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Forty Years of Corporation Law
Published online by Cambridge University Press: 16 February 2016
Extract
A reform of any body of law necessitates adopting new legal groundrules designed to improve the current situation. A reform is judged significant when the new rules have a major impact on society's daily life. In this respect, the last major reform in corporation law did not take place in the last forty years at all, but rather some 140 years ago, upon the implementation of the “limited liability” concept in England.
In the first chapter, I analyze the term “significant reform” in the context of corporation law. I clarify why the concept of limited liability can be characterized as such a reform. In addition, we will note several other legal subjects that could have been construed as significant reforms.
- Type
- Corporation Law
- Information
- Israel Law Review , Volume 24 , Issue 3-4: Israel Law—Forty Years , Summer–Autumn 1990 , pp. 702 - 725
- Copyright
- Copyright © Cambridge University Press and The Faculty of Law, The Hebrew University of Jerusalem 1990
References
1 For a general survey on the subject see Levy, Smithand Sarnat, , The Stock Exchange and Investing in Securities (Schocken, 1978, in Hebrew) 36ff.Google Scholar
2 The concept of limited liability frees the small investor from having to hold his private assets as security against the firm's debts. Had any given investor's liability been unlimited, he would have to constantly monitor the firm's solvency as a means of protecting his own personal assets. He would also have to monitor the other investors' solvency, because they would all be jointly and severally liable to make good unfulfilled corporate obligations. In addition, he would have to invest his property in as small a number of firms as possible, in order to minimize the chances that at least one of them reach bankruptcy, and would thus not be able to diversify away risk. For these and other severe implications for investment without limited liability, see Easterbrook, and Fischel, , “Limited Liability and the Corporation” (1985) 52 U. Chi. L. R. 89CrossRefGoogle Scholar, and Procaccia, U., “On Laws, Contracts and Things: An Economic Approach to Basic Jurisprudential Concepts” (1988) 18 Mishpatim 395Google Scholar.
3 In general, every financial risk related to a specific firm (as opposed to general market risks), is given to diversification. See Modigliani, and Pogue, , “An Introduction to Risk and Return: Concepts and Evidence” (1984) 30 Fin. Analysts J.68, at 76Google Scholar.
4 Posner, R.A., Economic Analysis of Law (Boston, 3rded., 1986) 369Google Scholar.
5 As quoted by Diamond, A.L.in Orhnial, , ed., Limited Liability and the Corporation (London, Croom Helm, 1982) 42Google Scholar.
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8 The classic study that clarifies the phenomenon of separation is Berle, and Means, , The Modern Corporation and Private Property(1932)Google Scholar, and compare Werner, , “Management, Stock Market and Corporate Reform — Berle and Means Reconsidered” (1977) 77 Colum L.R. 398CrossRefGoogle Scholar.
9 This disparity between the welfare of the firm and that of its managers is termed the Agency Problem. Its proper solution is the theme of much study. See, for instance, Jensen, and Meckling, , “Theory of the Firm — Managerial Behavior, Agency Costs and Ownership Structure” (1976) 3 F. Fin. Econ. 305CrossRefGoogle Scholar; Fama, , “Agency Problems and the Theory of the Firm” (1980) 88 J. Pol. Econ. 288CrossRefGoogle Scholar.
10 Eisenberg, , The Structure of the Corporation(1976) 137ff.Google Scholar
11 Wolfson, , The Modern Corporation (New York, 1984) 75ff.Google Scholar
12 For justification for such democratization see, for example, Nader, Greenand Seligman, , Constitutionalizing the Corporation — The Case for Chartering of Giant Corporations(1976)Google Scholar.
13 See Procaccia, , New Company Laws in Israel(The Hebrew University of Jerusalem, 1989, in Hebrew) ch. 27Google Scholar.
14 The leading case is Foss v. Harbottle, (1843) 2 Hare 461,67 E.R. 189 and compare Clark, R.C., Corporate Law (Boston, 1986) 639ff.Google Scholar
15 This privatization can also be effected by significant incentives to someone who is not necessarily a shareholder, such as counsel for the nominal plaintiff. This method is effected in the United States. See Henn, H.G.and Alexander, J.R., Corporations (St. Paul, 3rded, 1983) 1107ff.Google Scholar
16 Some legal systems are content with assisting the nominal shareholder to cover his expenses. The British common law reached this conclusion. See Wallersteiner v. Moir (No. 2) (1975) 1 All E.R. 849. Obviously, a method enabling the derivative plaintiff both to cover his expenses and enjoy the rewards of his successful legal proceedings is too far-reaching, since the incentive provided to initiate proceedings exceeds the optimum.
