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General incorporation laws "to a great extent . . . leave the right of forming a corporation and of acting in a corporate capacity free to all, subject to such limitations and safeguards as are required for the protection of the public." The only argument for restricting corporate powers, he claimed, was that notice of the limited liability of shareholders needed to be communicated to potential creditors. "And this seems to be the chief office of the general incorporation laws which are now in force nearly everywhere." 145
The source of corporate power was, for Morawetz, the shareholders. The principle of majority rule was derived, as in a partnership, from unanimous shareholder consent. So the majority could not go beyond the purpose specified in its charter without the unanimity of the shareholders. Thus, the doctrine of ultra vires, originally derived from the grant theory of the corporation, should be replaced by the requirement of unanimous shareholder agreement, as in a partnership. Regulation of corporate activity would come not from the state but from the shareholders.
Morawetz's effort to disaggregate the corporation into freely contracting individuals must have seemed at the time the only entirely logical conclusion to draw in light of the triumph of general incorporation law. It not only dispensed with an increasingly fictional conception of the corporation as a creature of the state, it also made it possible to fit corporation law into the now dominant individualistic mode of private contract law.
The tendency to reconceptualize the corporation along partnershipcontractualist lines continued during the i88os. In 1884, two years after Morawetz's treatise, Henry O. Taylor, another New York lawyer, wrote A Treatise on the Law of Private Corporations Having Capital Stock, which was aimed, he said, at "dismissing this fiction" of the "legal personality" of the corporation so that "a clearer view" of individual rights and interests could be determined "without unnecessary mystification." 146
Taylor was supported by John Norton Pomeroy, the California lawyer who was simultaneously putting forth this argument on behalf of the corporation in the Santa Clara case. Pomeroy emphasized the significance of general incorporation laws in rendering older conceptions of incorporation anachronistic. "The common-law conception of the `legal personality' of the metaphysical entity constituting the corporation, entirely distinct from its individual [members], arose at a time when corporations were all created by special charters," Pomeroy wrote. This situation had changed under general incorporation laws in which "persons complying with a few formal requisites can organize themselves into a company for almost any business purpose . . . these associations differ very little in their essential attributes from partnerships." 147
It is not entirely clear to what extent the legal thinkers who advocated a partnership-contractualist conception of the corporation during the 188os were motivated by any particular political vision or attitude toward corporations. Overtly, they seemed only to wish to bring corporation law into line with the new reality of free incorporation. Pomeroy and Justice Field clearly believed that the partnership theory offered the greatest chance of success in protecting the corporation under the Fourteenth Amendment. Yet their individualistic language harkened back to earlier Jacksonian criticisms of corporations as special privileges and monopolies. And despite the fact that the clear tendency of attacks upon the traditional theory that corporations were creatures of the state was to undermine any claims to special state control of corporations, the partnership theory was soon treated as supporting an anti-corporate position.
Perhaps that was a correct understanding of its ultimate tendency. For example, Henry 0. Taylor, the New York lawyer and corporate law treatise writer, appears to have been aware that his effort to dismiss the "fiction" of corporate personality for producing "unnecessary mystification" might also call into question the legitimacy of limited shareholder liability. Like Chief Justice Taney, 148 Taylor observed that limited liability was "the logical outcome of the notion of a corporation as a person, as a subject of rights and liabilities distinct from its members," 149 a notion he was doing his best to undermine.
There were many suggestions during the 189os that a contractual theory might subvert corporate privileges. Writing in 1892, Dwight A. Jones focused on the delegitimating tendency of the partnership theory.
The main value of a corporate charter arises from the fact that powers and privileges are thereby acquired which individuals do not possess. It is this that makes the difference between a business corporation and a partnership. In the former there is no individual liability. . . . There is no death. . . . It is not policy therefore for a corporation to break down its own independent existence by burying its original character in the common place privileges of the individual. . . . Any mingling of corporate existence with the existence of the shareholders will weaken corporate rights. I"
Indeed, opponents of corporate consolidation during the 189os often advocated elimination of the corporate form and return to the partnership. One of the most influential American economists, Henry C. Adams, saw in the extension of the corporate form the root cause of the growth of economic concentration that was destroying competitive society. "[T]hese corporations," he wrote in 1894, "assert for themselves most of the rights conferred on individuals by the law of private property, and apply to themselves a social philosophy true only of a society composed of individuals who are industrial competitors." '51 Adams's solution was to limit the benefits of the corporate form to those "natural monopolies" that could actually demonstrate economies of scale.'52
Was there not good reason, then, to suspect that any contractualist theory of the corporation was only the first step toward attacking the corporate form itself? In igoo Christopher G. Tiedeman published his Treatise on State and Federal Control of Persons and Property in the United States,'53 a greatly expanded and retitled version of his influential Treatise on the Limitations of Police Power (1886). The later book is filled with the anguish of the old conservative witnessing the rise of industrial concentration. Tiedeman wrote:
It does not take a very keen observer to note that, for the past fifteen or twenty years, the tendency to the establishment of all-powerful and all-controlling combinations of capital . . . has been increasing year by year in this country. . . . The rapid accumulation of vast fortunes has inspired some of their possessors with the desire for the acquisition of power through the control of industries of such great extension and scope, that they may earn the appellation of kings instead of princes of industry. If this economic tendency were left unchecked, either by economic conditions or law, the full fruition of it would be a menace to the liberty of the individual, and to the stability of the American States as popular governments. . . . 154
Finally, Tiedeman brought the power of incorporation itself into focus:
[A]ll attempts to suppress and prevent combinations in restraint of trade must necessarily prove futile, as long as the statutes of the State permit the creation of private corporations. . . . The grant of charters of incorporation . . . only serves to intensify the natural power which the capitalist in his individual capacity possesses over the noncapitalist, by the mere possession of the capital. I advocate, as a return to a uniform recognition of the constitutional guaranty of equality before the law, the repeal of the statutes which provide for the creation of private corporations. 155
The contractualist view of the corporation as essentially no different from a partnership began to come under attack from the moment it was presented. Its most forceful claim was that any entity theory of the corporation was fictional and an anachronistic carryover from a bygone era of special corporate charters. Yet the picture of the corporation as a contract among individual shareholders was itself becoming a nostalgic fantasy at the very moment the partnership view was most forcefully put forth.
