Introduction
This paper provides an account of the historical lineage of the registered company constitution, focusing on the enforceability of individual shareholder rights against the company. Orthodox accounts of the company constitution’s bindingness tend to posit that the ‘statutory covenant’, which was first enacted in the Joint Stock Companies Act 1856 and is now found in section 33(1) of the Companies Act 2006, has, since its enactment, been the sole source of the constitution’s bindingness as between shareholders and the company. Building on modern scholarship, contemporary commentaries, and relevant authorities, this paper proposes an alternative account. It argues that when the statutory covenant was enacted, the subscribers and the company were regarded as actual contractual parties to the constitution. The only legal effect of the statutory covenant was to make assignees and allottees of shares (‘non-subscriber shareholders’) parties by putting them in the position that they would have been in had they covenanted, at the time at which they joined the company, to observe the constitution.
It is further argued that when read in light of this alternative account, the authorities demonstrate that the enforceability of rights in the constitution by individual shareholders against the company was determined not by the statutory covenant, but by ordinary principles of private law. The courts in the second half of the nineteenth century treated ‘insider rights’ – rights that the articles of association confer upon members qua members – as property rights. This means that the ability to enforce insider rights was transmitted when shares were assigned or allotted, so that insider rights were enforceable by all shareholders, including non-subscriber shareholders, against the company. On the other hand, ‘outsider rights’ – rights that the articles purport to confer on individual shareholders in a capacity other than that of shareholder – were not treated as property rights, so they were not transmitted when shares were assigned or allotted, and they could not be enforced by non-subscriber shareholders against the company.
If these arguments are accepted, the significance is twofold. First, by unearthing the role of contract and property law in determining which shareholder rights in the articles can be enforced against the company, this paper proposes a solution to the long-lasting controversies surrounding the effect of insider and outsider rights. This solution has the advantages of applying to the modern law whilst also being consistent with the bindingness of the constitution as it was understood by the framers of the 1856 Act and the judiciary in the second half of the nineteenth century. Secondly, it uncovers a crucial step in the process by which a shareholder’s proprietary interest in their shares came to be understood as consisting of a bundle of assignable rights deriving from the constitution, as opposed to an equitable interest in the company’s assets. Previous scholarship has identified that by the mid-nineteenth century the courts had concluded that shares were a new kind of chose in action but had not determined their precise proprietary nature. It is proposed here that judicial recognition of insider rights as property rights after 1856 determined the nature of this new kind of property. This ability to insist upon performance of insider rights constituted, and still constitutes, the core of each shareholder’s property interest in their shares.
The arguments proceed as follows. Section 1 examines the academic controversies regarding the statutory covenant’s scope and the enforceability of insider and outsider rights. Section 2 considers some pre-1856 developments, arguing that by 1856, modern-style insider rights had emerged and a need had arisen for clarity on the proprietary nature of shares. This section also examines the pre-1856 covenant-based company constitution and the scarcity of authorities on its bindingness. Section 3 considers the Joint Stock Companies Act 1856, focusing on post-1856 insider rights and the constitution’s bindingness as it was understood when the statutory covenant was first enacted. Section 4 analyses the cases on the enforceability of shareholder rights in the constitution, arguing that these authorities consistently support the preceding arguments. The paper ends with some conclusions.
1. Academic controversies on the statutory covenant and insider and outsider rights
Since the modern registered company’s advent in 1856, UK companies legislation has contained a ‘statutory covenant’. All versions of the statutory covenant enacted between 1856 and 1985Footnote 1 are, from a modern perspective, oddly worded. The provisions deemed the shareholders, but not the company, to have covenanted to observe all of the provisions in the memorandum and articles, but stated that the shareholders and the company were bound by the memorandum and articles. Orthodox accounts regard this omission of the company as a drafting oversight caused by ‘entity blindness’Footnote 2 and assume that the courts have always treated the company as a deemed covenantor.Footnote 3 This apparent entity blindness has been explained as a product of a legislature not yet accustomed to the concept of widely available corporate personality.Footnote 4 According to this narrative, the statutory covenant has, since its inception, been, and still is, the sole source of the constitution’s contractual force, creating privity of contract by deeming the company to have covenanted with each shareholder, and each shareholder to have covenanted with the company and all other shareholders. The key academic contributions on the constitution’s bindingness all proceed on this basis.Footnote 5
If one accepts the orthodox accounts, the historical law relating to the bindingness of the articles is puzzling. It seems far-fetched that the legislature, having specifically legislated in 1844 for companies to be registerable with corporate personality,Footnote 6 had by 1856 become so afflicted by entity blindness that the company’s legal identity was forgotten about when the statutory covenant was drafted. Moreover, if the orthodox account is accurate, the authorities on the enforceability of the articles by shareholders are difficult to explain. There are many authorities that insider rights are enforceable against the company. The main academic contributions attribute this enforceability to the effect of the statutory covenant.Footnote 7 On the other hand, it is widely recognised that the authorities on outsider rights seem inconsistent,Footnote 8 with some cases seeming to suggest that shareholders can, by suing qua shareholders, enforce outsider rights,Footnote 9 and others suggesting that shareholders cannot enforce outsider rights.Footnote 10 A variety of explanations seeking to reconcile the authorities have been offered by academic commentators,Footnote 11 but none have found universal acceptance.Footnote 12 A related difficulty posed by the orthodox account is that if the statutory covenant creates privity of contract between the company and the shareholders in respect of all of the provisions of the articles, it is difficult to see why the enforceability of insider and outsider rights should be treated differently.Footnote 13
