Driving nails in the coffin of corporate law

This article is adapted from Economics, Capitalism, and Enterprise: Contradictions in Corporate Law, Economics, and Law Firm Theory, part of the Routledge series on the Economics of Legal Relationships, ISBN 978-0367895563.

I explained the end of modern company law in a previous article: It’s the end of company law as we know it (Business Law Today, January 29, 2021). The purpose of this article is to recognize the death of modern corporate law, drive nails into the coffin and bury it.

The first nail in the coffin concerns the right of shareholders to protection from creditors.

Shareholders often have “limited liability”. ie protection against claims from creditors of society.

However, in order for shareholders to have limited liability for corporate debt, shareholders must assume some liability, as would be the case, for example, if directors were the representatives of shareholders (which I will discuss below). Limited or other liability of the shareholders necessarily means that property owned by the shareholders can be used to satisfy the claims of the company’s creditors. This means that creditors can bring a claim against the property of the shareholders.

In insolvency proceedings, the unsecured assets of the insolvent company are used to satisfy the claims of unsecured creditors. We must therefore ask ourselves what property owned by shareholders can be used to satisfy claims of creditors against society.

Posner, for example, wrote that “a shareholder’s liability for corporate debt is limited to the value of his shares”.[1] When “the value of his shares” Posner means market value, the market value of shareholders ‘shares is determined by the market and absolutely no market value of shareholders’ shares can be used to satisfy corporate creditors. This means that corporate creditors cannot assert any claim against shareholders for the market value of their shares.

However, if Posner was referring to the book value of the shares by “the value of his shares” (total company capital, ie assets minus liabilities divided by the number of shares issued), this also does not meet the requirement of liability for corporate creditors. The total assets belong to the company. Therefore, the net assets are also owned by the company. However, since net worth is equity, it is the company that owns the equity, not the shareholders, and therefore the equity that is used to pay the corporate debt is the equity of the company, not that of the shareholders.

While shareholders may lose the entire value of their shares if the market price drops to zero, the value of their shares cannot be used to satisfy claims of creditors because, firstly, the value of their shares is not determined by the value of the company’s capital and, secondly, because Corporate creditors cannot assert any claim on the shareholders’ assets. The shareholders’ risk of loss is limited to the market value of their shares, none of which is used to pay corporate debts.

There is no such thing as “limited liability” for shareholders unless limited liability means zero. Shareholders have no limited or other liability. What “limited liability” really means is “limited risk”. Shareholders run the risk of their shares dropping to zero in value, but this is not related to liability for corporate debt. Therefore Posner was wrong. Shareholders’ liability for corporate debts is not limited to the value of their shares, as shareholders accept no liability for corporate debts and the value of their shares cannot be used to pay off corporate debts.

In order for the shareholders to be liable to the creditors of the company, the shareholders would have to owe the creditors of the company a contractual or illicit obligation. On closer inspection, however, we find that the shareholders have no obligation under property and company law to the creditors.

For example, the Delaware General Corporation Law states: “A shareholder’s joint liability for claims against the dissolved company must not exceed the amount paid to that shareholder upon dissolution” (emphasis added).[2] At first glance, the law seems to say that shareholders are liable for corporate debts, but it is not.

Upon dissolution, the net assets of the company will be distributed to the shareholders. The collective liability of shareholders of a dissolved company for claims against the dissolved company is merely a request by the company’s creditors to recover the net assets that belonged to the company and were wrongly distributed to the shareholders. It is therefore not the liability of the shareholders as they have never been entitled to receive a distribution of the company’s net assets.

But perhaps more importantly, the law refers to “the collective liability of a shareholder of a dissolved company for claims against the dissolved company”. A dissolved society no longer exists.

A second nail in the coffin of modern company law concerns the right of shareholders to dividends and distributions. Shareholder rights, or rather their lack of dividends, are known, but the implications are often ignored. The effects of shareholder rights or lack of rights on dividends are also often ignored.

