In The Death of Liability,(1) Professor Lynn M. LoPucki argues that American businesses are rendering themselves judgment proof.(2) Using the metaphor of a poker game, Professor LoPucki claims American businesses are increasingly able to participate in the poker game without putting "chips in the pot."(3) He argues that it has become easier for American companies to play the game without having chips in the pot because of the ease with which a modern debtor can grant secured credit,(4) because of the growth of the peculiar form of sale known as asset securitization,(5) because foreign havens for secreting assets are now available,(6) and because firms can use traditional ways of avoiding legal liability--such as scattering their assets among subsidiary corporations.(7)
In Part I, I describe Professor LoPucki's thesis, and in Part II, I present an empirical response to it. Part II is composed principally of data collected from the Compustat database, which contains financial information on almost all American public companies. The data on secured debt, asset-to-liability ratio, and the presence of insurance show that the story Professor LoPucki tells is fictional. Part III explains why. It offers reasons that firms choose not to judgment proof themselves and considers various barriers to judgment proofing. The analysis explains not only why judgment proofing is less prevalent today than Professor LoPucki suggests, but also why it is unlikely ever to grow into a serious problem in the United States.
It is important to understand what in Professor LoPucki's thesis is explicit, what is implicit, and what is unclear. First, Professor LoPucki does not say merely that certain persons and firms have found ways to avoid their just liability by putting their assets beyond the reach of their creditors. A debtor's divestiture of assets in the face of creditors' claims or operation with too little capital are well-known and ancient practices. The infamous Twyne's Case(8) cast a shadow over modern commercial security law by suggesting that a debtor commits a fraudulent conveyance when he secretly conveys security to a creditor while retaining possession of the property. Taking secret security, making fraudulent conveyances, operating with insufficient capital, and distributing one's assets to shareholders in preference to creditors have been practiced for hundreds of years; they are explicitly not the subject of Professor LoPucki's complaint.
He makes a stronger claim. Through his poker game metaphor, he claims that "[m]ajor players are reducing their stakes"(9) and that "[s]ome large businesses now employ [judgment-proofing strategies] and market forces are driving their competitors to do the same."(10) Thus, he claims not that a few businesses are doing the things that businesses and individuals have always done, and not only that it is now possible with modern devices to do these things more broadly, but that American businesses are, in fact, judgment proofing themselves,(11) and that there is a trend for a larger number of all firms to do the same.(12) His assertion is not merely that devices are available; it is an empirical assertion that these devices are being used more systematically than ever before and that their use will become more widespread in the future.
It is important also to understand who Professor LoPucki believes are the victims of these transactions. The victims are not conventional unsecured creditors with contract claims; they are creditors with claims imposed by tort and statute.(13) Professor LoPucki recognizes that contract creditors--creditors ranging from banks to finance companies to suppliers--can and will bargain for protection.(14) He is concerned about people who are sometimes referred to as "involuntary" creditors,(15) creditors whose claims are thrust upon them as a result of an accident or a violation of a statutory obligation of the debtor. Common examples include parties injured by auto accidents, asbestos exposure, and environmental contamination, and any other victim of tort liability, whether the liability arises from an intrauterine device, a breast implant, or a cigarette.
Although he does not say so in clear terms, Professor LoPucki should be less concerned with the run-of-the-mill tort claimant--the person who is injured in a collision with a truck owned by General Electric--than with victims of mass torts. Victims of random and conventional negligence are usually covered by insurance,(16) and where that is not true, the costs of paying their claims are not significant enough to encourage judgment proofing. Even if a pharmaceutical company were to find it within its interest to judgment proof itself, it would have plenty of assets with which to answer run-of-the-mill negligence and products liability claims. LoPucki's real concern is with mass torts and large-scale statutory liability.