Notably, section 33(1) of the Companies Act 2006 expressly included, for the first time, the company as a deemed covenantor. The reason for this change was to correct what was regarded as the accidental omission of the company from 1856 onwards.Footnote 14 But section 33(1) was not intended to change the law.Footnote 15 Moreover, the updated provision says nothing about which shareholder rights are enforceable against the company. Thus, according to Worthington and Agnew, despite section 33(1)’s updated wording, ‘the same uncertainties seem destined to plague this area’.Footnote 16
2. Some pre-1856 developments
(a) Insider rights and the legal nature of shares
At the turn of the nineteenth century, there were relatively few companies,Footnote 17 each with relatively few shareholders. Share denominations were high,Footnote 18 shareholders often had direct involvement in the company’s affairs,Footnote 19 and trade in shares was generally conducted privately.Footnote 20 From the second quarter of the century onwards, in response to rapidly increasing needs for capital, especially in the railway sector,Footnote 21 vast numbers of shares were issued across wide geographical areas, many in small denominations.Footnote 22 So-called ‘financial shareholders’ – investors attracted by the potential for financial returns, and to this end prepared to forgo close involvement with the company’s managementFootnote 23 – became prevalent, and a sophisticated market for trading securities developed.Footnote 24 These changes catalysed important and interconnected legal developments, including a shift in the balance of power in companies from shareholders to the board, the evolution of the company as an entirely separate entity, and widely available limited liability.Footnote 25
(i) The emergence of insider rights
Freeman et al provide evidence, in this period, of a general trend of constitutions reducing shareholders’ direct management powers in favour of increased board powers and protection of shareholders’ financial interests.Footnote 26 This trend saw the emergence of recognisably modern insider rights. As many shareholders’ supervisory powers in these new-style constitutions were exercisable through the general meeting,Footnote 27 individual voting rights were important.Footnote 28 The right to a duly declared dividend became ‘enshrined as the most important and best-protected’Footnote 29 shareholder benefit. Shareholder pre-emption rights on new share issues were also common.Footnote 30 Some previously common individual shareholder rights (eg rights of individual access to company accounts, and preferential access to aspects of the company’s business) were gradually abandoned.Footnote 31
There is also evidence of outsider rights appearing in constitutions, and of official disapproval of this practice. The 1844 report of the Select Committee on Joint Stock Companies, set up to investigate fraudulent practices within joint stock companies, expressed disapproval of the inclusion in constitutions of a classic kind of outsider right – life tenures for directors, as well as other ‘provisions … of a similar nature’.Footnote 32 Moreover, in 1850, Francis Whitmarsh, Registrar of joint stock companies, complained of ‘speculative promotors’ who inserted into deeds of settlement clauses for remunerating themselves ‘to a very large amount’.Footnote 33
(ii) The changing legal nature of shares
Shares were traditionally understood as equitable interests in the company’s assets. With the advent of the financial shareholder, this view became economically unrealistic. Shares became ‘marketable commodities, liquid assets, titles to revenue easily converted by their holders into money’.Footnote 34 Ireland has demonstrated that the courts gave legal effect to this new reality in a series of cases, most of which concerned bequests of shares that would be void if the shares were realty, but valid if they were personalty.Footnote 35 Most of the cases involved the Mortmain Act 1736, which prohibited bequests of land to charities.Footnote 36 In Bligh v Brent,Footnote 37 the shares would only pass under the terms of the testator’s will if they were personalty. The traditional position was that whether shares were realty or personalty depended on whether the company’s assets comprised realty or personalty. The new position, as exemplified by Bligh, was that shares were personalty, irrespective of the nature of the company’s assets.Footnote 38
Although these cases established that shares were personalty, they did not determine the precise nature of this new kind of chose in action. This is perhaps because, to decide these cases, the courts usually needed only to determine with certainty what the shares were not (ie not realty). In Bligh, for example, the court reasoned that the shareholder’s interest was in profits arising from the company’s activities, rather than in the company’s realty, but did not explain the legal principles by which the shareholder acquired this interest, or which rights comprised the interest. As Talbot and Kokkinis put it, in the wake of the Bligh line of cases, there was a need for ‘clarity as to what this new form of property consisted in’.Footnote 39 This issue is revisited below in Section 4, where it is argued that the cases on insider rights provided this clarity.
(b) The deed of settlement company
Deed of settlement companies were unincorporated companies, first devised in the wake of the Bubble Act 1720, that utilised private law mechanisms to mimic the advantages of incorporation.Footnote 40 They were founded and governed by a deed of settlement which created a trust.Footnote 41 This trust vested the company’s assets in trusteesFootnote 42 with a view to enabling the trustees to sue and be sued on the company’s behalf,Footnote 43 and conferred upon the shareholders an assignable equitable interest in the company assets.Footnote 44 The deed of settlement was also a sophisticated partnership agreement, containing the company’s ‘articles’,Footnote 45 ie its constitution.
Deed of settlement companies were effective business vehicles,Footnote 46 and their numbers ‘surged’ in the 1830s.Footnote 47 Fraudulently promoted deed of settlement companies were, however, widely blamed for a financial crash in 1836,Footnote 48 leading to the Joint Stock Companies Act 1844, which introduced widely available incorporation by registrationFootnote 49 with a view to bringing deed of settlement companies under regulatory control.Footnote 50 The 1844 Act imposed onerous compliance requirementsFootnote 51 and it was ineffective in combatting fraud.Footnote 52 It was soon replaced by the Joint Stock Companies Act 1856. There are, however, two features of the law relating to deed of settlement constitutions that are especially helpful for understanding certain post-1856 developments that are discussed in Section 3 below.
