Company Law Lecture Notes PDF

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Summary

Overview Development The first well-known companies, the East India Company (EIC) and the South Sea Company (SSC), were incorporated and created by the charter granted by the state. Such companies were created by the state, by law, and with a clear political and economic purpose. The dramatic failur...

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Overview Development • The first well-known companies, the East India Company (EIC) and the South Sea Company (SSC), were incorporated and created by the charter granted by the state. • Such companies were created by the state, by law, and with a clear political and economic purpose. • The dramatic failure of the SSC had legal and political ramifications, which helped to shape the emerging industrial capitalism from which our modern company law doctrines arise.

Merchant Capitalism.

Industrial Capitalism Investor-Oriented Capitalism

Capitalism Capitalism is an economic system that works around the concept of wealth creation in the pursuit of economic growth for the nation. Merchant Capitalism Industrial Capitalism Merchant capitalism focuses on simply Industrial capitalism is more fully moving goods from a market where they developed and focuses on commercial are cheap to a market where they are finance and the influence of the mode of expensive. the production of goods •

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In this period, the state sought to control speculative elements of the economy through general incorporation Acts, and 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 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 for the benefit of financiers to enjoy the profits of industrial capitalism. Although the key legal doctrines that describe the modern company developed in the 19th century, it was a gradual development in the context of the larger companies that characterized developed capitalism, but also coexisted with companies that did not – it was a mixed economic picture. As such, no one doctrine or case law caused a seismic shift in the legal conception of the company, but all were important stages. 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.

Merchant Capitalism & Early Companies • In its earliest form, ‘company’ denoted a group of persons engaged in business rather than a distinct legal form. • Therefore, a company could be legally incorporated, or equally, it could not. • The earliest incorporated companies were generally incorporated for some public purpose, e.g. banking, infrastructure, or as a religious institution. They were also known as corporations rather than companies and some preceded any form of capitalism. • From around the 14th century, incorporation was achieved through the grant of a charter by the Crown. After the Civil War, incorporation was achieved by an Act of Parliament. Statutes were also used to extend the royal prerogative so that they could grant charters with enhanced privileges.

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On the other hand, unincorporated companies were formed through differing levels of informal understandings. However, in terms of the post-formation characteristics between incorporated companies and unincorporated companies, there were no significant differences between the two forms. The state allowed both forms to coexist and did not attempt to control company formation, until its own financial interest were threatened in a scheme it entered into with the SSC. This led to the passage of the Bubble Act 1720, and eventually the financial collapse of the English stock market.

Bubble Act 1720

Government needs funding

Government borrows by creating permanent and transferrable debt

Joint stock companies raises capital from investors (shareholders)

Joint stock companies buy government debt

Emerge of speculation

Government secures deal with SSC

Joint stock companies distribute government interests as dividends to shareholders

Government pays interest to joint stock companies

Rise in share prices

Government's scheme with SSC under threat

Passage of Bubble Act 1720

Unincorporated companies prohibited from trading freely transferable shares

SSC Financial Crisis

Government Borrowing • The lead up to these events was the rudimentary beginning of speculation in shares and government borrowing. • In respect of speculation in shares, capital was raised by entrepreneurs through the sale of shares in both chartered (incorporated) companies (often from moribund companies) and unincorporated companies. Capital raised by joint stock companies was used to finance merchant venture (at this time, merchant capitalism has not been superseded by industrial capitalism). They were also used in banking and infrastructure. • The government borrowed by creating a permanent and transferrable debt; the largest joint stock companies bought this debt from capital raised from their investors; the government paid the interests to the companies; and the companies distributed it as dividends to their shareholders. The 3 companies involved in this process were the Bank of England, the EIC, and the SSC. • Large scale speculation emerged in the 18th century and new joint stock companies were proposed. This rise in speculation is attributable to the catastrophic ‘solution’ to the steady growth of government borrowing.

Government-SSC Scheme • However, in the 17th century, the government was still mired in debt. It then entered into negotiations with the SSC to consolidate this arrangement so that the SSC alone would hold all of the national debt and interest. • The SSC planned to profit by charging investors more for their SSC shares in the national debt than the company had paid for it. In order to persuade government creditors that SSC shares were a valuable investment, the directors inflated the share price to create demand. The SSC also funded dividends from new issues and offered interest-free loans to investors to buy shares. Through these strategies, the SSC hoped to circulate the investors’ money profitably and indefinitely. The speculative price represented shareholders’ demand, which was based on their misguided belief that the SSC was making real value. • Following the success (albeit short-lived) of the SSC, more dubious joint stock companies that were not actually creating real value and mainly without charters began to successfully sell shares in companies with little or no feasible business, such as the public’s appetite for shares. Their legal status did not impact on their credibility as there was no distinction between companies on the basis of their legal formation. • This eventually posed a problem to the government and the SSC as these smaller, nonchartered speculations were starting to undermine the credibility of the SSC scheme, and the government was too interwoven and dependent on this scheme to not act. Passage of the Bubble Act 1720 • As such, the government passed the Bubble Act 1720, which prohibited the sale of freely transferable shares by companies operating without royal charters i.e. unincorporated companies. • As well as drawing a distinction in law, the government also clearly hoped to draw a distinction in investors’ minds between incorporated and unincorporated companies and to draw investment away from other smaller speculations. • By inhibiting the schemes of smaller companies, the government protected its larger scheme with the SSC. • However, the Bubble Act 1720 did not protect the SSC, but hastened its demise. The extreme language of the Bubble Act 1720 undermined public confidence in share trading. • After a short initial boost, the SSC’s share price collapsed, with it the fortunes of many, bringing about a financial crisis.

