Учебный год 22-23 / Critical Company Law

54 Critical company law

economic activity. Williston’s contemporary understanding of the company form is testimony to that assertion. When Williston was writing in 1888, Salomon had not yet been decided, so while he described many of the elements of a company’s separateness from its shareholders, he did not refer to a company being a separate legal person, emptied of people. It required the proper maturation of legal process for that, the judgment of Salomon! While the material basis for the company’s separation was in place, a freely transferable share in a market for shares, the understanding of the leading international law school was that the company did not have a completely separate legal personality. The doctrine, while reflecting a material reality, did not emerge until the courts had su ciently processed its own concepts and drawn them together into one overarching general principle. The notion of separate corporate personality for all incorporated companies was not complete until Salomon and so Williston could not make reference to it or indeed conceptualise the company in exactly that way.

An economic determinist perspective has a tendency to minimalise the importance of other societal facets such as law and ideology so that it often needs to overlook details which are not consistent with the economic model. On the other hand, a legal perspective sees little but the progression of a purely legal narrative and can give no explanation for these changes, nor provide a framework in which to anticipate future changes. Both approaches have their limitations, which might be transcended by an approach which embraced the relationship between law, economics and ideology. The role of limited liability legislation as formative of the doctrine of separate corporate personality is a case in point. The 1855 Limited Liability Act enabled investors to protect themselves from personal liability for their company’s debts. Today, limited liability is synonymous with separate legal personality and it is di cult for students of law, taught in legal narratives alone, to conceive of the doctrine in the absence of limited liability. Yet, historically the 1855 Act and its incorporation into later consolidating Acts did not result in the immediate emergence of the doctrine of separate corporate personality, thus showing the limitations of legal narratives. However, this is not to say that economic determinism provides all the answers, because statutory limited liability did have some part in the emergence of separate corporate personality. Accordingly, limited liability can only be sensibly viewed as one of the elements which led to the reconceptualisation of the company.

Historically, the notion of limited liability was a controversial one and the Act itself was fiercely debated in and outside Parliament. Eventually, it was passed because it was believed that it would enhance investments in companies by attracting the many potential smaller investors. The Act’s promoters reasoned that the wider populace would cease their reticence in regard to share purchases if they were assured that the company’s debts would not fall to them personally. Clearly, as minority shareholders they would not expect to protect their investment by being actively involved in the company’s

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business. Instead they could be outside investors, treating their shares as sources of revenue, much in the manner of a government bond.

This was the reasoning and some of it was borne out in subsequent events. For example, LM Sealy notes that following the passage of the Act, attendance at annual general meetings fell dramatically.90 Company shareholders were observably becoming passive investors. Thus it would follow that if a signifi- cant percentage of shareholders were acting as outside investors, interested only in dividends, the judiciary would begin to conceive of shareholders in terms of their separateness from company activities and by extension the company. An enhanced popularity of a company share, which the 1855 Act undoubtedly contributed to, is an essential factor in the rise of a market in shares which Ireland et al rightly identify as central to the share’s emergence as a tradable piece of property, disconnected from the company’s tangible assets.

On the other hand, the e ect of limited liability on company law history can be exaggerated. Limited liability did not unleash a public clamouring for shares any more than it greatly enhanced the numbers of entrepreneurs keen to incorporate as limited liability companies. The reasons for this seem to lie in the realm of both ideology and economics. Ideologically, the notion that limiting one’s liability was an indication of dubious or sharp practice continued to dominate Victorian thinking. Limited liability, obtained under this Act both cheaply and easily, was considered by many sections of society as an indicator of immorality. And, as the parliamentary debates leading up to the Bill indicate, those in favour of limited liability as a method to enhance investment were closely pitted against those who decried it as a ‘rogue’s charter’. The previous fraudulent behaviour of the South Sea Company and many other smaller joint stock companies was written deeply into the public consciousness. Parliamentary committee reports indicate that the public distrusted limited liability companies, seeing little possibility of creditors and suppliers taking the risk of contracting with an organisation where none was personally responsible for the debts.91 Within parliament MPs expressed frequent concerns that limited liability companies would undermine the good reputation of British merchants. At a very fundamental level a trader who took personal responsibility for the debts gained in the course of trading was thought to be an honest businessman. Limited liability shirked economic and moral responsibility.92

Furthermore, some years after the 1855 Act, the actual record of companies incorporated with limited liability tended to reinforce public distrust.

90Seely, LM, Cases and Materials in Company Law, 2001, London: Butterworths.

