The Company and its Constituents

After incorporation the company either stands for the collectivity of shareholders or the company exists separately from its shareholders.  The fundamental basis of the company in turn determines the legal and economic relationship of the company to its constituents. Contested areas of corporate law, which include issues concerning the appropriate liability of corporate constituents, relate to these contested models of the company.

In my recent paper, I consider two models of the modern company. The contractual model has its origins in early unincorporated forms with corporateness being derived from the collectivity of the shareholders. The entity model has its origins in early incorporated forms, with corporateness bestowed by the State and with the company as an artificial legal person existing separately from shareholders.  The two forms have existed in parallel throughout the history of the modern company.

Which model is normatively superior? Through an analysis of key cases, the paper concludes that the entity model better distinguishes the different legal relationships corporate constituents have with the company.

Both models have ancient origins. For the contractual model, it is in the Roman societas, or simple partnerships. Partnerships that used double-entry bookkeeping to separate the partnership fund as joint stock from the partners emerged in England in Elizabethan times. In terms of capital lock-in, the utilization of joint stock was an intermediate step between simple partnerships and modern companies. Shareholders gave up the right to withdraw their capital, but only for a limited period.  These joint stock companies were not incorporated, and the joint stock fund was separated for accounting purposes, not legally.

A variation of the contractual joint stock company form, where joint stock was equitably separated by settling corporate assets in a trust, became significant in the eighteenth century during the period when the Bubble Act 1720 restricted access to incorporation. Chancery was more efficient than the common law courts in dealing with the concept of funds, with the equitable rights of the members as beneficiaries firmly established.

The origins of the entity model are in the early universitas or corporation, a mechanism by which the Crown or Parliament granted powers to cities, churches, and universities as legal persons. Only legal persons were capable of bearing rights and duties, but legal persons did not need to be natural persons or (eventually) even be comprised of natural persons. The concept of persona ficta or artificial legal persons was transplanted into English common law in 1612 in The Case of Sutton's Hospital ((1612) 10 Co Rep 23a, 77 ER 960). Coke CJ said that the corporation was ‘invisible, immortal and rest[ing] only in intendment and consideration of the law.’

In business corporations chartered by the Crown and later Parliament, members could choose to subscribe to a series of terminating joint stocks linked to voyages.  Permanent capital had replaced discrete joint stocks in the English East India Company by 1657. The business corporation, as a persona ficta created by the State, was a separate legal entity from its shareholders.

Business corporations and contractual joint stock companies were therefore different legal forms existing in parallel.  As the two forms were functionally and economically similar, they were treated in the same way by some eighteenth-century commentators but not by the courts. The Chancery Court presided over by Lord Eldon consistently treated contractual joint stock companies legally as partnerships. 

That distinction between incorporated form and the contractual form did not survive the introduction of the general incorporation statutes in England. The modern company was initially considered to be an association of shareholders in the same way as a contractual joint stock company.  Companies incorporated through the process set out in the general incorporation statutes were not viewed as separate legal entities from their shareholders as evidenced by the legislature considering that limited liability for shareholders required a statutory intervention.

The English company transitioned from being a collectivity of shareholders to being legally separate from its shareholders through the second half of the nineteenth century. Statutory limited liability meant that capital needed to be identified and separated from shareholders. The law evolved to protect the permanent capital in the company from shareholders and their creditors.

The consequences of incorporation led to a gradual recognition that the modern companies, like earlier business corporations, were separate legal entities from their shareholders with Lord Halsbury LC in Salomon v Salomon & Co Ltd describing the company as ‘an artificial creation of the Legislature’, echoing Coke CJ in Sutton and resurrecting the persona ficta concept.

The entity model did not however prevail. The contractual model gained traction in the twentieth century when used by US corporate law scholars laying the groundwork for agency theory and for modern law-and-economics contractual conceptions of the company. Although the modern neoclassical version originated in the US, its taxonomy of management as agents of shareholders resonates with corporate law scholars and jurists outside the US as it mirrors the perceived legal position for companies in the late 18th and early 19th centuries when much corporate law doctrine developed. 

What are the consequences of the entity model on the relationship of the company with its corporate constituents? Governing bodies for corporations predate general meetings for investing shareholders. In corporations, the guardianship role of the governing body was key. Canon law treated the corporate person as a persona ficta where its corporators were guardians of property that belonged to no-one. Regular general meetings for shareholders were an important innovation first seen in business corporations in the seventeenth century. Small investing shareholders were not empowered by increased control over management but rather by the role of the governing bodies, supported by sworn oaths, to act in the interests of all shareholders. The transition was away from personal accountability for property and consumable surplus to individual investors, and towards economic accountability for a return on capital.

Susan Watson is Professor of Law in the Faculty of Law and the Faculty of Business and Economics at the University of Auckland.