Multi-Fold Effects of SSC Financial Crisis • This financial crisis brought multi-fold effects to the development of companies and company law. • Not only did the Bubble Act 1720 gave privileges to incorporated companies (only incorporated companies were permitted to sell freely transferable shares), the parliament passed other Acts to regulate and limit the market in shares. • Coupled with legal prohibition, there was generalised 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. • On the other hand, speculation became more stable as a corporate charter testified to the soundness of a business as the parliament granted charters only to exceptionally viable and respectable businesses. The result of this legislative activity was to restrict the role of chartered companies in the economy, and to encourage unincorporated forms of businesses, e.g. partnerships. Indeed, the later development of the industry in the 19th century (the Industrial Revolution) emerged from unincorporated businesses.

Deed of Settlement Paradoxical Effect of Legal Mechanisms • 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 start-up capital, a trust known as a Deed of Settlement was devised, which would be the base of the organisation. • The Deed of Settlement created an organisation structure composed of management and a large group of external investors.

Management

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External Investors

Deed of Settlement

Under the Deed of Settlement, 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 terms of the Deed of Settlement circumvented the Bubble Act 1720’s prohibition against sale of freely transferable shares by unincorporated companies, as these shares were transferable subject to the deed’s terms. Paradoxically, the success of the Bubble Act 1720 and other legal innovation prompted the proliferation of unincorporated companies, although these Acts intended to restrict them. Unincorporated companies were also unregulated as they involved private legal arrangements between individuals. Unlike corporations that received royal charters and hence concession from the state with implied public responsibilities, these companies represented the property interests of members who had contracted for self-interested commercial motives. The fundamental of modern company law gradual developed around the schism around the Bubble Act 1720. By the turn of the 19th century, unincorporated companies increasingly became less observant of the Bubble Act 1720, particularly in respect of raising capital and limited liability. Furthermore, they did so quasi organisations with no regulatory oversight. This lack of regulation meant that the possibility of financial crisis and massive fraud raised its head again.

Legality of the Deed of Settlement • The sorts of businesses that caused concern were large unincorporated associations involved in foreign ventures, such as gold mining in the Americas or speculative merchant endeavours. In addition, in the early decades of the 19th century, industrial capitalism was establishing itself and would come to dominate the old merchant capitalism and finance capitalism throughout the century. • The courts and parliament intervened in the development of both of these areas, shaping through law and policy the different stages of capitalism and describing the outcome. • In respect of the unincorporated organisations which nonetheless garnered investment from wide range of shareholders, the courts often intervened to prohibit using the Bubble Act 1720. • The legality of an unincorporated company operating on Deeds of Settlements was successfully challenged in Rex v Dodd as being contrary to the Bubble Act 1720 on the

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basis that their shares where only partly paid up and were transferable. The company was condemned for purporting to have limited liability and its small initial payment that leaves a large portion of uncalled capital was described as being designed to “lure the unwary.” Following which, for many decades, the judiciary maintained this resistance to unincorporated associations raising investment from the public, particularly when speculative bubbles threatened. When speculation rapidly increased from 1824 to 1825, the courts reacted. In Joseph v Pebrer, the court held that unincorporated companies that have freely transferrable shares are illegal organisations under the Bubble Act 1720. Joseph v Pebrer was decisive moment for the parliament that immediately burst the bubble in shares and share prices fell.

