Учебный год 22-23 / Critical Company Law

14 Critical company law

would be to operate a legal doctrine that reflected mere fiction,39 as we shall see in detail in Chapter 2. In England, the gradual expansion of capitalism altered shareholders’ relationship with their company as the growth of industry resulted in a corresponding growth in the numbers of those investing in the company without a controlling interest. Lack of controlling interest coupled with the introduction of limited liability meant that shareholders, on the whole, ceased to attend AGMs, or take part in the management of the company. Thus, their personal relationship and connection to the company in which they held shares diminished, and shares were purchased solely for the purpose of accessing profit.

Furthermore, throughout the nineteenth century, judicial understanding of the share was connected to the size of company involved. Large companies with hundreds of non-involved shareholders were understood to have shares that were a right to dividend but not a right to company assets. In contrast, shares in small companies with involved shareholders were understood to be ‘quasi-partnerships’40 and thus bequeathed the shareholders with rights far in excess of those in larger companies. As the former understanding of the shareholder and share become generalised, the judicial interpretation of the nature of the share in all companies was that shares represented rights to revenue, not rights in the company assets. As the tangible assets belonged to the company it became materially and conceptually distinct from its owners – a state of a airs that is expressed in the doctrine of separate legal personality.

THE ORIGINS OF MODERN AMERICAN

CORPORATE LAW

In America, as previously noted, the demands of industrialisation came later in the century, but once established, a modern corporate law which reflected English law was accelerated by States competing for incorporations. This state competition for incorporations is a quintessentially American phenomenon emerging at the end of the nineteenth century as an immediate result of New Jersey’s amendment to its Incorporation Act 187541 in 1889. This amendment, generally attributed to the entrepreneurial activities of New York attorney James B Dill (who lobbied the New Jersey legislature for further liberalisation of the existing law), was proposed as a scheme to pass a general incorporation law that would be so desirable to incorporators that it would allow the incorporating state to make money from incorporation fees and an

39 Although the idea of the company as a fiction is precisely the argument put forward by Easterbrook and Fischel, among other economics and law scholars.

40Ebrahimi v Westbourne Ltd [1973] AC 360.

411889 NY Laws 265.

English and American company law 15

annual franchise tax.42 It was followed by The New Jersey Holding Company Act 1891, which permitted corporations to control or own the stock or assets of other firms. A revised version of this was passed in 1896, which by-passed nearly all the restrictions on corporate structure by removing time limits on a corporation’s existence, permitting a wide scope of business activity, facilitating mergers and setting no limit on capitalisation.

The popularity of these liberal corporate laws was overwhelming. In 1896, New Jersey granted 834 charters and received $800,000 in filing fees and franchise charters. By 1903, 2,347 firms had incorporated there, between them paying $2,189,000, an amount that accounted for 60 per cent of the state’s revenue. An astonishing 95 per cent of the country’s major corporations were incorporated in New Jersey including Standard Oil, US Steel, Amalgamated Copper and the American Sugar Refining Corporation. By 1902, New Jersey had paid o its state debt and abolished property taxes.43

Like the preceding practice of granting special charters, New Jersey’s liberal corporate law was roundly denounced for its tendency to encourage ‘big business’, but like the special charters money spoke louder and the success of this legislation led 42 other States to adopt similarly liberal laws. The state of Delaware, in particular, sought to mirror the New Jersey legislation and in 1899 it passed the Delaware Corporation Act, which largely copied the New Jersey Act. So similar were these Acts that a case heard in Delaware in 1900 held that legal precedent in New Jersey could be legal precedent in Delaware, thereby imbuing Delaware corporate law with instant maturity.44

However, despite the e orts of Delaware and others, New Jersey remained the incorporator’s choice, a mantle that it wore until the passage of a series of anti-trust laws known as the ‘Seven Sisters Act’, passed at the insistence of Governor Woodrow Wilson45 and immediately resulting in the abandonment of New Jersey by incorporators in favour of Delaware’s incorporation law.46 To this day Delaware famously remains the preferred state of incorporation and by the end of the twentieth century its incorporations included half of all Fortune 500 companies, more than 40 per cent of all companies listed on the New York Stock Exchange, 82 per cent of publicly traded firms that had reincorporated over the last 30 years and 90 per cent of New York Stock Exchange companies that reincorporated between 1927 and 1977.47

42And would allow Dill and his associates to make money from their company that was set up to advertise the benefits of incorporation in New Jersey and to act as agents for interested parties.

43Op. cit., Urofsky.

44Wilmington City Ry Co v People’s Ry Co Del Ch 1900 – cited op. cit., Butler, p 162.

45Cary, WL, ‘Federalism and corporate law: Reflections upon Delaware’ (1974) Yale Law Journal Vol 83, No 4, March, 64.