Some of the contractualists seemed to have had in the backs of their minds an ideal of what in a later age would be called "shareholder democracy." But during the 188os it was beginning to become clear that the managers, not the shareholders,
were the real decision makers in large, publicly owned enterprises. 156 Ironically, Morawetz published his contractualist theory in the same year that Standard Oil was organized into the first of the great trusts. Soon the oligarchic tendency of the trusts became a point of standard observation.
During the i88os, the judicially imposed requirement of shareholder unanimity for fundamental corporate changes continued to provide the doctrinal foundation for a partnership theory of the corporation. But during the 189os, several states, including the commercially significant jurisdictions of Delaware, New York, and New Jersey, passed statutes that overthrew the unanimity rule for corporate consolidations. Many of these statutes also substantially enhanced the power of the board of directors to initiate such action. 157
By the time of the First World War, it was common for legal writers to observe that "the modern stockholder is a negligible factor in the management of a corporation." 158 "It cannot be too strongly errphasized," another wrote, "that stockholders today are primarily investors and not proprietors." 159
The Demise of the Trust Fund Doctrine: The New Relationship of the Shareholder to the Corporation
One of the best measures of the shift in the conception of shareholders from "members" to "investors" in the corporation is the demise of the "trust fund doctrine" beginning in the 189os. The demise of the doctrine was paralleled by the growth of corporations, the diversification of corporate ownership, and the subsequent expansion of the stock market.
The rise of the natural entity theory at the same time presented a picture of the corporation that legitimated the doctrine's demise.
The origin of the doctrine is found in justice Story's celebrated opinion in Wood v. Dummer (1824), 160 declaring that the capital stock of a corporation was a trust fund for the benefit of corporate creditors. Its central purpose was to make the stockholders of an insolvent corporation liable for their failure to pay the full or par value of any stock to which they subscribed from a corporation. 161 This question of the extent of shareholder liability for "watered stock"-stock issued for less than par value-represented one of the two or three most important issues in corporate law during the late nineteenth century and generated hundreds of cases and thousands of pages of legal writing.
Accusations of widespread corporate fraud and financial manipulation focused on the watered-stock question. And amid the wreckage of the 1893 depression, judges and legal writers faced the fact that enforcement of the trust fund doctrine had "punished the innocent and unsettled hundreds of millions of dollars of investments." 162
In one case prior to the depression, the U. S. Supreme Court held stockholders liable for watered stock more than twenty-five years after the company failed. 163 In observing the changes that the depression had produced, William W. Cook wrote: "Corporation ruin has created corporation law." 164
HISTORY OF LIMITED SHAREHOLDER LIABILITY. It is not usually appreciated that truly limited shareholder liability was far from the norm in America even as late as 1900. 16' Though by the time of the Civil War the common law had evolved to the point of presuming limited shareholder liability in the absence of any legislative rule, in fact most states had enacted constitutional or statutory provisions holding shareholders of an insolvent corporation liable for more than the value of their shares. The most typical provision, which first appeared in an 1848 New York statute providing for general incorporation of manufacturing companies, 166 imposed double liability on shareholders. By the end of the nineteenth century, this provision "ha[d] been copied, in its essential features, in almost every State in the Union."167 Many other constitutional or statutory enactments imposed even more extensive potential liability on shareholders. 168 As a result, the distinction between the liability of the members of a corporation and a partnership, so clear to modern eyes, was still regarded as a matter of degree rather than of kind throughout the nineteenth century. And even within the strictest limited liability jurisdictions, the trust fund doctrine promulgated by the courts made innocent shareholders potentially liable for the difference between the par value and the purchase price of their shares.
