Учебный год 22-23 / Critical Company Law

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their powers flowing from the company’s constitution’. A director would only avoid liability for this act if the company agreed to allow it by a special resolution. A shareholder could continue to exercise some autonomous intervention if the transaction in question had not yet become a legal obligation. Under s 35(2) a member could bring proceedings to restrain the doing of an act which was outside the company’s capacity if it was at a pre-contract stage or if it referred to a donation, neither of which arrangements were legally enforceable.160

Under s 35A a transaction which involved a director acting outside his powers under the constitution was no longer voidable by the company if the person dealing with the company was acting in ‘good faith’ in his dealings. Good faith in this context was presumed under s 35A(2)(c) and bad faith would not be assumed ‘by reason only of his knowing that an act is beyond the powers of the directors under the company’s constitution’ under s 35(2)(b). Section 35A(4) reproduced the same shareholder intervention as held in s 35(2) and s 35A(5) made directors liable for any loss to the company caused by their exceeding their authority. In contrast to s 35(3), an ordinary resolution would be su cient to e ect ratification of a director’s breach of duty. A person would not be considered to be acting in good faith if he was connected with the company in the ways specified in s 322A of the 1985 Act.

By the by, the provisions on directors’ authority were somewhat untidy. Section 35A stated that ‘the power of the board of directors to bind the company, or authorise others to do so, shall be deemed to be free of any limitation under the company’s constitution’. This seemed to imply that only transactions agreed by the board of directors would fall under s 35A but that it would not apply to transactions entered into by single directors. The latter transactions would continue to be covered by the old common law protections. These protections began with Turquand’s rule161 in 1856, which stated that when a company denies that an individual (usually a director) has the authority to bind the company and therefore the company was not bound to certain transactions, the court may uphold a claim by a third party who believed that the individual did have the authority to do so. That belief needed to be reasonable and to be reasonable there must have been no constructive notice of the individual’s lack of authority. Therefore if the limitation on the individual’s authority was held in the company constitution, the third party was deemed to have constructive notice of it and the company would not be bound to the transaction. Constructive notice was abolished by s 35B of the 1985 Act which stated that ‘a party to a transaction is not bound to enquire as to whether it is permitted by the company’s memorandum or as

160Re Halt Garage Ltd [1982] 3 All ER 1016.

161Royal British Bank v Turquand (1856) 6 E & B 327. This rule was really an application of agency principles.

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to any limitation on the powers of the board of directors to bind the company or authorise others to do so’. Thus Turquand’s rule was modified to only include those cases where the company ‘holds out’ an individual as acting with the company’s authority.162 Latterly it has been suggested that s 35A may apply to transactions undertaken by one single director.163

In the third phase and in accordance with the recommendations of the CLR’s Final Report, companies formed under the 2006 Act will have unrestricted capacity unless they specifically choose to limit their objects. Section 31(1) of the 2006 Act states that ‘unless the company’s articles specifically restrict the objects of the company, its objects are unrestricted’. Furthermore, if a company wishes to make any amendments to its objects it must give notice to the registrar, who will register them and it will take e ect from the date of the notice on the register.164 Any such amendment will not a ect any rights or obligations of the company ‘or render defective any legal proceedings by or against it’.165

In respect of companies which continue to restrict their capacity in their articles s 39 of the 2006 Act replaces s 35 of the 1985 Act with the following revisions. Section 35(2) and (3) have been removed as superfluous given that a company may have unlimited objects and a director’s liability in respect of failure to observe the company constitution is now held in s 171 of the 2006 Act.166 Section 39(1) and (2) of the new Act replace s 35(1) and (4) of the old Act.

Section 40 restates ss 35A and 35B of the 1985 Act except that first, the part of s 35B which referred to enquiries into limitations in the company’s memorandum has been removed, and second, ‘the power of the board of directors’ (held in s 35A(1) of the 1985 Act) is replaced by the phrase ‘the power of the directors’. This suggests that s 40 is applicable to the acts of all directors and not just the acts of a fully quorate board.

