Rothbard's Defense of Contractual Limited Liability

by Gary North
by Gary North

One of the advantages of reading either Mises or Rothbard is that each man presents his case for liberty axiomatically. Each begins with a few premises and thereby develops an entire system of social thought from these premises.

Mises begins with the axiom of action: men choose. Rothbard begins with self-ownership. We read in For a New Liberty:

The libertarian creed can now be summed up as (1) the absolute right of every man to the ownership of his own body; (2) the equally absolute right to own and therefore to control the material resources he has found and transformed; and (3) therefore, the absolute right to exchange or give away the ownership to such titles to whoever is willing to exchange or receive them. As we have seen, each of these steps involves property rights, but even if we call step (1) "personal" rights, we shall see that problems about "personal liberty" inextricably involve the rights of material property or free exchange. Or, briefly, the rights of personal liberty and "freedom of enterprise" almost invariably intertwine and cannot really be separated.

Much as I appreciate Mises, I believe that Rothbard begins where all economic reasoning should begin: the question of ownership. I agree with Tom Bethell's observation in his book, The Noblest Triumph: Adam Smith made a strategic intellectual error when he began with the division of labor rather than the central issue of private property. This error set back the intellectual case for free markets by almost two centuries.

I began my 1987 book, Inherit the Earth, with a chapter on ownership. My debate with Rothbard begins here. I see God as the original owner, with property being delegated to man (chapter 2).

We both agree that ownership is the central issue. So, when I come to a debate over this or that policy issue regarding economics, I always begin here: "Who is the owner?" Similarly, when I come to a judicial issue involving conflict, I ask: "Who is the victim?" The underlying principle of biblical justice is this: victim's rights. I wrote a book with this title.

THE RIGHT OF CONTRACT

As we have seen, Rothbard affirmed "the absolute right to exchange or give away the ownership to such titles to whoever is willing to exchange or receive them." This is the foundation of the right of contract in his system.

He placed no limits on these rights, just so long as the exchange does not involve aggression against anyone else. He then makes this observation:

While opposing any and all private or group aggression against the rights of person and property, the libertarian sees that throughout history and into the present day, there has been one central, dominant, and overriding aggressor upon all of these rights: the State.

He saw nothing good coming out of the State. I mean nothing. If any policy or practice had its origin in the State, Rothbard opposed it, both axiomatically and operationally. This is what is unique about his social and ethical thought. For him, this is an axiom: State = bad, both morally and operationally.

For Rothbard, the right of contract means immunity from the State. It also means immunity from violent action by others. If two people decide to make an exchange in terms of a set of non-violent principles, no third party has the authority to interfere. The terms of exchange are established by the contracting parties, not by a third party. This is fundamental in Rothbard's defense of contract. In The Ethics of Liberty, he writes:

In contemplating the law of a free society, therefore, the libertarian must look at people as acting within a general framework of absolute property rights and of the conditions of the world around them at any given time. In any exchange, any contract, that they make, they believe that they will be better off from making the exchange. Hence all of these contracts are "productive" in making them, at least prospectively, better off. And, of course, all of these voluntary contracts are legitimate and licit in the free society.

There is no legal appeal beyond these contracting parties. What the doctrine of the divine right of kings attributed uniquely to kings, and what the divine right of the British Parliament in 1688–89 substituted for the divine right of kings, Rothbard assigns to the non-coercive individual, and by implication, to voluntary contracts made by autonomous individuals.

LIMITED LIABILITY

In Rothbard's system, individuals possess the legal privilege of specifying their mutual obligations. There is no higher appeal beyond them. His discussion of limited-liability laws rests on this moral and judicial foundation.

Rothbard denied that limited liability is a grant of privilege by the State. He wrote the following in Power and Market (1970), which had originally been in the original manuscript of Man, Economy, and State.

