The Rise of the Uncorporation.

• Author: Hayden, Grant M.
• Position: Book review

THE RISE OF THE UNCORPORATION. By Larry E. Ribstein. New York: Oxford University Press. 2010. Pp. xvi, 277. $65.

INTRODUCTION

A corporation is not a contract. It is a state-created entity. It has legal personhood with the right to form contracts, suffer liability for torts, and (as the Supreme Court recently decided) make campaign contributions. (1) However, many corporate law scholars have remained wedded to the conception--metaphor, model, paradigm, what have you--of the corporation as a contract or "nexus" of contracts. (2) The nexus of contracts theory is meant to point up the voluntary, market-oriented nature of the firm and to dismiss the notion that the corporation owes anything to the state. (3) It is also used as a justification for preserving the corporate law status quo. Since the corporation is contractual in nature, the argument goes, corporate structure reflects what the participants have freely chosen. (4) The basic corporate structure-shareholders vote for the board of directors, who then appoint the officers--is seen not as the decision of state legislatures, but as the free choice of investors, directors, boards, and indeed all of those who are involved with the corporation. (5) To question this structure is to dispute the market choices of those who are, presumably, in the best position to make these decisions.

In The Rise of the Uncorporation, Larry Ribstein (6) paints an alternative picture. It is a picture not of organizational perfection but of political intermeddling. Rather than claiming that the corporation is the efficient result of market forces, Ribstein depicts it as a large, insensate beast, blundering about the business landscape and leaving destruction in its wake. For most of the twentieth century, the corporate form was the only option for firms looking for limited liability, and as a result it was used far more frequently than it should have been. It was not until the birth of the limited liability company ("LLC") that a new era--that of the "uncorporation"--came into being. Now that businesses are truly free to choose amongst business organizational firms, Ribstein argues, the uncorporation will continue to gain popularity, and the corporation's presence will shrink down to a more appropriate size.

Ribstein's narrative is a fascinating one. It takes the traditional law and economics story of the corporation and turns it on its head. Instead of seeing the corporation as the hero of our political economy, Ribstein casts it as the villain--or at least, Frankenstein's monster: a brutish creature that means well but cannot help itself from wreaking havoc. And Ribstein is quite clear that this creature was not the result of market adaptation through private agreements. No, this monster is a creation of the state--if anything, the market was forced to adapt to what the government had wrought. Now that the uncorporate hero has arrived on the scene, the economic potential of free organizational forms will be unleashed.

The rise of "uncorporations"--a set of business entities that differ in significant respects from the standard corporate model--requires a reconsideration of many of the core principles of corporate law. As Ribstein himself points out, many of the facets of the corporation that we take for granted--a board of directors, shareholder voting, capital lock-in, fiduciary duties--are not necessary for a successful business organization (pp. 67-72). LLCs, LLPs, trusts, and other business forms have been growing exponentially in the last twenty years. The popularity of these business forms demonstrates that many parties prefer an alternative to the corporation. Their success should also prompt a reconsideration of corporate theory. (7)

This Review evaluates the contractual approach to the corporation in light of the rise of the uncorporation. It argues that state corporate law, rather than contractual decisions, frames the structure of the modern corporation. Even when it was possible to deviate from this structure, corporate law did not encourage such deviation. And once federal securities and tax laws are factored in, the current corporate structure becomes something close to mandatory. The development of uncorporations highlights this corporate inflexibility. Many uncorporate forms, for example, provide for a mix of labor, management, and capital in the governance regime. With their diversity of ownership structures, uncorporations should provide additional impetus for the reexamination of the corporate governance structure. Moreover, they might signal the final gasp of the nexus of contracts theory--at least in its descriptive guise. Requiescat in pace.