Section 41 restates s 322A of the 1985 Act and states that whether a person is dealing in good faith with the company in accordance with s 40 depends on whether he or she is an insider or an outsider.167 An insider includes a director of the company or of its holding company or a person connected with any such director, and their involvement will render the transaction voidable at the instance of the company.168 In any event, such a party will be liable to account to the company for any gain he made from the transaction and to indemnify the company for any loss or damages resulting from the

162Freeman & Lockyer v Buckhurst Park Properties Ltd [1964] 2 QB 630.

163Smith v Henniker-Major & Co [2002] BCC 544.

164Section 31(2).

165Section 31(3).

166See Chapter 5.

167Section 41(1).

168Section 41(2)(b).

Chapter 4

Corporate governance I: the theories in context

Corporate governance broadly refers to the political, economic, cultural, social and legal mechanisms which govern the activities of corporations. It covers a vast array of scholarship, government policy and law which lay various claims to the proper emphasis of corporate governance, the nature of the company and problems of internal control. American scholarship has continued to set the agenda in this area and as there are such similarities between American corporate law, English company law and corporate ownership patterns, it will be substantially drawn upon in this chapter.

Corporate governance concerns in England and similarly in America are centred on the basic agreed premise that share ownership is widely dispersed between many shareholders, none of whom hold a controlling interest. For example, one study indicated that in England’s top 20 companies, no one shareholder owns more than 20 per cent of the stock.1 Corporate governance discussions, therefore, are largely focused on the issue of management and how to control it. In the absence of a controlling shareholder who can guide management in a shareholder-centred direction, management may pursue non-shareholder-orientated goals. This theory, the premise of most corporate governance, is widely attributed to Berle and Means’s 1933 study outlined below. However, the interpretation of and response to this theory have been varying. Much of the orientation of corporate governance concerns in England have been about how to control directors and how to ensure that they pursue the interests of shareholders and not themselves. In the next chapter we will see the varied mechanisms used by the judiciary to a ect just that end, but broadly speaking under common law, a director is a fiduciary who owes a duty of utmost honesty to the company. Here the company is generally construed as the interests of shareholders as a whole. Accordingly, a director will be in breach of his fiduciary duty if he acts in his own selfinterest under the self-dealing rules. The control of directors’ activity is also

1La Porta, R, Lopez-de-Silanes, F and Scheifer, A, ‘Corporate ownership around the world’ (1999) 54 J Fin 471.

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the concern of a number of government reports published from the 1990s onwards and now incorporated in the Combined Code.

On the other hand, it is clear from much of the post-war literature on corporate governance and the separation of ownership from control thesis (discussed later in this chapter) that the notion of a company whose directors were no longer bound by the shareholder-orientated goal of profit maximisation was for a time greeted as an entirely positive development in British capitalism. Corporations in this period began to be conceived as public organisations, capable of balancing the interests of all those involved from shareholders to consumers and employees. The corporation was viewed as a vehicle for social progress as well as dividend creation. However, from the 1980s onwards the emphasis of corporate governance discussions has been around achieving profit maximisation and shareholder primacy. The most dominant theory here is contractarianism, which recommends the promotion of shareholders’ interests through such mechanisms as minimising agency costs and facilitating market control. Agency costs, an issue which often features in American literature on corporate governance post–1980, refers to the cost to the company of monitoring directors to ensure their compliance with profit maximisation goals. In English and American corporations, agency costs are said to be reduced by marketand law-based mechanisms, such as hostile takeovers, information from capital markets and minimal legislative interference.

