Trust Law Essays

Trust Law Essays-69
The trust’s success in wielding corporation-like powers suggests that the corporation’s role in legal history was smaller than—or at least different from—the one we have long assigned to it. In any case, Lord Chancellor Nottingham began fully protecting all forms of trust property from a trustee’s unsecured creditors in the late seventeenth century. The litigation that followed is a rich source of information about what the trust accomplished in structuring the company’s legal affairs. Let us first consider entity shielding and its close cousin, capital lock-in. This Essay thus lays the groundwork for a new account of the corporate form and its place in the development of modern business. I am grateful to many students for exceptional research assistance, including Jesse Boretsky, Jacob Gutwillig, Adam Hofri, Tanya Kapoor, Hilary Ledwell, Rory Minnis, Jevon Potts, Cobus Van der Ven, and Bernice Yu. Before we can understand what exactly the water company case and others like it teach us, it will be useful to walk through the chronology of the trust’s appearance in business over time. These are perhaps the most fundamental features of organizational law. I argue that the corporate form was not, as we have often been told, the exclusive historical source of the legal powers that enabled modern business. The trust also has a history in other common law jurisdictions outside the United States, such as Australia, Canada, and Scotland. Duxbury, Business Trusts and Blue Sky Laws, 8 Minn. See Henry Hansmann & Reinier Kraakman, The Essential Role of Organizational Law, 110 Yale L. 387, 393–98 (2000) (identifying the phenomenon that later would become known as “entity shielding”).

The trust’s success in wielding corporation-like powers suggests that the corporation’s role in legal history was smaller than—or at least different from—the one we have long assigned to it. In any case, Lord Chancellor Nottingham began fully protecting all forms of trust property from a trustee’s unsecured creditors in the late seventeenth century. The litigation that followed is a rich source of information about what the trust accomplished in structuring the company’s legal affairs. Let us first consider entity shielding and its close cousin, capital lock-in. This Essay thus lays the groundwork for a new account of the corporate form and its place in the development of modern business. I am grateful to many students for exceptional research assistance, including Jesse Boretsky, Jacob Gutwillig, Adam Hofri, Tanya Kapoor, Hilary Ledwell, Rory Minnis, Jevon Potts, Cobus Van der Ven, and Bernice Yu. Before we can understand what exactly the water company case and others like it teach us, it will be useful to walk through the chronology of the trust’s appearance in business over time. These are perhaps the most fundamental features of organizational law. I argue that the corporate form was not, as we have often been told, the exclusive historical source of the legal powers that enabled modern business. The trust also has a history in other common law jurisdictions outside the United States, such as Australia, Canada, and Scotland. Duxbury, Business Trusts and Blue Sky Laws, 8 Minn. See Henry Hansmann & Reinier Kraakman, The Essential Role of Organizational Law, 110 Yale L. 387, 393–98 (2000) (identifying the phenomenon that later would become known as “entity shielding”).

