THE UNIVERS'I' Of CHICAGO

Volume 4 Spring Quarter • 1955 Number 3

This I believe to be unsound. The various state corpo­ ration laws are not codes in the true sense, though some of them are so described. Nor is the British Companies Act, despite its length and elaboration. All the statutes presuppose basic common law and equitable principles most of which are nowhere embodied in legislation. And these basic principles are derived from the same roots in our common heritage. Furthermore, the various corpora­ tion laws show striking similarities. That all this is so as regards the various states of the Union is recognized by your national law schools, which teach, not the corporate law of any particular state, but the general principles of American corporation law. That these principles are generally the same as those applying to English corpora­ tion law is the only ground on which the Harvard Law School could attempt to justify their temerity in bringing me, an English lawyer, to Harvard to teach American corporation law. In the course of this teaching (and learning) I have been struck by the basic similarities. But I have also been impressed by the divergencies. These divergencies are, I believe, of some interest and significance and worthy of study by the lawyers of both our countries. If I fail to Gower Professor convince you of this, it will, I think, be due to my own deficiencies (of which I am very conscious at this mo­ Corporation Law in England ment) rather than to the inherent barrenness of my and America subject. The seeds of the Anglo-American business corporation By L. C. B. GOWER -now probably the most important economic institution Sir Ernest Cassel Professor of Commercial in the world-had been sown prior to the eighteenth Law at the London School of Economics century but had not then produced any very notable fruit. All that the American colonists took with them from A lecture delivered at The Law School England was an embryonic law of corporations-munic­ My intention today is to draw certain contrasts between ipal rather than business corporations-and an embryonic the state present of corporation law in Britain and in the law of partnership. The first English attempt at corporate United States. This might be thought necessarily to be a legislation, the wordy and obscure Bubble Act, was and pointless unprofitable activity. Since each of the passed in 1720 as a result of the South Sea Bubble. It was states has its own corporation code and Great Britain has designed to curb the growth of unincorporated joint­ both in form and in content another, differing from that stock companies, but its actual result was very different, of of the how can any states, there be any common as we now know from the pioneer research work of an ground on which to base a comparison or contrast? American scholar, Dr. Armand Dubois. Paradoxically it 2 The Law School Record Vol. 4, No.3

to of the distinctive roles of and caused the government to exhibit great reluctance partnerships corporations, a re­ she never drew the distinction between them with the grant charters of incorporation and thus produced birth of the unincorporated association which the act had same clarity as England has since 1844. We then recog­ the form was not sought to destroy. It was not until 1844, when a general nized that partnership intrinsically suited to for act of Parliament provided for incorporation by simple large joint-stock enterprise, partnership prin­ mutual trust and confidence the registration, that incorporation was readily granted in ciples presuppose among members which is if their number is England. Moreover, even then the members of the corpo­ impossible unduly ration remained fully liable for the corporation's debts; large. The English legislature therefore prescribed a limit -a limit which is now If the number of mem­ it took another eleven years before limited liability was twenty. recognized. This somewhat arbitrary separation between bers exceeds twenty, the association must register as a incorporation and limited liability accounts for the fact corporation. By a stroke of the pen the formerly common with a mem­ that to this day in Britain every limited company has to unincorporated joint-stock company large became In America no such announce its members' irresponsibility by having the bership impossible. develop­ ment in states where for cer­ word "Limited" at the end of its name. Such a separation occurred, and incorporation was a late date the between incorporation and limited liability was not, of tain purposes not recognized until association continued to flourish. Hence course, unknown in America (for some years it prevailed unincorporated the Massachusetts or business trust which the in Massachusetts), but in general you made much less represents distin­ heavy weather of this matter than we did, and none of final evolution of the unincorporated company, now from the in that the members your states insists on the word "Limited" as the sole per­ guished partnership missible indication of incorporation. are free from personal liability-a refinement which Eng­ In England, therefore, incorporation with limited lia­ land never succeeded in attaining. which bility by a simple process of registration is less than a At this time a further development took place the course of hundred years old-it attains its centenary only this year. may have had some significance. During Having regard to the transcendent role played by Eng­ the nineteenth century (starting with New York and land in the mercantile community during the nineteenth Connecticut in 1822), most American states borrowed and early twentieth centuries this is difficult to credit; from continental Europe the device of the limited part­ but so it is. Prior to 1855 joint-stock enterprise had existed nership. England did not do so until 1907; until then but had operated principally in the guise of the unincor­ legal freedom from personal liability could be attained the business porated company or partnership. The legislation of 1844 only through incorporation. Accordingly, and 1855 adopted this familiar form of organization and world and its astute legal advisers proceeded to adapt the conferred on it the boon of corporate personality and corporate form for use by the one-man firm or small­ limited liability. Hence the modern English business family concern, thus defeating the obvious legislative in­ corporation has evolved from the unincorporated partner­ tent to restrict corporations to large associations and ship based on mutual agreement rather than from the partnerships to small ones. This development, finally corporation based on a grant from the state and owes sanctified by the House of Lords in the famous case of more to partnership principles than to rules based on Salomon v. Salomon in 1897, led to the private company corporate personality. This is reflected in the fact that we