The essential structure of judgment proofing.

Summary

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Protecting corporate assets from legal judgments

A businesses can divide its corporate structure into an operating entity and an owning entity to escape judgment debt that arises from law suits. The operating entity conducts the business and is vulnerable to any liability the company may suffer. The owning entity controls corporate assets but is not subject to liability. Such a corporate structure renders businesses judgment proof. No principle of law exists that would allow courts to combine the two separate entities to combat judgment proofing.

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The essential structure of judgment proofing.

In order to insulate itself against debts resulting from unfavorable judgments, a business entity may seek to operate unencumbered by significant assets. In this essay, Professor Lynn LoPucki revisits this issue of "judgment proofing" and responds to arguments that large businesses cannot operate in judgment-proof conditions. He identifies a single structure that describes virtually all judgment proofing: a division of risks of liability and assets into two or more separate entities sharing a symbiotic relationship. An "operating entity" conducts the business activities and carries the risks of tort liability, while an "owning entity" owns the business assets. While the two entities are bound together by contract, the bifurcation of assets and risks shields the business from judgment debt. Professor LoPucki argues that current law cannot collapse the two entities into one for purposes of satisfying judgments, and concludes that large businesses of any type can successfully render themselves judgment-proof.

In The Judgment Proof Problem,(1) Steve Shavell demonstrated that judgment-proof debtors have suboptimal incentives to exercise care or purchase liability insurance. Such debtors will tend to impose above-optimal levels of risk on third parties and to carry insufficient liability insurance. Carried to its logical extreme, the "judgment-proof problem" is that judgment-proof debtors can commit torts with impunity.

The immediate implications of Shavell's 1986 observations were in the fields of tort and insurance law. But concern about judgment-proof debtors quickly spread to the fields of corporate and commercial law as scholars in those fields recognized the broader implications of Shavell's analysis. The revered institutions of corporate limited liability and secured credit were, in Shavell's terms, judgment proofing. Whenever they mattered at all, they generated the judgment-proof problem.

In response to the skewed incentives of judgment-proof debtors, corporate and commercial law scholar...

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