Finally, the question may be raised: Are corporations themselves mere grants of monopoly privilege? Some advocates of the free market were persuaded to accept this view by Walter Lippmann's The Good Society. It should be clear from previous discussion, however, that corporations are not at all monopolistic privileges; they are free associations of individuals pooling their capital. On the purely free market, such men would simply announce to their creditors that their liability is limited to the capital specifically invested in the corporation, and that beyond this their personal funds are not liable for debts, as they would be under a partnership arrangement. It then rests with the sellers and lenders to this corporation to decide whether or not they will transact business with it. If they do, then they proceed at their own risk. Thus, the government does not grant corporations a privilege of limited liability; anything announced and freely contracted for in advance is a right of a free individual, not a special privilege. It is not necessary that governments grant charters to corporations.

The State possesses no original ownership in Rothbard's system. It does not even possess delegated ownership.

Any argument that challenges the legal right of contract between autonomous individuals must of necessity invoke a higher law than the right of self-ownership and a higher court than the mutually contracting parties. For Rothbard, there is no higher law or higher court.

If limited liability contracts are prohibited by law, then there is a major limitation on the right of voluntary contract.

In 1970, R. J. Rushdoony published Politics of Guilt and Pity. The book is generally as good as the title, and the title is terrific. In a chapter titled "Limited Liability and Unlimited Money," he argued that the nineteenth-century corporation was a creation of the State. He then went on to argue that paper money is limited-liability money (p. 260). It was a clever argument. It persuaded me for over a decade. But then I recognized something that I had not seen before. The historical model for the limited-liability corporation was the church. That forced me to re-think his argument.

TO JOIN A CHURCH

Let us say that I want to join a church. As a future member of this local church, I wish to avoid legal liability for anything the elders do that might inflict damage on someone else in the name of the church. For example, if they decide to excommunicate someone from membership, and that person then sues the church in a civil court, I do not want to have all of my assets at risk in that court. This is not a hypothetical situation. Churches do get sued by excommunicants. This undermines the authority of churches. The state's authorities are sometimes happy to do this. It increases the power of the state.

The church can specify this arrangement in writing before anyone joins. Members agree to this as a condition of joining. This contract – called a church covenant – can also specify that the church's judicial decisions not be matters of future lawsuits in a civil court.

What libertarian principle is violated here? What Christian principle is violated here?

Over time, civil law in the West formally recognized the existence of an implicit agreement with respect to the legal immunity of church members. The state does not create this legal immunity. On the contrary, the state has recognized a previously existing legal immunity. To argue that the state should no longer recognize this immunity in the name of a universal principle of full liability without any exceptions is to grant enormous power to the state to undermine both custom and contract.

Today, investors in corporations are governed by commercial limited-liability law. Critics of limited-liability law argue that this is a grant of privilege by the state. But would they also argue that a comparable grant of immunity from lawsuit for church members is a state-granted privilege? The existence of such immunity long preceded the modern nation-state. Conclusion: it is not a grant of privilege.

In the late nineteenth century, Anglo-American civil law began to acknowledge a right of contract that had always governed churches. In doing so, the state made possible the modern economy, which is marked, above all, by increasing per capita investment.

It is not random that the most rapid period of economic growth in mankind's history took place from about 1875 to 1914 – the era of the modern limited-liability corporation. It took place because the state, at long last, extended the same right of contract to businessmen that churches had enjoyed from the beginning. Rothbard wrote in Man, Economy, and State (1962), "The great advantage of the joint-stock company is that it provides a more ready channel for new investments of saved capital" (p. 369).

A GRANT OF PRIVILEGE?

The modern nation-state has asserted an original authority over the granting of limited liability. We should not take this assertion seriously. What the modern State does is to restrict by law the right of contract. This means that a group of people, acting in the name of the divine right of the State, assert the monopoly privilege of limited liability. Then they sell the right of incorporation or grant it to their favorites.

The Anglo-American nation-state ever since the days of the Tudor kings has claimed the monopoly privilege to grant such a right of contract. That is, it claims an original privilege, which it can then ladle out to cronies and purchasers of privilege.

