The Tale of the Silver Fox: The Co-Evolution of Property Rights and Contractual Arrangements in Limited Liability Companies

Abstract

Law, in particular the law of business organizations, is a byproduct of normative solutions, or a sort of extended phenotype. Facing the emergence of new forms of business organizations, legislatures in European countries such as Portugal, Spain, Italy, France, the United Kingdom and also in the United States have created systems of property rights in order to ensure equilibrium not only within the corporate structure, but also among the interests and protections each corporate constituency claims for itself. One of the ways to facilitate this equilibrium is to provide default rules that restrict the transfer of shares of private limited liability companies (“PLLCs”) or give leeway to company members to introduce such restrictions in the articles of association.

In this article, I adopt a bottom-up perspective to evaluate the dynamics and evolution of the markets, and I compare them to evolution in nature by looking at the environment where this evolution occurs. It has long been claimed that evolution in nature is different from institutional evolution. However, the law provides the tools necessary for institutional engineering just as biology supplies the scientist with the necessary cognitive equipment to undertake experiments based upon the artificial selection of species. The output of this comparison should be one that, normatively speaking, enables legislatures, regulators, and courts--in particular, those in common-law jurisdictions to create optimal legal solutions that are able to break the engrained status quo and manifestations of socio-economic and doctrinal path-dependence, or situations of pleiotropy in the law, if necessary. The term pleiotropy is used here to explain that, evolutionarily, there are unintended consequences for legal rules and legal institutions stemming from the interaction between market and law. Pleiotropy refers to the inheritance of legal solutions, which is different from the concept of path-dependence often used in economics and political science. Thus applied, fields of corporate law, contract law, and property law are shown to be related in unexpected ways.

Using transfer restrictions or restrictions on changes to the structure of ownership of PLLCs as a ground for experimentation, this paper tries to unveil the legal and economic purposes of setting such restrictions.

Keywords: LLCs, Operating Agreement, Property Rights, Legal Pleiotropy, Unintended Consequences