(i) The use of covenants
The constitution’s legal force derived from covenants.Footnote 53 At the company’s inception, the subscribers covenanted ‘with the trustees, and each of the trustees covenant[ed] with the rest of the [subscribing] shareholders, for the due performance of [the] articles’.Footnote 54 There was no direct rule requiring unincorporated companies to be created using sealed contracts (specialities), but it was inconceivable for lawyers to attempt to create them using unsealed contracts. Common law claims for breaches of sealed and unsealed contracts were governed by different rules, a consequence of their having since medieval times been subject to separate forms of action.Footnote 55 Several features of specialties made them more suitable than unsealed contracts for creating a secure and unambiguous constitutional document which, if necessary, could be litigated upon by the trustees.Footnote 56 Specialties had more ‘force’ than unsealed contracts.Footnote 57 In particular, it was difficult for parties to dispute the terms of specialties,Footnote 58 parties could only be released from obligations under specialties by ‘a release under seal’,Footnote 59 specialties could bind heirs,Footnote 60 and a generous limitation period applied to actions on specialities.Footnote 61
Deeds also played a crucial role by ensuring that persons other than the subscribers might become shareholders. Requiring them to attach their seals to the deed of settlement, and to covenant to observe its stipulations, was the most expedient means of ensuring that the articles would bind these newcomers. It was therefore customary for company constitutions to require share transfers to be made by a three-part deed between the assignor, the assignee and the trustees.Footnote 62 This document would include a covenant by the assignee with the trustees whereby the assignee promised to comply with the company’s articles. It was also standard practice for the deed of settlement to require incoming shareholders to sign and seal the deed of settlement itself.Footnote 63
(ii) The scarcity of shareholder claims
Pre-1844 deed of settlement companies existed ‘on the fringes of legality’.Footnote 64 There was a risk that shareholder litigation could end up with the company falling foul of the Bubble ActFootnote 65 or the common law offence of ‘acting as a corporation’.Footnote 66 Shareholders who did decide to litigate (and who were not constrained by arbitration clauses) faced the hostile atmosphere of the Court of Chancery,Footnote 67 where the rules on joinder required that all shareholders, however numerous, be made parties to claims.Footnote 68 This was a powerful deterrent for disgruntled shareholders, as compliance typically generated ruinous costs.Footnote 69 For example, Televantos highlights Baldwin v Lawrence Footnote 70 in which ‘Lord Eldon refused to allow a bill for direction as to the meaning of a deed of settlement company’s articles of association on the basis that it was not brought by all the shareholder-partners’.Footnote 71 In this climate, shareholder claims were rare, and there are no authorities on the enforceability of insider and outsider rights in unincorporated companies.Footnote 72
3. The Joint Stock Companies Act 1856: articles of association and the enactment of the statutory covenant
The Joint Stock Companies Act 1856 Act introduced the modern-style registered company.Footnote 73 The deed of settlement, which had been retained under the 1844 Act, was replaced as the primary source of the company’s constitution by the memorandum and articles of association. The 1856 Act was the product of an unlikely combination of political influences, including arch-liberals and socialists, whose ideas converged in their belief that deregulation would make business vehicles accessible to entrepreneurs from a relatively wide cross-section of society, thereby promoting fair competition.Footnote 74 The outcome was ‘the most liberal and unregulated company law regime in Europe’Footnote 75 – a regime that, if not wholly underpinned by, was certainly in alignment with laissez-faire principles. Within this new regime, freedom of contract and self-regulation would provide the optimum environment for proper corporate governance standards.Footnote 76 The state should not do for shareholders what they ‘can do for themselves’ because this would leave them susceptible to fraud.Footnote 77 In this spirit, the 1856 Act contained few mandatory provisions relating to corporate governance. The articles were the primary source of shareholder protections.Footnote 78 Default model articles were provided, although companies were free to adopt whatever articles the promoters saw fit.
(a) Insider and outsider rights in the articles
(i) Insider rights and their continuing importance
During the second half of the nineteenth century, the numbers of companies increased rapidly, shareholders continued to be drawn from an increasingly wider pool of society, and the reconceptualisation of shares as marketable commodities continued.Footnote 79 Insider rights were a key component of constitutions that were increasingly tailored towards attracting the new kind of shareholder.Footnote 80 The model articles,Footnote 81 which provided the state’s view of an ‘ideal’ balance of shareholder and board rights,Footnote 82 contained default insider rights relating to entitlement to share certificates,Footnote 83 share transfers,Footnote 84 the respective rights of joint owners of shares,Footnote 85 pre-emption rights on new share issues,Footnote 86 voting rights,Footnote 87 dividends,Footnote 88 access to company accounts,Footnote 89 and printed copies of the company’s annual balance sheet.Footnote 90 The model articles, however, including many of those concerning insider rights, were either partly or entirely rejected by the majority of companiesFootnote 91 in favour of articles conferring increased board powers at the expense of the power of the general meeting.Footnote 92 It was particularly common for the staggered voting rights in the model articles to be abandoned in favour of insider rights conferring ‘one vote per share’.Footnote 93
Insider rights were thus crucial to the liberal corporate governance regime. But if shareholders were to help themselves, the state needed to ‘give them powers to take matters into their own hands, especially if things went wrong’.Footnote 94 If the majority wished to enforce the articles, there was usually no need for litigation. In the event, however, of majority indifference to breaches of the articles, individual shareholders might wish to enforce their rights. For the new regime to work as envisaged, the articles needed to be enforceable in court.Footnote 95
(ii) Outsider rights
Guinnane et al have shown that, towards the nineteenth century’s end, certain outsider rights, such as articles purporting to entrench directors for certain tenures, were relatively common, and that they attracted hostility.Footnote 96 In 1894, the Investor’s and Shareholder’s Guide described outsider rights as ‘most mischievous provisions’ that ‘lurk’ in articles,Footnote 97 although the authors thought them ‘not legally binding upon the company’ unless adopted post-incorporation.Footnote 98
(b) The statutory covenant and the original parties to the constitution
For this paper’s purposes, the 1856 Act’s most significant provisions are sections 7 and 10, which introduced the statutory covenant by providing that the memorandum and articles respectively:
shall, when registered bind the Company and the Shareholders therein to the same Extent as if each shareholder had subscribed his Name, and affixed his Seal thereto or otherwise duly executed the same, and there were in such Memorandum [read ‘Articles’ for s 10] contained … a Covenant to conform to all the Regulations of such Memorandum [read ‘Articles’ for s 10], subject to the Provisions of this Act.
This choice of words was heavily influenced by the constitutional framework of deed of settlement companies.Footnote 99
The orthodox view that the omission of the company as a deemed covenantor is attributable to improvident draughtsmanship hinges on two presuppositions, both of which can be countered. The first is that Parliament intended the contractual effect of the constitution, as between the company and the shareholders, to derive solely from the statutory covenant. The second is that the legislature, when formulating the statutory covenant, overlooked the company’s separate legal personality. But evidence indicates that the purpose of the statutory covenant was not to serve as the sole source of the shareholders’ and the company’s rights and obligations in the articles. Rather, the statutory covenant appears to have been conceived simply as a means by which to streamline the new registration process. Section 3 of the 1856 Act prescribed a minimum of seven, but no maximum number of, subscribers to the memorandum. According to Sir Henry Thring, the statute’s lead draughtsman:
The procuring of more than seven signatures to the memorandum of registration is a needless expense, as section 7 provides that every person on becoming a shareholder is bound by the memorandum to the same extent as if he had subscribed his name and affixed his seal thereto, and had thereby covenanted to conform to all its regulations.Footnote 100
Section 10 served the same purpose for the articles.Footnote 101 Thring’s characterisation of the statutory covenant as a cost-saving provision, with no indication that it served any function other than to obviate the need for numerous shareholders to sign the constitution, suggests that the only intended legal effect of sections 7 and 10 was to render non-subscriber shareholders bound by the constitution.