Other areas of scholarship discussed includes the ‘law matters’ thesis. Here, Anglo-American corporate law is said to exhibit ‘good law’ tendencies because these systems enable capital markets to develop by encouraging wide share dispersal. In contrast continental Europe, and civil law systems in general, are said to exhibit ‘bad law’ tendencies, which inhibit share dispersal and instead encourage the continuance of controlling shareholder patterns within companies or the continuance of family-owned firms. In these jurisdictions capital markets are relatively underdeveloped, a situation which is considered to hinder economic development. Good law systems are said to be characterised by mechanisms which enhance share dispersal. These include a strong legal tradition of protecting minority rights which encourage small investors and a national political context which is conducive to the development of ‘good law’.

Alternatively, other writers indicate that shareholding in Anglo-American companies is less widely dispersed than the figures would suggest or at least the significance or e ect of the higher dispersal is exaggerated. Furthermore, higher levels of dispersal might indicate a greater level of concentration of wealth rather than greater levels of wealth distribution because in highdispersal economies a smaller proportion of a company’s stock is required to maintain control. From this perspective, the Anglo-American company acts as a much more e cient vehicle for enhancing the wealth of the wealthiest of society than its European counterparts.

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The vast ocean of literature on this subject means that only a small but representative pool of scholarship may be drawn upon. This chapter will be organised under the following headings:

•the emergence of the ‘separation of ownership from control’ thesis;

•the nature of ownership and control in a Berle–Means corporation and the era of the social corporation;

•anti-organisationalism, neo-liberalism and the free market: corporate governance and shareholders;

•neo-liberalism translated into corporate governance: the problem of management in the Berle–Means corporation;

•politics, law and ideology;

•economic ownership and the refutation of the separation thesis;

•the third way, company reform and ‘enlightened shareholder value’.

THE EMERGENCE OF THE ‘SEPARATION OF

OWNERSHIP FROM CONTROL’ THESIS

The ‘separation of ownership from control’ thesis emerged from an empirical study of America’s largest corporations undertaken by Adolf Berle and Gardiner Means in the wake of the Wall Street crash of 1929. Their thesis formed a significant part of the intellectual landscape which replaced the laissez-faire ideology which had previously dominated American economic policy. Together with Louis D Brandeis, Adolf Berle and Gardiner Means became the primary architects of Roosevelt’s ‘New Deal’ package in respect of corporate activity and provided the theoretical and practical basis for new controls over America’s security market. Legislatively, this included the 1933 Securities Act (designed to ensure an informed market of investments) and the Securities Exchange Act of 1934 (aimed at correcting trading abuses).2

Louis Brandeis’s main theoretical contribution was to insist upon greater disclosure in order to flush out the interconnection between finance, industry and infrastructure which was harmful to competition and industrial development. Furthermore, he argued that a lack of disclosure gave false information to investors as to the real value of securities. In Other People’s Money he had argued that interlocking directorates meant conflicts of interests were unavoidable and enabled the few to profit at the expense of the many, smaller investors.

Brandeis’s analysis of the problem of big business led him to conclude that capitalism needed to be more open. He therefore recommended that federal

2The Glass–Steagal Act forbade commercial banks to play on the stock market in order to draw a distinction between investment and commercial banking.

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law should emphasise disclosure on securities which he summed up in his famous adage, ‘sunlight is said to be the best of disinfectants; electric light is the most e cient policeman’.3 In Brandeis’s view, the availability of information for investors would scupper the financier’s ability to charge misleading prices and create financial bubbles. Information would protect the investor and safeguard the integrity of the market.

Likewise, Berle and Means agreed on the necessity for federal legislation to protect investors. Their research had made it clear that shareholders were too powerless and passive to protect themselves because the growth of the capital market and large corporations had resulted in a separation of ownership from control. In this ground-breaking thesis on corporate governance they argued that power within large corporations had shifted from investors to managers, which they demonstrated by the empirical studies published in The Modern Corporation and Private Property.4 Written in the wake of the crash, this book contained detailed empirical data about stock ownership patterns in large corporations which showed that even the largest stockholders held only a tiny percentage of the whole. Their evidence indicated that business had undergone an ‘evolution of control’, from ‘control through complete ownership’ to ‘majority control’, to ‘control through legal device’, to ‘minority control’, through to the full and final evolution, ‘managerial control’. It was an evolution of control which resulted in a shift of power from those that owned the corporation, stockholders, to those that controlled it, the managers.5