17 For the reasons for including all these proceedings in one conceptual basket, and the great importance of these proceedings, see Bebchuk, A.and Procaccia, U., “Acquisition of Companies” (1988) 13 Iyunei Mishpat 71Google Scholar.
18 An elegant expression of this view can be found in Manne, “Mergers and the Market for Corporate Control” (1965) 13 J. Pol. Econ. 110Google Scholar; Easterbrook, and Fischel, , “The Proper Role of the Target's Management in Responding to a Tender Offer” (1981) 94 Harv. L.R. 1161CrossRefGoogle Scholar.
19 A strong stream of the literature emphasizes the forseeable dangers of such inefficient acquisitions. See, for instance, Lipton, , “Corporate Governance in the Age of Finance Corporatism” (1987) 136 U.Pa.L.R. 1CrossRefGoogle Scholar.
20 This standard was set down, for instance, in Bebchuk, A., “The Sole Owner Standard for Takeover Policy” (1988) 17 J. Leg. Stud. 197CrossRefGoogle Scholar. Compare Schwartz, “The Sole Owner Standard Reviewed”, ibid., at 231.
21 See Lipton, supra n. 19, at 11 and Fleischer, Bialkinand Green, , New Techniques in Acquisitions and Takeovers(1985) 70Google Scholar.
22 The accepted procedure for unloading a loan taken by the buyer onto the target company is the following: the buying firm takes a loan from the organization financing the takeover, and in exchange, collateralizes its assets to that firm. The loan funds serve to buy the target company. After the acquisition, the buyer controls both the acquiring firm and the target company, and he is capable of carrying out a merger. The final result is that the united legal entity must return the loan to the financing body. Frequently the united firm cannot meet such a heavy debt, unless by massive sales (spinning off) of part of its holdings, such as profitable subsidiaries.
23 I did not include indirect legislative amendments since they do not explicitly change the statutory letter of the Ordinance.
24 Companies (Amendment) Ordinance, 1949 (2 L.S.I. 108); Companies Ordinance (Amendment) Law, 1950 (4 L.S.I. 185); Companies Ordinance (Amendment No. 2) Law, 1952 (6 L.S.I. 163); Companies Ordinance (Amendment) Law, 1953 (7 L.S.I. 79); Company Law Amendment (Miscellaneous Provisions) Law, 1953 (8 L.S.I. 37); Companies Ordinance (Amendment No. 7) Law, 1961 (15 L.S.I. 19); Companies Ordinance (Amendment No. 8) Law, 1961 (15 L.S.I. 131); Companies Ordinance (Amendment No. 9) Law, 1965 (19 L.S.I. 121); Securities Law, 1968 (22 L.S.I. 266); Bankruptcy and Companies' Winding Up (Amendment of Provisions) Law, 1969 (23 L.S.I. 278); Companies Ordinance (Amendment No. 12) Law, 1971 (25 L.S.I. 158); Companies Ordinance (Amendment No. 13)Law, 1975(29L.S.1.114); National Insurance (Amendment No. 16) Law, 1975 (29 L.S.I. 129); Auditors (Amendment No. 3) Law, 1978 (32 L.S.I. 254); Partnership Ordinance (Amendment No. 2) Law, 1980 (34 L.S.I. 96); Companies Ordinance (Amendment No. 17) Law, 1980 (35 L.S.I. 45); Bankruptcy Ordinance (Amendment) Law, 1983 (37 L.S.I. 67); Companies Ordinance (Amendment No. 2) Law, 1987 (S.H. no. 1211, p. 72).
25 This amendment was rather heavily commented on. I have expressed my opinions in Procaccia, U., “Recent Developments in Company Law Legislation: Ultra Vires and Constructive Notice” (1981) 11 Mishpatim 368Google Scholar.
26 See, for instance, Sealy, supra n. 7, at 17 ff.
27 Cary, W.and Eisenberg, M.A., Cases and Materials on Corporations (New York, 5thed., 1980) 38ff.Google Scholar
28 The rules regulating fraud on the minority are extremely restrictive. Usually the court will not grant a remedy, unless the majority transferred wealth belonging to either the company as a whole or to the minority to itself. See Gower, L.C.B., Modern Company Law (London, 4thed., 1979) 616ff.Google Scholar