to which a few years later the legislature itself granted in England still do not talk about "business corporations" special immunities. American efforts to evolve the close or about "corporation law" but about "companies and corporation as a suitable substitute for the partnership, company law." limited or unlimited, did not come until somewhat later refer later. In America, on the other hand, the Bubble Act seems, and met with difficulties to which I shall be­ wisely, to have been ignored-despite the fact that it had I have stressed these differences in the relationship at various times in been extended to the Colonies by an act of 1741. After tween partnerships and corporations the Declaration of Independence, incorporation, by special our respective histories because I believe they explain differences between our modern acts of the state legislatures, was granted far more readily many of the present than in England, and the unincorporated joint-stock systems of corporate law. But before I elaborate this to date this historical company, though not unknown, was correspondingly less point perhaps I may bring up rapid to the de­ important. In a number of industrially important states survey by a brief reference twentieth-century concerned incorporation by registration under a general act came velopments. In the main we have both been the earlier than in England-thirty-three years earlier in with the same two vital problems: first, protection New York-and, when it came, the model which the of investors when they buy corporate securities, and, legislative draftsmen had in mind was the statutory cor­ second, the subjecting of corporate management to some poration rather than the unincorporated company or sort of control by the stockholders. In England measures partnership. Hence modern American corporation law to this end have been taken by revisions of the Companies a detailed owes less to partnership and more to corporate principles. Act at intervals of roughly twenty years after the But, although America was earlier in her recognition investigation by an expert committee appointed by Vol. 4, No.3 The University of Chicago Law School 3

Board of Trade-the government department exercising general supervision over companies. In America all but two of the states have tackled the first problem by blue­ sky laws, which, if they have done nothing else, have produced a nation-wide picture of such devastating com­ plication as seriously to hamper the tasks of an interstate issuer and of the securities industry. But, happily, you have more recently made a determined attack on both problems through federal legislation setting up the Secu­ rities and Exchange Commission and, in so doing, have produced a body of rational corporation law which, in many respects, is the envy of the English.,speaking world. To this, too, I shall revert later. It is in the context of this historical sketch that I want to draw attention to certain contrasting aspects of our modern of law. In the at systems corporate time my Professor Gower delivering his lecture in Law South disposal I have had to paint the history in the broadest strokes, and I can select a few for similarly only topics of the public company. England has succeeded in adapt­ further treatment in outline only. ing the same form so that it also meets the requirements I have stressed the already differing reliance on part­ of the incorporated partnership. America has not been Let me illustrate nership principles. this further. In both quite so successful. Why? and America it is the England recognized that business The reason for our success, I think, is that the consti­ corporation performs at least two distinct economic pur­ tution of the English business corporation is still regarded it enables skilled poses. First, entrepreneurs to enlist as essentially contractual. Whereas the American statutes masses of large capital which they employ to the advan­ tend to lay down mandatory rules, the English Com­ of the absentee owners. Here we have the tage publicly panies Act relies far more on the technique of the Part­ owned the wealth and of corporation, importance which nership Act, providing a standard form which applies exceed that of most of the states of North may America. only in the absence of contrary agreement by the parties. Second, it enables the small partnership or single trader Much that in America is mandatory is in England in­ to personify the business and to separate its assets and cluded only in the optional model constitution-the liabilities from those of its members. Here we have what famous Table A. And this, or whatever the parties substi­ calls the and England "private company" America the tute for it, is expressly declared by the act to bind the "close it is less corporation." Economically, important company and the members as though it were a contract than the public corporation, but it is anything but insig­ under seal. In particular this contractual constitution nificant; indeed, in view of the grave expense of making deals with the method of appointing the directors, with a issue of it is a vital link in public securities, probably the the division of powers between them and the stock­ of from process growth private firm to large public com­ holders, and, subject to important exceptions, with the In some the needs of the two pany. repects types differ. meetings and votes of each. In America these matters The needs centralized public corporation management have generally been fixed by statute and fixed in a way from owners. distinguished the In the private or close which shows that the draftsman envisaged their applica­ this not be needed or corporation may desired; probably tion to publicly owned corporations. I need not remind the and the shareholders will be same managers the you of the difficulties which these statutory norms have and will not people clearly differentiate what they do in caused to those wishing to provide safeguards perfectly one from what do in the capacity they other. The idea that reasonable in the case of dose corporations. Leading must as directors for the benefit they manage fiduciary of cases, such as McQuade v. Stoneham, Clark v. Dodge, themselves as beneficial owners passive will strike them and Benintendi v. Kenton Hotels, illustrate these diffi­ as nonsense. in the legalistic Again, public company the culties. To an Englishman it is strange that corporate shares of stock must be the freely transferable; so-called codes such as that of Delaware, which are notoriously lax "owners" demand a liquid investment. In the close in failing to provide important safeguards against abuses, this is not to corporation likely be wanted any more than should nevertheless be strict in matters which seem to us it is in a The partnership. incorporators want to continue to be essentially matters for the parties themselves to as albeit with the partners advantages of corporate per­ settle. There are now clear indications that the same view do not want other sonality; they people to be able to step is beginning to appeal to American courts and legis­ into the shoes of their co-partners. latures. As a result of the Benintendi case the New York

