by Roderick Ramage, solicitor, www

Can companies be trusted? Some aspects of Tesco law

by Roderick Ramage, solicitor, www.law-office.co.uk

first published in New Law Journal (newlaw.journal@lexisnexis.co.uk) on 12 May 2006

DISCLAIMER

This article is not advice to any person and may not be taken as a definitive statement of the law in general or in any particular case. The author does not accept any responsibility for anything that any person does or does not do as a result of reading it.

What Clementi forgot to mention.

PREAMBLE:

Sir David Clementi’s report (Final Report Review of the Regulatory Framework for Legal Services in England and Wales (December 2004)) had as its brief to consider what “regulatory framework would best promote competition, innovation and the public and consumer interest in an efficient, effective and independent legal sector” and to make recommendations. His recommendations to liberalise the legal services market included the creation of alternative business models, which would enable the ownership of law firms to be split from their management, so that a law firm could have outside equity investors or an existing business (eg Tesco, the RAC and the Co-Op) could provide legal service to the public. The government accepted most of his proposals in its White Paper (The Future of Legal Services: Putting Consumers First October 2005 CM 6679) and a Legal Services Bill is expected to be published soon).

corporations and individuals

Law and morals are uneasy bedfellows. A corporation is a legal person but the concept of a moral or an immoral corporation is an oxymoron. A corporation is an artificial person with such powers as are given to it by statute or its constitution, its memorandum and articles of association in the case of companies incorporated under the Companies Acts 1985 or earlier. One should not fall into the trap of assuming that a company has human attributes because it operates through the agency of human beings, or because of the fact that it is a person, or even the fact that it may have rights under the Human Rights Act 1998: see eg Marpa Zeeland BV and another v Netherlands (App No 46300/99) (ECHR), Ashworth Hospital Authority v MGN Ltd [2002] UKHL 29 and Cream Holdings Ltd v Banerjee [2004] UKHL 44, [2005] 1 AC 253 HL).

In this article I use the word “corporations” to mean commercial (for profit) companies, some or all of whose shareholders are not its directors or managers (ie with outside investors), and “individuals” to mean not only natural persons but also (i) partnerships of natural persons and (ii) companies in which all the shareholders are also directors or managers (ie with no outside investors). The distinction is important in the context of trust, morality etc.

Individuals are capable of being greedy, dishonest and generally nasty and they can also be generous, conscientious and generally want to do the “right thing”. That is human nature. The conduct of individuals is governed by influences including the law, economics and morality. For some individuals money is the only purpose of work and for others it what you hope to get if you do your work right (about whom Clementi is mildly sceptical – Chapter F para 55) and for these, there are other motivations to govern how and why work is done.

In contrast corporations have only one function, which is to make profits, and if they have to lie, cheat, steal or kill to make money, they will do so: although tobacco companies have no intention of killing anyone, it is beyond medical doubt that their activities do kill (ie shorten the lives of) their customers. This is not a wild anti-globalisation accusation, but a statement of a long established basic principle of company law. Corporations may obey the law (or even do the right thing), but not on moral grounds or because it is the right thing to do. Someone will have worked out whether it is more profitable to obey the law or to flout it and pay the fine.

the law

The company law duty of a corporation’s directors, long and well established by the courts, is to look after the interests of the shareholders, which means the maximisation of profits (whether income or capital). Directors who pursue any other aim, with a minor exception for employees in s309 of the Companies Act 1985, are in breach of their legal duties. The two most commonly cited authorities for this are the English case of Hutton v West Cork Railway and the US case of Dodge v Ford Motor Co: summarised below.

Hutton v West Cork Railway Co (1883) 23 ChD 654, CA

The facts of this case are that the company was to be wound up, having transferred its business to another company, and, between the transfer and the winding up, resolved at a general meeting to pay one thousand guineas as compensation for loss of office to certain employees, although they had no legal claim for it. The resolution was invalid, as the company was no longer a going concern and existed only for the purpose of winding-up.

In this case Lord Justice Bowen stated:

“The law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company … The Master of the Rolls there held that the company might lawfully expend a week’s wages as gratuities for their servants; because that sort of liberal dealing with servants eases the friction between masters and servants, and is, in the end, a benefit to the company. It is not charity sitting at the board of directors, because as it seems to me charity has no business to sit at boards of directors qua charity. There is, however, a kind of charitable dealing which is for the interest of those who practice it, and to that extent and in that garb (I admit not a very philanthropic garb) charity may sit at the board, but for no other purpose.”

