The beginnings of incorporation | Brian JM Quinn | May 26, 2014


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The beginnings of incorporation

Prior to the late 19th century, few states had general enabling laws with respect incorporations.  Incorporation was not a right, but rather a privilege granted by state governments on individual groups of promoters.  At that time,  the incorporation of a business required a legislative act by the state in which the corporation was to do its business.  As a consequence, there were few corporations in the US.  When legislatures granted incorporations, the majority of incorporations were limited to enterprises intended to engage in infrastructure development.  The earliest corporations in the US were corporations formed to develop canals, turnpikes and bridges.  It was not uncommon for state legislatures to grant monopoly rights to develop certain critical infrastructure.  It was also not uncommon for states to invest in these enterprises by way of a contribution of land for the use of the infrastructure corporation.  

By the early 20th century, general enabling laws, which granted everyone the right to incorporate, began to take hold in states across the country.  One of the motivations for the switch to general enabling laws was a backlash to the high degree of corruption in state legislatures.  Promoters seeking support for acts of incorporation often found that support the old-fashioned way - by means of a bribe.  By turning the power dynamic on its head and making the act of incorporation ministerial rather than discretionary, state legislatures were robbed of an important motivation for corruption. 

In his dissent in a 1933 case, Ligget v Lee (288, US 517), Justice Brandeis discussed the development of general enabling laws and the related concepts of "charter mongering" (or, competition amongst the states for incorporations in the period following adoption of the general enabling laws):

The prevalence of the corporation in America has led men of this generation to act, at times, as if the privilege of doing business in corporate form were inherent in the citizen; and has led them to accept the evils attendant upon the free and unrestricted use of the corporate mechanism as if these evils were the inescapable price of civilized life and, hence, to be borne with resignation. Throughout the greater part of our history a different view prevailed. Although the value of this instrumentality in commerce and industry was fully recognized, incorporation for business was commonly denied long after it had been freely granted for religious, educational and charitable purposes. It was denied because of fear. Fear of encroachment upon the liberties and opportunities of the individual. Fear of the subjection of labor to capital. Fear of monopoly. Fear that the absorption of capital by corporations, and their perpetual life, might bring evils similar to those which attended mortmain. There was a sense of some insidious menace inherent in large aggregations of capital, particularly when held by corporations. So, at first, the corporate privilege was granted sparingly; and only when the grant seemed necessary in order to procure for the community some specific benefit otherwise unattainable. The later enactment of general incorporation laws does not signify that the apprehension of corporate domination had been overcome. The desire for business expansion created an irresistible demand for more charters; and it was believed that under general laws embodying safeguards of universal application the scandals and favoritism incident to special incorporation could be avoided. The general laws, which long embodied severe restrictions upon size and upon the scope of corporate activity, were, in part, an expression of the desire for equality of opportunity.

(a) Limitation upon the amount of the authorized capital of business corporations was long universal. The maximum limit frequently varied with the kinds of business to be carried on, being dependent apparently upon the supposed requirements of the efficient unit. Although the statutory limits were changed from time to time this principle of limitation was long retained. Thus in New York the limit was at first $100,000 for some businesses and as little as $50,000 for others. Until 1881 the maximum for business corporations in New York was $2,000,000; and until 1890, $5,000,000. In Massachusetts the limit was at first $200,000 for some businesses and as little as $5,000 for others. Until 1871 the maximum for mechanical and manufacturing corporations was $500,000; and until 1899, $1,000,000. The limit of $100,000 was retained for some businesses until 1903.

In many other states, including the leading ones in some industries, the removal of the limitations upon size was more recent. Pennsylvania did not remove the limits until 1905. Its first general act not having contained a maximum limit that of $500,000 was soon imposed. Later, it was raised to $1,000,000; and, for iron and steel companies, to $5,000,000. Vermont limited the maximum to $1,000,000 until 1911 when no amount over $10,000,000 was authorized if, in the opinion of a judge of the supreme court, such a capitalization would tend "to create a monopoly or result in restraining competition in trade." Maryland limited until 1918 the capital of mining companies to $3,000,000; and prohibited them from holding more than 500 acres of land (except in Allegany County, where 1,000 acres was allowed). New Hampshire did not remove the maximum limit until 1919. It had been $1,000,000 until 1907, when it was increased to $5,000,000. Michigan did not remove the maximum limit until 1921. The maximum, at first $100,000, had been gradually increased until in 1903 it became $10,000,000 for some corporations and $25,000,000 for others; and in 1917 became $50,000,000. Indiana did not remove until 1921 the maximum limit of $2,000,000 for petroleum and natural gas corporations. Missouri did not remove its maximum limit until 1927. Texas still has such a limit for certain corporations.

