External and Internal Asset Partitioning: Corporations and Their Subsidiaries

By Henry Hansmann, Yale Law School, and Richard Squire, Fordham University School of Law

In our book chapter “External and Internal Asset Partitioning: Corporations and Their Subsidiaries,” forthcoming in The Oxford Handbook of Corporate Law and Governance, we analyze the economic consequences of external and internal asset partitioning, and we consider implications of our analysis for creditor remedies that disregard partitions between corporate entities. “Asset partitioning” is the use of standard-form legal entities, such as the business corporation, to set boundaries on creditor recovery rights. “External” partitioning refers to the legal boundaries between business firms and their equity investors, while “internal” partitioning refers to the legal boundaries among the constituent entities (parents and subsidiaries) within corporate groups.

The chapter begins by cataloguing the economic benefits and costs of corporate partitioning. The benefits identified include reduced equityholder monitoring costs, liquid shares, shareholder diversification, reduced creditor information costs, correction of debt overhang, liquidation protection, and bankruptcy simplification. The costs of corporate partitioning are accounting costs and the agency costs of debt. We compare the economics of external and internal partitioning, and we find that internal partitioning provides fewer potential benefits while often generating higher costs. Corporate subsidiaries do, however, also provide non-partitioning benefits such as tax advantages, regulatory compliance, and the preservation of transferable bundles of contracts.

The final part of the chapter considers whether cost-benefit analysis predicts how courts actually apply de-partitioning remedies, with particular emphasis on veil piercing and enterprise liability. We conclude that courts should employ the distinction between external and internal partitioning when applying creditor remedies that disregard corporate partitions, and we identify factors — in addition to whether a partition is internal or external — that courts should consider when deciding whether to de-partition. For example, we argue that the presence of guarantees which pierce corporate partitions on behalf of select creditors militates in favor of the use of de-partitioning remedies for general creditors.

The full chapter is available here: External and Internal Asset Partitioning: Corporations and Their Subsidiaries.