Both and America have a England evolved type of statute was modified so as to provide in one jurisdiction suited to corporate body brilliantly meet the requirements some of the flexibility inherent in the English model. 4 The Law School Record Vol. 4, No.3

deemed to have accounted for that. In other cor­ More recently a New Jersey case (Katcher v. Ohsman) words, is freed from the double taxation in­ has shown a marked change in judicial attitude which porate trading earlier rule. volved in America. This somewhat mixture may herald a general reversal of the rigid illogical means that cor­ Similar considerations apply to restrictions on the of corporate and partnership principles America to be transfer of shares. English law has always regarded com­ porate trading is far less likely than in constitution tax-wise and at least to pany shares as creatures of the company's disadvantageous equally likely be Whereas tax law has tended and therefore as essentially contractual choses in action. advantageous. English to the American revenue Hence there is no legal objection to the contract forbid­ encourage private, company, law has tended to the close the ding or restraining the freedom of transferability of the discourage corporation; new in the Internal Revenue Code shares or rights which it creates. Indeed, one of the essen­ provision entitling certain to elect to be taxed as tial conditions of recognition as a private company is partnerships corporations accentuate tend­ that the constitution should "restrict the right to transfer (but not vice versa) may perhaps this its shares." The most common form of restriction is to ency. to make give the directors an unfettered veto on transfers, thus Before leaving the private company I ought nature evolution has not with­ enabling them to preserve the essentially personal it clear that its proceeded entirely of the association just as effectively as in a partnership. out problems. The famous case of Salomon v. Salomon, down the No one has ever argued that such a far-reaching restric­ which is its parent, laid corporate entity prin­ have found tion, or an option or right of first refusal vested in the ciple with such rigor that English judges other shareholders, is invalid. (Perhaps I may here add much greater difficulty than their American colleagues in parentheses that the option must be vested in the in piercing the corporate veil when public policy so de­ various immunities to other shareholders, not in the company itself, for in mands. Further, the granting of un­ caused to be taken of them England a company cannot purchase its own shares private companies advantage convenient to less they were expressly issued as redeemable preferred by public companies which found it oper­ shares and then only subject to stringent safeguards.) ate through private subsidiaries. This abuse made it for the to subdivide com­ This conception of a share as a contractual chose in necessary legislature private and to action is not, of course, unknown in America. As Holmes panies into two classes-exempt nonexempt-and the most from said in one of his early cases: "Stock in a corporation restrict prized advantage (freedom pub­ to the world its balance sheet and ... creates a personal relation analogous otherwise than lishing profit-and-loss to the class. To be technically to a partnership. There seems to be no greater account) exempt exempt, companies and conditions to objection to obtaining the right of choosing one's asso­ must satisfy detailed rigorous designed insure that are concerns. allow­ ciates in a corporation than in a firm." But in America they genuine family Still, for these there can be little doubt that the contractual aspect has always had to struggle with ing complications, the has met a need felt the conflicting notion that a share is "property," the aliena­ private company satisfactorily in America but for which American law has not tion of which must not be unreasonably restrained. Hence equally restrictions which in England would have been freely as yet supplied an equally satisfactory instrument. allowed have been struck down. Only recently do the In most respects, therefore, the English legislature and American courts seem to be allowing the contractual courts have relied on partnership principles to a greater American. But there are some concept to triumph. A strong example of this is the re­ extent than have the converse is true. One is in cent Massachusetts case of Lewis v. Hood. But as yet respects in which the example under this development has stopped short of allowing an abso­ connection with the doctrine of pre-emptive rights to sub­ lute veto. which the existing stockholders have the right Similarly in the sphere of taxation English law has scribe for further capital issued by the company. England has never this doctrine as a allowed the partnership analogy to prevail to a greater adopted compulsory legal rule. similar are conferred extent than in America. True, England agrees with Commonly rights expressly in the constitution of a and, until the America in regarding the incorporated company as a private company, latest the. Table A so But separate taxpaying person and to this extent distinguishes revision, optional provided. in the absence of the restraint on it from a partnership which is not. True, too, there is express provision only directors is that entailed the rule that must the possibility that corporations will be subject to taxes the by they act as fiduciaries when further In other from which individuals are free. On the other hand, the issuing capital. law has been what some Ameri­ corporation is not subject to the additional surtax ap­ words, English always can wish American law had been and what it plicable to individuals in the higher tax brackets, and, writers has now become in states. The strict rule, within limits similar to those imposed by your accumu­ many original was a of lated earnings tax, surtax will be avoided on plowed-back however, logical application partnership prin­ profits. As regards distributed profits, the stockholders ciples, and the partnership analogy was expressly adopted was formulated in 1807 in the will be liable to surtax on the dividends received but not when the rule originally to ordinary income tax-the company's assessment is Continued on page 20 20 The Law School Record Vol. 4, No.3 daughter, eighteen, attending University of Illinois in art embarrassment to the company. Rightly or wrongly, school, and son, Larry, fifteen. Home address: 6623 N. Kil­ English law has in this respect treated the stockholder as Ill. Office: 8999 Palmer River patrick Ave., Lincolnwood, St., a creditor rather than a partner. Ill. Grove, I turn now to a consideration of the two matters WOLFSON, LEo.