Scholars and practicing lawyers alike consider legal entities to be essential. Who can imagine running a large business without using a business organization, such as a corporation or partnership? This Article challenges conventional wisdom by showing that vast enterprises--with millions of customers paying trillions of dollars--often operate without any meaningful use of entities.
This Article introduces the reciprocal exchange, a type of insurance company that operates without any meaningful use of a legal entity. Instead of obtaining insurance from a common nexus of contract, customers directly insure one another through a dense web of bilateral agreements. While often overlooked or conflated with mutual insurance companies, reciprocal exchanges include some of America's largest and best-known insurance enterprises.
This Article explores how it is possible to run an international conglomerate with essentially no recourse to organizational law as it is normally conceived, and it then draws out the important implications of these findings. The viability of reciprocal exchanges stands as a powerful foil to the academic consensus that legal entities are somehow essential, while nevertheless validating the underlying logic that led scholars to elevate entities in the first place.
TABLE OF CONTENTS INTRODUCTION I. THE ESSENTIAL ROLE OF ENTITIES A. Transaction Costs 1. Contracting 2. Opportunism B. Limited Liability C. Entity Shielding 1. Liquidation Protection 2. Priority of Claims II. THE RECIPROCAL EXCHANGE A. Basic Structure B. History C. Entities: Absent or Incidental III. ENTERPRISE THROUGH EXCHANGES A. Transaction Costs: Agent as Nexus B. Limited Liability: Constructive Notice When It Matters 1. Operating Without Limited Liability 2. Obtaining Limited Liability C. Entity Shielding: Lock In and Priority by Other Means 1. Liquidation Protection 2. Priority of Claims IV. Questioning the Essentiality of Entities A. Functional Essentiality 1. The Scale of Functional Contribution of Entities 2. Removing Entities to Accommodate Values: Health Care Sharing Ministries 3. Removing Entities to Reduce Risk: Person-to-Person Lending B. Ontological Essentiality C. Normative Essentiality CONCLUSION INTRODUCTION
Scholars and practitioners generally agree that any large enterprise must be run through a legal entity such as a corporation. While a minority view questions whether business entities are really necessary, (1) the leading academic voices argue that use of a legal entity confers benefits that would be "effectively impossible" to obtain through other means. (2) For example, an entity reduces the transaction costs of coordinating an enterprise's many patrons, (3) limits liability for shareholders, (4) and protects a business from untimely dissolution. (5) The widespread consensus is that legal entities are essential to economic life as we know it.
This Article challenges the regnant view by documenting and analyzing a domain of mass commerce in which legal entities are substantially absent. In this domain, millions of people exchange trillions of dollars, and they do so without meaningful recourse to legal entities. (6) That domain is insurance, as conducted by reciprocal exchanges.
A "reciprocal exchange" is an insurance enterprise in which all insurance subscribers contract directly with one another, promising to pay a share of any losses the others suffer. A thick braid of contracts unites a circle of natural persons, each of whom participates as part of the enterprise, with no legal entity at the contractual core.
The theoretical significance of reciprocals has gone unnoticed because reciprocals themselves have gone unnoticed. Most scholars and insurance practitioners appear to be unaware that reciprocals exist, (7) and some even deem them to be impossible. (8) Yet reciprocals provide almost 10% of America's property and casualty insurance, (9) which totals to about 5% of all the nation's insurance. (10) Almost one in six doctors buy malpractice insurance from a reciprocal. (11) Moreover, some of America's best-known insurance enterprises are reciprocal exchanges. For example, USAA and Farmers Insurance, both among the ten largest insurers in the United States, (12) are reciprocals. (13) Reciprocals are too important to ignore.
