Articles The Death of Liability Lynn M. LoPuckit CONTENTS I. LIABILITY SYSTEM PRINCIPLES .......................... 8 A. Enforcement Only Against Properti. .................... 9 B. Property of the Debtor ............................... 9 C. Transferability of Property. .......................... 10 D. Exemption ........................................ 10 E. Subordination .................................. 11 F. Discharge on Demand .............................. 12 G . Productive Use ................................. 12 H. Enforcement Only After Judgment ...................... 13 I. Territoriality ...................................... 13 II. JUDGMENT-PROOFING STRATEGIES ....................... 14 A. Secured Debt Strategies ............................. 14 B. Ownership Strategies ............................... 19 1. Parent-Subsidiary'................................. 20 2. Asset Securitization.............................. 23 C. Exemption Strategies ............................... 30 D. Foreign Haven Strategies ............................ 32 III. CONSTRAINTS ON JUDGMENT PROOFING ................... 38 A. The Self-Inunolation Argument ......................... 40 t A. Robert Noll Professor of Law, Cornell Law School I ha'e benefitted gratl, from comments received in workshops at the UCLA, Cornell. Duke. and Harvard lass schools and from cons ersations %%ith Michael Cannon, Steve Schwarcz, Bob Thompson. and John \\eistart I thank Deborah DeMott, Frances Foster, Jesse Fried, Steve Harris, Kate Heidi, Dan Keating. Bill Klein. Dasd Lander. Ronald Mann. Thomas Redding, Bernard Rudden, Steve Schwarcz. Gary Schwartz. Bob Thompson. Jim Whitc. Elizabeth Warren, and Julianna Zekan for comments on earlier drafts. Debbie Carmichael for editonal asistance, and David Conway and Jennifer Bae for assistance with research B. The PrecariousPosition of Managers .................. 42 C. The Marginality of Liability ......................... 43 D. Legal and Clerical Costs ........................... 47 E. Culture and Politics .............................. 51 IV. RADICAL SYSTEM RESPONSES .......................... 54 A. Shareholder Unlimited Liability ...................... 55 1. Passive Strategies ............................. 56 2. Pass-Through Strategies ........................ 57 3. Trust Strategies .............................. 58 4. Foreign Investment Strategies .................... 59 B. Involuntary Creditor Priority ........................ 61 C. Asset-Provider Liability ............................ 64 D. EnterpriseLiability ............................... 67 E. Trading PartnerLiability .......................... 69 F. Liability Insurance ............................... 71 1. The Limitations of Liability Insurance ............... 72 2. The Lack of Economic Incentives to Purchase Liability Insurance .................................. 76 3. The Limitations of Compulsory Liability Insurance ...... 80 4. Designing a Compulsory Liability Insurance System ..... 83 5. The Political Limits of Compulsory Liability Insurance ... 85 G. FinancialResponsibility Requirements ................. 88 V. CONCLUSION ...................................... 89 19961 Death of Liability Think of the liability system as a poker game. Each person, corporation, or other entity in the economy is a player. Players risk their chips, that is, their wealth, by tossing them into the pot, that is, investing them in liability- generating economic activity Chips contributed to the pot are at risk of loss; the system can take them to satisfy liability. Chips withheld are not at risk. This poker game has an odd twist to it. Withholding chips does not reduce significantly the amounts players can win or players' likelihood of winning. Even players who don't put any chips in the pot-that is, players who are judgment proof-can keep playing the game and are eligible to win. Why do players put chips in the pot? No rule requires them to do so. There are social, cultural, and economic pressures. But mostly, they do so for convenience. A wealthy player who wants that wealth availablefor use, but not in the pot to be lost through liability must build arcane legal structures and document them through extensive record keeping. In recent years, computer techmology has dramatically reduced the cost of record generation and, consequently the cost of keeping chips out of the pot. Major players are reducing their stakes. By doing so, they are breaking down the social norms and cultural barriers that prevent fitrther reductions. The process is feeding on itself Soon no one will have significant chips in the pot. When that happens the fundamental nature of the game will change. Liability will die. Law is a system for controlling human behavior. In contemporary society, governments