-Partner, C. J. Wolfson & Co. Formerly which I have previously described as the vital corporate associated with law firm now known as Becker & Levinson, problems of this century: the protection of purchasers at which time left of law to be Peebles, 1930-42, practice of securities and the control of stockholders over man­ associated with present business. Former president, Men's agement. Both are, of course, aspects of the generic prob­ Club of Beth Am; former president, Men's Apparel Club lem of investor protection. of Indiana. Former vice-president, National Association of On the first I do not to much. Both Men's Apparel Clubs. Married to Janet Harris, Ph.B. Uni­ aspect propose say our countries least if most of state versity of Chicago, 1932. Has two sons, ages twelve and (at your "blue-sky sixteen. Home address: 7733 Luella Ave., Chicago 49. Office: laws" be disregarded) have relied in the main on the 307 W. Van Buren St., Chicago 7. same philosophy-that of disclosure. Both have provided sanctions, civil and criminal, for misstatements or mate­ rial and indeed reverse the Addendum omissions which supplement strict common-law fraud principles. But ex post facto Well, that's it for the first twenty-five! It sim­ might sanctions are far less effective than initial scrutiny of the procedures if you would let the Law School know plify prospectus to insure its accuracy and completeness. In from time to time what are for the next you doing America this vital task of initial screening has been in­ This to mind the fact that, after the twenty-five. brings trusted to government agencies-the Securities and Ex­ above success story, the School might think it exaggerated change Commission-in cases to which the Securities unless some healthy contributions are from forthcoming Act applies. It is here that English law appears extraor­ of The Law School has made everyone you. great dinarily lax to the American observer. The Companies strides. Those of who are in touch know that there you Act requires registration at the Companies Registry of are a new set of "greats" the minds of the truly training the prospectus and prescribes its contents. But neither future. The School has outgrown its physical It capacity. the Registry nor anyone else is given the task of pre­ needs your help and deserves your support. liminary investigation to insure the accuracy of the To all of the best of to be wished for. you everything information disclosed, and until 1948 there was not even To those of who have taken the trouble to fill out you a mandatory "waiting period." The explanation of this your questionnaire, it has been a real pleasure to hear apparent anomaly is found in the different and infinitely from it is a loss to the School not to have you; genuine simpler organization of the securities industry in Eng­ heard from the others. ahead to our fiftieth, Looking land. The over-the-counter market scarcely exists, and however, it is hoped that another classmate will groom in practice no public offering can be made without ob­ himself to further this adulatory saga of the Class of '30. taining a quotation for the shares on one of the recog­ nized stock exchanges, normally London. These stock Corporation Law- exchanges have their own rules which in many respects Continued from page 4 are far more stringent than those of the act and which the of the in the national case of Gray v. Portland Bank. Why in this respect Eng­ require publication prospectus where it will be commented on and criticized land should have rejected an obvious partnership analogy press by the financial columnists. The issue must be I cannot explain; but, when I review the difficulties that sponsored members of the in will be the strict rule has caused in America, I cannot but think by Exchange and, practice, undertaken and underwritten one of a small number that we were wise to do so. by of houses as call Again, the American courts have adopted the partner­ issuing ("investment bankers," you of To their own ship analogy as regards the stockholders' rights to in­ them) high repute. protect reputations and to their freedom from sanc­ spect the corporate books and records. The English courts preserve possible legal these and houses have rejected it, holding that a stockholder as such has tions, brokers, dealers, issuing subject the issues which back to the most no right to inspect the financial records. It is perhaps they stringent scrutiny. This transcends doubtful whether in practice this puts the American scrutiny, moreover, investigation merely of will want to insure that the stockholder in a much stronger position than his Eng­ accuracy-the sponsor.s issue is sound as well as In other lish confrere. Reports suggest that in many (perhaps financially legally. our more unified most) cases his rights will not be recognized by the words, we, with simpler and organiza­ have been able to leave the vital task of to corporation without a lawsuit. Without this he may tion, screening even be denied access to the list of stockholders-some­ private enterprise instead of to public authorities. That thing that he could always obtain in England. Still, in this system works pretty well is, I think, shown by the the absence of statutory regulation, he clearly has greater fact that in recent years there have been only a handful out of legal rights-rights which may be a source of grave of criminal prosecutions arising misleading pro- 20 The Law School Record Vol. 4, No.3 daughter, eighteen, attending University of Illinois in art embarrassment to the company. Rightly or wrongly, school, and son, Larry, fifteen. Home address: 6623 N. Kil­ English law has in this respect treated the stockholder as Ill. Office: 8999 Palmer River patrick Ave., Lincolnwood, St., a creditor rather than a partner. Ill. Grove, I turn now to a consideration of the two matters WOLFSON, LEo.