91Hannah, L, The Rise of the Corporate Economy, 2nd edn, 1976, London: Methuen.

92One can observe the continuity of this ideology in present-day prohibitions on barristers operating with limited liability, a prohibition to which solicitors and even architects were subject to until very recently.

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As HA Shannon’s work evidences, in the period between 1856 and 1883 onethird of limited liability companies never began business, 28 per cent were declared insolvent, 32 per cent ceased operating voluntarily and 11 per cent just petered out. This left just approximately 6 per cent with a successful, ongoing trading record.93 But the relative lack of popularity of the limited liability company may also be explained by other factors. Industrial Britain of the mid-nineteenth century had very high capital requirements, companies required capital and post-1855 investors were able to invest without personal liability. And yet, incorporations were sluggish. There is much evidence to suggest that businesses that were particularly well established, as opposed to new more speculative businesses, were generally family controlled firms. These businesses often chose to remain as unincorporated associations because the family could retain control and because they could reinvest in the firm using internally generated capital.

Work by PL Payne indicates that high profit rates in this early part of the nineteenth century, coupled with the relative ease by which unincorporated associations could be tailored to reduce personal liability, meant that there was little use for the limited liability form.94 Furthermore, other evidence suggests that the limited liability form was attractive to investors who were themselves close to bankruptcy, which deterred wealthy investors from entangling their money with those of more dubious solvency.95 Indeed, unlimited companies were much less prone to failure than limited companies. In the 1864 report in the register of companies, which looked at the performance of companies registered between 1856 and 1864, 24 per cent of limited companies were shown to have failed compared to only 11 per cent of unlimited companies.96 Je rey’s evidence shows that between 1856 and 1862, 2,488 limited liability companies were formed, although the total of paid-up share capital was only £34 m, a fifth of the £170 m invested in stock over that period.97 The reticence to incorporate is also evidenced by comparing the numbers of incorporations in America. Between 1863 and 1890, the number of incorporated companies grew by 400 per cent, but in less industrialised America, that number was 1,400 per cent for the same period.98

93Shannon, HA, ‘The first five thousand limited liability companies and their duration’, (1933) Economic History 4, pp 290–307.

94Payne, PL, British Entrepreneurship in the Nineteenth Century, 1997, London: Macmillan.

95Manne, HG, ‘Our two corporation systems: Law and economics’ (1967) Virginia Law Review 53, 259.

96Smart, M, ‘On limited liability and the developments of capital markets: An historical analysis’ (1996) Working paper, University of Toronto, p 20.

97Je reys, J, ‘The denomination and character of shares, 1855–1885’ (1948) Economic History Review.

98Forbes, KL, ‘Limited liability and the development of the business corporation’ (1986) Journal of Law, Economics, and Organization 2, pp 163–77.

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The English reliance on the unincorporated business form for the ideological and economic reasons noted above resulted in the relatively slow development of England’s capital markets. As an adjunct to this observation, some writers have attributed Britain’s failure to maintain its early international dominance with its failure to quickly develop its capital markets. For example one paper argued that:

Britain’s earlier industrial success may have led to a build-up of retained earnings among firms, allowing owners of existing, profitable ventures to delay the incorporation decision. This contributed to the problems of adverse selection in limited liability debt markets and induced a development trap for British firms.99

However, capital markets had been developing in England for many decades and financial arrangements between people, or choses in action, had been emerging as pieces of exchangeable property since the eighteenth century. Choses in action have been defined in various ways but the chief di erence between a capital form such as a modern share and pre-eighteenth-century choses in action was the latter’s lack of transferability. It existed as a right personal to the holder rather than a piece of intangible property which was freely transferable. An early definition of choses in action described them as follows:

Things in action is when a man hath cause or may bring an action for some duty due to him, as an action of debt upon an obligation, annuity, or rent, action of covenant or ward, trespass of goods taken away, beating and such like: and because they are things whereof a man is not possessed, but for recovery of them is driven to his action, they are called things in action.100

Later, arrangements that were previously ‘things whereof a man is not possessed’ became things of which he was possessed and could dispose of although they were ‘uncorporeal’. And as the meaning of a chose in action reformulated, so, for example, Howard Elphinstone, writing in 1893, argued that the company share was a chose in action with some ‘diversities’. The owner of shares could enforce his rights against the company by action; however, ‘he has no rights over any specific chattel belonging to the company’.101 On the other hand the shareholder held a prima facie right to sell his share and thus the rights contained in it.

99Op. cit., Smart, p 20.

