liability banks (State-charter) 3 3 3

(2) Unlimited liability joint-stock banks 18 9 0

(3) Limited liability joint-stock banks - 0 0

(4) Reserve liability joint-stock banks - - 7

Source: Adapted from Acheson, Hickson, and Turner (2010: 250).

So more than one liability option existed, and more than one option was actually selected,

during each of the three time-points surveyed by Acheson et al. (2010). We can observe that

absolute unlimited liability had disappeared by 1889, but there is no sign of convergence to limited

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liability in the modern sense during the period covered in their study. Questions for historical

empirical researchers remain. But, for now, we can conclude that the banking sector in England,

Scotland, and Ireland seems to have functioned for a significant time without limited liability in

the modern sense.

Reserve liability

The fourth and last type of bank liability to appear in UK banking, in the 1880s, was reserve

liability. Enacted in the aftermath of the City of Glasgow Bank’s collapse, the Companies Act

(1879) intended to facilitate the conversion of existing unlimited joint-stock banks to limited

liability companies. The main innovation of this Act was that it allowed the creation of “reserve

liability” – a sum of capital that could be called only upon insolvency and liquidation of the

company. Unlike uncalled capital, which could be used by directors of solvent companies to

complete projects, reserved capital was used to protect creditors. Again, reserve liability offered a

continuum rather than a single liability regime. Many banks selected double or triple liability, and

others had different multiples of nominal par-value of the shares.

Reserve liability was also common in the US. Some states imposed double liability on all

corporate shareholders, while many imposed it particularly on banks. This requirement was

initially imposed by clauses in specific charters and then state general statutes – even state

constitutions. In 1863, the Federal Government entered the field of regulation of banks with the

National Banking Act. This Act required that “each shareholder shall be liable to the amount of

the par value of the shares held by him, in addition to the amount invested in such shares”. A year

later, the Act was amended to make the liability of each shareholder proportional to their

shareholding. Most states implemented the federal legislation in their own laws, making

shareholders in banks bear proportionate double liability (Blumberg, 1985: 599–601).

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 5. The Transition to Period III: Convergence to a single, uniform liability regime

In both the UK and the US, the decades between the late-19th century and the mid-20th century

marked a critical turning point in this history, worth of scholarly attention in its own right. The

transition saw a divergent menu of liability regimes across a continuum converge into to a single

model – that of limited liability as we recognize it today.

Jurisdictions that had made unlimited liability the mandatory regime in the early 19th

century now, one by one, shifted to full limited liability. As we have seen, Massachusetts did this

in 1830. Rhode Island was the last New England state to enact limited liability for manufacturing

companies. 28 Gradually, perhaps with the exception of the banking sector, general incorporation

acts that included the limited liability attribute expanded beyond manufacturing.

Interestingly, California was slower to turn to fuller limitation of liability of shareholders,

opting instead for pro-rata unlimited liability, which took until 1931 to be fully abolished

(Weinstein, 2005). Yet the late introduction of the limited liability regime did not prevent

California from achieving a much faster rate of growth than most other US states. Indeed, the rate

of growth of manufactured goods in California was faster in the 1920s than that of any other US

state; several sectors flourished in a fifty-year period in which California was not yet offering a

full limited liability regime. I am not arguing here that a significant share of California’s growth

rate should be attributed to the pro-rata liability regime; but nor is there any compelling argument

that the lack of full limited liability slowed down its phenomenal growth. We know from Mark

Weinstein’s illuminating study (2003) that the shift to a limited liability regime had no significant

28
The State of Pennsylvania never fully recognized unlimited liability corporations. The judiciary read the limited
liability of shareholders as one of the manifestations of the corporate personality attribute.

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effect on share prices, which suggests that the previous regime did not repress the value of

corporations. The point I am making here is that California serves as one more example of an

economy that was able to grow fast and facilitate the expansion of big business corporations and

functioning stock markets without adopting a limited liability regime.