46New Jersey repealed the Seven Sisters Acts in 1917 but it never regained its lost business in incorporations.

47Cox, Hazen and O’Neal, Corporations, Aspen Law and Business 1997.

16 Critical company law

The competition for incorporations facilitated the emergence of large financiers who could organise a corporate network that enabled them to control business through stock ownership. Early on in the existence of New Jersey’s liberal corporation law, monopolies and trusts rapidly emerged. As Urofsky noted, ‘the drive toward consolidation reached a peak between 1898 and 1901, when 2,274 firms disappeared as a result of merger, and merger capitalisation totalled $5.4 bn’.48

One of the largest of these monopolies was the United States Steel Corporation, formed in 1901 by the House of Morgan. When John Pierpoint Morgan became sole manager, following the death of his entrepreneurial father, Junius, in 1890, he took over the reorganisation of the railroads by purchasing shares and creating a ‘voting trust’, by which device he was able to control the activities of numerous railroad companies, and by 1898 he had control of virtually all the important railway lines.49 Through these ‘trusts’ the US Steel Corp became the first billion-dollar corporation in the world, controlling 213 manufacturing plants and transport companies, 41 mines, 1,000 miles of railroads, 112 ore vessels and 78 blast furnaces.50 In other words, it encompassed finance, industry, fuel and transport. Another classic example of these so-called trusts was Rockefeller’s Standard Oil Company, formed in 1870 with $1 m in capital. Rockefeller’s strategy was to buy controlling shares in less profitable refineries and to bring them within his business fold. In 1882 he formed the Standard Oil Trust, which became the financial and business centre of the whole of the petroleum industry, controlling Wall Street’s City Bank. By 1895, Standard Oil was worth $150 m.

Critics of these kinds of trusts argued that such large corporations were capable of gross abuse of economic power because they connected many sectors of production under the same corporate umbrella. Foremost among these ‘anti-big businesses’ was Louis D Brandeis, a former corporate lawyer known as the ‘people’s attorney’, who spent much of his long career investigating the relationship between investment banks and industry which large corporations seemed to spawn.51 In 1914, he published many of his findings in Other People’s Money, which drew upon much of the testimony given to the Pujo Committee52 evidencing the rise and dominance of ‘finance capital’

48Op. cit., Urofsky, p 174.

49This is often cited as a positive development. The railroad’s initial construction was under the control of a large number of promoters and had become very unstable and speculative in nature.

50Op. cit., Urofsky.

51He was so called because he gave up his practice in order to give free legal representation to the poor.

52The House Banking and Currency Committee chaired by Arsene Pujo set up to investigate claims that the banking crisis in 1907 had been instigated by a few financiers. The Committee’s disclosures helped to create a climate of public opinion that led to the passage of the Federal Reserve Act 1913 and the Clayton Antitrust Act 1914.

English and American company law 17

(the factual relationship between investment bankers, industry and infrastructure) in American capitalism. In particular, he evidenced the relationship between JP Morgan & Co, National City Bank, First National Bank, the Steel Trust and the railroads. Brandeis showed that JP Morgan & Co and the aforementioned investment bankers, directly or through their trust companies, held hundreds of interlocking directorates in banks, transportation systems, public utilities companies, insurance companies and industrial and trading corporations. The capital value of these arrangements he estimated to be $22 bn.53

Brandeis was not alone in his concerns and for many years businessmen and politicians were divided on the issue of federal controls over corporations

– legislation which would halt the competition for incorporations which facilitated big business. Ultimately, however, the ability of the national government to impose a federal corporate law was both constrained and complicated. For example, the judiciary tended to take a pro-business position. The first important federal measure to attempt to limit the power of large companies, the Sherman Anti-Trust Act, passed in 1890, provided for the prohibition of trusts that ‘unreasonably restrained interstate trade’. However, in the matter of US v EC Knight Co 54 the Supreme Court ruled that federal government could not regulate the Knight sugar-refining monopoly because it was a manufacturer and manufacturing was not ‘commerce’. Furthermore, in the hands of the judiciary the Sherman Act became an e ective piece of anti- trade-union legislation as it became widely accepted that strikes which were organised across state lines did constitute a ‘restraint of trade’ that was, in the judiciary’s view, ‘unreasonable’.