29 See my article, “Winding-up at the Suit of Minority Shareholders” (1977) 8 Mishpatim 13Google Scholar.
30 In England as well, where a similar amendment to the law exists since 1948, there have been very few legal decisions proscribing oppression. See Pennington, R.R., Company Law (London, 5th, 1985) 742ff.Google Scholar
31 In Shasha Investment Corp. v. Bank Adanim Ltd. (1988) 42(i) P.D. 14, Judge Vinograd describes the purpose of sec. 235 (the statutory provision regulating cases of oppression) in the following words: “The purpose of the amendment was to prevent the damage to oppressed members of a company, that could be incurred by an order to wind up a company; and to allow them, under circumstances when there is in fact justification to hold that it is just and equitable to wind up the company's affairs … some other assistance that would not unfairly harm their rights” (emphasis added — U.P.) Further on, Judge Vinograd explains that the assistance will be given only in those cases where the majority acted “in bad faith or fraud which enabled them to usurp property rights from the minority”. It is clear that this restrictive interpretation neutralizes the significance of sec. 235 almost completely. See also Matzot Israel Company Ltd. v. Ravina (1986) P.M. 221, where President Evenor reaches a similar conclusion.
32 See Eisenberg, supra n. 10, at 165 ff. And compare Conard, , “A Behavioral Analysis of Directors' Liability for Negligence” (1972) Duke L.J. 895Google Scholar.
33 Sec. 96(12) of the Companies Ordinance delegates to the public-outside director a wide range of privileges to obtain vital information, and sec. 96(13) enables him to consult an expert, at the company's expense: if as a result of his investigations, the public-outside director gleans information on illegal activity, improper business management or activity harmful to “moral integrity”, sec. 96(14) commands him to report it to the board of directors, and if necessary, to the Securities Authority. If the public-outside director disregards this duty, according to sec. 96(19Xb) he is subject to criminal sanctions. A first report as required by law was documented in the claim of Prof. S. Shetreet, public-outside director at Bank Leumi, regarding malfunctions in his company, in June 1988.
34 The legislature aids this conceptual cloudiness in different ways. It is especially interesting to note the amendment to the Municipalities Ordinance. The Municipalities Ordinance (Amendment No. 32) Law, 1987 determines in sec. 1(1) that a municipal council will choose its representatives on the board of directors of municipal firms. Sec. 1(2) declares: “It is the duty of municipal representatives to insure that activities of municipal corporations will not exceed their statutory authority; the fiduciary obligation they owe the municipality will always be over and above their obligation toward the corporation”. This strange injunction has indeed not entered into the laws dealing with non-municipal firms, but it reflects an objectionable state of mind.
35 For the interaction between these means of control and alternative means of control, see, for instance, Brickley, and James, , “The Takeover Market, Corporate Board Composition and Ownership Structure—The Case of Banking” (1987) 30 J.Law and Econ. 161CrossRefGoogle Scholar.
36 An empirical assessment of the duties of the outside director in general (not to be confused with the typically Israeli public-outside director) can be found in Baysinger, and Butler, , “Corporate Governance and the Board of Directors—Performance Effects of Changes in Board Compositions” (1985) 1 J. Law Econ.and Org. 101Google Scholar.
37 A specially critical view of the unspectacular performance of outside directors can be found in the publication National Legal Center for Public Interest, The American Law Institute and Corporate Governance (1987).
38 In fact, the list is longer yet. Examples of statutes influencing corporate law that are not surveyed in this list, are the Joint Investments Trust Law, 1961 (15 L.S.I. 79), and the Trust Law, 1979 (33 L.S.I 154).
39 22 L.S.I. 266.
40 Gross, , Securities Law and Stock Exchange Law(The Center for Business Research, Tel Aviv University, 1973) 27ff.Google ScholarSee also the classic study by Brandeis, L.D., Other People's Money(1914) ch. 5Google Scholar.
41 See, for instance, Joslin, , “Federal Securities Regulation from the Small Investor's Perspective” (1957) 6 J. Publ. L. 219Google Scholar.
42 See, for instance, Benston, , “Required Disclosure and the Stock Market – an Evaluation of the Securities Exchange Act of 1934” (1973) 63 Am. Econ. R. 132Google Scholar. Others criticize the disclosure policy, saying that the obligation of disclosure relates to minor, insignificant details, whereas the more important features are difficult to disclose, and the disclosure laws tend to ignore them. See Kripke, , “A Search for Meaningful Securities Disclosure Policy” (1975) 31 Bus. Law. 293Google Scholar.
43 Limitation of Use of Inside Information, chapter 8A, is a new chapter added in 1981 in Securities (Amendment No. 6) Law, 1981 (35 L.S.I. 319).
