Limited
liability on trial: the commercial crisis of 1866 and its
aftermath
James Taylor,
(jct1@ukc.ac.uk)
Supervisor: Professor Hugh Cunningham
On
This paper
explores reactions to the crisis, focusing on how the crisis affected attitudes
to the recently introduced principle of limited liability. This was a potential
turning point in the history of company law in
I
The immediate
background to the crisis of 1866 was a promotion boom beginning in 1863. This
was facilitated by Acts of 1856, 1858, and 1862, which extended limited
liability to all companies of seven or more members on simple registration.[3]
In 1862, 500 new limited companies were registered in
Parliament, however, was slow to react. It was not until March 1867 that a group of Liberal MPs, led by the prominent railway director Edward Watkin, moved for a select committee on the operation of the Limited Liability Acts. They painted a gloomy picture of the state of the corporate economy. 266 companies were currently in liquidation, and the shares of most of the rest were at a discount.[5] This was, they argued, a suitable time for the House to ‘carefully review a law containing so much that was novel and experimental.’[6] Parliament was obliged to investigate the causes of the crisis, as it had affected ‘classes which before had never been known to be much connected with joint-stock enterprises…farmers, tradesmen, domestic servants, peers, and peasants’.[7] Now was the time to review and amend the law ‘before the transactions in connection with it became so large that it would be almost beyond the power of Parliament to deal with it.’[8]
What is perhaps most remarkable about this intervention was not the criticisms of limited liability, but the moderate tone in which these criticisms were made, and the limited scope of the proposed reforms. Watkin stressed that the system was ‘founded on a principle essentially sound’,[9] and that ‘the evil approached with boldness might with ease be removed’.[10] Indeed, the Conservative Government would not countenance any reform which challenged the foundations of the legal regime established in the 1850s. Sir Stafford Northcote, President of the Board of Trade, assented to a select committee, but in doing so he was ‘anxious to have it understood distinctly that…we do not intend to impugn in any way the principle of limited liability’, which he thought had been made to bear more of the burden of blame than was just.[11]
II
However, more critical views were aired before the Committee, which met through spring 1867. The share market was still in deep depression, and showed little sign of recovery. The number of company promotions had fallen considerably.[12] The Committee heard the views of seventeen witnesses, mostly City figures, each of whom had his own diagnosis of the crisis, and his own solutions to the problems facing the corporate economy. These solutions can be categorised as follows.
First were voluntary measures intended to facilitate companies’ efforts to make themselves more attractive investment outlets. The crisis had revealed that despite the Acts of 1856-62, shareholders could still find themselves facing de facto unlimited liability from the large uncalled margin on the shares they held. To rectify this, it was proposed to allow companies to reduce both the denomination of their shares, and their total capital.
Second were restrictive measures to increase the stability of companies in the interests of shareholders and creditors. These included limiting the borrowing powers of companies, requiring that a fixed percentage of shares be paid up, and preventing companies from dealing in their own shares, to make rigging the market more difficult.
Third came proposals to make directors more responsible and to bring the interests of directors and shareholders closer together. Several witnesses doubted that directors should continue to enjoy limited liability, and proposed that en commandite, the French system of directorial unlimited liability be introduced. It was also suggested that directors be obliged to take shares in their companies, and that they be made personally liable for acting ultra vires.
Fourth were proposals to protect the public by restricting access to limited liability. This would be achieved by empowering the Joint-Stock Companies’ Registrar to refuse those applications for incorporation that he judged not to be in the public interest.
