Other People's Money, and How the Bankers Use It

by Louis Dembitz Brandeis

NULLIFYING THE LAW

But this wholesome rule of business, so clearly laid down, was practically nullified by courts in creating two unfortunate limitations, as concessions doubtless to the supposed needs of commerce.

First: Courts held valid contracts between a corporation and a director, or between two corporations with a common director, where it was shown that in making the contract, the corporation was represented by independent directors and that the vote of the interested director was unnecessary to carry the motion and his presence was not needed to constitute a quorum.

Second: Courts held that even where a common director participated actively in the making of a contract between two corporations, the contract was not absolutely void, but voidable only at the election of the corporation.

The first limitation ignored the rule of law that a beneficiary is entitled to disinterested advice from all his trustees, and not merely from some; and that a trustee may violate his trust by inaction as well as by action. It ignored, also, the laws of human nature, in assuming that the influence of a director is confined to the act of voting. Every one knows that the most effective work is done before any vote is taken, subtly, and without provable participation. Every one should know that the denial of minority representation on boards of directors has resulted in the domination of most corporations by one or two men; and in practically banishing all criticism of the dominant power. And even where the board is not so dominated, there is too often that “harmonious coöperation” among directors which secures for each, in his own line, a due share of the corporation’s favors.

The second limitation—by which contracts, in the making of which the interested director participates actively, are held merely voidable instead of absolutely void—ignores the teachings of experience. To hold such contracts merely voidable has resulted practically in declaring them valid. It is the directors who control corporate action; and there is little reason to expect that any contract, entered into by a board with a fellow director, however unfair, would be subsequently avoided. Appeals from Philip drunk to Philip sober are not of frequent occurrence, nor very fruitful. But here we lack even an appealing party. Directors and the dominant stockholders would, of course, not appeal; and the minority stockholders have rarely the knowledge of facts which is essential to an effective appeal, whether it be made to the directors, to the whole body of stockholders, or to the courts. Besides, the financial burden and the risks incident to any attempt of individual stockholders to interfere with an existing management is ordinarily prohibitive. Proceedings to avoid contracts with directors are, therefore, seldom brought, except after a radical change in the membership of the board. And radical changes in a board’s membership are rare. Indeed the Pujo Committee reports:

“None of the witnesses (the leading American bankers testified) was able to name an instance in the history of the country in which the stockholders had succeeded in overthrowing an existing management in any large corporation. Nor does it appear that stockholders have ever even succeeded in so far as to secure the investigation of an existing management of a corporation to ascertain whether it has been well or honestly managed.”

Mr. Max Pam proposed in the April, 1913, Harvard Law Review, that the government come to the aid of minority stockholders. He urged that the president of every corporation be required to report annually to the stockholders, and to state and federal officials every contract made by the company in which any director is interested; that the Attorney-General of the United States or the State investigate the same and take proper proceedings to set all such contracts aside and recover any damages suffered; or without disaffirming the contracts to recover from the interested directors the profits derived therefrom. And to this end also, that State and National Bank Examiners, State Superintendents of Insurance, and the Interstate Commerce Commission be directed to examine the records of every bank, trust company, insurance company, railroad company and every other corporation engaged in interstate commerce. Mr. Pam’s views concerning interlocking directorates are entitled to careful study. As counsel prominently identified with the organization of trusts, he had for years full opportunity of weighing the advantages and disadvantages of “Big Business.” His conviction that the practice of interlocking directorates is a menace to the public and demands drastic legislation, is significant. And much can be said in support of the specific measure which he proposes. But to be effective, the remedy must be fundamental and comprehensive.