Models of Corporate Regulation: The Mandatory/Enabling Debate

CORPORATE PERSONALITY IN THE 20TH CENTURY, C Rickett, R Grantham, eds., pp. 215-270, Hart Publishing, Oxford, 1998

73 Pages Posted: 19 Sep 2006

See all articles by Ian Ramsay

Ian Ramsay

Melbourne Law School - University of Melbourne

Abstract

This book chapter is a revised version of a paper presented at a conference to mark the centenary of the decision of the House of Lords in Salomon v Salomon & Co Ltd. Few law judgments would be worthy of a major conference 100 years after they are handed down. Yet the decision of the House of Lords in Salomon v Salomon & Co Ltd continues to generate much discussion. A later judgment referred to the decision in Salomon as constituting “the foundation of our modern company” while one commentator refers to the decision as “calamitous”.

The decision in Salomon remains important today because a number of the matters considered by their Lordships are still being debated. For example, when is it appropriate to grant limited liability to an organisation? This was fundamental to the decision in Salomon yet remains important today when we consider recent debates concerning whether or not certain professions such as solicitors and accountants should be able to incorporate and thereby gain the benefits of limited liability. Is it appropriate to grant limited liability to a company which, although having more than one shareholder, may in fact reasonably be described as a “one person” company because of the dominance of one particular shareholder? Again, this was fundamental to the decision in Salomon and we finally saw this debate resolved in Australia in late 1995 with the enactment of the First Corporate Law Simplification Act which allows a proprietary company to be formed with only one shareholder.

What is the appropriate balance between protecting shareholders of a company by granting them limited liability and protecting unsecured creditors who will bear additional risk where shareholders have limited liability? In Salomon it was the unsecured creditors represented by the liquidator of Salomon & Co Ltd who lost. This issue remains central to a number of significant corporate law debates when we consider statutory provisions of the Australian Corporations Law which impose liability on the directors of a company which engages in insolvent trading. These statutory provisions have, as their objective, the protection of unsecured creditors.

There is a further issue arising from the decision in Salomon. To what extent should corporate regulation be essentially mandatory or enabling (in the sense that regulation has, as its objective, the promotion of private agreements between participants in companies on the basis that they are typically in a better position to understand and contract for their own needs rather than the government)? How did this issue arise in Salomon? The English Companies Act of 1862 allowed companies to be incorporated with seven shareholders. The Act specifically granted shareholders limited liability. Aron Salomon had a company duly incorporated in accordance with the Act on 28 July 1892. He held 20,001 shares in the company and his wife, daughter and four sons each held one share.

Once there is formal compliance with these provisions allowing for incorporation, is this sufficient to obtain limited liability? A negative reply was given by the Court of Appeal where the judges stated that more than formal compliance with the statutory provisions was required. Lindley LJ stated that “the incorporation of the company cannot be disputed”. However, he, along with the other judges of the Court of Appeal, did not believe that the legislature intended to give “one person” companies limited liability. The decision of the Court of Appeal was overturned by the House of Lords.

In the chapter, I examine in greater detail issues relevant to the debate on whether corporate regulation should be mandatory or enabling. In Part II, I look more closely at mandatory and enabling systems of regulation. In Part III, I provide some examples, drawn from Australian corporate regulation, of mandatory rules which have had high costs associated with them. In Part IV, I discuss mandatory corporate disclosure rules as a case study of the mandatory/enabling debate. In Part V, I return to a key theme evident in Salomon - limited liability. Should we promote and facilitate limited liability or strictly regulate the circumstances where limited liability should be permitted? Finally, in Part VI, I turn to examine the implications of two significant recent developments (the growth of institutional investors and electronic commerce) for the mandatory/enabling debate.

Suggested Citation

Ramsay, Ian, Models of Corporate Regulation: The Mandatory/Enabling Debate. CORPORATE PERSONALITY IN THE 20TH CENTURY, C Rickett, R Grantham, eds., pp. 215-270, Hart Publishing, Oxford, 1998, Available at SSRN: https://ssrn.com/abstract=931304

Ian Ramsay (Contact Author)

Melbourne Law School - University of Melbourne ( email )

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+61 3 8344 5332 (Phone)

HOME PAGE: http://law.unimelb.edu.au/about/staff/ian-ramsay

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