When the doctrine came under attack during the 18gos, its defenders emphasized that its main function was to protect creditors who had a right to suppose that the stated capital stock of a corporation reflected its real value. For a corporation to sell shares at discount was, they argued, a fraud on subsequent creditors. But unlike its original partnership rationale, this argument for the trust fund doctrine already conceded that corporations were separate entities and that the stockholders were only investors, not owners, managers, or members of a corporation. If the trust fund doctrine was simply designed to give notice to protect creditors, the doctrine's opponents replied, it could only apply to subsequent creditors, since existing creditors could not have relied on a subsequent issue of watered stock.
By degrees, courts beginning in the 189os gradually eroded the trust fund doctrine. One of the most important immediate influences in producing the change was the rise of a national stock market, which definitively converted shareholders into impersonal investors. Yet, this was only the culmination of a long-term transformation by which shareholders, once regarded as members of a corporation, not fundamentally different from partners, came to be treated as completely separate from the corporate entity itself.
THE STRUCTURAL TRANSFORMATION OF THE CORPORATION. In order to comprehend the changes in legal doctrine during the 189os, we should first understand the dramatic changes in the structure of the business corporation, as well as the market for stock that developed during the 188o-19oo period.
The major changes were in the size and scale of industrial companies. Before 1890, only railroads constituted "large, well-established, widely known enterprises with securities traded on organized stock exchanges, while industrials, though numerous, were small, scattered, closely owned, and commonly regarded as unstable."169 Most of the manufacturing enterprises of the i88os have been described as "small" companies, with a net worth under $2 million. For the sake of comparison, there were extremely few "very large" companies worth more than $io million, and even enterprises classified as "large" (worth between $5 million and $1o million) were also "fairly rare."170 By contrast, "each of the country's ten largest railroads had more than $ioo million of net worth and the largest of them all, the Pennsylvania Railroad, had over $200 million." 171
In manufacturing, "the partnership form of organization predominated. . . . Where enterprises were incorporated, and, therefore, had outstanding securities, these were generally held by a small group of persons and were infrequently offered for sale to the public." 172
Most of the leading manufacturing companies were family-owned. Even two of the "very large" companies, Singer Manufacturing and McCormick Harvesting Machine, were controlled by and had a majority of their stock owned by the family. And Andrew Carnegie's combined steel interests, which constituted among the very largest of manufacturing enterprises, were organized as closely owned partnerships until they converted to the corporate form in 1892.173
Nearly all of the distributive enterprises-wholesalers like Marshall Field in Chicago, and retailers like R. H. Macy's in New York and John Wanamaker in Philadelphia-were organized as partnerships, as were companies in gold mining and oil drilling. And while the processing branch of industry-oil refining, sugar refining, lead smelting-was the first category in which large-scale, publicly owned enterprises (besides railroads) developed during the i88os, the meat processing giants, Swift and Armour, retained the partnership form well into the 188os:
Before 18go a man with excess capital to invest was likely to put his money into real estate. If lie chose to buy securities, he had a relatively narrow range from which to select. The principal type of security investment was in railroading. Industrial securities, except in the coal and textile industries, were almost unknown. 174
Those industrial securities that did exist were usually exchanged only in "direct person-to-person sales." 175 Between
1890 and 1893, however, industrials began to be listed on the New York Stock Exchange and to be traded by leading brokerage houses. Only after 1897, in the midst of the merger movement, did companies publicly offer shares of stock, replacing the system of private subscriptions that had prevailed throughout the nineteenth century. Between 1896 and 1907, the number of shares traded on the Stock Exchange soared from 57 million to 26o million. 176 It is perhaps at this point that we can clearly identify the beginning of the shift away from "the traditional point of view" of shareholders as "the ultimate owners, the corporate equivalent of partners and proprietors." 177
THE OVERTHROW. When Seymour Thompson published his six-volume treatise on corporation law in 1895, he lamented the fact that the trust fund doctrine had only recently "been greatly modified" by American courts-"so much so, that it may now be doubted whether the capital of a corporation is a trust fund for its creditors in any different sense than the sense in which the property of a private person is a trust fund for his creditors." 178
Beginning in 1887, the New York Court of Appeals overthrew the trust fund doctrine.179 And, in a widely followed opinion, the Minnesota Supreme Court held in 1892 that only fraud could permit a creditor to recover against a holder of watered stock. 180 The most important consequence of this shift to a fraud theory was that in a majority of jurisdictions only subsequent creditors-those who presumably had relied on representations about the capital stock of the corporationcould sue on watered stock.181
But the most controversial departures from the trust fund doctrine appeared in a series of cases decided by the U.S. Supreme Court in 1891 through 1893. In the leading case of Handley v. Stutz (1891),182 the Court, while purporting to reaffirm the trust fund doctrine, distinguished between the original subscription to corporate shares, to which traditional trust fund shareholder liability applied, and a subsequent issue of shares at a discount by a "going concern," which created non-liability. Even Seymour Thompson conceded that where an established corporation "finds itself in urgent need" of money, "it would be a hard and perhaps a mischievous rule that would prevent it from reselling the shares at their market value." 183 Yet he protested that, taken together, Supreme Court decisions had "overturn[ed] all former rulings" of the Supreme Court and "totally obliterat[ed]" 184 the trust fund doctrine.