If not as a partnership, then how should an enterprise with multiple investor-owners whose property interests in the enterprise are to be transferable/tradable shares legally operate? As a trust or as a corporation? If entity shielding is the only concern, it should not make that much of a difference.

Since long before widespread enactment of general incorporation statutes (mid-19th century) the business trust had been shielding the underlying assets of ongoing large investor-owned enterprises from being taken individually by a co-owner and/or his creditors. This ring-fence function has come to be known as entity shielding, whether in the case of a trust (where the equitable property/ownership interests are transferable shares of beneficial interest) or in the case of a corporation (where the legal property/ownership interests are transferable shares of stock). The creditor of the co-owner of an ongoing enterprise may be able to grab the owner’s legal or equitable interest in the enterprise itself, i.e., the shares, but not the enterprise’s underlying assets. Those are “reserved” for the creditors of the enterprise. An ongoing, solvent enterprise with numerous co-owners could not practically function otherwise. If its plant, equipment, and inventory were vulnerable to being taken at any time by a co-owner and/or his creditors, the enterprise would lack the certain stability, duration, and cohesion necessary to be commercially viable. In other words, entity shielding helps “businesses hold their assets together.” John Morley, The Common Law Corporation: The Power of the Trust in Anglo-American Business History, 116 Colum. L. Rev. 2145, 2167 (2016). The creditors of the enterprise, of course, still will have access to its underlying assets. Capital lock-in is an application of entity shielding, namely when the enterprise itself restricts such access. Entity shielding is not to be confused with limited liability, which insulates the owners of an enterprise from the contract and tort liabilities of the enterprise itself.

Entity shielding is by no means the exclusive domain of the corporation, which is a creature of statute. “An analog of entity shielding first appeared in the trust…[,a creature of equity,]…in the late Middle Ages as a direct consequence of the division between legal and equitable title that characterizes the trust.” Id at 2168-2169. Legal title to the entrusted property being in the trustee rather than in the debtor co-beneficiary, the creditor was foreclosed from reaching the entrusted property itself. Section 10 of the Statute of Frauds, enacted by Parliament in 1677, afforded a trust beneficiary’s creditors access to the equitable interest, but not the underlying trust property itself. This is functionally entity shielding. “Although a trust had never been a legal entity, the doctrines of Chancery, as modified by…various statutes, ensured that the assets that legally belonged to a trustee were shielded from a beneficiary’s creditors almost as though they belonged to a distinct entity.” Id at 2170. Fraudulent conveyance legislation is not an insignificant statutory doctrinal modification, to be sure, but one that applies to corporation-transferees as well as trustee-transferees. Also, nowadays, entity-shielding would not be available even post-inception in the case of a trust settlor who had retained an equitable interest in all the trust’s principal. This is the case even when the trustee is independent, is vested with sole principal-invasion discretion, and there is no fraud in the fact pattern. See generally §5.3.3.1 of Loring and Rounds: A Trustee’s Handbook (2023), the relevant portion of which section is accessible via this link to my 10/1/2022 JDSUPRA posting: https://www.jdsupra.com/legalnews/judge-alice-m-batchelder-endeavors-to-l-06897/. (Specifically in the posting’s appendix)

Entity shielding is not to be confused with trust-entity doctrine, which is the subject of §8.15.77 of the Handbook. Section 8.15.77 is reproduced in the appendix immediately below. It goes without saying that entrusted assets are off-limits to the trustee’s personal creditors. See §8.3.1 of the Handbook. The Handbook itself is available for purchase at https://law-store.wolterskluwer.com/s/product/loring-rounds-trustees-hanbook-2023e/01t4R00000Ojr97QAB.