Returning to the British case, as we have seen, the 1862 Companies Act enabled

incorporators to design the liability regime of the corporation in its Memorandum of Association.

The Memorandum could establish a “Company limited by Shares” in which shareholders were

liable only for the unpaid balance on the shares, or a “Company limited by Guarantee,” in which

the shareholders undertook to contribute a set amount in the event of the winding-up of the

company. So the 1862 Act, which became a model for company acts throughout the British

Empire, was an enabler. It allowed the formation of companies with limited liability in the modern

sense – that is, companies with liability for unpaid-up capital with varying percentages of paid-up

capital and reserve liability, with different multipliers. The selection of the liability model was

made at the individual corporation level: the convergence to a single liability model did not happen

at statute level. We can see, then, that the universal process of convergence took decades to

complete, but its exact rate and timing are under-studied and deserving of additional investigation.

Reserve liability, be it double liability, triple liability, or other multipliers, could be

achieved on the corporate level or on the regulatory level. Insofar as I can tell, initially, different

corporations selected varying levels of liability, but during in the transition to Period III the

voluntary adoption of double or triple liability eventually faded-out. One notable exception was

the banking sector. As we have seen, in England, forty banks with full limited liability operated

alongside sixty-two reserve liability banks in 1889, while reserve liability remained a feature of

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British banking until the mid-1950s (Turner, 2014: 132; Turner, 2017). In the US, reserve liability

(in the form of double liability) was imposed by state regulation and federal regulation.

The double liability requirement for new banks was revoked in the federal banking

regulation in 1933–35. The Great Depression and the introduction of deposit insurance as part of

the New Deal are considered the main motives for this revocation. The federal Act that applied to

existing banks was repealed in 1959. State-level laws and bank charters gradually gave up on

reserve liability as well (Macey and Miller, 1992).

6. Conclusions and Implications

I have justified here my claim that both common narratives of the history of the origins of the

limited liability attribute of the business corporation are mistaken. Limited liability in the modern

sense was not an attribute of the first business corporations around 1600, and nor was the British

General Limited liability Act of 1855 a watershed in the history of this attribute. I believe the

preconditions for the manifestation of the attribute of limited liability in the modern sense were

created both in Britain and the US in around 1800. The understanding that shareholders could be

either liable, or not, for corporate debts, and that corporations could have unlimited liability was

new. So the first turning point in the history of limited liability was the separation of this attribute

from the legal personality attribute and the creation of a new dimension offering different liability

regimes. The second turning point, more than a century later, was the completion of a process of

convergence to a single, uniform and universal liability regime at the far end of the continuum,

rendering full limitation of shareholder liability the standard. Limited liability in the modern sense,

I contend, is less than a hundred years old.

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 So what does the revised history of limited liability I offer here tell us about economic

performance? And the theory of limited liability? The corporate economy and the stock market

began to function in our Period I, long before limited liability in its modern sense was first

manifested. An economy comprising thousands of public corporations, featuring hundreds of

thousands of shareholders and liquid stock exchanges in which wide segments of society invested,

expanded over the course of our Period II, in the era of divergent liability regimes. These

corporations – with their unlimited liability, liability to unpaid capital, and double and triple

liability – contributed the lion’s share of the GDP of industrialized economies up until the end of

the 19th century (Figure 2).

Figure 2: Growth of GDP per Capita in Britain and Periodization of Limited Liability (Our World

in Data, 2015)

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 Period III, post-convergence into our modern, uniform full limited liability regime, is not,

I believe, one in which a perfect, fully-efficient liability regime was selected in the service of

economic growth. Take the example of investment banking – the last major sector to converge to

the modern liability model. Until 1970, the New York Stock Exchange required that investment

banks be organized as partnerships in which partners bore unlimited liability, or closely-held

corporations in which shareholders could be personally liable for debts. In three waves, in the early

1970s, around 1985, and lastly with Goldman Sachs in 1999, they all eventually became

corporations with limited liability and went public (Morrison and Wilhelm, 2008). By 2007, these

banks had reached an unprecedented debt-to-equity leverage ratio of 25 to 35 (Figure 3).