This construction makes sense if it is appreciated that, at the time of the statutory covenant’s enactment, the company and the subscribers were understood to be actual parties to the constitution. The subscribers, having executed the constitutional documents,Footnote 102 were original parties, so it was unnecessary for them to be deemed covenantors. Similarly, it was unnecessary for the company to be a deemed covenantor. Like the subscribers, it was an original party. When Sir Robert Lowe, Vice-President of the Board of Trade, introduced the Bill to the Commons, he announced that ‘every company affected by the Act is to sign a document which … which we propose to call a “memorandum of association”’.Footnote 103 This suggests that Lowe regarded the subscribers’ cumulative endorsement of the memorandum as making the company a party from the moment of registration.Footnote 104 As Ireland points out, prior to the emergence of modern separate personality, a process not finalised until the Salomon decision,Footnote 105 companies ‘were regularly conceptualised as their members merged into a legally distinct entity’.Footnote 106
The courts consistently construed the statutory covenant in this manner. Lord Selborne LC explained in Oakbank Oil Company v Crum Footnote 107 that the company was bound by its articles because:
Each party must be taken to have made himself acquainted with the terms of the written contract contained in the articles of association … [the company] must also in law be taken … to have understood the terms … of the contract which [it] has made.Footnote 108
Moreover, Astbury J later observed: ‘[m]uch of the difficulty is removed if the company be regarded, as the framers of the section may very well have so regarded it, as being treated in law as a party to its own memorandum and articles’.Footnote 109 The cases considered in Section 4 below reinforce this construction. For now, it should be emphasised that this construction is consistent with fact that the statutory covenant stated that ‘the Company and the Shareholders’ were bound by the articles, whilst only deeming shareholders to have covenanted – it referred to the full extent of the contractual force of the constitution as between the company and the shareholders, but only generated the contractual relations which subjected non-subscriber shareholders to the burden of the obligations in the articles.
(c) There was (and still is) ambiguity in the statutory covenant
Although the company’s omission as a deemed covenantor was no error, there was an ambiguity in the provision’s wording. It did not specify when the shareholder’s covenant was deemed to have been executed. To modern readers, the stipulation that the constitution was binding ‘as if each Shareholder had subscribed his Name and affixed his Seal thereto or otherwise duly executed the same’ might be interpreted as meaning that newcomers were deemed to have done this at the time of the company’s formation. On this basis, all shareholders would be deemed to have become parties when the company became a party, so all shareholders would be covenantees of the company’s covenant to observe its articles.
But Victorian judges read the statutory covenant differently. Subscribing a name and affixing a seal was interpreted as referring to the aforementioned practice of requiring incoming shareholders of deed of settlement companies to sign and execute the deed of settlement upon joining the company. Furthermore, the phrase ‘or otherwise duly executed the same’ was understood to derive from the practice of requiring incoming shareholders of pre-1844 companies to covenant to observe the articles. This interpretation would likely have come especially naturally to judges who had dealt professionally with deed of settlement companies.Footnote 110 According to this interpretation, each non-subscriber shareholder was deemed to have covenanted at the time at which they joined the company. As Jessel MR explained, the statutory covenant’s effect was that ‘the articles of association, when registered, shall bind the company and the members thereof to the same extent as if each member had subscribed his name and affixed his seal thereto; but that means at the time of becoming a member’.Footnote 111
According to this construction (the authorities on which are discussed below in Section 4), the subscribers and the company were parties to the constitution at the time of incorporation, so the subscribers were original covenantees of the company’s covenant to observe its articles. But non-subscriber shareholders, not being covenantees (deemed or otherwise) of the company’s covenant, could not rely on privity of contract to claim the benefit of the company’s obligations in the articles. Attempts by non-subscriber shareholders to enforce the articles against the company fell outside of the scope of the statutory covenant, and were a matter to be determined by ordinary principles of private law.
This construction is still applicable under section 33(1) of the 2006 Act. The new provision adds the company as a deemed covenantor, but it does not state when the covenants are deemed to have been executed. If the company’s covenant is deemed to have been executed when the company was incorporated, whilst the covenant of each non-subscriber shareholder is deemed to have been executed when they joined the company, then the same considerations regarding privity of contract apply – the statutory covenant will not confer upon non-subscriber shareholders the benefit of the company’s covenants.
4. The authorities supporting this construction
(a) The approach of Victorian courts to corporate law
It is worth noting that there are several traits of the Victorian English judiciary which have been identified by scholars as characteristic of the manner in which the courts adjudicated on corporate law disputes, and which are relevant to understanding the cases on the enforcement of individual shareholder rights in the articles. First, the courts took a ‘formalistic approach’ towards corporate law legislation which involved ‘restrict[ing] themselves to interpreting the letter of the statute’,Footnote 112 Salomon v Salomon Footnote 113 being a classic example of this approach. The judicial interpretation of the statutory covenant as referring to the full contractual effect of the constitution, but only deeming non-subscriber shareholders to be bound, is consistent with this formalistic approach.