Note, finally, that Professor LoPucki should be concerned principally with injuries caused by business enterprises, not with torts by individuals. It is a rare individual who can cause enough personal injury or property damage to make it worth his while to escape liability. Most of us seriously injure others only with our automobiles. Most personal automobile liability has been dealt with by state law that requires insurance or proof of financial responsibility.(17) Among sole proprietors, the only persons who might fit Professor LoPucki's area of concern are physicians.
In the end, the boundaries of Professor LoPucki's claims are fuzzy. The grandiose title, which echoes Grant Gilmore's famous attack on contract doctrine,(18) the assertions about "major players,"(19) and the disclaimer of any interest in contract liability lead me to believe that Professor LoPucki is concerned principally, if not exclusively, with the tort and statutory liability of public commercial firms.(20) Nevertheless, his discussion of exemptions and "foreign havens" suggests that he is speaking of individuals, for exemptions and foreign havens strategies are unavailable for, or not suited to, corporate judgment proofing.(21) In the face of these conflicting indications about the boundaries of his thesis, I give him the benefit of the doubt by addressing my analysis principally to potential judgment proofing by publicly traded companies. Most individuals have always been judgment proof, and few private companies can cause sufficient statutory or tortious liability to cause a significant social problem. If Professor LoPucki is mainly concerned with contract liability, he has turned upon his own thesis. If he is actually concerned with individuals or private companies, he is dealing with a problem of modest social consequence.(22)
Professor LoPucki identifies four judgment-proofing strategies. First is the granting of secured debt.(23) Under both state law and federal bankruptcy law, the typical perfected secured creditor must be fully satisfied before money is paid to a competing tort or statutory claimant.(24) There are some exceptions to these rules, but they are not significant for tort claimants.(25) Professor LoPucki correctly identifies Article 9 of the Uniform Commercial Code as a convenient and inexpensive way of granting secured credit and as a law that facilitates the granting of more secured credit than the former law would have allowed.(26)
Second, Professor LoPucki identifies "ownership strategies,"(27) i.e., ways in which a potential debtor can put its assets into the hands of third parties while yet continuing to enjoy the benefits normally associated with ownership. The most obvious of these is to create liability in a thinly capitalized subsidiary and then to devise a way to transfer the profits that are generated in the subsidiary into the hands of the parent. A second method, analogous to the granting of a perfected security interest, is asset securitization, in which companies sell their intangible assets to a person who is allowed to collect the payments on those assets in preference to those who have tort and other claims against the original seller.(28) A variation on this theme is the "sale and leaseback" of tangible assets--a transaction that puts the asset beyond the reach of creditors, but allows the original owner to enjoy its use for a fee.(29)
Professor LoPucki's third category is "exemption strategies."(30) Under the law of all states(31) and under the Federal Bankruptcy Code,(32) certain assets may be held by individual debtors free from the claims of other parties. Typically, these assets are items such as homesteads and life insurance. Such laws cannot be used by firms that do business as corporations or partnerships.(33)
A fourth category identified by Professor LoPucki is "foreign haven strategies."(34) Under these strategies, an individual might put his assets in a trust in the Cook Islands, for example, and continue to enjoy the benefits, yet, under Cook Island law, be able to keep them free from the reach of creditors in the United States.
As I suggest above, the last two categories--exemption strategies and foreign haven strategies--are not relevant to corporate liability.(35) They apply, if at all, only in insignificant ways to firms in commercial activity and cannot be used to protect corporate assets against tort and statutory claims of any magnitude.
ECONOMIC THEORY AND REALITY
The Theoretical Problem
It is impossible to quarrel with Professor LoPucki's claim that it would be a wonderful thing to play poker with the assurance of no loss and with the possibility of great gain. Before I explain why this poker game probably does not exist and why it is unlikely ever to exist, let me belabor the obvious by using an example to show why an investor would welcome the opportunity that Professor LoPucki posits.
Consider an investor who could borrow at 8% and earn a return on equity of 20%. If this person put up $10 million of his own money and raised...