1. CORPORATION AS CONTRACT

   The nexus of contracts theory, generally attributed to Jensen and Meckling's Theory of the Firm, holds that the firm--and by extension the corporation--is merely a central hub for a series of contractual relationships. (8) Jensen and Meckling emphasize that the firm is a "legal fiction;" it is "not an individual" and has no real independent existence. (9) Their approach seeks to disaggregate our notion of the corporation as an entity and break it down into its component parts. (10) These parts are the contractual relationships between the various parties involved with the firm: executives, directors, creditors, suppliers, customers, and employees. The corporation itself doesn't really exist; it is merely the nexus (or connection or link) amongst these various corresponding relationships. (11) To view the corporation as an entity is to confuse the legal fiction for reality. Instead, corporate law should merely be an extension of contract law and should focus on facilitating these interrelationships in the most efficient manner. (12)

   The nexus of contracts theory has been extremely influential in shaping corporate law theory over the past three decades. (13) But despite its dominance, there is still confusion over whether the theory is a descriptive model, a normative prescription, or some combination of both. (14) Jensen and Meckling presented a positive theory of the corporation and its concomitant relationships. (15) That thread has been picked up in the legal literature, with Easterbrook and Fischel cementing the concept in place, (16) But even at the most basic of levels, the "corporation as contract" claim is simply incorrect. Corporations are not creatures of contract. One cannot contract to form a corporation. (17) The individuals involved must apply to a state for permission to create such an entity. The fact that this permission is readily granted (as long as fees and taxes are paid) does not change the fact that permission is required. (18)

   The fallback position of contractarian scholars is that the nexus of contracts model is not a literal claim. (19) But it's often difficult to determine when the theory crosses the line from abstract metaphor to description of reality. (20) To say that we should conceive of the firm as a nexus of contracts for certain purposes is different than saying that corporations actually are simply a nexus of contracts. (21) Yet both characterizations are used interchangeably. (22)

   Moreover, contractarians often seek to minimize the role of the state to such a degree that it becomes vestigial. Easterbrook and Fischel, for example, claim that when it comes to the corporation, "what is open to free choice is far more important to the daily operation of the firm, and investors' welfare, than is what the law prescribes." (23) Corporate law thus becomes a way of facilitating the other aspects of the corporation--the more important, contractually based ones. As they claim:

   Why not just abolish corporate law and let people negotiate whatever contracts they please? The short but not entirely satisfactory answer is that corporate law is a set of terms available off-the-rack so that participants in corporate ventures can save the cost of contracting. There are lots of terms, such as rules for voting, establishing quorums, and so on, that almost everyone will want to adopt. Corporate codes and existing judicial decisions supply these terms "for free" to every corporation, enabling the venturers to concentrate on matters that are specific to their undertaking. (24) Thus, contractarians have two competing sets of positive claims, with two sets of normative takeaways. (25) These claims intersect and overlap, to varying degrees, in the various instantiations of the nexus of contract approach. First, contractarians argue that the corporation is primarily contractual, and as such it represents terms that the parties have freely chosen for themselves. Since the terms have been freely chosen, we can presume they are efficient. (26) This claim leads to the normative perspective that since the corporation is merely an intersection of voluntary agreements, corporate law should facilitate freedom of contract and eschew mandatory rules. (27) The second set of claims, however, suggests that corporate law does provide default or even mandatory terms in situations where the terms are approximations of the will of the parties, or (more controversially) would lead to more efficient results. (28) The case is easier to make with default rules, of course, as they can be trumped by explicit terms to the contrary. However, some default terms are "sticky" enough that they become something close to mandatory. In such cases, the imposed term must be something that "almost everyone will want to adopt." (29) The contractarian must be careful here, as an emphasis on the efficiency of sticky defaults will slide over into noncontractrianism. But the concern for these near-mandatory terms is mitigated because there is choice amongst the fifty states as to the laws of incorporation. (30)

   Larry Ribstein is a contractarian. At least, his work has demonstrated agreement with the descriptive and the normative aspects of the nexus of contracts theory. His most direct discussion of the theory is...