A Trans-Atlantic Doctrinal Orientation Made Concrete: Ohio’s First 'Modern' Business Corporation Act (1927)

Abstract

Ohio’s corporation laws were suboptimal in the 1920s. The statutory framework was jerry-built, legislators reacting in haste to address the latest corporate scandal or controversy, with no doctrinal foundation other than a residual (if receding) animosity to corporations, corporations being associated with special privileges and monopoly. Yet the state’s economy in the Second Industrial Revolution was robust and Ohio c. 1920 was politically ascendant (both major parties nominating Ohioans as their presidential standardbearers).

Ohio’s early twentieth-century corporate law reformers believed the task at hand was not to enter into a “race” to attract corporate charters - - they were adamant about the dangers of “chartermongering” - - but to allow Ohio-based business persons active in the state’s robust economy to use a flexible, enabling set of corporate statutes to arrange the legal aspects of their enterprises, rather than chartering in some other jurisdiction. If Ohio was competing with Delaware and other “charter mongering” states, it was a defensive competition. The reformers’ intention was to have a state other than Ohio be the state “whose corporation laws are [most] unpopular with business interests.”

In 1926, after years of calls for corporation law reform, the Ohio State Bar Association appointed a special committee to effect reform. That five person special committee was comprised of prominent corporate practitioners from around the state, two of whom had written treatises on Ohio corporation law and one of whom had been Chief Justice of the Ohio Supreme Court. Two prominent academic legal experts were engaged as consultants to the special committee, Professor Robert Stevens of Cornell Law School, principal draftsperson to the Uniform Business Corporation Act, and A.A. Berle, Jr., at that time a corporate finance practitioner in New York’s innovative financial markets and sometime Harvard Business School adjunct professor who was also a prolific author in legal academic and other journals. Harvard’s William Z. Ripley, of Wall Street and Main Street fame, also assisted the special committee.

The special committee anchored their Ohio General Corporation Act of 1927 (the “1927 act”) in a contractarian theory of the corporation. At this point in their respective careers, Stevens and Berle were contractarians. While the special committee borrowed from the corporation laws of several American jurisdictions, particularly New York, Florida and Maryland, in crafting the 1927 act, its most significant and, to the legal historian, striking doctrinal borrowings were from the English Companies Act. Reflecting a trans-Atlantic doctrinal orientation, the special committee expressly modelled the 1927 act on the then-effective English Companies Act. As a result, “private ordering” of the sort then permitted under English company law was to be made available to Ohio businesspersons, entrepreneurs and their legal advisors.

Private companies - - companies that had forgone the power to offer securities to the general public - - were the clear majority of companies being formed in the 1920s under the English Companies Act. American scholars had noted the essential similarity of the English private company and the American “close corporation.” The special committee intended in the 1927 act to provide the entrepreneurs behind Ohio’s small and medium sized enterprises (which far outnumbered publicly-listed Ohio corporations) with the “private ordering” flexibility with respect to their “close corporations” that English entrepreneurs enjoyed with respect to their private companies.

The 1927 act’s contractarian foundation is evident in the act’s statutory treatment of the ultra vires doctrine, a treatment that closely followed Professor Stevens’ Uniform Business Corporation Act treatment. “Private ordering” was available under the 1927 act, not only for governance matters (what the special committee referred to as the corporation’s “indoor management”) but also in corporate finance matters, with entrepreneurs and their legal advisors given nearly free reign in terms of securities design.

Unlike Professor Stevens’ contemporaneous Uniform Business Corporation Act, the 1927 act ultimately did not codify what is now referred to as the “duty of care.” The decision not to codify was deliberate, not an oversight. By the 1920s, Ohio law had settled, in this context, on a standard of conduct that Professor Kershaw terms “situation-adjusted ordinary care.” When the “duty of care” was implicated in 1927 act provisions, the special committee was quite protective of directors. The special committee was aware of the multitude of plaintiff stockholder lawsuits in Ohio alleging corporate mismanagement, particularly in the context of the declaration of illegal dividends. It sought to address the issue of a director’s statutory liability for negligence in the declaration of dividends by first reconciling the applicable legal requirements to then-contemporary accounting standards and then providing directors a defense (similar to that available under English company law) to statutory negligence claims based upon reliance on accountant-prepared financial reports and statements or similar reports and statements certified by corporate officers.

What is now referred to as the directors’ “duty of loyalty” was also left uncodified in the 1927 act. There were several strands in the Ohio law of director self-dealing. Transactions authorized by boards without a quorum of disinterested directors were invalidated under Ohio law, subject to the right of the interested director(s) to seek compensation from the corporation in quantum meruit. Other conflict of interest transactions involving directors and their corporations, such as “common director” transactions, were subjected to close judicial scrutiny, but were upheld on a showing that the transaction was fair to the corporation (or invalidated on a showing of unfairness). There was, in Ohio, no movement in the law of director conflicts of interest from strict invalidation to fairness analysis of the sort recounted in Professor Marsh’s “self-dealing narrative,” a narrative falsified by Professor Kershaw.

Immediately after its enactment, the 1927 act was acclaimed as an important legislative achievement “representative as it was of much of the nation’s best thought in matters corporate.” A number of jurisdictions incorporated concepts from the Ohio code into their own laws. But the period that began with the Great Depression dampened enthusiasm for Ohio’s contractarian and “private ordering” corporate model. Federal courts issued high-profile decisions (opinions still cited today) on corporate governance matters, especially in the bankruptcy and securities laws contexts, displacing or at least eclipsing state corporate law. At the state level, the Illinois corporation act of 1933 did not follow Ohio, having many more mandatory provisions and ultimately becoming the backbone of the Model Business Corporation Act of 1950.

The 1927 act doctrinal framework remained intact in Ohio through the 1960s, when concepts from Delaware’s corporate code (such as Delaware’s 1967 indemnification statute) and, more important, the Model Business Corporation Act, began to be incorporated into the Ohio statutes. The contractarian, pro-”private ordering” structure of the 1927 act has been further obscured by the repeated legislative enactments (especially the 1986 reforms) intended to protect Ohio public companies against takeovers and Ohio public company directors from liability claims for actions taken to defend against takeovers and also by the development of a judge-made jurisprudence applicable only to closely held corporations.

In an important sense, the 1927 act anticipates the contract-based "private ordering" that is the most distinctive feature of contemporary corporate law and alternative business entity practice. While the 1927 act was not well "marketed" as a legal product to lawyers or business persons in other jurisdictions, and hence has become virtually unknown outside Ohio, such "marketing" was never the intent of the special committee that authored the legislation. Its more modest intention, one formed after a long and informed trans-Atlantic review of English precedent and practice, was to enable Ohio businesspersons, entrepreneurs and their legal advisors to "private order" a corporate framework suited to their particularized business needs.