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In the earliest kind of trust—which was originally called a “use” For simplicity, I generally avoid archaic terms in favor of their modern counterparts. The trustee would then hold the property on the original owner’s behalf, with the understanding that at some future date, the trustee would convey the property back to the original owner or his wife, children, or others as the original owner instructed. at 136; Geoffrey Gilbert, The Law of Uses and Trusts 72–73 (London, E. Titling property in the name of a trustee raised the prospect that the trustee and his creditors might take the property for themselves. The Chancellor’s innovations consisted of three key doctrines that helped to control misconduct by trustees. Together, these innovations enabled a trustee to play the same basic role as a corporation. 299 (1931); Comment, The Doctrine of Merger as Applied to Commercial Trusts, 29 Yale L. 97 (1919); Comment, Massachusetts Trusts, supra note 146; Comment, Massachusetts Trusts and the Income Tax, 28 Yale L. 690 (1919); Comment, The Nature of Massachusetts Business Trusts, 27 Yale L. 677 (1918); Note, Taxation of Business Trusts, 42 Yale L. Dunn, Trusts for Business Purposes (1922); Robert Gardner Mc Clung, Representative Massachusetts Trusts (1912); Wilber A. Thompson, Business Trusts as Substitutes for Business Corporations (1920) [hereinafter Thompson, Business Trusts]; Edward H. In the first half of the nineteenth century, partnership treatise writers uniformly agreed that although the default rules of partnership allowed a partner to withdraw his capital and dissolve the partnership at any time, this rule could easily be changed by agreement. or felony, to qualify the causes of its dissolution. continue[] beyond the legal period of dissolution, in the hands of his children or representatives.” Niel Gow took a similar position in his treatise, arguing that even “[i]n the absence of an express [contract], there may be an implied, contract, as to the time for which a partnership shall endure . Joseph Story, Commentaries on Equity Pleadings § 132 (Bos., Charles C. 1840) [hereinafter Story, Equity Pleadings] (describing partnership dissolution as an exception to the general principle that partners did not all have to be joined where they were too numerous). It thus appeared, for all intents and purposes, that unincorporated companies were able to lock in their capital as effectively as incorporated companies. The form of limited liability the trust offered varied throughout history and was not always exactly like the limited liability we now know in modern corporations.

Before the trust appeared in large, corporation-like business companies, it had a long and varied career as a device for conveying real property. Later on, the term “cestui que use” would come to refer to beneficiaries. For descriptions of the trust as a device for avoiding the feudal incidents, see id. Giving land to a trustee was not without risks, however. With the Chancellor’s enforcement, the arrangements between landowners and their trustees ceased to be mere contracts and became instead the formalized, property-like arrangements that we now know as trusts. Rommel, Tax Liability of Business Trusts: See, e.g., William C. The only cases involving a company organized as a trust between 17 were Lynch v. The clearest evidence comes from the earliest treatises on partnership. ; and where that is the case, the partnership cannot be destroyed by the act of the party until the contemplated period arrives.” Andrew Bisset, A Practical Treatise on the Law of Partnership 55 (Harrisburg, Pa., I. As we will see below, the requirement that every shareholder be joined was unique to dissolution proceedings—in most other proceedings the joinder of every one of a business trust’s stockholders was not required. was thus to recognize dissolution as a unique problem and to make capital difficult to withdraw.

Throughout modern history, the common law trust frequently allowed businesses to obtain many of the same doctrinal advantages as then-existing versions of the corporate form, including limited liability, entity shielding, capital lock-in, tradable shares, legal personhood in litigation, and a sensible scheme of fiduciary powers. That it remained popular afterward is more surprising. See Hansmann et al., Rise of the Firm, supra note 25, at 1336.

And the trust offered these features in a format that was cheaper and easier to access than the corporation. The first entities to be used in big businesses were corporations. Entity shielding stops the owners and creditors of a business from taking the assets of the business away before the assets have had a chance to perform their intended purpose and produce an investment return.

When the United Kingdom passed its first general incorporation statute in 1844, for example, trusts outnumbered corporations in the United Kingdom by a ratio of more than ten to one. The sale of these monopoly rights naturally upset the would-be competitors of the chartered businesses, and after Parliament expelled James II in the Glorious Revolution of 1688, Parliament itself became the primary source of incorporation for English businesses. Originally chartered as an overseas trading company, the South Sea Company moved into a complicated financial business of creating a market for government-issued debt. The concept known as “capital lock-in” is an application of this principle of entity shielding. Lady Shrewsbury (1632) 118 Selden Society 636 (Ex Ct) 636 (2001) (same); Scott, Law of Trusts, supra note 41, § 132 n.5 (citing Earl of Worcester v. In a series of statutes passed in 1377, Parliament created what we now know as the law of fraudulent transfers by prohibiting a person from giving his property to a friend or trustee in order to avoid his creditors. .” These statutes were only a partial solution, however. The statute’s effect was classically summarized in Forth v. Although a trust had never been a legal entity, the doctrines of Chancery, as modified by the various statutes, ensured that the assets that legally belonged to a trustee were shielded from a beneficiary’s creditors almost as though they belonged to a distinct entity.

