The New Business Entities in Evolutionary Perspective
Henry Hansmann, Reinier Kraakman & Richard Squire | 2005 U. Ill. L. Rev. 5
The new types of business forms that have developed over the past thirty years all combine the freedom of contracting that is traditional to the partnership with the pattern of creditors’ rights that is traditional to the business corporation. Legal scholars differ on the issue of whether these new business forms are more partnership-like or corporation-like. Those taking the partnership-like view argue that the degree of freedom of contract is the essential difference between the traditional corporation and partnership forms, while those adhering to the corporation-like view argue that the pattern of creditors’ rights is the essential difference. The authors support the latter view. They argue that an examination of the evolution of business entities reveals that the traditional inflexibility in corporations served importantly to protect creditors’ rights, but as substitute sources developed to protect the rights of all investors, the need for inflexibility diminished and freedom of contracting in the corporate form flourished.
In this essay, the authors first discuss the historical evolution of business entities, focusing on the primary role that creditor protection has played in that evolution. Next, the authors argue that, although legal scholars generally focus on limited liability when discussing creditor protection and the distinction between the corporation and the partnership, the principal feature distinguishing the corporation from the partnership is “entity shielding”—a term referring to the allocation of different rights to different groups of creditors in the assets of a firm. After discussing the importance of strong entity shielding—a characteristic of the corporation but not the partnership—and how it complements limited liability, the authors conclude that the development of new business forms is the culmination of the process of extending strong entity shielding to unrestricted types of entities and, therefore, the new business forms should be viewed as generalizations of the business corporation rather than the partnership.