Repeal of the Bubble Act 1720 • On the other hand, as it wanted both control and enable speculation, the parliament also passed a series of Acts to promote investor capitalism throughout the 19th century. • Its first post-Joseph Act was the repeal of the Bubble Act in 1825. • Unsurprisingly, the repealing Act faced little resistance due to a near universal hostility to an Act that was seen to both inhibit incorporation and to encourage financial speculation in unregulated associations. The repealing Act also allowed the Board of Trade to advise the Crown on the granting of limited liability. • A small number of legislative changes were also introduced to make incorporation process easier. The Chartered Companies Act was passed in 1837 to simply the incorporation process and gaining limited liability. After registering a deed of partnership and dividing the capital into shares, which allowed for transfers, the persons concerned were granted limited liability. • However, parts of the judiciary continued to cast doubt on the legality of unincorporated associations. In Blundell v Windsor 1837, the court stated that “where the parties assumed to act in a corporate character, or made their shares transferrable without restriction,” they should be declared illegal. • The judiciary also continued to strike down unincorporated associations selling freely transferable shares even after the repeal of the Bubble Act 1720, following a common law prohibition (Duvergier v Fellows 1832) that predated the Act. Duvergier v Fellows 1832 held that “there can be no transferable shares of any stock, except the stock of corporations or of joint stock companies created by Acts of Parliament.” Joint Stock Companies Act 1844 • It was clear that the legal position for business associations and investors would only be secured by incorporation. • The Parliament therefore passed the Joint Stock Companies Act 1844, a general incorporation Act that enabled easier incorporation and responded to the problem that the opaque and private nature of unincorporated associations enabled and encouraged fraud by promoters and directors. • The Joint Stock Companies Act 1844 therefore ensured that the large partnerships under the scrutiny of the courts could become legal companies, but only if they made disclosures and commitments to guard against fraud. Unincorporated associations with freely transferable shares with 25 or more members must register to become companies under the Joint Stock Companies Act 1844. • In this way, the large partnerships might become visible, publicly-registered companies. The Joint Stock Companies Act 1844 sets out stringent requirements in respect of company capital and liabilities and for their disclosure. This would assist unwary investors in investment choices. • However, the Joint Stock Companies Act 1844 did not provide for limited liability and each member was liable for the company’s debts.

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The greatest significance of the Joint Stock Companies Act 1844 – the protection of the company against challenges as to its legality was also rendered vain by Garrard v Hardey 1843 and Harrison v Heathorn 1843. In Garrard v Hardey 1843 and Harrison v Heathorn 1843, the court disagreed with earlier cases and held that the raising and transferring of stock was not illegal per se. Accordingly, the common law position was that an association that traded freely transferable shares was generally legal unless there was evidence of fraud or “nuisance to the public.”

Legal Conceptualisation of Shares Lack of Distinction between Shareholders’ Property Interests and the Company • In early capitalism, companies traded, and shareholders claimed profit. However, their claims were not yet commodified claims to value, and were still integrated with the assets and liabilities of the company. • The corporation held its assets as trustees for the shareholders, who were “in equity coowners.” In Ashby v Blackwell, shareholders were held to be connected in equity to the obligations that the corporation owed to the outside world. This obligation was treated in law as part of a company’s assets and they could be enforced through equity. Following which, the court in Dr Salmon v The Hamborough Company upheld creditor’s claims to have the company’s debt paid by its members. • As such, there was an overall lack of distinction between shareholders’ property interests and the company in early company law. The significance of the common law rule on a member’s liability for a company’s debts is that it indicates the common understanding that the company and the members had a property interest in the same assets, and therefore similar liabilities if those assets became deficits. Turning Point – Bligh v Brent 1837 • The court in Bligh v Brent, against all previous authorities, held that the share was an interest in the profits of the company and not a beneficial interest in the assets. • Hence, although the assets were realty, the interests of shareholders were personalty because claims to surplus were personal interests. • In doing so, the assets, as distinct from the profits arising from those assets, were formulated as 2 different forms of property: the company owning the assets, and the shareholder owning the profits.

Bligh v Brent Company owns assets •

Shareholder owns profits

By Poole v Middleton, shares in joint stock companies were effectively independent property. It was concluded that when a share was transformed into an independent piece of property (following Bligh v Brent), the company was capable of being conceptualised as a separate entity that owned its own assets and held responsibility for its own debts.

Limited Liability • Limited liability is a privilege given to investors by the state. Investor capitalism will not develop without limited liability and it is one of the key political choices that a state will make: whether to keep the economy personal with unlimited liability, or garner wide impersonal investment for companies with limited liability.

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The Joint Stock Companies Act 1844 did not provide limited liability until 1855 when it was amended to give limited liability to shareholders of companies registered under the Act, provided that they voted to do so by a 75% majority. In order to enjoy this protection, the company was subject to stringent requirements in respect of its financial status. E.g., dividends distributed that rendered the company insolvent would be repayable by the directors, and if the company lost 75% of its subscribed capital, the business of the company would have to immediately cease and the company would be wound up. The outcome of further parliamentary debates on limited liability was the passage of the Industrial and Provident Societies Act 1852, which gave cooperatives some corporate identity but not limited liability. The parliament then passed the Limited Liability Act 1855.

Joint Stock Companies Act 1856 • The Joint Stock Companies Act 1856 further liberalised access to both corporate status and limited liability. It also made inv...