The rest of these companies all preferred to remain as trusts. Until 1844, Parliament had a rather cumbersome method for incorporating a business: It passed a special act of incorporation for each company it formed. Parliament and the South Sea Company perceived in the new unincorporated companies a source of competition for capital as well as a threat to the investing public, and so they worked together to pass the so-called Bubble Act of 1720. 139, 176 (1924) (noting the “business trust had [not] confined its operations to the oil business” but instead had “invaded the field of most of our business”). Aaron, The Massachusetts Trust as Distinguished from Partnership, 12 Ill. Capital lock-in allows a business to restrict its owners, as well as the owners’ creditors, from taking away the business’s property. A substantial amount of case law suggests equitable interests were not assignable. The 1571 statute, for example, prohibited a transfer for the purpose of avoiding creditors notwithstanding “[a]ny Pretence, Color, fayned consideration expressing of Use [i.e., trust] or any other Matter or Thyng to the contrary . They allowed a creditor to seize an interest only in a fraudulent trust, not in a legitimate trust. Much as the creditors of a modern corporate shareholder can seize a shareholder’s shares but not the property that legally belongs to the corporation, likewise a trust beneficiary’s creditors could seize the beneficiary’s equitable interest but not the property that legally belonged to the trustee. Before examining the details of trust law doctrine, it is first useful to understand how the trust initially emerged and how it worked in the organization of a business. Since the tax only applied to land that a man owned in his own name at death, the tax did not apply if the land legally belonged to a trustee, rather than to the deceased. The trust thus became a fixture of late-medieval England. Turner, The Equity of Redemption: Its Nature, History and Connection with Equitable Estates Generally 43–46 (1931). This claim is based on extensive digital searching of the English reports. By the early nineteenth century, the evidence that unincorporated companies could lock in their capital becomes more direct. but in fact the doctrine behind it served an important practical purpose: It locked in a company’s capital. Parts I and II of this Essay begin by showing how the trust worked in business and by demonstrating that the trust remained persistently popular in business even after the passage of general incorporation statutes. It turns to previously unexamined primary legal sources such as case reports and legal treatises to show that for much of modern history, the trust offered each of the key legal features that we now associate with the modern corporate form, including entity shielding and capital lock-in, limited liability, legal personhood in litigation, and a sensible scheme of fiduciary powers. The trust helped a landowner avoid the feudal incidents by allowing him to manipulate the way the law applied. The reason the phenomenon is somewhat difficult to see in early joint-stock companies is that very few unincorporated joint-stock companies appeared in the Court of Chancery during the eighteenth century, presumably because of the incompleteness of Chancery reporting. They find that the vast majority of trust-based companies declared in their deeds of settlement that they would exist indefinitely. Little & James Brown 1841) [hereinafter Story, Commentaries on the Law of Partnership] (“[A] partnership may expire by the mere efflux of the time, which limits and bounds its duration under the terms of the original contract, by which it is created.”). See 3 James Kent, Commentaries on American Law 26 (N. This Essay challenges a central narrative in the history of Anglo-American business by questioning the importance of the corporate form. As Professors Henry Hansmann and Ugo Mattei have shown, this was an extraordinary innovation because it limited the rights of a trustee’s creditors even if the creditors had not personally agreed to the limitations. Today, an unsecured creditor can seize any property—real or personal—of a debtor as long as the property is not already committed to a security interest. Since no one could take real property from a trustee unless the trustee specifically pledged it, there was no point in cutting off the claims of creditors who had no pledge. The historiographical value of is nevertheless enormous because it appears to be the first reported case ever to have involved a business company organized as a trust, and the judges who resolved the case were forced to address a number of key issues about the basic features of the company. The trust, of course, existed in a larger context of laws beyond judicial doctrine that included statutes and legislative acts. Thus, while the trustees faced personal liability, the