The king was said to be above the civil law. Only God is superior to the king's authority, the people were told. This is the judicial meaning of "the divine right of kings": no higher earthly court of appeal. The king therefore claimed limited liability as a monopoly. That claim ended in Anglo-American law no later than 1688: the Glorious Revolution. Parliament wanted in on the deal. Parliament's claim ended in 1783 in the North American colonies. Then Congress wanted in on the deal. Then the U.S. Supreme Court. And so it goes. The state wants its divine rights: complete limited liability except from God, who is thought to be on an extended vacation.

This state's perennial argument in favor of state sovereignty over the right of contractual limitations of liability should not be taken at face value. It is in fact a highly self-serving view of the power of the state.

Henry VIII stole monastic property in order to enhance the revenue of the state, but he and his successors were not so arrogant as to argue that church members were legally liable for whatever church officers did as representatives of the church. Even today, politicians will not touch this third rail.

If civil courts can lawfully impose complete liability on investors in corporations, then it in principle has the right to impose the same liability on church members. To join a church is to open your wallet to those who would take the church to court. If this principle were enforced by the state, it would have the effect of forcing the church underground.

If a law banning the right of contract regarding limited liability were enforced by the state, it would have a similar effect on the capital markets. Overnight, American capital would disappear. Call it "green flight." There would be a collapse of the stock market dreamed of only by the most wild-eyed newsletter publishers – my kind of guys.

Let me assure you, I could write a direct-mail ad piece that would make me rich beyond the dreams of avarice if American politicians ever began considering the adoption of a view of strict liability of contracts. I would show subscribers where to invest their money off-shore after selling their shares of American-based corporations. Any nation that made it clear that limited contractual liability is available to all comers would gain a windfall the likes of which CNBC commentators only dream about.

This law would de-capitalize America overnight. Americans would be not just become impoverished. The resulting contraction of the division of labor would probably lead to starvation. There would be a run on the banks that even Alan Greenspan, acting as the nation's equivalent of Donna Reed in It's a Wonderful Life, could not overcome.

STRICT LIABILITY OUTSIDE OF CONTRACTS

In For a New Liberty, Rothbard has a section against the Friedmanites' view of pollution. Friedman would allow companies to pollute property not owned by them under a system of legal immunities granted by the State. Rothbard regarded this as a violation of property rights.

The Friedmanites concede the existence of air pollution but propose to meet it, not by a defense of property rights, but rather by a supposedly utilitarian "cost-benefit" calculation by government, which will then make and enforce a "social decision" on how much pollution to allow. This decision would then be enforced either by licensing a given amount of pollution (the granting of "pollution rights"), by a graded scale of taxes against it, or by the taxpayers paying firms not to pollute. Not only would these proposals grant an enormous amount of bureaucratic power to government in the name of safeguarding the "free market"; they would continue to override property rights in the name of a collective decision enforced by the State. This is far from any genuine "free market," and reveals that, as in many other economic areas, it is impossible to really defend freedom and the free market without insisting on defending the rights of private property.

Rothbard was not here discussing limited-liability corporations. He was arguing that Friedman's view of the limited liability of some polluters to pollute at some bureaucrat-established price is a denial of the right of contract and its protection. This context has nothing to do with the right of individuals – buyers and sellers – to work out mutually beneficial arrangements on their own, without interference from the state.

Rothbard was arguing against Milton Friedman and all those economists who would allow pollution at some government- established price. He was not speaking of mutually contracted arrangements but rather a form of violence against third parties, whose property rights have been violated. It was in this context – not in the context of the limited-liability corporation – that he quoted Robert Poole:

"A libertarian society would be a full-liability society where everyone is fully responsible for his actions and any harmful consequences they might cause."

CONCLUSION

Rothard's doctrine of the right of individuals to make contracts that limit their personal liability points to the legitimacy of the modern corporation. Rothbard was clear: Any attempt to undermine this right is an infringement on contract.

But, long before the limited-liability corporation, there was a limited-liability church. I want to go to join a church without worrying about what the U.S. Supreme Court determines regarding my liability as a member. A 5 to 4 decision by this most monopolistic of all American institutions does not in fact constitute the really supreme court.

September 28, 2005

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