100Elphinstone, H (1893) 9 LQR 26, p 312, quoting Termes de la Ley, s.v. Chose in Action.

101Ibid, p 314.

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Ireland et al, in concurrence with Marx’s work on finance capital, stated that as markets in titles to revenue developed throughout the nineteenth century, shares were no longer regarded as choses in action but as independent property forms. Following other titles to revenue such as government bonds, in this transformation, the company share began to become a thing in itself when, and only when, a market in shares began to develop. ‘In the absence of a public share market, shares could not develop as fictitious capital with a value in themselves.’102 A market in shares, they argued, began to develop with the popularity of the railway shares which were sold in local exchanges in small accessible denominations. And, although dividends were very depressed they continued to be very popular.

The e ects of these developments on shares, however, were qualitative as well as quantitative. Shares were not only more numerous, they were now marketable commodities, liquid assets, easily converted by their holders into money . . . a gulf emerged between companies and their shareholders and between shareholders and their shares.103

Detailing the emergence of capital markets in Britain Michie’s The London Stock Exchange, A History, shows that during the nineteenth century Britain’s securities markets reoriented from being markets in government bonds (including foreign government bonds) to being markets in joint stock company shares. The London Stock Exchange (LSE), established in 1801, introduced the first major regulations on the sale of bonds and stocks signalling the emergence of a mature market in financial products. It imposed restrictions on membership so, for example, individuals who were involved in business were not permitted to join.104 Furthermore, it introduced new codes of conduct.

The LSE began life dealing mainly in government bonds. However, by the mid 1820s the National Debt was producing a poor rate of return, estimated by Michie to be 3.8 per cent in 1822 and 3.3 per cent in 1824.105 Investors switched first to foreign bonds and then second to shares. Trading in foreign bonds took place in the Foreign Funds room which was established for that purpose but, as a measure of the rising popularity of shares, by the 1830s a large proportion of the LSE’s membership used this room for marketing shares. Michie estimates that by 1838 ‘278 brokers, out of a total membership of 675 – or 40 per cent – were involved in the buying or selling of shares, with many dealers also participating’.106 The growing popularity of shares grew

102Op. cit., Ireland et al, p 158.

103Ibid, p 159.

104Michie, R, The London Stock Exchange, A History, 1999, Oxford: Oxford University Press.

105Ibid, p 53.

106Ibid, p 59.

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exponentially following the explosion of railway shares on the market. By 1845 most of the trade in the Foreign Funds room was of national railway shares, forcing the LSE to rearrange its markets and later extending into new buildings in No 9 Throgmorton Street.107 However, much of the significance of the burgeoning market in railway shares lay in its e ect on the provinces and its popularity and familiarity to the nation’s people, thus normalising share owning:

Popular as railway shares were on the LSE, threatening to overwhelm all other business, their impact on the provinces was even more dramatic. Whereas in 1825 the paid-up capital of Britain’s railways was a mere £0.2 m, rising to £7.5 m in 1835, by 1840 this had increased more than sixfold to £48.1 m and then almost doubled again to £88.5 m in 1845.108

Furthermore,

Membership of existing provincial stock exchanges shot up, with Liverpool reaching 220 in 1846 and Manchester 89, while a rash of new stock exchanges appeared all over the country. By the end of 1845 there were some 18 stock exchanges in existence compared with three at the beginning of the decade, and most major provincial towns possessed one.109

The culture of shareholding spread throughout the nation as the markets in these shares were local and accessible and such shares were issued in reasonably small denominations. In this form and within a thriving market, railway shares could freely exchange as a form of money capital. The owners of these shares were purchasing a financial investment rather than a role in a business and could not judicially or materially be described as being involved in the business. Most shareholders were distinct from the company, which was run by managers and major investors. In this context railway companies were emerging as distinct legal beings.

Industrial shares, however, lagged behind, as they lacked the two attributes of railway shares, that of being in small denominations and that of having a growing market. Later in this century the former lack was addressed by the law in the form of the 1867 Companies Act. This Act provided for the subdivision of a company’s shares following a shareholder resolution. This allowed previously unwieldy shares to be transformed into saleable portions. Shares in industrial companies characterised by quasi-partnership forms of ownership which remained under the control of the original entrepreneurs or

107Ibid, p 60.

108Ibid, p 63.

109Ibid.

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family ownership tended to exist in very large and unwieldy denominations which were not easily marketable. The 1867 Act addressed this problem by allowing these shares to be broken down into small marketable portions.

