MY FAVOURITE CASE:Professor Blanaid Clarke, the newly appointed McCann FitzGerald chair of corporate law at Trinity College Dublin
What is your favourite case?
The 1883 case of Hutton v West Cork Railway Co. It’s still quoted a huge amount – if you pick up any company law book you’ll see a reference to it. It deals with several key corporate governance issues.
Essentially the UK Court of Appeal held that a payment of £2,550 to officers and directors of the West Cork Railway Co was invalid. At the time, the business had been sold and the company was being dissolved. The court said the payment wasn’t “reasonably incidental” – in other words substantially related – to the carrying on of the company’s business for “the company’s benefit”.
Lord Justice Bowen, who was famous for applying legal principles to business in a very pragmatic way, said: “The law doesn’t say that there are to be no cakes and ale, but that there are to be no cakes and ale except such as are required for the benefit of the company.”
That’s why this is such a famous case – Lord Justice Bowen ruled that you can look after your employees and other stakeholders, as long as it is to the benefit of the company.
He went on to explain what he meant, saying that it was acceptable for an employer to “send porters to have tea in the country” at the company’s expense. He then made the point, which gets to the nub of the corporate social responsibility debate today, that “a company which always treated its employees with draconian severity and never allowed them a single inch more than the strict letter of the bond would soon find itself deserted”.
That’s very, very clever and progressive.
Why is it your favourite case?
It’s very useful as a teaching tool. For example you can ask students if they think when Lord Justice Bowen referred to “cakes and ale”, he envisioned six city bankers spending £44,000 on Chateau Pétrus while dining out in London in the halcyon days, and whether that equates to heading off for “tea in the country”. When the judge talked about the payment of £2,550, do they think he contemplated a payment as large as Fred Goodwin’s £16 million pension?
People tend to have gut reactions to these things. If you ask students if it’s justifiable for a company to pay someone a salary of €1 million, they may initially say “absolutely not”.
But if you put it to them that this payment could be linked to the benefit of the company, for example it might increase performance by providing motivation or loyalty or allowing the company to attract a better candidate, they may take a different view as to whether or not it’s acceptable.
This case opens students’ minds to these sorts of questions and shows them that these issues aren’t black and white.
What I like about Lord Justice Bowen’s approach is that it gives you a criterion on which to base a decision. It’s not about being absolutely prescriptive, but instead asking what is the benefit to the company? It’s still a very good guiding principle.
Is this case still relevant today?
Very much so. Although the payment to the West Cork Railway Co-directors was ultimately held to be invalid, this was only because the company was being wound up and therefore there was no company to benefit from it.
However the most important part of the judgment is what it says in relation to a going concern situation: you can look after your employees as long as it benefits the company. Lord Justice Bowen doesn’t make a specific statement about who the beneficiaries are in this context, but it’s clear he’s incorporating a broad range of stakeholders, as opposed to just shareholders.
What we’ve learned from the financial crisis is the danger of pursuing a short-term profit-maximisation strategy, where actions are taken which lead to huge increases in earnings and a huge return for shareholders for a period of time. The problem is that this is not sustainable. In the case of financial institutions, this strategy jeopardised their stability. They didn’t consider the long-term benefit of the company, or they wouldn’t have engaged in these practices.
Chuck Prince, the former chief executive of Citigroup, said: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance.”
That’s exactly the opposite to Lord Justice Bowen’s company benefit principle. It was fine for Prince – he was paid a salary of $53 million over his four years – but his actions certainly didn’t benefit the company.
The great thing about this case is that Lord Justice Bowen’s judgment is consistent with a more modern view – that directors have to run the company not just for the shareholders, but for a broader group that extends to employees, customers and the community at large. That’s why it is still so significant today.