-Partner, C. J. Wolfson & Co. Formerly which I have previously described as the vital corporate associated with law firm now known as Becker & Levinson, problems of this century: the protection of purchasers at which time left of law to be Peebles, 1930-42, practice of securities and the control of stockholders over man­ associated with present business. Former president, Men's agement. Both are, of course, aspects of the generic prob­ Club of Beth Am; former president, Men's Apparel Club lem of investor protection. of Indiana. Former vice-president, National Association of On the first I do not to much. Both Men's Apparel Clubs. Married to Janet Harris, Ph.B. Uni­ aspect propose say our countries least if most of state versity of Chicago, 1932. Has two sons, ages twelve and (at your "blue-sky sixteen. Home address: 7733 Luella Ave., Chicago 49. Office: laws" be disregarded) have relied in the main on the 307 W. Van Buren St., Chicago 7. same philosophy-that of disclosure. Both have provided sanctions, civil and criminal, for misstatements or mate­ rial and indeed reverse the Addendum omissions which supplement strict common-law fraud principles. But ex post facto Well, that's it for the first twenty-five! It sim­ might sanctions are far less effective than initial scrutiny of the procedures if you would let the Law School know plify prospectus to insure its accuracy and completeness. In from time to time what are for the next you doing America this vital task of initial screening has been in­ This to mind the fact that, after the twenty-five. brings trusted to government agencies-the Securities and Ex­ above success story, the School might think it exaggerated change Commission-in cases to which the Securities unless some healthy contributions are from forthcoming Act applies. It is here that English law appears extraor­ of The Law School has made everyone you. great dinarily lax to the American observer. The Companies strides. Those of who are in touch know that there you Act requires registration at the Companies Registry of are a new set of "greats" the minds of the truly training the prospectus and prescribes its contents. But neither future. The School has outgrown its physical It capacity. the Registry nor anyone else is given the task of pre­ needs your help and deserves your support. liminary investigation to insure the accuracy of the To all of the best of to be wished for. you everything information disclosed, and until 1948 there was not even To those of who have taken the trouble to fill out you a mandatory "waiting period." The explanation of this your questionnaire, it has been a real pleasure to hear apparent anomaly is found in the different and infinitely from it is a loss to the School not to have you; genuine simpler organization of the securities industry in Eng­ heard from the others. ahead to our fiftieth, Looking land. The over-the-counter market scarcely exists, and however, it is hoped that another classmate will groom in practice no public offering can be made without ob­ himself to further this adulatory saga of the Class of '30. taining a quotation for the shares on one of the recog­ nized stock exchanges, normally London. These stock Corporation Law- exchanges have their own rules which in many respects Continued from page 4 are far more stringent than those of the act and which the of the in the national case of Gray v. Portland Bank. Why in this respect Eng­ require publication prospectus where it will be commented on and criticized land should have rejected an obvious partnership analogy press by the financial columnists. The issue must be I cannot explain; but, when I review the difficulties that sponsored members of the in will be the strict rule has caused in America, I cannot but think by Exchange and, practice, undertaken and underwritten one of a small number that we were wise to do so. by of houses as call Again, the American courts have adopted the partner­ issuing ("investment bankers," you of To their own ship analogy as regards the stockholders' rights to in­ them) high repute. protect reputations and to their freedom from sanc­ spect the corporate books and records. The English courts preserve possible legal these and houses have rejected it, holding that a stockholder as such has tions, brokers, dealers, issuing subject the issues which back to the most no right to inspect the financial records. It is perhaps they stringent scrutiny. This transcends doubtful whether in practice this puts the American scrutiny, moreover, investigation merely of will want to insure that the stockholder in a much stronger position than his Eng­ accuracy-the sponsor.s issue is sound as well as In other lish confrere. Reports suggest that in many (perhaps financially legally. our more unified most) cases his rights will not be recognized by the words, we, with simpler and organiza­ have been able to leave the vital task of to corporation without a lawsuit. Without this he may tion, screening even be denied access to the list of stockholders-some­ private enterprise instead of to public authorities. That thing that he could always obtain in England. Still, in this system works pretty well is, I think, shown by the the absence of statutory regulation, he clearly has greater fact that in recent years there have been only a handful out of legal rights-rights which may be a source of grave of criminal prosecutions arising misleading pro- Vol. 4, No.3 The University of Chicago Law School 21

case inside information in in the se­ spectuses, and, since the war, not a single reported of dealings corporation's We have started even to of a civil action for damages or recision. curities. hardly develop your facts" and we have no There is, however, one respect in which we are more "special doctrine, "insider-trading" rules to those under the Securities socialized than you in this field. Since the beginning of comparable Exchange Act. The farthest we have is to for a the war, the consent of the Treasury has been required gone provide of directors' so that for any issue by which a company raises more than £50,- special register holdings, any dealings in shares directors should be revealed. 000 (say, $150,000) in any year. This restriction is, of by re­ Both countries have been the course, designed to insure that our limited capital oppressed by difficulty of a for the sources are employed in accordance with national priori­ evolving satisfactory procedure enforcing both it is unless a ties. But even here the Treasury has subcontracted (as it directors' duties. In recognized that, stockholder's individual are the were) to private enterprise (much as you did with your rights infringed, primary Voluntary Credit Restraint Program in 1950-52), for the remedy is an action by the company or a stockholder's do not call it a "deriva­ Treasury acts on the advice of a committee of industrial­ derivative suit. We in England we that that is what it is. On ists, bankers, and the like known as the Capital Issues tive action," but recognize rule in Committee, which works on instructions about priorities the other hand, the prevailing many jurisdictions that the stock­ given to it from time to time by the Chancellor of the and under the Federal Rules of Procedure on the direc­ Exchequer. In practice this curb has not proved too pain­ holder must first serve a demand for action on stockholders also does not ful to the business world; indeed, in recent months con­ tors and sometimes prevail it seems to be derived from the sent has been granted so readily that there is talk of re­ in England, although v. which still survives in pealing the restriction as no longer needed. The main old rule in Foss Harbottle, Eng­ an emasculated and somewhat form. complaints in the past have been about the former policy land in mysterious of refusing permission for bonus