Briefly stated, they argued that complete ownership existed when a single individual or a small group owned all or almost all of the stock. As the owner retained legal powers of ownership and could use it to elect and dominate management, ownership and control were ad idem.6 In a majority-controlled business, most of the powers of sole ownership were retained by the majority stockholder although a minority owner could block special resolutions such as charter amendments, thus undermining the absolute nature of the majority’s control. However, if there were a number of minority shareholders, their ability to act with one voice against the majority would be severely hindered. In both scenarios control was still exercised by stockholders, those who owned.7

In control by legal device, strategic minority ownership could ensure control of the corporation without the need for a majority holding. Berle and Means used the example of ‘pyramiding’, where a stockholder owning the majority of the stock in the corporation at the top of the pyramid could

3Today, disclosure laws in America are referred to as sunshine laws.

4Berle, A and Means, G, The Modern Corporation and Private Property, 1932, London, Macmillan.

5Ibid, p 67.

6Ibid.

7Ibid.

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control all the other corporations further down the pyramid. They observed, for example, that the Van Sweringen brothers controlled eight railroads worth $2 bn with $20 m in stock through use of the pyramid system.8

In a minority-controlled corporation, a minority stockholder could control the activities of the corporation because the other stockholders were many and scattered. Furthermore, minority control could be bolstered by the issue of non-voting stock. For example, their evidence showed that Rockefeller tended to own around only 14.9 per cent of Standard Oil stock, but few would suggest that Rockefeller did not exercise absolute control over ‘his’ company.9

The final stage in the evolution of control, management control, is the distinctive portion of their analysis. Management control, they maintained, prevailed in large corporations where stockholders had no economic power or personal desire to exercise control. In a management-controlled corporation, the wide distribution of stockholding resulted in no one stockholder having su cient voting power to control the activities of its management. And, as management itself would have little or no stock, their self-interest would be better served by making pro-management decisions than it would by making decisions beneficial to shareholders. The latter approach might benefit them in their capacity as shareholders, but would be minimal compared with the more direct benefits of pro-management decisions such as selfrewarding bonus schemes. In this scenario, control over the corporation was in the hands of, and serving the interests of, those whose self-interest might not be the same as the owner’s. So, unlike the previous models, control in these large corporations, later referred to as Berle–Means corporations, became disconnected from ownership.10

Berle and Means’s separation of ownership from control thesis has dominated all subsequent debates on corporate governance and is the premise on which all discussions on corporate governance rest. However, its meaning and significance change in accordance with the political context in which it is expressly or impliedly being interpreted.11 Broadly speaking, during periods when the political environment is characterised by a broad-based socialism, the ideological, legal and policy response to corporate governance tends to emphasise Berle and Means’ analysis of the weakened nature of ownership in

8Ibid, p 69.

9Ibid, p 77.

10Berle and Means defined management-controlled corporations with examples like the

Pennsylvania Railroad Co, whose top 20 stockholders owned just 310,518 shares or 2.7 per cent of the total stocks and its 19 directors held just 0.7 per cent of the total stock. Likewise, the United States Steel Corporation’s 13 directors held just 1.4 per cent of total stock. Figures from 1928.

11Impliedly, because the separation is so embedded in corporate governance that many writers have ceased even referring to it.