The second issue began to change in the 1870s. Whilst trade in joint stock company shares was limited largely because there was relatively little for sale, by the 1870s businesses which had operated as partnerships began to convert into joint stock companies. In Michie’s account from 1863 to 1913, 147,932 businesses were registered as joint stock companies. And while many continued to have closely held shares, by the 1880s the largest established companies began to issue shares to the general public:

The result was a far greater awareness of, and interest in, domestic industrial and commercial securities on the London Stock Exchange. The paid-up capital of such securities quoted rose from a mere £43 m in 1883 to £690.9 m in 1903 and then to £917.6 m in 1913.110

The increase in shares on the market generally and the facility to have small-denomination shares substantially contributed to share marketability. But as Michie points out, an increased availability of shares did not necessarily make them attractive investment prospects so that even by 1877, it was estimated that at least 1,082 of the 1,367 issues were unmarketable. Prior to this, ‘at any one time only around 10 per cent of all quoted securities could command a ready market as jobbers had to have a realistic expectation of undoing the deals they made’.111

The developments in the capital market, in business practice, in popular culture and in the law all contributed to the judgment in Salomon. The strength of Ireland et al’s perspective is in highlighting the importance of the burgeoning share market in changing the nature of the share and the doctrine of separate corporate personality. A market in freely transferable shares, although still dominated by railway shares, was thriving at the time of Salomon’s case, as was a popular understanding of the share as a claim to profits rather than the business itself. Thus their Lordships were reflecting the general nature of shareholding in late Victorian England, which did not involve shareholder liability.

However, it remains important to recognise the role of the law in this. The repeal of the Bubble Act, the more permissive regimes of the 1856 and 1862 Companies Acts, the Limited Liability Act and the 1867 Act all helped establish legal and ideological boundaries around the share allowing to it emerge and function as a separate piece of property. The share became an entitlement to dividends partly because shareholders were protected from further

110Ibid, p 94.

111Ibid, p 95.

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business liabilities because the Limited Liability Act had made these liabilities the company’s alone. Furthermore, this was a general feature of all companies so registered and not simply of those whose incorporation documents specified limited liability.

Furthermore, it is also important to recognise that the earlier judgments in cases such as Bligh v Brent do not advance our understanding of the doctrine of separate corporate personality as much as Ireland et al maintain, as these judgments were largely based on the particular facts of the case. Specifically these judgments were based upon the particular terms of the charter or act of incorporation of the company in question. So, contrary to Ireland’s assertion that historically, incorporation was not the source of a company’s separation, we can instead state that sometimes it was: it really depended on the bespoke terms of a company’s incorporation document. No general company law existed during the first half of the nineteenth century and therefore no general principles as to the nature of the company and its shares could emerge. It is only when company law developed more principles that were applicable to all companies, in both common law and statute, that one can identify the distinct role of shareholders in a modern company. Once that is established, the boundaries of the company may be identified.

Separate corporate personality is indeed a doctrine which overwhelmingly supports and protects investors and one which recognises the two di erent worlds occupied by capital markets on the one hand and industrial markets on the other. But it is a doctrine which was gradually given form and articulated by the law and it is the law which is its staunchest defender.

Chapter 3

The company constitution, the company contract: ideology and the law

The company constitution refers to the body of rules which regulate the activities of those involved in the company. Under the 2006 Act the company’s constitution comprises the articles of association and any resolutions relating to the company constitution.1 It is also expected to include other important information relating to the company held in the incorporation documents. The articles of association include rules which govern the company’s internal management. These rules form the terms of the statutory contract which exists between company member qua member and the company. Section 33 of the 2006 Act specifies that the provisions of the company’s constitution ‘bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe those provisions’. Its previous incarnation in s 14 of the 1985 Act formed the basis of many cases assessing the nature of the contractual relationship between company and member.

There has been a long-standing trend in company law and company law scholarship to describe this area of law in contractual terms.2 The company constitution and the rights of members under the constitution, in particular, have been frequently articulated within the paradigm of the contract. The siren call of this paradigm has been particularly amplified by certain aspects, or quirks, of company law. These include such things as the right of the company’s incorporators to register their own articles of association, and s 33 of the 2006 Companies Act, which, as noted above, specifies a contractual relationship between shareholder and company.3

The purpose of this chapter is to examine critically the use of the contractual model in both company law scholarship and in the black letter law pertaining to the relationship of members to the company and to each other

1Companies Act 2006, s 17.

2And more recently to understand company law per se in contractual terms.

3Previously s 14 of the 1985 Act and therefore the section cited in most relevant articles and cases to date.