Although there is some debate as to the extent to which laissez-faire ideology influenced Victorian judicial decision-making,Footnote 114 the courts’ fundamental approach to shareholder protection was consistent with laissez-faire. As a general rule, the courts were reluctant to interfere in companies’ internal affairs,Footnote 115 and judicial protections for shareholders were weak.Footnote 116 But the courts’ doctrinal commitment to ‘the liberty of the individual, the freedom of contract, and the sacredness of property’ was so intense that Lord Devlin likened it to a ‘Victorian Bill of Rights’.Footnote 117 As Atiyah put it, judges developed the notion that there was a ‘“natural” background of law … in which property rights were secured, and contracts were enforced’. Giving effect to these contract and property rules was ‘not conceive[d] of as interference at all’.Footnote 118
This was the heyday of legal formalism in contract law.Footnote 119 Victorian judges understood a ‘concept of contract which could dismiss all differences of time and place, of circumstances and people, [and] had no need for trivial distinctions between sale and hire-purchase, mortgages and leases, commercial and consumer contracts’.Footnote 120 The courts’ role was simply to give effect to the ‘will of the parties’Footnote 121 as expressed in a contract. This formalism permeated corporate law, wherein the courts ‘were enforcers of contracts such as articles of association’,Footnote 122 and upheld all contractual provisions that were ‘not directly contrary to law’.Footnote 123 This approach can be observed in the cases considered below on the enforcement of insider and outsider rights when there was privity of contract. Moreover, the aforementioned judicial reverence for the ‘sanctity of property’Footnote 124 also pervaded corporate law in the second half of the nineteenth century, wherein litigants could take ‘private action backed by strong courts, which were renowned for protecting private property rights’.Footnote 125 This approach is evident in the cases, also considered below, in which the benefit of insider rights was treated as property.
(b) Claims that fell within the scope of the statutory contract
(i) The company enforcing the articles against shareholders
The statutory covenant caused each shareholder to assume the burden of the shareholders’ obligations in the articles, and the company the corresponding benefit. The proposition that the statutory covenant is the source of the company’s ability to enforce articles against shareholders has been affirmed many times by the courts,Footnote 126 and need not be considered further.
(ii) The constitution’s inter se bindingness
The statutory covenant deemed each shareholder to have covenanted, upon joining the company, with the other shareholders. The ability of individual shareholders to invoke this inter se bindingness against other shareholders appears to have been little-discussed by nineteenth century courts.Footnote 127 It seems to have been taken as given that such claims would be restricted to breaches of individual shareholder rights that had been committed by the other shareholders, as opposed to by the company.Footnote 128 This left little room for infringements that could be the subject of inter se claims by individual shareholders, and this issue apparently was not dealt with judicially until Rayfield v Hands,Footnote 129 decades after the other issues in this paper became settled. Here, an outgoing shareholder was able to enforce a right to compel the other shareholders to purchase his shares as per a provision in the articles. According to the construction presented in this paper, every shareholder’s deemed covenant would be effective from the moment at which they joined the company. This would mean that no individual shareholder would be able to rely on privity of contract to claim the benefit of the covenants of any shareholders who joined before they did. Consistently with this construction, Vaisy J held that the plaintiff could rely on privity of estate, as laid down in Smith & Snipes Hall Farm Ltd v River Douglas Catchment Board Footnote 130 on the running of the benefit of freehold covenants which touch and concern the land, to claim the benefit of the disputed right. Privity of estate, as it relates to shareholder claims against the company, is revisited in more detail in section (d) of this section of the paper.
There is, however, an important line of cases in which a resolution of the general meeting was held invalid because the statutory covenant created contractual relations between the members inter se which prevented the majority from binding the minority by passing resolutions which were inconsistent with the articles and thus in breach of the obligations owed by all members to other members. These cases are important because they are usually treated as authorities that the statutory covenant rendered the company contractually bound by shareholder rights in the articles.Footnote 131 In Wood v Odessa Waterworks Company,Footnote 132 the articles provided that properly declared dividends should be paid in cash. The shareholders passed a resolution to pay a dividend in bonds. The plaintiff, a shareholder, obtained an injunction restraining the board from acting on the shareholders’ resolution because the latter was invalid.Footnote 133 Sterling J expressly cited the statutory covenant,Footnote 134 declaring that:
the question is, whether this is a matter as to which the majority of the shareholders can bind those shareholders who dissent. The articles of association constitute a contract not merely between the shareholders and the company, but between each individual shareholder and every other. Footnote 135
Therefore, although it is often cited as such, Wood is not an authority that the statutory covenant is the source of the enforceability of insider rights by shareholders against the company.
Both Imperial Hydropathic Hotel Company v Hampson Footnote 136 and Quin & Axtens v Salmon Footnote 137 have been cited as authorities that shareholders can, by suing qua members, invoke the statutory covenant to enforce outsider rights against the company.Footnote 138 In Imperial, the articles conferred a certain tenure upon the directors. Hampson, a director and shareholder, successfully claimed that a special resolution to dismiss him was void because the articles conferred no such power on the general meeting.Footnote 139 Cotton LJ said that the articles ‘under the Act are a contract between all the shareholders to comply with the regulations within’.Footnote 140 Accordingly, the case depended on the inter se enforceability of the articles, ie ‘whether a majority at a general meeting can bind those who are not there, and take no part in it … whether in the present case the contract between these shareholders has been followed’.Footnote 141
Automatic Self-Cleansing Filter Syndicate Company Ltd v Cuninghame Footnote 142 was decided on the same reasoning. An ordinary resolution was passed directing the board to sell the company’s undertaking. The resolution was held void because, on proper construction of the articles, only a special resolution could interfere with the general power of management conferred upon the board by the articles. Cozens-Hardy LJ explained that:
[T]he articles of association are a contract between the members of the company inter se. That was settled finally by the case of Browne v La Trinidad, if it was not settled before. We must therefore consider what is the relevant contract which these shareholders have entered into …Footnote 143
In Quin,Footnote 144 the articles empowered the managing directors, including Salmon, to veto board decisions to lease company property. The majority of directors wanted a lease to be granted. Salmon invoked the veto. Ordinary resolutions were passed, at the instigation of directors who controlled the general meeting, requiring the company to grant the lease. Salmon, who was also a shareholder, obtained an injunction restraining the company from acting upon the resolutions. Farwell LJ regarded Salmon’s claim as ‘entirely governed’Footnote 145 by Automatic. The resolutions were void because they were inconsistent with the articles, and thus contravened the inter se contractual relations that the statutory covenant generated between the shareholders who voted in favour of the resolutions and the other shareholders. This left the board, which, owing to the veto, opposed the lease, as the only organ of governance competent to determine whether the lease should be granted.Footnote 146 The House of Lords agreed – the case rested on ‘[t]he bargain made between the shareholders’Footnote 147 in the articles. In Browne v La Trinidad,Footnote 148 the source of the reasoning in Automatic, the Court of Appeal refused to permit a shareholder to enforce an outsider right against the company. That Quin rests on reasoning derived from Browne reinforces the argument that Quin is not an authority that the statutory covenant empowers shareholders to enforce outsider rights against the company.