As political views clashed on the issue of federal control of incorporations, Bills were proposed and disappeared.55 President Theodore Roosevelt, famous for ‘trust busting’ and supportive of federal incorporation, presided over years of debate that saw those who were opposed to federal control (because of its unconstitutional nature) pitted against those in favour. And it was by no means a simple split between politicians and businessmen – opposing groups did not always fall into predictable alliances. For example, those in favour of federal incorporations included the traditional anti-big-businesses, Dill, author of the New Jersey legislation, and members of the industrial aristocracy such as John Morgan. Yet, despite the support for federal incorporation in theory, the wording of such legislation often caused considerable dispute. When a major amendment to the Sherman Act was presented to

53As the revelations in respect of the relationship between Citibank, Worldcom, Enron and Salomons reveal, little has changed in the organisation of American capitalism. The Money Programme, BBC2, 9 June 2003.

54156 US 1 (1895).

55Op. cit. Urofsky, p 176, notes that between 1901 and 1914 over 20 such measures were introduced into Congress.

18 Critical company law

congress, it was opposed by many sectors of business because it exempted unions from anti-trust legislation.56

By the end of Roosevelt’s term, the successful use of the Sherman Act against two major trusts had lessened the support of previously supportive elements of big business for federal legislation and the project was deprioritised.57 State competition for incorporations would continue unabated.

Concerns about the abuses inherent in overly large corporations did not dissipate and were finally and dramatically realised in the Wall Street crash of 1929. And so it was not until the presidency of the next Roosevelt, Franklin D, that significant federal legislation was passed to control the activities of corporations. In the wake of the Wall Street crash, it was no longer feasible to a support a laissez-faire policy and in 1933 the Securities Act was passed (designed to assure an informed market of investments) followed by the Securities Exchange Act of 1934 (aimed at correcting trading abuses).58 The leading political and intellectual architects of these measures were Louis D Brandeis, Adolf Berle and Gardiner Means.

As previously noted, the People’s Attorney had long maintained that the interconnection between finance, industry and infrastructure was harmful to competition and industrial development. Furthermore, he argued it 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 many small-time investors, therefore the crash had vindicated many of Brandeis’s conclusions.

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 law should emphasise disclosure on securities. Likewise, Berle and Means agreed on the necessity for federal legislation to protect investors that were too powerless and passive to protect themselves. They famously 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.59 In this book, written in the wake of the crash, detailed empirical data about stock ownership patterns in large corporations showed that even the largest stockholders held only a tiny percentage of the whole. They concluded that business had undergone an ‘evolution

56The Hepburn Bill 1908.

57In Standard Oil Co of New Jersey v US (1911) 221 US 1, the Supreme Court found that the Sherman Act had been violated as it had unreasonably restrained interstate trade. It was ordered to dissolve.

58The Glass-Steagal Act forbade commercial banks to play on the stock market in order to draw a distinction between investment and commercial banking.

59Op. cit., Berle and Means.

English and American company law 19

of control’, which had resulted in a shift of power from those that owned the corporation, stockholders, to those that controlled it, the managers.

Their analysis led to federal control over that which represented financiers’ interests, securities, by promoting a system that protected the interests of passive stockholders. As for areas of corporate law that were unrelated to securities exchange, that was left to individual states engaging in a competition to attract incorporations, making corporate law in America a system of federal control over securities with state control over all other aspects of corporate activities. So in the areas of corporate law which guides management and shareholder control, states compete to provide the law most likely to attract incorporators who are those likely to be majority investors, management or both.

This competition is dominated by the liberal corporate law of Delaware and since the 1980s it has been popular in American academies to view this ‘Delaware e ect’ as a positive attribute of American corporate law because it most accurately reflects the market. Known as the ‘race to the top’, its exponents agree that market-driven corporation laws most e ciently promote a thriving economy.60 Notably, Easterbrook and Fischel argue that competition benefits shareholders as it forces states to adopt rules that enhance shareholder value.61 They argue that the stock market acts as a way of disciplining directors by providing up-to-date information on their competency as facilitators of profit maximisation.62 Moreover, they assert that states without proshareholder and pro-market legislation facilitated uncompetitive companies that were vulnerable to take-over. In another version of the ‘top’ theory, Roberta Romano argues that it is the stability and predictability that a state can o er that accounts for Delaware’s popularity. Dubbed the ‘race for predictability and stability’, this theory holds that Delaware continues to be very popular despite the fact that many other states have adopted their liberal rules and the fact that the costs associated with incorporation are high. Professor Romano argues that Delaware’s dependence on incorporation revenues perpetuates a self-interest in maintaining the predictability and stability in its law. Furthermore, she states that the presence of a small judiciary with corporate expertise together with long-standing precedent on corporate issues reassure incorporators that the law in Delaware will be predictable.

In contrast other theorists assert that state competition for incorporations had led to a ‘race to the bottom’.63 This theory, in a nutshell, says that state

60From early work such as that of Ronald Coase to more recent work by Reiner Kraakman and Henry Hansmann in The Anatomy of Corporate Law, Oxford, 2004.

61Op. cit., Easterbrook and Fischel.

