Critical Company Law

Lorraine Talbot

• Publisher: Routledge
• Year: 2015
• ISBN:
  9781317570820
• Edition: 2
• Topic: Law
• Subtopic: Law Theory & Practice
• Index: Law

The second edition of Critical Company Law provides a framework in which to understand how the company functions in society and a thorough grounding in modern legal doctrine. It shows how modern company law is shaped by a multi-layered history of politics, ideology, economics and power. Through the lens of political economic theory the book shows how the company becomes the mechanism through which the state makes political choices about distributing societies' wealth and through which it responds to economic crises. The current law reflects an economy marked by a disjuncture between the low profits of the productive economy and the high profits of the finance economy. Critical Company Law examines areas of company law to show how they reflect a fragile economy inexorably drawn to social and economic inequality and short-termism.

These include:

• The Doctrine of Separate Corporate Personality

• Groups of Companies and Tort Liabilities

• Company Formation and the Constitution

• Directors' Duties and Authority

• Corporate Capacity

• Shares and Shareholders

• Raising and Maintaining Capital

• Minority Protection

In this uniquely hybrid book the legal topics are treated with detail and clarity, providing an engaging introduction to the key topics required for a student of company law.

Chapter 1
The state’s creation of the body corporate through law and politics

A short history

Chapter Contents

i. Merchant capitalism and early companies

ii. Industrial capitalism and the shaping of investor capitalism

a. Controlling (and enabling) speculation

b. The commodification of the share

c. Limited liability

d. The effect of limited liability on business

iii. Conclusion

The first well-known companies, the East India Company and the South Sea Company, were incorporated and created by charter granted by the state. Such companies were clearly created by the state, by law and with a clear political and economic purpose. They were both part of the early merchant capitalist economy. The dramatic failure of the South Sea Company had legal and political ramifications, which helped to shape the emerging industrial capitalism from which our modern company law doctrines arise. It is this latter period with which this chapter is most concerned. In this period, the state sought to control speculative elements of the economy through general incorporation Acts, it then sought to encourage investment and speculation with limited liability. By the end of the century, all companies, large and small, had separate corporate personality and limited liability.¹

There are three important points to establish at the beginning of this chapter. First, developed capitalism does not designate a period when capitalism is at its most profitable and is generally characterized by much lower profit rates than developing industrial capitalism.² Up until around the final quarter of the nineteenth century in Britain, profit rates were very high and rates of investor capitalism very low. The modern company (and an investor-orientated capitalism) fully emerged in the latter part of the century when the economy was experiencing significantly lower profit rates. Secondly, much of the legal machinery that was put in place legislatively, to make the company a suitable vehicle for outsider investors, was the result of political choices made in the midst of intense political debate within and outside of parliament. No debate was more intense that that around limited liability, a debate ultimately won for the benefit of financiers keen to enjoy the profits of industrial capitalism. Thirdly, although the key legal doctrines that describe the modern company developed in the nineteenth century, they developed gradually. They also developed in the context of the larger companies that characterized developed capitalism but which coexisted with companies that did not. It was a mixed economic picture. No one doctrine and no one case caused a seismic shift in the way the company was legally conceived, but all were important stages in that journey. Taken as a whole, they form a body of law that describes and provides for the legal separateness of the company, an independent board of directors and the commodification of value created by the company.

i. Merchant capitalism and early companies

Although capitalism is an economic form, which has its own distinct dynamics, it exists, as Polanyi so eloquently describes, in conditions that the state creates. It is not self-preserving and self-defining. The state allowed some business forms, it prohibited others and privileged yet others. There were consequences to all of these political choices. In its earliest form, the word company denoted a group of persons engaged in business rather than a distinct legal form. A company, therefore, could be legally incorporated, or equally, it could not. Those companies that were incorporated were generally incorporated for some public purpose, such as banking or infrastructure, or as a religious institution. They were also known as corporations and some preceded any form of capitalism. From around the fourteenth century, incorporation was achieved through the grant of a charter by the Crown or, after the Civil War, by an Act of Parliament. Statutes were also used to extend the powers of the royal prerogative so that they could grant charters with enhanced privileges.³ Unincorporated associations, in contrast, were formed through differing levels of informal understandings. However, in terms of their post-formation characteristics, there were no significant differences between the two forms. The state allowed both forms to coexist and did not attempt to control company formation generally until its own financial interests were threatened in a scheme it entered into with the South Sea Company, which led to first the passage of the Bubble Act 1720,⁴ and then the financial collapse of England’s stock market.

