Enterprise without Entities

By Verstein, Andrew | Michigan Law Review, November 2017 | Go to article overview

Enterprise without Entities


Verstein, Andrew, Michigan Law Review


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 "mutuals."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, mutuals 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. …

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