Most witnesses supported the measures in the first category. The other proposals were more controversial, especially the third and fourth, as these challenged the system of general limited liability established a decade earlier. But they did attract significant levels of support. Charles Wordsworth QC, author of manuals on company law, was in no doubt of the need to make directors more responsible for their actions. He argued that, unlike the paid agents of private individuals, they could not be adequately superintended: ‘there is not, and cannot be, any effective control or check which the members can exercise over the directors’.[13]
Swinton Boult, a prominent insurer, wanted to make incorporation dependent on a preliminary inquiry into the feasibility of the scheme proposed, in order to protect the public. He held that only legitimate enterprises should be registered:
a great many objects for which companies are formed now, are not at all fit objects for companies to undertake, and would not be undertaken with a bona fide intention, and…those are the very companies which lead unsuspecting people, and people of small means, and ignorant people, into trouble…[14]
Reforms of an interventionist nature also received support from six other witnesses including George Curzon, the Company Registrar and Lord Romilly, the Master of the Rolls. But the dominant voices on the Committee, particularly the Liberal triumvirate of William Forster, George Goschen, and Robert Lowe, the architect of the 1856 Act, made their aversion to such reforms quite clear. Forster told Romilly that his proposals to increase the liability of directors were ‘an interference with the freedom of trade’.[15] Lowe insisted that efforts to make the Registrar stronger would ‘put to sleep all private vigilance’,[16] and thought it best ‘to do all we can to inculcate in people that they had better trust to themselves than to others in these matters’.[17]
In this way, the virtues of self-reliance were invoked in defence of the recently constructed edifice of company law. Individualist ideology, for so long hostile to collective joint-stock enterprise, was now employed to justify it. There was no sense in erecting more safeguards against fraud and deception, it was claimed, because shareholders did not make use of the facilities already provided for their benefit. More than one witness compared investors to sheep,[18] while William Newmarch, the financier and banker, stated that
If a person is foolish enough to take shares in a concern about which he knows nothing, and about the directors of which he knows nothing, he must take the consequences.[19]
As a result, the report advocated only the uncontroversial voluntary measures of capital reduction which, it was believed, would restore confidence in joint-stock enterprise and, by reducing the uncalled margins on company shares, would make liability more genuinely limited. Those who thought limited liability itself had exacerbated the crisis, and called for the principle to be moderated, were ignored.
The significance of what
was included in, and what was excluded from, the Committee’s report did not
escape Walter Bagehot:
The doctrine of limited
liability was extremely unpopular…But the committee declined…to…impair the
principle. Many most plausible proposals were pressed upon them, but they said,
‘Let people make what contracts they like; if they choose to take shares in bad
companies, let them take such shares; if others choose to trust such companies,
let them trust them’.
Bagehot realised that limited liability had done more than weather the challenge posed to it by the events of 1866, it had emerged stronger and more entrenched than ever. The Committee ‘was asked to confine limited liability; it has extended and completed it’.[20]
The limited liability question boiled down to a disagreement between those who blamed the severity of the crisis on the fact that liability was too limited, and those who blamed the fact that liability was not limited enough. The Committee members subscribed to the latter theory, and wanted to allow companies to make their shares fully limited. The Conservative Government followed this line and framed a Bill closely based on the Committee’s report which passed both Houses with a minimum of debate. The priorities of both the Liberal and Conservative parties were to stabilise, restore confidence in, and support, joint-stock enterprise, rather than reform it in any significant way.
III
Limited liability companies had acquired a particularly poor public image. The Conservative weekly Judy punned:
From the public’s experience of the Court of Bankruptcy for the last twelve months, it is suggested that in future limited liability companies be designated as Unlimited Lie-Ability Companies.[23]
These were
not unfounded prejudices. 36 per cent of the companies formed between 1856 and
1865 ceased to exist within just five years of their promotion.[24]
Company fraud left a huge impression on the public, and figures who had engaged in dubious practices, such as the
Liberal MP Sir Samuel Morton Peto, contractor of the
Let us have no ex post facto laws, but let it be understood that the Directors of the next Assurance Company that collapses shall be hanged. The process can do no harm, and may do much good.[25]
Punch’s rival, Fun, developed the idea in a poem entitled ‘The Perfect Cure’, written by ‘a sufferer’. The refrain, ‘Let’s Hang a Director’ summed up the frustration felt by beleaguered victims of corporate bad behaviour.[26]
IV
Yet directors were not hanged, nor was the public’s concern with over-mighty boards and fraudulent promoters translated into a tightening up of company law. Rather than a concerted campaign for a change in the law, there was a more diffuse spirit of cynicism and disillusion with joint-stock enterprise, and an assumption of the inevitability of fraud and corruption. This was largely because most of those voicing criticisms of the system shared some of the basic assumptions of its most extreme supporters.
The Select Committee of 1867 had believed that caveat emptor should regulate all joint-stock transactions: that the defrauded had only themselves to blame, and that it was worse than useless to try to impose any central control on promoters and directors. All that was required was the reform of personal behaviour, for if no one invested in fraudulent companies, they would die out. The satirical magazines shared these assumptions and were quick to censure investors who lost their money in fraudulent schemes due to their gullibility and greed. Speculation was frequently likened to alcoholism or crime, ills that could admit only of a personal solution: the temptation would always be present, and it was up to the individual to resist.[27]
The press was hopeful that after the experience of 1866, the public was learning to refrain from dabbling in the Stock Exchange, and was sticking to honest labour and safe investment. Judy carried ‘The Railway Shareholder’s Dirge’, which ends with a chastened investor vowing never to trust directors again:
And by Three per Cents abiding