44 Chapter 9A of the Securities Law issued as part of the Securities (Amendment No. 9) Law, 1988 (S.H. no. 1261, p.188).
45 Ch. 8(B) of the Securities (Amendment no. 9) Law, ibid.The essence of ch. 8(B) is that every violation of the Securities Law, Joint Investment Trust Law, or of any indenture evidencing bond-emissions, will be henceforth actionable if it results in actual damage.
46 See Amendment No. 9, supra n. 44, at sec. 54a.
47 The way to assess the success of amendments to the prohibition of insider trading, is to measure the degree of involvement of insiders in trade prior to the publication of the confidential information. If insiders are involved in trade, it is to be expected that their buy or sell orders will push the rates toward the final rate attained at the time of disclosure of the nonpublic information. On the day of publication, it is not, therefore, to be expected that the rates will fluctuate dramatically. If the insiders are not involved in trade, such large fluctuations are to be expected. Empirical evidence in Israel proves that publicizing confidential information does not usually influence the share rates in a dramatic fashion. For the difficulties of enforcement in other jurisdictions see, for instance, Jaffe, , “The Effect of Regulation of Changes in Insider Trading” (1974) 5 Bell J. of Econ. 93CrossRefGoogle Scholar.
48 Procaccia, U., “Corporate Codification and Corporate Structure — The Case of Israel” in Argyriadis, , ed., Volume in Honor of Professor N. Deloukas(Athens University Press, 1990)Google Scholar.
49 Beaver, , The Nature of Mandated Disclosure — Report of the Advisory Committee on Corporate Disclosure to the S.E.C.(1977)Google Scholar, reprinted in Posner, and Scott, K.E., Economics of Corporation Law and Securities Analysis (Boston, 1980) 317Google Scholar.
50 29 L.S.I. 162.
51 For this issue in general, see Hanson, , Parliament and Public Ownership(1960)Google Scholarand also The Report of the Committee for the Preparation of the Government Companies Law Proposal (1971).
52 34 L.S.I. 239.
53 For instance, the Companies Law of California includes several separate sections in the Companies Code, the first being “General Corporation Law” and the second is “Nonprofit Corporation Law”.
54 For the theoretical nature of the nonprofit corporation, see for instance, Hansmann, H.B., “Reforming Nonprofit Corporation Law” (1981) 129 U.Pa.L.R. 497CrossRefGoogle Scholar.
55 It ought to be mentioned that the process of incorporating a nonprofit organization in Israel is notably inefficient. The fact is particularly unpleasant on the background of the speed and efficiency characterizing the registration of regular companies.
56 (1961) 15 P.D. 1151. See also Companies Registrar v. Kardosh (1962) 16 P.D. 1209.
57 See my book, supra n. 13, at ch. 6.
58 Sealy, supra n. 7, at 56 ff.
59 (1978) 32(ii) P.D. 281.
60 For instance, Brown v. British Abrasive Wheel Co. (1919) 1 Ch. 290.
61 Sealy, supra n. 7, at 35 ff. explains British judges' devotion to the letter of the law by the fact that corporation law was the responsibility of judges of the Equity Courts. They were habituated in implementing the Law of Trust, that obliges strict literal observation of the law, and lacked financial experience, needed in the administration (and supervision) of business ventures.
62 (1981) 35(iv) P.D. 197.
63 For further comments on the Bardigo case see my article, supra n. 2, at ch. 5(3).
64 (1984) 38(iii) P.D. 253; 7 S.J. 183.
65 Similar proceedings have long been common in the American legal system. For their description, see, for instance, Henn and Alexander, Corporations, supra n. 15, at sec. 241. The request for an additional hearing in the Kossoy case was refused for the express reason that the President of the Supreme Court found that the opinion of the court was not sufficiently innovative to warrant an additional hearing: Kossoy v. Feuchtwanger Bank (1984) 38(iv) P.D. 505.
66 For the conceptual approach of the Supreme Court in the Kossoy case, see supra n. 64, at 285. As to the analogy of the relevant rules of negligence, see, for instance, Jerusalem Municipality v. Gordon (1985) 39(i) P.D. 113; Ya'ari v. State of Israel (1981) 35(i) P.D. 769.
67 Both the rule and its exceptions are summarized in Gower, supra n. 28, at 639-640.
68 For instance, North West Transportation v. Beatty (1887) 12 App. Cas. 589 (P.C.).
69 On the integration of the corporate law into the civil infrastructure, see Procaccia, , “Three Basic Issues in Drafting a New Corporations Code” (1984) 13 Mishpatim497, at 499Google Scholar.
70 An overview of the A.L.I, project can be found in Perkins, R.B., “The All Corporate Governance Project in Midstream” (1986) 41 Bus. Law. 1195Google Scholar.