issues ("stock divi­ In practice derivative actions are in England relatively uncommon. We have not been faced with the same dends," as you call them) which, rather anomalously, of "strike" or suits and have not require Treasury consent notwithstanding that no new problem blackmailing had to enact to curb this abuse. This money is raised. special legislation is because of the rule that the loser More interesting, perhaps, are our different attempts general English pays the whole of the the winner's advocate's to solve the problem of the management-shareholder re­ costs, including fees. and the more types, lationship. The fundamental principle is, of course, the Any litigation, especially fancy is therefore an unattractive Hence actions same in both countries: the directors and officers are gamble. against directors have been rare. occur if fiduciaries owing duties of care, loyalty, and a modicum Normally they only the into when the of skill. By and large the application of this principle to company goes liquidation, Companies a so Act affords the summary against particular facts is, far as I can judge, much the same. liquidator remedy miscreant directors and officers. Our main has English courts tend to be strict when they can apply a problem been while the remains a rule of thumb-such as the rule that directors must not that, company going concern, the derivative action is not an effective sanction. take personal advantage of a corporate opportunity. They is to cause the to cease to be a move with less assurance when they have no fixed stand­ One solution company concern. The of has ard to guide them: American courts are perhaps rather going winding-up companies long been from in and more ready-or, perhaps, I should say less unready-to separated jurisdiction bankruptcy, hold that directors' actions exceed the permissible bounds rules for liquidation-voluntary and compulsory-have a of our Of of their business judgment. In both countries some dif­ comprised large part companies' legislation. ficulty has been found when the controlling directors particular importance in the present context is the rule the court to wind a on the have taken the precaution of securing a favorable reso­ enabling up company ground which is another lution at a general meeting. In both countries lip service that it is just and equitable-a ground This can be used to is paid to the alleged rule that the majority must exercise relic of the partnership. power put· an end to a course of conduct on the of their votes as fiduciaries. But in neither country do the oppressive part controllers. Once a is the decisions, as I understand them, really support this. In the winding-up made, liqui­ and the court and the both the true rule seems to be that the majority must not dator, supervised supported by Board of has effective of expropriate the property of the company or of the minor­ Trade, powers investigation solution seems to be available ity, and here again I think that American courts have and recovery. A similar inherent been more successful in applying this rule. Certain it is in America as part of the equity jurisdiction, that the supervision of the SEC in certain reorganiza­ and greater use of it has been advocated. But a recent this in the tions has prevented unfairness to minority interests, such attempt in New York to employ expedient was not successful. as preferred shareholders, in circumstances in which the case of a foreign corporation is that English requirement of confirmation by the court has The weakness of this solution, however, liqui­ unfortunate from the failed to provide an adequate safeguard. America, too, is dation may be singularly viewpoint if are far in advance of England as regards restraining abuse of those oppressed, particularly they preferred 22 The Law School Record Vol. 4, No.3

stockholders with restricted rights to repayment of capi­ power to appoint an inspector to investigate the affairs tal. Hence a the latest English Act provides by Section 210 of company. This is one of the very few respects in an alternative remedy under which any shareholder who which the powers of the Board of Trade exceed those complains that the affairs of the company are being con­ of your SEC. The Board may exercise this power in a ducted in a manner to oppressive some part of the mem­ variety of circumstances; for example, if there are cir­ bers may petition the court, which may impose upon the cumstances suggesting oppression of minorities, or fraud parties whatever settlement it considers just. The court's or misconduct by the directors, or failure to give the order may regulate the future conduct of the company's stockholders information which they might reasonably affairs, may alter the terms of its constitution, or may expect. The inspector (normally an independent barris­ direct one party to buyout the other. This remedy, it ter, solicitor, or accountant) reports to the Board, and will be resembles observed, Section 225 of the Delaware normally the report is published. This alone may cause Law and Section 25 to Corporation of the New York Gen­ the wrong be remedied; indeed, that may occur as a eral Corporation Laws in that it enables an individual result of preliminary investigations by the officials of the shareholder to bring an action in his own right free from Board. If this does not suffice, the report should at least the restrictive provisions applying to derivative actions. provide the stockholder with the essential ammunition. But, unlike these sections, it is of general application and But he himself may still not need to use it, for the not restricted to, or primarily directed at, disputed Board of Trade is empowered to institute civil or crim­ elections. inal proceedings or to petition for winding up or for There have as yet been few reported instances of the the new alternative remedy under Section 210. Hence, if application of this section, and, so far as my information the individual stockholder can persuade the Board to goes, none of them-reported or otherwise-has been act, he may find that all his chestnuts are pulled out of successful. Nevertheless, I can testify from personal ex­ the fire for him without any expense to himself. It is perience that the section has been of undoubted value therefore not surprising that this remedy is of growing especially in the case of small companies. Threats of an popularity and that complaints have been made to the Board in well over a application have in many cases brought the misbehaving hundred cases in the last six years. directors to heel without further action, and, in view Inspectors have been appointed in sixteen of these cases, of the difficulties under an adversary system of enabling and in many others preliminary discussions have brought the court to find a solution and forcing it on the parties, about a settlement agreeable to the complainant. I suspect that this new weapon in