(c) Claims governed by actual privity of contract between the company and the subscribers
If the formalist Victorian approach to contract law is recalled, there is no reason to think that ordinary privity of contract would not have applied to the original parties to the constitution of registered companies. So, in addition to the company being able to enforce rights in the articles against the subscribers, the latter should have been able to enforce all such rights, including outsider rights, against the company. One might wonder why the courts would develop rules applicable only to subscribers. But from the perspective of Victorian contact-related formalism, determining the contractual relationship between subscribers and the company did not involve creating special rules for subscribers. It simply involved applying the rules that always applied to original parties to contracts.Footnote 149
Cases on the enforcement of the articles between the company and the subscribers are fairly scarce. Nevertheless, when pieced together, they support the argument that the company and the subscribers were original parties to the constitution, and that these contractual relations arose independently of the statutory covenant. Recall that the statutory covenant’s purpose, as articulated by Thring, was to spare non-subscriber shareholders the trouble of making themselves parties to the constitution. Thring did not think that the subscribers fell within the scope of the statutory covenant. Recall also the statements by Lowe, Lord Selborne and Astbury J to the effect that the company was a signatory to its own constitution. There is also a House of Lords authority, Venezuela Central Railway Co v Kisch,Footnote 150 which shows that subscribers, unlike other shareholders, were parties to the articles independently of the statutory covenant. The plaintiff, who was induced to contract to purchase shares in a company by misrepresentations that appeared in its prospectus, sued to have the contract rescinded. The articles qualified what was said in the prospectus, to the extent that notice of the contents of the articles would have been fatal to the misrepresentation claim. The defendants argued, inter alia, that the plaintiff was a member, so that, by virtue of the statutory covenant, he should be treated as if he had signed and sealed the articles and thus had notice of their contents. Lord Cranworth, explaining the court’s decision that the plaintiff had not become a member because his share purchase had been induced by fraud, contrasted the plaintiff’s position with that of subscribers:
[the statutory covenant] provides … that the articles of association shall bind every member of the company as if he had subscribed and sealed the same, and had covenanted to conform to all the articles thereof. If the Respondent had actually subscribed and sealed these articles, he certainly could not have alleged want of notice as to the [contents thereof]. But he never did subscribe or seal them; and in order to make them binding on the Respondent, under the provisions of the [statutory covenant], it is necessary to shew that he had become a member of the company.Footnote 151
In Re Appletreewick Lead Mining Company Footnote 152 an outsider right was held enforceable by a subscriber against the company. The articles stated that, in consideration of an assignment of their interests in a mine to the company, the subscribers, including the defendant, were to take their shares fully paid.Footnote 153 The company’s liquidator later claimed that the defendant was liable as a contributory who had received the shares unpaid. The defendant, however, convinced the court that the relevant article constituted a valid contract between himself and the company for the shares to be issued to him fully paid.Footnote 154 Malins VC emphasised that the defendant was a party to the contract because he was a subscriber. Also note here that the report of Browne, in which the Court of Appeal refused to permit a non-subscriber shareholder to enforce an outsider right, emphasises that ‘[t]he plaintiff was not one of the subscribers …’.Footnote 155
(d) Insider rights as property rights
According to the construction proposed in Section 3(c), above, the statutory covenant created no privity of contract upon which non-subscriber shareholders could rely to enforce individual shareholder rights in the articles against the company. It will now be argued that, to determine which individual shareholder rights could be enforced by non-subscriber shareholders against the company, the courts deployed a doctrine akin to privity of estate. The ability to enforce rights that were integral to a shareholder’s status as shareholder – ie insider rights – was given proprietary effect, so the right to enforce them was transmitted to non-subscriber shareholders when they became shareholders.Footnote 156 Outsider rights, on the other hand, were not given proprietary status, so could not be enforced by non-subscriber shareholders against the company.
(i) Privity of estate in land law: giving proprietary effect to the benefit of contractual provisions
Prior to considering the cases on insider rights, it should be emphasised that whether and when contractual rights could become annexed to property were not novel legal questions. There were various situations, well-known to the Victorian judiciary, in which the question would arise as to when an assignee of property should take the benefit of covenants that were ancillary to that property right. The ancient doctrine of privity of estate was developed to deal with precisely this kind of scenario.
The grant of a lease and the issue of shares conferred assignable property upon the recipient, whilst in both cases the grantor (ie the landlord or the company) retained interest and influence in relation to the property. The mutual rights and obligations of landlords and tenants, like those of companies and shareholders, are laid down in relational contracts. Lease agreements can include covenants that have nothing to do with the parties’ capacity as landlord or tenant; parallels can be drawn here with outsider rights in articles of association. The common law long agoFootnote 157 reached the conclusion that the benefit and burden of leasehold covenants which touched and concerned the demised propertyFootnote 158 were transmitted to assignees upon assignment of the lease and/or the reversion, ie they were enforceable when there was privity of estate between the parties. The right to enforce property-related leasehold covenants (ie the right to insist on performance of the contractual rights that attached to the land) formed a key dimension of the leasehold estate obtained by the assignee. Similarly, the right to performance of articles conferring insider rights is best understood as a property right obtained by every non-subscriber shareholder upon acquiring shares in the company.
Similar issues arose in cases concerning freehold covenants. Of particular interest is the doctrine of ‘building schemes’.Footnote 159 When a developer (roughly analogous here to the company) sold plots of land to purchasers (roughly analogous to the subscribers) subject to identical restrictive covenants intended to benefit all properties within the scheme of development, the benefit of these covenants, so long as they were not personal covenants, would pass to later assignees of land within the scheme (roughly analogous to non-subscriber shareholders).Footnote 160
The reasons for enforcing insider rights as property rights were arguably stronger than were the reasons for enforcing covenants that touched and concerned land. An original tenant’s assignee, for example, could hypothetically derive some benefit from possession of the land even without being entitled to enforce any leasehold covenants. But what utility would shares be to a shareholder who could not enforce insider rights? Very little, because such a shareholder would have no ability to enforce the rights that are fundamental to their ability to enjoy any benefits of share ownership (eg rights to duly declared dividends, rights relating to the assignability of their shares, voting rights, or rights to surplus on dissolution).
