The History of LLCs
Two hundred years ago, if you were to invest in a shipping sailboat going across the ocean, the owners were personally responsible for not only the cargo and the ship but everything that went wrong; if it ran into a dock or another ship, the owners were responsible. This caused the owners to be afraid to take risks. The nice thing about a limited liability system is that it’s a bargain with the government where the government wants to encourage commerce by allowing you to limit your risk.
There was a revolutionary case about two hundred years ago called The Rebecca. This case was the first time the courts in the United States established the principle of limited liability where if there was a problem with the ship, the courts held the owners weren’t responsible for anything beyond their investments. The next major revolutionary thing that happened in the corporation system was the 14th Amendment to the Constitution after the Civil War. What the 14th amendment did was took people and made them into citizens.
A More Modern Form of the LLC
According to the US Supreme Court in a case about twenty years after the 14th Amendment was adopted, Santa Clara County v. Southern Pacific Railroad Co., the court extended that personhood to artificial business entities. What happened as a result of that was it gave business entities the constitutional right of equal protection under the law, like natural persons. This means a corporation incorporated in Delaware could do business in California and that state could not discriminate against it in favor of California corporations.
This created a level playing field for business entities and encouraged interstate commerce. People forming businesses were no longer stuck with forming a business in their home state if the law governing that corporation was not favorable. They could change the law by going to Delaware, forming a business-friendly corporation, and using it in any other state. This also incentivized states to compete to innovate their corporate laws so they would attract people from outside the state to create a company in Delaware. That innovation resulted in about one-third of government revenue coming from a legal industry related to businesses incorporated there. Delaware not only had good statutes, just as importantly, it developed case law through the Court of Chancery, the state’s special business court with specialized business expert lawyers appointed as judges without juries. It is all bench trials with well-reasoned opinions. It continues to be an exciting time to incorporate in Delaware and do business elsewhere.
However, the world changes and innovations have continued. Corporations have become a little old-fashioned and staid. A corporation has strict rules and formalities with bureaucracy including stockholders, directors, officers, and annual meetings. In 1977, the state of Wyoming invented something called the Limited Liability Company. It was very slow to take off. In fact, Delaware, which is known for being first, waited until 1991 to have their own LLC law. Today, LLCs are being formed three or four to one compared to corporations. It’s not uncommon to have corporate law shift to a new form of entity. Looking to the future, you should ask why you are using a safe but old-fashioned corporation or LLC when you could be using a series LLC to protect multiple assets.
