My recent book, ‘Company Law: A Real Entity Theory’, advances a real entity theory of company law. I argue that the company is a legal entity allowing an organization or firm to act autonomously in law and that company law establishes procedures facilitating autonomous organizational decision-making.
The theory builds on the insight that organizations are a social phenomenon outside of the law and that these are autonomous actors in their own right. They are more than the sum of the contributions of their participants. They also act independently of the views and interests of their participants. This occurs because human beings change their behaviour when they act as members of an organization. We develop and conform to shared standards. Habits, routines, processes, and procedures form and a culture emerges. These take on a life of their own affecting the behaviour of the participants. Participants can affect organizational behaviour and modify habits, routines, procedures, and culture but this takes time and effort. Organizations are social facts. They are real in their consequences. Company law finds this phenomenon and evolves with a view to supporting autonomous action by organizations.
The book does not take a position on the normative question of whether stakeholders should have more influence than they currently have. The theory presented in the book holds irrespective of how the law fine-tunes the influence over corporate decision-making.
The theory advanced in the book explains the law at a positive level. Separate legal personality, for example, overcomes the fact that organizations are social rather than brute facts. It enables organizations to act as independent subjects in the eyes of the law. The Companies Act 2006 also sets out a procedural framework for the operation of an organization. It defines roles for participants and assigns powers to these roles thus facilitating decision making that leads to autonomous organizational action. The Companies Act appoints the corporate constitution to further formalize the procedures for the taking corporate decisions. In large companies, routines are further defined through policies. The Companies Act requires listed companies, for example, to develop a policy for executive remuneration.
The capacity of companies used to be limited by the objects stated in its memorandum. The effect of limited capacity fits with an approach based on contract law. If an arrangement is set up through a contract the rights arising from that contract are necessarily limited by its terms. The ultra vires doctrine was abolished because it turned out to be unsuitable for the operation of commercial organizations. Now all non-charitable companies have to have unlimited capacity.
The Companies Act endows directors with authority to bind the company in contract and authorize others to do so. This authority cannot be limited by the constitution of the company and so the company can act through its directors independently from its shareholders. Through this, the law recognizes companies as autonomous actors. Companies are also autonomously liable criminally and recently attribution rules have been developed that connect to organizational fault.
The duties of the directors are owed to the company and, while the shareholders are the primary indirect beneficiaries of those duties, the law integrates the interests of creditors and also of wider society. Moreover, the law is primarily focused on ensuring compliance with the Companies Act and the constitution rather than with the enhancement of economic interests. The law does not instruct the directors to maximize return however defined. The directors are responsible for defining in their subjective judgement what is best for the success of the company (CA 2006, s 172). The objective standard of skill and care (CA 2006, s 174) was introduced with the public interest in mind. It is interpreted by reference to the organizational role performed by each individual director. Directors are encouraged to operate a process giving them adequate financial information, ensuring supervision of delegated activity, and compliance with the law. The Company Directors Disqualification Act 1986 serves as a mechanism through which the public interest is integrated into company law. The enforcement of this Act is funded by the public purse rather than by the company or its shareholders. The UK Corporate Governance Code adds a further procedural dimension to the operation of the board of directors.
Agency theory is useful to illuminate the problems arising in conflict-of-interest situations but the law governing such transactions goes beyond protecting the economic interests of the company. It requires all conflicted transactions to be approved by the company through the relevant procedures. A director who failed to seek such approval is liable even if the company benefitted economically from the transaction.
The directors have exclusive responsibility to record financial information and to create financial and narrative reports. The content of the records and the reports is set out in the respective accounting regulations and cannot be modified by the shareholders. Directors are also bound by the distribution rules which prioritize the interests of creditors over those of the shareholders. The characterization of the directors as agents of the shareholders is not only formally wrong because the directors owe their duties to the company rather than to its shareholders. It also does not adequately reflect the depth and breadth of the directors' overall responsibilities.
The shareholders have substantial governance rights but they should not be characterized as principals of either the directors or of the company. This is because the law has put in place restrictions for the benefit of minority shareholders and creditors that limit the ability of the shareholders to exercise their rights freely. It is also because they are bound by the distribution rules and so are not free to determine the amount of return to be paid to them.
Eva Micheler is an Associate Professor (Reader) at the Law Department at LSE and a member of the management committee of the Systemic Risk Centre at LSE.