Dodge v Ford Motor Co, 204 Mich 459, 170 NW, 668 (1919)

In this case Henry Ford and the directors of the Ford Motor Co had decided not to pay a dividend despite substantial retained earnings in the company and substantial profits in the particular year in question. The reason for the decision expressed by Henry Ford was that the money was be used for plant expansion so that the Ford industrial system could be expanded for the general benefit of society. That may have been a very noble reason but that reason was not directed at the profit of the company and thus it was not a basis for refusing to pay a dividend. A refusal to pay a dividend had to be based on the best interests of the corporation and decisions that are in the best interests of the corporation were assumed to be those that promoted future profits. (Copied with thanks from chapter 27 of Notes on Business Associations by Professor Mark Gillen of the University of Victoria Faculty of Law.)

The key passage in the judgment is the following.

“The difference between an incidental humanitarian expenditure of corporate funds for the benefit of the employees, like the building of a hospital for their use and the employment of agencies for the betterment of their condition, and a general purpose and plan to benefit mankind at the expense of others, is obvious. There should be no confusion (of which there is evidence) of the duties which Mr Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his co directors owe to protesting, minority stockholders. A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the non distribution of profits among shareholders in order to devote them to other purposes.”

(back to the theme)

If the Company Law Reform Bill is enacted (Royal Assent is said to be expected in the Autumn 2006), directors’ general duties will be codified. Clause 156(1) says: “A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefits of the shareholders as a whole.” This is widely worded, but in the case of a “normal” commercial company, whose members are investors for the purpose of profit, it will not change the duty to maximise profits.

regulation and conclusion

I am sure that there is no doubt that a corporation can and will work to the highest professional standards if it pays to do so, but I am not sure how far I would rely on Clementi’s illustration (Chapter F para 22) of a corporation’s commercial interest in doing so: “Unlike most high street solicitors, companies such as these have nationally known brand names to protect, which may be a powerful incentive to operate in a proper manner.”

In Chapter F para 41 Clementi cites the following point made by the Bar Council.

“… the conflict that would inevitably arise between the commercial interests of the owners and the ethical duties on which the practice of law is based. An owner of a law firm who was not a lawyer and therefore not subject to those duties would be perfectly entitled to pursue his own financial interests, even in circumstances where those conflicted with the best interests of clients of the firm or with other core values of the legal profession.”

He dismisses it in para 42 with these words. “It is not clear, however, that the Bar Council’s argument is correct.” However, in dismissing the argument, he does not address the underlying company law, but merely lists the key points of his proposed regulatory framework.

Thus we are left with a proposal in which conflicts of duty for professional staff are structurally built into a new model for professional practice (legal disciplinary practice – LDP) with outside investors, so one must rely on regulation alone to ensure that corporate providers of law services behave in a “proper manner”.

When you regulate individuals, eg to maintain professional standards, you are half way there, because most of us want, more or less, to do the right thing but need guidance, and a few need to be stopped in their tracks. Regulating corporations is totally different. No matter how “good” an individual working for a corporation might be, the corporation itself knows nothing of good or bad, of public interest or doing what is right. Its directors’ duties are not to do what is right, unless it happens to be in the corporation’s (ie its shareholders’) interests. A regulator of a professional individuals has only to deal with the bad apples (hopefully a minority) and give guidance to the rest of us, but a regulator of a profession of corporations must deal with bodies, which are driven solely by their non-professional shareholders’ demand to maximise profits, and so must set procedures on the assumption that there is no intrinsic willingness to follow guidelines.

The consequently increased reliance of regulation alone carries two dangers, one being over-regulation and the other being that high grade crooks are smarter than regulators. If we are to have outside shareholders, we will also need a corporate structure, which, whilst not losing the profit motive, draws back from the excesses to which we are inevitably driven by Hutton v West Cork Railway and Dodge v Ford. The Company Law Reform Bill offers a possible answer to this in clause 156(2), which says: “Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, his duty is to act in the way he considers, in good faith, would be most likely to achieve those purposes.” This would enable a regulator to require that an LDP with non-lawyer investors and managers is incorporated with the purpose of (say) practicing law to the highest professional standards. If that would put too great a restriction on outside investors, one must assume that, where there is a conflict of interest, commercial pressure will be bound to outweigh professional standards.

It is a sad that in this debate we lawyers seem (with the exception of the Bar Council) to have by and large ignored a bit of law that we ought to know better. By all means let Tesco et al provide legal services, but not, please, as solicitors.

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