The lead up to these tumultuous events was the rudimentary beginning of speculation in shares and government borrowing. In respect of the former, capital was raised by entrepreneurs through the sale of shares in both chartered companies (often from moribund companies) and unincorporated associations. Capital raised by joint stock companies was used to finance merchant venture; merchant capitalism had not yet been superseded by industrial capitalism. By 1689, fifteen companies with stock worth £0.9m traded overseas.⁵ They were also used in banking and infrastructure and in 1695 there were 150 joint stock companies with shares worth £4.3m. There was a growing interest in shares and joint stock companies in the latter part of the century. In 1671, the Royal Africa Company had 200 subscribers paying £500 each. But in 1694, the Bank of England had 1,509 subscribers at £795.⁶ Michie notes that by the 1690s, stock jobbers (those selling shares) had become so common that there was enough public interest to publish share prices. However, larger scale speculation emerged in the eighteenth century and between 1719 and 1720, 190 new joint stock companies were proposed, which were estimated to raise £220m. This rise in speculation can largely be attributed to the catastrophic ‘solution’ to government borrowing, which had been steadily growing over some time. In 1693, the government borrowed by creating a permanent, transferable debt. The largest joint stock companies bought this debt from capital raised from their investors, the government paid the interest to the companies, and the companies distributed it as dividends to its shareholders. The three companies involved in this process were the Bank of England, the South Sea Company and the East India Company.

In 1719, the government, still mired in debt, entered into negotiations with the South Sea Company to consolidate this arrangement so that the South Sea Company alone (a company, using a moribund charter with no identifiable trade and few assets) would hold all of the National Debt.⁷ The company planned to profit by charging investors more for their South Sea Company shares in the National Debt than the company had paid for it. As Balen explains, the plan was to purchase the debt at par, a £100 worth of debt for £100 of shares, but then to persuade the holders of government debt to exchange them for South Sea Company shares at a higher rate.⁸ In order to persuade government creditors that South Sea Company shares were a valuable investment, the directors inflated the share price by legal device and extravagant claims designed to create demand.⁹ The South Sea Company funded dividends from new issues and offered interest-free loans to buy shares. Through these and other strategies, the company hoped to circulate investors’ money profitably and indefinitely.¹⁰ The speculative nature of this activity, in which nothing of value was being created, meant that share price represented shareholders’ demand and that demand was based on their misguided belief that the company was making real value.

This particular speculative bubble might have continued for much longer had not its own success prompted similar schemes to make money on the back of rising share prices.¹¹ All manner of dubious joint stock companies – with, but mainly without – charters began to successfully sell shares in companies with little or no feasible business, such was the public’s appetite for shares. Their legal status did not impact on their credibility as no distinction was made between companies on the basis of their legal formation. Culturally, they were joint companies, like the South Sea Company and the Bank of England. Problematically, for the government and for the South Sea Company, these smaller speculations were starting to undermine the credibility of the South Sea Company scheme itself. The government was too deeply interwoven and dependent on the scheme not to act. It passed the Bubble Act of 1720, which prohibited the sale of freely transferable shares by associations operating without a charter. As well as drawing a distinction in law, it clearly hoped to draw a distinction in investor’s minds between incorporated and unincorporated companies and to draw investment away from the more speculative companies. By inhibiting these smaller companies’ schemes, it was hoped that the South Sea’s larger scheme would be protected.¹² In the event, the Bubble Act did not protect the South Sea Company, indeed it probably hastened its demise.¹³ The extreme language of the legislation undermined public confidence in share trading, per se, and after a short initial boost, the South Sea Company’s share price collapsed and with it the fortunes of many.

The effects of this financial crisis on the development of companies and of company law were multifold. It gave privileges to incorporated companies, which unincorporated associations could not enjoy, although the latter were still described as companies. Only incorporated companies (corporations) were permitted to sell freely transferable shares under the Bubble Act. In addition, parliament passed other Acts to regulate and limit the market in shares.¹⁴ Coupled with this legal prohibition was a generalized aversion to and distrust of trading in shares. Accordingly, the sale of shares became considerably more restricted and orientated around a handful of corporations operating mainly in banking, infrastructure and foreign trade. The Bank of England, for example, had 4,837 investors in 1726.¹⁵ On the other hand, this trade was stable and much less speculative, in part, because a corporate charter testified to the soundness of a business. Parliament granted charters only to businesses that were exceptionally viable and respectable.

The result of this legislative activity was to restrict the role of chartered companies in the economy and to encourage unincorporated forms of business organizations, such as partnerships.¹⁶ Indeed, the later development of industry in the nineteenth century (the Industrial Revolution) emerged from businesses that were unincorpo-rated and did not use freely transferable shares. Partnerships, which could be of varying sizes, were the popular legal form for manufacturing and other key industries in Britain’s rapidly developing capitalist economy. When a business required a larger amount of start-up capital, lawyers devised a trust (known as a Deed of Settlement) on which to base the organization.¹⁷ The Deed of Settlement created an organizational structure composed of management and a large group of outside investors. In these so-called Deed of Settlement companies, the property of the company was held by a body of trustees and the shareholders were subscribers who agreed to be associated with the company and to hold shares in accordance with the terms of the deed. The restrictions in the deed seemed to circumvent the Bubble’s Act prohibition against freely transferable shares, as they were transferable subject to the restrictions in the deed. Paradoxically, as DuBois illustrates in his famous text on business at the time of the Bubble Act, the success of these and other legal innovations meant that unincorporated associations proliferat...