enforce law by essentially two mechanisms: incarceration and liability. These roughly correspond to the two spheres of the legal system: the criminal and the civil. In the criminal sphere, the wrongdoer is threatened with imprisonment; in the civil sphere, the wrongdoer is threatened with deprivation of wealth.' Liability is crucial because it is one of only two principal means 2 by which governments enforce law. I. Within both spheres, social shaming is a significant element of the sanction It Is less so in the c1%il sphere, and, as will be discussed in this Article. is declining in respects important to the subject at hand There is some crossover between the two spheres of the system The criminal la imposes fines and enforces them only by proceeding against the defendant's property See. eg.. Villiams, Illinois, 399 U S 235, 241-44 (1970) (holding that incarceration of indigent person beyond statutor) limit because of failure to pay fine denies equal protection). The civil law relies on the threat of incarceration for contempt of court in some aspects of the collection process. See. e.g., CAL. Ci'. PROC CODE § 482.080 (Vest Supp 1996) (providing for orders directing debtors to transfer property to Icvying officer and inclusion in such orders of notice that failure to comply may subject defendant to arrest and punishment for contempt of cour) 2. The distinction I make here between liability and incarceration as la\% enforcement mechanisms closely parallels the distinction made by Guido Calabrest and Douglas Melamed betuen "habiht) rules" and "property rules." See Guido Calabresi & A. Douglas Melamed. Properr' Rides. Diabhn Rules and Inalienability: One View of the Cathedral, 85 HARV L. REv 1089. 1092-93 t0972) Calabrest and Melamed refer to rules enforceable by criminal law or equitable remedy. ultimately backed b) the threat of incarceration, as "property rules." Id. at 1126 ("In other words. se impose criminal sanctions as a means of deterring future attempts to convert property rules into habilit) rules -). see also Ian A~rL, & Eric Talley, Solomonic Bargaining: Dividing a Legal Dirt tlenent to Facilitate Coasean Trade. 104 YALE LJ 1027, 1031 (1995); Louis Kaplow & Steven Shavell. Do lbabulin Rules Facilitate Bargainig' A Repl6 The Yale Law Journal [Vol. 106: 1 The liability system enforces liability through the entry and forcible collection of judgments for the payment of money. Although liability is most closely associated with products liability and other tort actions, money judgments are also the means for enforcing contracts, civil rights, labor and employment law, environmental regulations, federal tax law, intellectual property law, most kinds of property rights,3 and just about every other kind of law on the books. Without liability, the American legal system would be radically different. The liability system currently is mired in controversy over who should be liable, for what conduct, and for how much money. Yet this grand debate may be over the arrangement of the deck chairs on the Titanic. To hold a defendant liable is to enter a money judgment against the defendant. Unless that judgment can be enforced, liability is merely symbolic. The system by which money judgments are enforced is beginning to fail. The immediate cause is the deployment of legal structures that render potential defendants judgment proof.4 The liability system has long accepted that those who do not have the financial ability to pay judgments do not pay them. The system employs a complex web of social, economic, and legal constructs to determine who can or cannot pay. Those constructs can be, and are, manipulated by potential defendants to create judgment-proof structures. Many of the constructs are so deep-rooted in culture that they are virtually impossible to change. Included among them are secured credit, shareholder limited liability, national sovereignty, and the ownership of property. These constructs have existed in their current form for a considerable period. Their strategic manipulation has long been regarded as a problem for the liability system. Probably most individuals and businesses are either judgment proof,5 or capable of rendering themselves so between to Ayres and Talley, 105 YALE L.J. 221, 221-22 (1995) (describing "liability rule" as one under which "the injurer is free to harm the victim" and describing rule allowing victims injunctions as example of "property rule"). 3. Most property rights are in fact enforced through liability; neither criminal incarceration nor equitable order is available to the plaintiff. The defendant who negligently destroys the plaintiff's property in an automobile accident or an industrial accident does not go to jail; the sole sanction is likely to be a judgment for money damages.