the shareholders' This solution of the problem is similar to that which will more armory always be effective when brandished in certain American writers have advocated. It has the great terrorem than when actually wielded in court. But it is a merit that it prevents expense from deterring the prose­ of real weapon value, and I commend it to your attention. cution of just complaints, while obviating the danger of The other difficulty, and this would apply not only to a strike actions. The Board of Trade will not appoint an derivative action but equally to our new alternative inspector unless satisfied that there are strong grounds remedy if it stood alone, is that a stockholder is at a great for suspicion, but, if an appointment is made and mis­ disadvantage vis-a-vis the management as regards the conduct revealed, they will see that it is rectified, with­ information at his disposal. Something can be done by out leaving this to the hazards of private litigation. Fur­ compulsory disclosure through annual returns and re­ ther, as a method of obtaining information, it has certain ports and in particular through annual accounts. Until obvious advantages over the American rule allowing the recently we have been in advance of you in the amount stockholder himself to snoop through the company's of publicity thus required, but, in the case of companies records. As I have already pointed out, he will normally to which the SEC to an to Acts and Regulations apply, you have have fight action before he is allowed exercise now caught and overtaken us. The main flaw in the that right, and, if he is ultimately successful, he may American picture is that these regulations do not apply abuse the confidential information thus obtained. Both to all companies or even to all public ones. In any event, these disadvantages are avoided by the English solution. disclosure of this type, though it may enable the stock­ Fortunately, however, misconduct by directors is rela­ holders to detect the symptoms of sickness in the cor­ tively rare. Of greater practical importance than the porate body, is not likely to show him the cause of the pursuit of the dishonest is the removal of the lazy or ailment. It will certainly not provide him with the evi­ incompetent. In other words, the crux of the manage­ dence which he needs to bring a lawsuit against those ment-shareholder problem is to make more effective whom he suspects to be the source of the infection. What the exercise of the stockholders' rights at general meet­ he needs is some means of finding out before he em­ ings-especially their right to "hire and fire" the direc­ barks on litigation whether his suspicions are well torate. founded. Until recently the American rules relating to general In England an interesting solution to this problem meetings have been, to English eyes, extraordinarily lax. has been found by conferring upon the Board of Trade And in some respects they still are, despite the SEC Vol. 4, No.3 The University of Chicago Law School 23 proxy rules. If, as I have previously suggested, American voting machinery. And, here, your SEC proxy rules, acts make mandatory certain things which might well be when they apply, are far more effective than anything left to the incorporators to settle, there are other matters we have in England. There permission to vote by proxy which we in England have thought it essential to regulate is mandatory, and the notice of the meeting must ad­ by statute which your acts have left to the parties. For vertise the right to vote in this way. If the management example, we have thought it right to insist that a certain solicit proxies at the company's expense, they must solicit proportion (10 per cent) of the stockholders shall have all stockholders and not just a selected few-a point not power to compel the convening of a special general covered in the SEC proxy rules. Two-way proxies are meeting. Under many of your statutes the stockholders not compulsory under the act but are under the rules cannot do so unless the by-laws happen so to provide. of the London Stock Exchange, which amounts to the And it seems strange to us that in most states the stock­ same thing in the case of publicly held companies. More­ holders have no power to remove directors-at any rate, over, these rules provide that proxy forms must be sent in the absence of misconduct-until the expiration of out by management when any proposals (other than of their terms of office. Hence, if the staggered system of a purely routine nature) are being considered-here election is in operation, one who has acquired a majority again we are ahead of the SEC rules. But, and this is of the stock may have to wait not merely to the next the grave weakness, we have no detailed regulations re­ annual meeting but perhaps for several years before he garding the contents of proxy statements. In connection can gain control of the board. with some types of reorganization the act, it is true, Only if staggered elections are banned is the majority provides for the disclosure of certain matters-for ex­ shareholder in a reasonably strong position; if the recent ample, the interests of directors-but, in general, we decision in Wolfson v. Avery is upheld on appeal, this rely on the common-law rule banning tricky or mislead­ is so under Illinois law. But in some states the staggered ing circulars. voting system, especially if coupled with cumulative vot­ Similarly our stockholder-proposal rule is but a pale for ing, may postpone many years the time when the imitation of yours. Though it provides for inclusion of winner of a proxy fight can enjoy the full fruits of his members' resolutions and circulation of supporting litera­ victory. In England not only can a meeting be sum­ ture, it only applies when invoked by a hundred mem­ moned forthwith but the whole of the existing board can bers or those representing one-twentieth or more of the then be dismissed by ordinary resolution. This, you voting rights, and the expense has to be borne by them. may think, is carrying majority rule and stockholder Only in one respect is it superior-the supporting state­ democracy too far. ment may run to a thousand words instead of merely As you will have gathered, cumulative voting is un­ to a hundred. This at least has the advantage of enabling known in England, and I have never heard it advocated. the statement to be expressed in reasonable English in­ We still like to think of boards of directors as united stead of the jingle-esc prevalent here. In practice little use teams of managers rather than as representative of diver­ is made of this provision. As your experience has shown, gent interests overseeing the management. Perhaps we a resolution so proposed has virtually no chance of pass­ are very old-fashioned and behind the times-but that ing without independent proxy solicitation, and we have is a national characteristic. However, the