62Ibid.

63The free market, ‘race to the top’ theorists claimed the hegemony from the ‘race to the bottom’ theories of the post-war period where the political emphasis in both England and America was of community, rebuilding, national industry and socially responsible business.

20 Critical company law

competition for corporate charters harms smaller shareholders as it encourages the adoption of law that benefits managers and controlling shareholders, the likely incorporators. Foremost of the ‘race to the bottom’ theorists was Professor William Cary, who spent a substantial part of his career arguing for more federal controls over the activities of corporations, particularly in respect of directors. Cary argued that one of the principal problems with Delaware corporate law was not just the number of corporations it attracts but the extent to which corporate law in other states is defined by Delaware law.64 This, he argued, had the e ect of eroding all state or piecemeal federal attempts to create a more responsible approach to the governing of corporations.

Cary argued that the freedom held by individual states to determine their own corporation laws was an abdication of federal responsibility and maintained that the federal approach to corporate law was lop-sided since, having constructed certain legal norms in respect of securities, it failed to extend these to other areas of corporate law.

According to Cary, faced with competition for incorporation charters, individual states are unable and unwilling to set a di erent agenda.65 Furthermore, they do not seem to understand the connection between lax governance and corporate abuse. In Cary’s words, ‘at a state level there seems to have been a failure to recognise the di erence between the goals of industrial capitalism and the abuse of finance capitalism’.66 In short, he argued, Delaware law leads the way to corporate abuse, first, because decisions lean toward minimal standards of director responsibility67 and second, because these decisions are constantly cited by other jurisdictions as nearly half of all listed companies are incorporated there. In this way, a legal environment that specialises in fiduciary laxity is sustained.

Although Cary’s analysis is based on case law up to the 1970s and not beyond, there has been no substantial shift most areas of corporate law. For example, directors’ duties in American states are universally less onerous than those in England and Wales where both judiciary and government are agreed on the need to control directors and to ensure they represent the interests of investors.68 So, while the American courts have attempted to create an objective standard for a director’s duty of care, it is undermined by the infamous business judgement rule which states that no liability will arise for losses

64Op. cit., Cary.

65In Delaware, in 1971, franchise taxes represented $52 m out of a total of $222 m in state tax collections – one quarter of the total.

66Op. cit., Cary, p 668.

67Cary cites a number of examples of the former problem including directors’ non-disclosure of share purchases, misleading proxy material, misuse of dividends and abuse of subsidiary company at the expense of shareholders.

68The ‘no cakes and ale’ judgment is a classic example of the English approach.

English and American company law 21

caused by imprudence or honest errors of judgement. And, when the decision of Smith v Van Gorkom 69 stated that this rule did not apply to gross errors of judgement, such as the hasty action of an ill-informed board, the Delaware legislator passed a statute eliminating directors’ liability for negligence.70 English law does not allow such protection for directors although, as we shall see in Chapter 5, the Companies Act 2006 has adopted many Americanesque characteristics which allow directors much greater opportunities to expand their business interests.

CONCLUSION

Corporations in America and England have made a historical transition from being organisations that were neither distinct from the members nor distinct from public and governmental interests into organisations that are viewed as arrangements between private contractual individuals. As we shall see in the following chapters, many scholars believe that this has been one of the great ideological victories of the wealthy which has no basis in economic nor legal realities. Furthermore, it will be argued that the notion of the company as a private body is part of an ideological victory that is gaining momentum through the nexus of contract theories that emerged in the 1980s and remain in the hegemony today – these are the intellectual backbone of the Companies Act 2006.71

69Smith v Van Gorkom, 488 A 2d 858 (Del 1985). In 1980, the trade union senior management became aware that the stock was undervalued. Without consulting the board of directors, Van Gorkom, the owner of 65,000 shares, suggested a $55 per share cash-out merger with a company his friend Jay Pritzker owned. After several meetings, Pritzker agreed. Van Gorkom called a special meeting without informing the directors of its purpose. Despite a negative reaction from the directors, Van Gorkom proceeded with the meeting. In the board meeting he outlined the proposal but failed to mention that it was he that suggested the price. Donald Romans, the corporation’s chief financial o cer, had opposed the merger at the earlier meeting, but his recommendation was not asked for by the board. After two hours the merger agreement was signed without being read by the directors or Van Gorkom. An action was filed for breach of fiduciary duty and the court held that the directors did not adequately inform themselves as to Van Gorkom’s role in forcing the sale of the company and in establishing a sale price, were uninformed as to the intrinsic value of the company and were grossly negligent in approving a sale of the company in such a short space of time.

70Delaware General Incorporation Law, s 102(b)(7), allows personal liability of directors to be capped.

71Op. cit., Kraakman et al.