(ii) Authorities on insider rights as property rights
Several authorities emphatically confirm that insider rights are property-related rights, and that this is why they were enforceable. In Pender v Lushington,Footnote 161 the court held that nominees to whom shares had been transferred by Pender, in order that he could avoid a cap on votes per share, were entitled to exercise their voting rights, even though they were voting in accordance with Pender’s instructions. Jessel MR drew a direct analogy with leasehold covenants:
those who have the rights of property are entitled to exercise them, whatever their motives may be for such exercise … I [endorse], as a crucial test, whether, if a landlord had six tenants whose rent was in arrear, and three of them voted in a way he approved of for a member of Parliament, and three did not, the Court could restrain the landlord from distraining on the three who did not, because he did not at the same time distrain on the three who did. He admitted at once that whatever the motive might be, even if it could be proved that the landlord had distrained on them for that reason, that I could not prevent him from distraining because they had not paid their rent. I cannot deprive him of his property …Footnote 162
Several decades later, in Carruth v Imperial Chemical Industries Ltd,Footnote 163 Lord Maugham articulated the same point: ‘the shareholder’s right to vote is a property right, and prima facie may be exercised by a shareholder as he thinks fit in his own interest’. In Johnson v Lyttle’s Iron Agency,Footnote 164 the company attempted to forfeit a shareholder’s shares without following the procedure laid down in the articles. The shareholder was able to resist the forfeiture because, as James LJ explained, it:
did not comply strictly with the provisions of the contract between the company and the shareholders which is contained in the regulations of Table A. It was the established [general common law] rule … that no forfeiture of property could be made unless every condition precedent had been strictly and literally complied with.Footnote 165
Re Stranton Iron and Steel Company Footnote 166 and Moffatt v Farquar Footnote 167 are both cases in which a large shareholder transferred shares to nominees and the directors refused to register the transfers. In both cases, the courts upheld the shareholder’s right, derived from the articles, to transfer their shares and to have the transfers duly registered. In Stranton, Bacon VC explained that:
[t]he applicants are the owners of shares – a class of property of which one of the incidents is a right to transfer it – a right to make a present and complete transfer of it. It is the duty of the directors to receive and register that transfer … or to furnish some reason for refusing to transfer.Footnote 168
In Moffatt, Malins VC expressed very similar sentiments:
[t]his right of transfer is a right of property; and if the directors have an arbitrary power, from any fancy they choose to take up, to say there shall be no transfer, that is an annihilation of property … Such are the views which have been taken in all the cases that have occurred. It is always treated as a matter of property; and where a matter of property is concerned it must not be lightly interfered with.Footnote 169
Malins VC then reiterated his ‘very strong views … of the right of every shareholder in a joint stock company, as a matter of property, to protect that property from being interfered with’.Footnote 170
(iii) Authorities that the statutory covenant had nothing to do with insider rights
The authorities also demonstrate that the statutory covenant had nothing to do with the enforceability of insider rights. In none of the above-mentioned cases was the statutory covenant mentioned as the source of the right’s enforceability. Furthermore, in Oakbank Oil Company v Crum,Footnote 171 the House of Lords unanimously held, without mention of the statutory covenant, that a shareholder could enforce against the company a provision in the articles requiring the latter to pay duly declared dividends in proportion to shareholders’ shareholdings.Footnote 172 But in a near-contemporary case concerning the right of the company to enforce its articles against a shareholder, the leading judgment, delivered by Lord Blackburn (who also sat in Oakbank) did rest on the statutory covenant.Footnote 173 Most tellingly, Wedderburn, in his celebrated article on shareholder rights, cited 14 other cases in which insider rights were enforced against the company.Footnote 174 Although Wedderburn called them rights which ‘spring from the “contract under section 20”’,Footnote 175 in none of these cases was the enforceability of the insider right attributed by the court to the statutory covenant.
(e) Non-subscriber shareholders could not enforce outsider rights
The courts consistently refused to permit non-subscriber shareholders to enforce outsider rights against the company, invariably on the ground that they were not actual parties to the articles and so did not take the benefit of the outsider rights. Because outsider rights are personal rights, the property-related considerations which justified the enforcement of insider rights were inapplicable. This was confirmed in two famous Court of Appeal decisions. In Eley v Positive Government Security Life Assurance Company Footnote 176 a non-subscriber shareholder attempted unsuccessfully to enforce a right in the articles to a life tenure as the company’s solicitor. Lord Cairns LCFootnote 177 said that the article was a ‘covenant between the parties to it’, and that the plaintiff was ‘no party to it’.Footnote 178 Lord Cairns also exhibited hostility to outsider rights, tersely saying that ‘a contract of the kind suggested to exist in this case ought not to receive any particular favour from the Court’.Footnote 179 Similarly, in Browne v La Trinidad,Footnote 180 a non-subscriber shareholder sought to enforce against the company a certain tenure as a company director. Cotton LJ stated that ‘though a person in whose favour a stipulation is made in the articles may afterwards have shares allotted to him, he does not by that means become in the same position as if he had entered into a contract with the company’.Footnote 181 Recall here that the reporter in Browne emphasised that the plaintiff was a non-subscriber shareholder.Footnote 182 In neither case was any suggestion made that the claims would have succeeded had the plaintiffs sued qua members.