Shareholders have no right of ownership of corporate profits; The result belongs to society. Shareholders are therefore not entitled to dividends distributed from company profits. Under the Delaware General Corporation Law, “the directors of any company may declare and distribute dividends on the shares of their capital stock, subject to the restrictions set out in their articles of incorporation …” (emphasis added).[3] New York corporate law is similar. The right to receive dividends is just an expectation and not a right (and certainly not since Dodge v. Ford).[4] which even Berle and Means recognized: “[the] The shareholder of the modern corporate situation has given up a number of specific rights for certain indefinite expectations. “[5]

Shareholders have no ownership interest in the company or its assets. They therefore have no right to the distribution of their net assets, ie their equity. Shareholders are only entitled to a distribution of the net assets of a dissolved company that no longer exists. The company owns the equity. Equity consists of a portion of the result that was not distributed in dividends (“retained earnings”), which reinforces the principle that neither the company result nor the equity belong to the shareholders, but to the company.

Another nail in the coffin of modern company law concerns shareholders as “residual plaintiffs”, who are related to the distribution of net assets. The term “remaining applicant” refers to the proposal that shareholders have a right to net assets, i.e. equity, after all liabilities have been met by company assets.

In order to see that shareholders are not residual plaintiffs, we have to ask ourselves what exactly is the claim that “residual shareholders” have. What do you claim? Against whom or what? To be an applicant, a claim must be identifiable in a court of law. However, as previously indicated, shareholders have no right or interest in ownership of the company, its assets or its income.

While shareholders have the right to receive a distribution of the net assets of a dissolved company, they are not entitled to either the assets or the net assets of the company as a creditor is entitled to the assets of the company. A believer can bring a claim against the company in a court of law. A shareholder cannot assert a claim against the company in court. A creditor does not wait for the directors to declare an interest or principal payment. A shareholder must wait for the directors to declare a distribution. Shareholders are therefore not remaining beneficiaries as they have no claim that can be asserted in a court of law.

That shareholders are residual plaintiffs is an assumption that is not supported by either property law or company law. Shareholders have no greater entitlement to net assets than to total assets. The company owns the assets and the shareholders are not entitled to any of the assets. The company owns the equity, so the shareholders are not entitled to the equity.

Qui facit per alium facit per se. “Whoever acts through someone else acts himself.” This has been the literal basis of agency law for centuries.

I addressed agency law in my previous article. Here I further explain the legal impossibility of directors representing shareholders in order to drive another nail into the coffin of modern corporate law.

If directors are representatives of shareholders, then directors are those through whom another (the shareholder) is acting. Hence, we need to ask and answer the question that has been ignored for decades. How exactly do shareholders behave through directors? The answer to this question is found by first answering another question: Are shareholders legally allowed to act through directors? The answer to the second question is no. Under company law, shareholders are prohibited from acting through directors. So the answer to the first question is that shareholders actually do not act through directors.

The Delaware General Corporation Law states: “The business and affairs of all companies organized under this chapter are administered by or under the direction of a board of directors.”[6] New York and other states have similarly worded statutes. Company law therefore prohibits shareholders from acting through directors. If company law prohibits shareholders from acting through directors, company law prohibits directors from acting as representatives of shareholders.

The funeral march is long overdue. It’s time to bury modern corporate law.

About the author::

Wm. Dennis Huber is visiting professor at Nova Southeastern University. He is a CPA and has a JD, MA in Economics and an MBA from SUNY in Buffalo and an LL.M. from the Thomas Cooley School of Law. He has published more than forty articles on topics ranging from corporate and securities law to constitutional law, auditing, economics, accounting and public interest to forensic bookkeeping, bookkeeping and social accounting.

[1] Richard A. Posner, Economic Analysis of Law (9th Edition, 2014).

[2] Delaware General Corporation Law Section 282 (c).

[3] Delaware General Corporation Law Section 170.

[4] Dodge v. Ford Motor Co., 204 Mich. 459, 170 NW 668 (Mich. 1919).

[5] Alfred A. Berle & Gardiner C. Means, The modern company and private property (2nd edition, 1991, 244).

[6] Delaware General Corporation Law §141 (a).

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