(b) Limitations upon the scope of a business corporation's powers and activity were also long universal. At first, corporations could be formed under the general laws only for a limited number of purposes — usually those which required a relatively large fixed capital, like transportation, banking, and insurance, and mechanical, mining, and manufacturing enterprises. Permission to incorporate for "any lawful purpose" was not common until 1875; and until that time the duration of corporate franchises was generally limited to a period of 20, 30, or 50 years. All, or a majority, of the incorporators or directors, or both, were required to be residents of the incorporating state. The powers which the corporation might exercise in carrying out its purposes were sparingly conferred and strictly construed. Severe limitations were imposed on the amount of indebtedness, bonded or otherwise. The power to hold stock in other corporations was not conferred or implied.The holding company was impossible.

(c) The removal by the leading industrial States of the limitations upon the size and powers of business corporations appears to have been due, not to their conviction that maintenance of the restrictions was undesirable in itself, but to the conviction that it was futile to insist upon them; because local restriction would be circumvented by foreign incorporation. Indeed, local restriction seemed worse than futile. Lesser States, eager for the revenue derived from the traffic in charters, had removed safeguards from their own incorporation laws. Companies were early formed to provide charters for corporations in states where the cost was lowest and the laws least restrictive. The states joined in advertising their wares.The race was one not of diligence but of laxity. Incorporation under such laws was possible; and the great industrial States yielded in order not to lose wholly the prospect of the revenue and the control incident to domestic incorporation.

The history of the changes made by New York is illustrative. The New York revision of 1890, which eliminated the maximum limitation on authorized capital, and permitted intercorporate stockholding in a limited class of cases, was passed after a migration of incorporation from New York, attracted by the more liberal incorporation laws of New Jersey. But the changes made by New York in 1890 were not sufficient to stem the tide. In 1892, the Governor of New York approved a special charter for the General Electric Company, modelled upon the New Jersey Act, on the ground that otherwise the enterprise would secure a New Jersey charter. Later in the same year the New York corporation law was again revised, allowing the holding of stock in other corporations. But the New Jersey law still continued to be more attractive to incorporators. By specifically providing that corporations might be formed in New Jersey to do all their business elsewhere, the state made its policy unmistakably clear. Of the seven largest trusts existing in 1904, with an aggregate capitalization of over two and a half billion dollars, all were organized under New Jersey law; and three of these were formed in 1899. During the first seven months of that year, 1336 corporations were organized under the laws of New Jersey, with an aggregate authorized capital of over two billion dollars. The Comptroller of New York, in his annual report for 1899, complained that "our tax list reflects little of the great wave of organization that has swept over the country during the past year and to which this state contributed more capital than any other state in the Union." "It is time," he declared, "that great corporations having their actual headquarters in this State and a nominal office elsewhere, doing nearly all of their business within our borders, should be brought within the jurisdiction of this State not only as to matters of taxation but in respect to other and equally important affairs." In 1901 the New York corporation law was again revised.

The history in other states was similar. Thus, the Massachusetts revision of 1903 was precipitated by the fact that "the possibilities of incorporation in other states have become well known, and have been availed of to the detriment of this Commonwealth."

… Able, discerning scholars have pictured for us the economic and social results of thus removing all limitations upon the size and activities of business corporations and of vesting in their managers vast powers once exercised by stockholders — results not designed by the States and long unsuspected. They show that size alone gives to giant corporations a social significance not attached ordinarily to smaller units of private enterprise. Through size, corporations, once merely an efficient tool employed by individuals in the conduct of private business, have become an institution — an institution which has brought such concentration of economic power that so-called private corporations are sometimes able to dominate the State. The typical business corporation of the last century, owned by a small group of individuals, managed by their owners, and limited in size by their personal wealth, is being supplanted by huge concerns in which the lives of tens or hundreds of thousands of employees and the property of tens or hundreds of thousands of investors are subjected, through the corporate mechanism, to the control of a few men. Ownership has been separated from control; and this separation has removed many of the checks which formerly operated to curb the misuse of wealth and power. And as ownership of the shares is becoming continually more dispersed, the power which formerly accompanied ownership is becoming increasingly concentrated in the hands of a few. The changes thereby wrought in the lives of the workers, of the owners and of the general public, are so fundamental and far-reaching as to lead these scholars to compare the evolving "corporate system" with the feudal system; and to lead other men of insight and experience to assert that this "master institution of civilised life" is committing it to the rule of a plutocracy.


Questions for discussion

 1. Justice Brandeis observed that recently some had come to believe that the "privilege of doing business in the corporate form were inherent in the citizen." Should the people have the "right to incorporate" or should incorporation remain a "privilege?"

2. Why might a state engage in "charter mongering", otherwise known as the "race to the bottom?"



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May 31, 2016

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