contrary idea little of that. is not particularly modern-the Germans have for some As in America, battles for control have recently been time recognized the distinction between managers and frequent, though none has been on the mammoth scale overseers to which you now seem to be tending. regarded as appropriate here or not anything like a mil­ Our rules are also generally stricter than yours as re­ lion dollars. Nor have we yet had to decide whether the gards length of notice of meetings and the extent to "outs" can recover their costs from the corporate treasury which the business of the meeting must be detailed in if they succeed in becoming "ins." Nor have professional the notice. On most important matters at least twenty­ firms of proxy solicitors yet reared their well-groomed one days' previous notice must be givt:n, and it is in­ heads. We have one practice, however, which you might variably the practice, and generally legally essential, to perhaps borrow--that of providing that proxy forms set out the precise resolutions to be proposed unless these must be lodged with the company prior to the meeting. are merely part of the ordinary business of the annual This prevents the deliberate prolongation of the meeting general meeting. Resolutions of which the stockholders so that high-powered solicitation may cause the absent have not been warned are therefore unknown, because stockholders to change their votes. This provision is not they cannot lawfully be moved. Even amendments to mandatory but is invariably adopted in the constitution; resolutions included in the notice are only permissible to prevent abuse, the act insists that the time of lodg­ within very narrow limits. ment shall not be longer than forty-eight hours before However, all this is unimportant compared with the the meeting. problem of minimizing the advantage enjoyed by the In this short discussion I have deliberately stressed existing management through their control of the proxy those matters in which it seemed to me that English 24 The Law School Record Vol. 4, No.3

law is now richer and more experience might be worth your attention. I trust that poration incomparably high­ than its Answers to in so doing I have not given the impression that I regard ly developed English parent. many which have never been in English corporate law as generally superior. Nothing questions litigated England could be farther from the truth, and, had I been address­ can be found in the American reports. But, alas, how tries to find them. I cannot call ing a British audience, the emphasis would have been rarely any Englishman virtues to mind case in recent in which American very different. I should then have extolled the any years we could authorities on a of law have been drawn of your SEC legislation, from which certainly point corporate to attention an court. The reason is not borrow. I have already touched on some instances. There the of English far to seek: most think of American cor­ are others; for example, the regulation of trust indentures practitioners as an different and trustees for bondholders under the trust indenture poration law entirely alien system with act. statutes and different principles. In fact, as I have tried to the statutes be but I should have pointed out that most of your states emphasize today, may different, have either abolished the anachronistic ultra vires doc­ most of the principles are the same. Even when we carry out the overhaul of our we do trine or so drawn its teeth that it can no longer inflict periodical legislation, not, I as much attention as we should to American much hurt. In contrast, we in England have mitigated fear, pay Committee declared its rigor only to the extent of making it easier for a practice. For example, the Cohen that it would be to a for­ company to alter its authorized objects. In a recent Eng­ impossible produce legislative mula of trustees for deben­ lish case all but one of the debts of a company could not insuring the independence ture holders. do not seem even to have con­ be proved in its liquidation, because the company had They Indenture Act. Ad­ omitted to take advantage of this facility when it changed sidered Section 310(b) of the Trust its activities. mittedly the Committee on No-Par Shares carefully re­ viewed American but could do I should also have emphasized that most of your courts experience; they hardly have rightly refused to saddle those dealing with a cor­ otherwise, since they were being asked to adopt an poration with constructive notice of the contents of its American child. charter and by-laws. The unfortunate English rule in Unhappily the same is true of American reliance on this regard has partially destroyed the efficiency of the English authorities. Until the first World War it was common to find decisions cited in American admirable rule in Royal British Bank v. Turquand. This English cases. Now rare. And do not rule, that outsiders are not to be damnified by defects corporation it is very you even have the excuse that are in indoor management, has rightly been envied by many English reports inaccessible, American observers, but it would in practice be far more as American reports often are in England. I have already on a case law is useful if it were not for the limitations imposed by the admitted that nation-wide basis your unrealistic constructive notice doctrine. incomparably rich, but English law is at least as rich as of most states. Yet a who I should have chided us with being nearly fifty years that single Chicago lawyer behind the times in our refusal to allow no-par-value cannot find an Illinois case in point will diligently search shares which are certainly far more logical and easily until he finds one in New Mexico or Missouri. I would comprehended than those with an arbitrary nominal have thought that an English authority would be at value. We recently appointed a committee to consider least as persuasive, but he won't try to find one. The I is that it isn't in the legalization of no-par shares, and it reported favor­ reason, suppose, Shepard. ably. Despite the opposition of the Trades Union Con­ Whatever the reasons for this mutual ignorance, it is, I for cross-fertilization well gress-for entirely unworthy reasons to my mind-the think, unfortunate, might government has recently announced that it will introduce improve the strain of both breeds. If anything I have said should cause one of to evince suf­ legislation "in due course." So we may catch you up be­ today but you ficient in law to turn to it as fore too long and perhaps avoid your mistaken policy interest English company a last I shall feel that time has not been of making no-par shares unpopular by tax discrim­ resort, my ination. wasted. I can only hope that you will not think that I Finally, I should have pointed out that American cor- have wasted yours.

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