If reciprocals are forgotten, it may be because they are often confused with mutual insurance companies, or "mutuais." (14) Although both enterprise forms emphasize cooperation among customers, they nevertheless differ in important ways. They are subject to different governing statutory provisions. (15) Reciprocals present different risks of managerial expropriation because their compensation structures sometimes permit managers to extract substantial profits from the enterprise. (16) They raise different tensions between present and future policyholders; in a reciprocal, the present policyholders are due a refund if the reciprocal pays out less than the premiums collected, whereas mutual policyholders may have no direct claim to such a surplus--and will never enjoy its fruit if they cancel their policy before the mutual opts to pay a dividend. Such structural differences lead to meaningful economic differences. (17)
Most crucially for present purposes, mutuais and reciprocals also differ in their use of legal entities. Like almost all business ventures, a mutual relies on a legal entity, often a corporation, to operate; a mutual is peculiar only in that the legal entity happens to be owned by its policyholders. Conversely, the reciprocal exchange is neither owned by policyholders nor anyone else, since there is no legal entity to own. (18) Its members stand in direct contractual privity.
The viability of reciprocal insurance challenges the entity essentialism now dominant in the corporate law community and elsewhere. Without any entity, reciprocals have somehow been able to secure or foreswear the supposedly essential functions that entities provide. It turns out that creative applications of contract law, agency law, and insurance law suffice to support broad coordination. How? An enterprise's many patrons can appoint a common person (the "attorney-in-fact") to act as their agent, authorized to quickly sign multifarious contracts in their names. (19) Liability can be limited and prioritized within those contracts. (20) These limitations are binding on third parties because insurance regulation puts potential creditors on constructive notice of these agreements. (21) Entity-like functions follow, but sans entity.
This Article therefore deflates the importance of entities, but it does not necessarily undermine all arguments of entity theorists. To the contrary, the fact that reciprocals seek and find many of the core functions provided by entities underscores the importance of those functions. Reciprocals have used agency law to overcome transaction costs, and they have alloyed contract law and insurance regulation to create the pattern of creditors' rights that scholars refer to as "asset partitioning." (22) Though reciprocals do this without the state's helpful entities, public law is still important for establishing some of those entity-like benefits because insurance regulation gives the gift of constructive notice. (23) Entity essentialism is therefore honored in the breach. Entity theorists overstate the uniqueness of entities in achieving certain functions, but they are largely correct in highlighting those functions.
Indeed, even as reciprocals achieve those functions without entities, their circumnavigation traces the path of organizational law. Contractual limitations on liability or liquidation are usually binding only on those who have notice of them. (24) Organizational law avoids this problem by conjuring fictional persons entities. The reciprocal instead relies on insurance and agency law to construct fictional networks and fictional notice. Thus, reciprocals swap one set of legal fictions for another in the quest for certain key economic functions.
This Article gives reciprocals their first serious scholarly treatment, explains how they succeed without entities, and relates these findings to the most foundational questions in business law. (25) For example, the case for robust corporate social responsibility and corporate regulation rests most comfortably if entities are essential. (26) If the state grants irreplaceable benefits only through entities, then it may reasonably charge a quid pro quo, such as meaningful philanthropy or empowerment of workers. (27) This sort of "concession theory" argument is weakened if entities are just one path to enterprise.
The essentialism debate is not just a normative one, about what we should do in regards to the regulation of enterprise. It is equally a question of what we can hope for. 28 Entity essentialism is a crucial obstacle to unorthodox visions of commerce. (29) According to some techno-optimists, commercial life is bound to change radically in coming years. A series of terms (person-to-person, the sharing economy, gig-economy, micro-work, disintermediation, decentralization) suggest a world without traditional companies, hierarchies, or employment contracts. (30) In recent years, platforms have emerged to more directly link borrowers and lenders, (31) buyers and sellers, (32) riders and drivers, (33) and renters and letters. (34) Business futurists emphasize technology as a liberator, (35) but the transformation can never be totally successful if entities are in fact essential. (36) By contrast, if entities are optional, then we are free to ask how technology might facilitate new models of commercial connection. And this, paradoxically, might bring benefits most quickly to those least enamored of modern commercial life, such as religious objectors to health insurance and those cynical about the contemporary banking system. (37) This Article will explore what reciprocals can teach us about life without entities...