Figure 3: Leverage Ratios for Investment Banks, 2003-2007

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 Source: Chang, 2011

The rest of the story is familiar: the 2007 subprime crisis, the 2008 collapse of the

investment banks, $1,250 billion in accumulated losses suffered by banks worldwide, and a US

and European government financial bailout to the tune (according to one calculation) of $4,100

billion.29 I do not argue here that the crisis and losses were caused by the convergence of the

financial sector into a full limited liability regime. But higher leverage, assumption of higher risks,

and intense conflicts of interest between creditors and equity investors are a possible ramification

of the limitation of liability of hitherto personally-liable partners. I urge scholars not to assume

that the convergence was an evolutionary drive to efficiency and that the outcome of the

convergence – full limited liability in all sectors including investment banking – is necessarily

“first best”. The burden is on the dominant theory of limited liability to check and reconcile its

predictions with the consequences of the 2007 crisis. Some economists and lawyers took the

challenge it offered to re-evaluate the application of limited liability in the modern sense to

investment banks and the financial sector more generally, and proposed some tentative alternatives

to full limited liability (Dealbook, 2008; Hill and Painter, 2010; Admati et al., 2018).

Nor do I wish to claim that the theory of limited liability is worthless. It captures well the

shortfalls of unlimited liability. Full joint and several liability of each shareholder is a non-starter

in the 21st century. One should not use it as a straw person. The current theory can partly explain

the advantages of limited liability in the modern sense, but it fails to assess sufficiently the viability

of other liability regimes or the shortfalls and costs of full limited liability in the modern sense.

More empirical studies – comparing jurisdictions with different liability regimes, sectors with

29
For the bailouts: Anderson et al. (2008).

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different liability regimes, and the before-and-after of the introduction of a specific liability regime

– can take us a long way toward better understanding the economic history of the 19th century and

the economic theory of limited liability.

On the positive side, this paper offers a first take on explaining the transition from Period

I to Period II, namely the crystallization of the liability attribute and the opening-up of the liability

continuum. I do not offer here an explanation for the second transition, namely the convergence to

a single liability regime. But I reject the assertion that convergence was the outcome of an

evolutionary selection of the optimal liability regime (full limitation in the modern sense). That

interpretation mistakenly relegates Period II and the transition to Period III, in my

conceptualization, to the category of a mere hiatus, a footnote in the history of limited liability and

the rise of the corporate economy. But if full limited liability was the outcome of an evolutionary

process, why did it take more than a century to sort out the most efficient liability regime and why

the initial process was one of divergence rather than convergence? How could the Industrial

Revolution unfold before the recourse to limited liability? Who led this process and who benefitted

from it? Does the convergence have anything to do with the political economy of financial

regulation, with the Great Depression and the New Deal? Why did we end up with limitation of

liability for all types of debt, including tort debts, while theory doesn’t favour this (Hansmann and

Kraakman, 1991)? Current theory of limited liability does not provide tools for addressing these

puzzles (only a handful of historical-empirical studies touch upon aspects of them). I myself hope

to study the causes of this convergence in a continuing project. Such studies will be instructive for

a variety of issues including the legal-economic history of the corporation and the role of law and

organizations in economic development.

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 Aside from challenging the deeply-embedded historical narratives that surround the birth

of limited liability, this study also renders an understanding that is pertinent to today’s corporate

operations. The continuum that I posit – which opened up in the 19th century between unlimited

liability and full limited liability in its modern sense, and the various financial schemes and

institutional environments of the time – can be exploited to expand our imagination and consider

alternative liability regimes for different sectors (particularly the financial sector) and different

types of corporations in the 21st century.

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