71 For a crushing — and in our opinion justified — critique of the A.L.I. project, see Scott, K.E., “Corporation Law and the American Law Institute Corporate Governance Project” (1983) 35 Stan. L.R. 927CrossRefGoogle Scholar.
72 Other comprehensive amendments precede this one, dating from 1948, 1967, 1980, and 1981. An important amendment was added in 1989.
73 See Sealy, supra n. 7, at 56 ff.
74 A directive is a set of legislative instructions, somewhat resembling a “model law”, put out by the European Common Market to its member states, obligating their legislatures to adopt it into the respective domestic legal systems. Until now the EEC issued some dozen directives in company law, and there are more to come.
75 The first directive, gracefully accepted by the member states, was to cancel the ultra vires doctrine. Other directives, such as the fifth, has no real chance of being observed, This directive deals with codetermination of workers on the board of directors. Another major legislative attempt on the Continent is the draft of the European Companies Law. See the Bulletin of the European Communities, Supplement 4/75, Statute for European Companies.
76 The leading article on this subject is without question Coase, R.H., “The Problem of Social Cost” (1960) 3 J. Law and Econ. 1CrossRefGoogle Scholar.
77 See Fama's article, supra n. 9, and see also Williamson, , “Managerial Discretion and Business Behavior” (1963) 53 Am. Econ. R. 1032Google Scholar.
78 See, for instance, Gilson's, R.J.excellent book, The Law and Finance of Corporate Acquisitions (New York, 1986)Google Scholar.
79 See, for instance, Dam, K.W., “Class Actions — Efficiency, Compensation, Deterrence and Conflict of Interest” (1975) 4 J. Leg. Stud. 47CrossRefGoogle Scholar.
80 See, for instance, Scott's article, supra n. 71.
81 Gower, supra n. 28, at 613; Pennington, supra n. 30, at 678.
82 A basic assumption in this discussion is that the liability rule does not influence the extent or severity of negligence of the officers, i.e., it cannot change the “moral hazard”. This assumption is well-documented. See, for instance, Phillips, , “Principles of Corporate Governance—A Critique of Part IV” (1984) 52 Geo. Wash. L. R. 653Google Scholar. The assumption that negligent behaviour is completely disassociated from the liability rule is based on several cumulative intuitions: first, it is clear that officers will try to prevent damage due to negligence even without any legal sanction threatening them. Negligence does not bestow on them any personal gain — and if the firm is actually damaged they might be fired or lose their standing in the job market. If the damage due to negligence depresses share prices, their firm might become attractive as a target company for hostile takeover or private acquisition. This is usually accompanied by replacement of the senior executives. In this respect, liability for negligence is drastically different from the fiduciary obligations of the officers to the firm. In the latter instance, the reaction of the market to the damage caused to the firm might not dissuade the officers, because their personal gain from the fraud can surpass the personal indirect harm caused to each of them as a result of the market's reaction. Second, assuming the damage caused by negligence is insurable, it is clear that the insured officer does not see himself subject to personal sanction as a result of breach, since the financial burden will be assumed by the insurance company.
83 See my article, supra n. 48.
84 Unger, R.M., The Critical Legal Studies Movement(1983)Google Scholar.
85 See, for instance, his books The Affluent Society(2nded., 1969)Google Scholarand The New Industrial State(2nded., 1971)Google Scholar.
86 See, in general, Hopt, K.J., “New Ways in Corporate Governance — European Experiments with Labor Representation on Corporate Boards” (1984) 82 Mich. L. R. 1338CrossRefGoogle Scholar.
87 The traditional approach to this question was always much simpler—making a profit was considered the sole legitimate purpose of a firm. See, for instance, Parke v. Daily News (1961) 1 W.L.R. 493.
88 See, for instance, Nader, R.and Green, M.J., eds., Corporate Power in America (New York, 1973)Google Scholar.
89 An important ruling concerning this ideological issue is Medical Committee for Human Rights v. Security and Exchange Commission 432 F. 2d 659 (D.C., 1970).
90 Gilson, R.J., “Evaluating Dual Class Common Stock — The Relevance of Substitutes” (1987) 73 Va. L. R. 807CrossRefGoogle Scholar.
91 For the connection between the voting method for the board of directors and the political theory relating to the representation of minorities, see, for instance, Campbell, , “The Origin and Growth of Cumulative Voting for Directors” (1955) 10 Business Law. 3Google Scholar.
92 For a skeptical look at the issue of the company's responsibility to the public, see Engel, D.L., “An Approach to Corporate Social Responsibility” (1979) 32 Stan. L. R. 1CrossRefGoogle Scholar.