Notably, there do not seem to be any clear nineteenth century authorities that a non-subscriber shareholder could invoke the statutory covenant to enforce an outsider right against the company. Gregory,Footnote 183 whose survey of the authorities is the most comprehensive, cited what he regarded as five such cases. But, of these, Quin and Imperial, as explained above, were decided on the inter se enforceability of the statutory covenant. Of the other three, in Pulbrook v Richmond Consolidated Mining Co,Footnote 184 a director/shareholder was able to obtain an injunction restraining his exclusion from board meetings on the basis that he had been validly appointed in accordance with a share qualification clause in the articles.Footnote 185 Jessel MR, however, made no mention of the statutory covenant. Moreover, he suggested that the right to attend board meetings affected the plaintiff’s ‘individual interest as a shareholder’.Footnote 186 In Orton v Cleveland Fire Brick,Footnote 187 it was held that a director who had performed his duties was entitled to be remunerated in accordance with the articles. The statutory covenant was cited, but as authority that Parliament intended the company to be bound by its articles, not that the statutory covenant confers upon shareholders the benefit of the company covenants.Footnote 188 Indeed, there is no suggestion anywhere in the report that the director was a shareholder.Footnote 189 Furthermore, in Re Kemp, Wright J treated Orton as ‘no longer law’ – by then, it had been established that ‘the courts … treated directors’ service contracts as being separately made, but incorporating the articles’.Footnote 190 Finally, in Re Dale and Plant,Footnote 191 the company’s liquidator unsuccessfully argued that damages owed to the managing director were owed to him in his capacity as shareholder, not managing director. Although the articles purported to appoint the managing director, they did so pursuant to an agreement between him and the company, and Kay J did not mention the statutory covenant, let alone hold that it or the articles were the source of the managing director’s contractual rights. Thus, none of these five cases would seem to provide convincing support for the enforcement of outsider rights by non-subscriber shareholders, and they certainly do not displace the strong authorities of Eley and Browne,Footnote 192 especially given that, in Browne, Lindley LJ stated that there were cases ‘subsequent’ to Eley which showed that, by 1887, the law in this respect ‘must be taken as settled’.Footnote 193
(f) Clarity on shares as bundles of rights
Recall that by the mid-nineteenth century, the Bligh line of cases had determined that shares were a new kind of personalty, but there was a gap in the law because this line of cases had not determined the precise nature of this property. By 1901, Farwell J was able to assert confidently that a share is ‘an interest … made up of various rights contained in the contract [in the articles], including the right to a sum of a money or more or less amount’.Footnote 194 But Farwell J did not explain how to determine which rights in the articles comprise the share,Footnote 195 and the main academic contributions on the legal reconceptionalisation of shares cite no cases on this point either.Footnote 196 Pennington came the closest, but he argued that the statutory covenant generates ‘the contractual rights and obligations of each member’,Footnote 197 without drawing any distinction between insider and outsider rights.
According to the construction presented in this article, the nature of the rights that comprise the share was determined by the cases in which the benefit of insider rights, but not outsider rights, was given proprietary effect. These cases explain why all shareholders obtain the benefit of all rights in the articles that affect them qua shareholder. Indeed, this explanation is still applicable today – a modern share is generally understood as comprising ‘the bundle of rights attached to each share, as determined by the legislation and articles of association’.Footnote 198 This view was recently confirmed by Lord Reed, who described a share as consisting of ‘a right of participation in the company on the terms of the articles of association … including a right to vote on resolutions at general meetings, a right to participate in the distributions which the company makes out of its profits, and a right to share in its surplus assets in the event of its winding up’.Footnote 199
Conclusion
This paper, by examining the historical lineage of the company constitution, has challenged orthodox accounts of its bindingness by arguing that the enforceability against the company of individual shareholder rights in the articles was, from 1856 onwards, governed not by the statutory covenant, but by ordinary private law principles. Subscribers could rely on privity of contract to enforce all shareholder rights against the company, whilst non-subscriber shareholders could rely on privity of estate to enforce insider rights, but not outsider rights, against the company. This construction, which has overwhelming support from the authorities, relies on two key insights that have hitherto not been recognised by modern scholars, but which can be gleaned from contemporary sources.
First, the statutory covenant’s wording was not a product of entity blindness. The subscribers and the company were, as a matter of ordinary contract law, original parties to the constitution. The statutory covenant’s only intended function was to deem non-subscriber shareholders to have covenanted to observe the constitution. Secondly, each non-subscriber shareholder’s covenant was deemed to have been executed at the time at which they joined the company. The statutory covenant did not, therefore, confer upon non-subscriber shareholders the benefit of the company’s obligations. This meant that it was left to the courts to apply ordinary principles of property law to determine which shareholder rights could and could not be enforced by non-subscriber shareholders against the company.
By highlighting the role of ordinary contract and property law principles, and the consistency with which these principles were applied by the courts in cases concerning shareholder rights, the construction proposed here presents a novel and comprehensive solution to the long-standing academic controversy surrounding insider and outsider rights. The proposed construction also has implications for the modern law. The updated statutory covenant in section 33(1) of the 2006 Act deems the company to be a covenantor, so the company is no longer an actual contractual party. But if the company’s covenant is deemed to have been executed at the time of incorporation, and each shareholder’s covenant is deemed to have been executed at the time at which they joined the company, the ability of non-subscriber shareholders to enforce rights in the articles will continue to hinge on privity of estate. This interpretation of section 33(1), by determining which rights in the articles can be enforced by shareholders against the company, provides clarity on the contractual effect of the company constitution. It also has practical application because suing to enforce insider rights continues to provide an avenue for minority shareholders to invoke the articles against the company.Footnote 200 It might, however, be advised that future companies legislation should close the loophole that enables subscribers to enforce outsider rights. This would foreclose the possibility of unscrupulous subscribers inserting into the articles outsider rights that they could later enforce, an eventuality that cannot be entirely discounted, especially now that, with the advent of rapid electronic company registration, many subscribers of newly formed companies are likely to envisage retaining an ongoing interest in the company.Footnote 201
The arguments presented in this paper also have wider significance for accounts of the evolution of registered companies. This is because the cases on insider and outsider rights, when understood as they were understood by the judges who determined them, uncover a crucial step in the nineteenth century transformation of the share from an equitable interest in company assets into a novel kind of personalty. The judicial treatment of insider rights as property rights determined how and why the share came to be perceived as comprising a bundle of transferrable contractual rights deriving from the articles. This in itself was a very important part of the wider progress of corporate law towards recognising the reified company that is familiar today. Moreover, as the Supreme Court has recently confirmed, shares are still widely considered to consist of a bundle of transferrable rights deriving primarily from the articles. This paper’s findings, if applied to the modern law, provide a reasoned explanation – and, it is submitted, the explanation with the most convincing support from the case law – as to which of these rights comprise this bundle and why this is so. In short, the cases on the enforcement of shareholder rights against the company, when read in light of the analysis in this paper, reveal the property law principles that underpin the concept of the transferrable registered company share.
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