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the widely held corporation and thereby the potential for social change that this happenstance presents. Discussion orientates around the possibilities of constructing socially responsive and responsible corporations that can deliver socialist or social democratic policy objectives. However, when neo-liberal, pro-market thought is in the hegemony, the academy, business and government emphasise the management accountability portion of Berle and Means’ thesis. That is, the political values of liberalism such as individualism, personal and economic freedom, require that business operates for market goals rather than social goals. And, as the primary market goal of business is profit maximisation, and, as that goal serves the interests of shareholders, shareholder primacy becomes the desired goal of corporate governance for neo-liberals. Strategies to ensure that shareholder primacy is pursued involve various mechanisms to ensure that directors are fully focused to that end and are not pursuing the interests of other interested groups such as employees. The purest neo-liberal thought insists that the market generates enough controls to achieve management compliance and thus the aim of government should be non-intervention in companies and non-interference in the ‘free’ market. Others suggest that the government needs to intervene in market activities and corporate law in order to create the conditions for a free market. Both views essentially agree that the market is the source of corporate governance and the role of policy and corporate law is to support market activity.

The contemporary politics of the present administration have done little in substance to deviate from the neo-liberal position. New Labour’s third way politics have maintained a pro-market, pro-shareholder position while continuing a little of the social democratic rhetoric Labour previously represented. As we shall see in the final section, this approach is reflected in the reform process.

The following sections assess the prevailing political hegemony during the periods which proceeded Berle and Means’ thesis. They assess the e ect of these politics on the way in which corporate governance has been conceived and the way that di erent parts of the separation thesis have been emphasised.

THE NATURE OF OWNERSHIP AND CONTROL IN A BERLE–MEANS CORPORATION AND THE ERA OF THE SOCIAL CORPORATION

In The Modern Corporation and Private Property Berle and Means mapped out the evolution of control and ownership in large corporations. Ownership, they argued, had become something that was ‘passive’ and devoid of ‘spiritual values’. The shareholders of large corporations could not directly employ their wealth, the value of which was dependent on outside forces which were

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entirely out of their control.12 However, for Berle and Means such a development did not mean that economic catastrophe was inevitable. Nor did it necessarily mean that directors needed to be more carefully monitored. The evolution in ownership really meant that control needed to be exercised differently. Ownership of stocks in a large management-controlled corporation meant ownership of a liquid asset whose value was dependent on outside forces. The entitlement of an owner was, therefore, to have the liquidity of his asset maintained and its unrestricted transferability protected. The owner was also entitled to unencumbered, accurate information on the value of his property. It was therefore incumbent upon the ‘controllers’ of companies and on the law to ensure and protect these rights.

However, according to Berle and Means, the stockowner should not expect rights over and above those stated. In particular, he could not demand the same rights of ownership as could the owners of more tangible properties such as land because unlike the latter owners, stock owners bore little responsibility for their property. The stockowner did not and could not exercise control over his property aside from selling it. Ownership of stocks was a passive arrangement that did not involve or require the creative energy of the owner or indeed involve any of the personal responsibilities generally associated with ownership.13 For Berle and Means, stockholding was originally a property right but when the large corporation separated ownership from control, ‘ownership’ became a smaller bundle of legal rights that had an historical relationship with property rights but were not property rights themselves.14 The corporation was no longer subject to the demands of private ownership. The new passivity of stockowners in large corporations meant that they had forfeited the extensive rights and obligations of property ownership, and in the absence of an involved ownership the corporation was reconstructed as something more like a public institution. Accordingly, they argued, the fiduciary duty of a director in a widely held corporation should be akin to a trustee of a public organisation. Here the director’s duty to shareholders’ concerns would be of a limited nature, deferring to the director’s obligation to consider the well-being of the organisation as a whole.

The significance of the revised nature of stock owning in the modern corporation was famously debated by AA Berle and Merrick Dodd in the Harvard Law Review. Berle and Means’ position articulated above divided into two polarised positions, with Dodds postulating the pluralist perspective and Berle arguing for greater managerial accountability. Both of these positions held sway in the succeeding decades.

Unwittingly commencing the debate, Berle, assuming that there was no

12Op. cit., Berle and Means, p 79.

13Particularly in a limited liability company.

14Ibid, p 297.