shareholders lost nothing, allowing them the de facto equivalent of limited liability. The Essay shows that the corporate form was not, as we have long believed, the exclusive historical source of powers such as limited liability, entity shielding, tradable shares, and legal personhood in litigation. It was enough simply to have a rule that protected property from the secured creditors who had received the pledges. The reports of the case tell us about a company that came into being when the City of London agreed to lease a supply of water to an entrepreneur named Thomas Houghton. Rottschaefer, Massachusetts Trust Under Federal Tax Law, 25 Colum. Sometimes these statutes—such as the Bubble Act and the Registration Act of 1844 in England—intervened to make the trust less appealing than it otherwise might have been. Eventually, however, the trust would lose this feature before partially regaining it again in the early twentieth century. These powers were also available throughout modern history through a little-studied, but enormously important, device known as the common law trust. This rule was already implicit in the remedies against a trustee’s transferees and pledgees that the Chancery began enforcing in the mid-1400s. The people who bought the shares were technically beneficiaries of the trust, but as a practical matter, they resembled stockholders of a modern corporation, with the trustees holding the property of the firm much as a corporation might hold the property of a firm. The trust’s achievements in legal doctrine are nevertheless important because they challenge the notion that the corporation was the exclusive source of key doctrinal technologies. In the early nineteenth century, courts began treating joint-stock-company trusts as though they were partnerships for purposes of limited liability. The trust was widely and very effectively used to hold the property of unincorporated partnerships and associations in England and the United States both long before and long after the passage of general incorporation statutes in the mid-nineteenth century. See supra notes 40–41 and accompanying text (discussing the use of specific performance and property recovery as remedies). The reports of the judges’ opinions do not say exactly how many members of the public ultimately purchased these 900 shares, but the reports do say that the shareholders were numerous—so numerous, in fact, that bringing all of those shareholders before the court would have been “impossible” Houghton was the moving force behind the enterprise, and he planned to use the proceeds of the stock offering to reimburse himself for the cost of purchasing the lease and then to make the improvements that the lease required. When the city’s contractor finally finished work on the pipe, the pipe turned out to be defective, carrying only six tons of water per hour, instead of the nineteen tons the city had originally promised. Powell, The Passing of the Corporation in Business, 2 Minn. The enormous power of the trust in judicial doctrine suggests that although the corporation may have had certain advantages, these advantages did not lie in the technical doctrinal features that scholars of corporation law have tended to focus upon. English case reports from judicial opinions in the first half of the nineteenth century thus show trustees holding the property of docks, See In re The Vale of Neath & S. The privileges of incorporation were given out one by one to a single business at a time. 610, 610 (1994) [hereinafter Harris, The Bubble Act]; Margaret Patterson & David Reiffen, The Effect of the Bubble Act on the Market for Joint Stock Shares, 50 J. Modern historians have found that the Bubble Act was widely ignored and that it did not stop trusts from becoming widespread in the organization of English business in the eighteenth and early nineteenth centuries. 127, 128, 153, 156, 160, 161 (1923) [hereinafter Hildebrand, Massachusetts Trust I] (citing cases involving trusts in the oil industry); cf. Hildebrand, Liability of the Trustees, Property, and Shareholders of a Massachusetts Trust, 2 Tex. Entity shielding is crucially important in two respects. Parliament thus provided a more complete solution in the Statute of Frauds in 1677. The value and strength of the trust’s asset-partitioning powers are evident in the trust’s early use in secured lending and the resolution of insolvencies. German observed that the trust had become ubiquitous as a security device “for Surety of divers Covenants in Indentures of Marriage and other Bargains.”); see also Chetwynd v. The creditors could take the trustee’s personal farm, for instance, but not the farm he held in trust for the beneficiaries. See Claire Priest, Creating an American Property Law: Alienability and Its Limits in American History, 120 Harv. Thus, there was no need for a rule in early trust law that protected real property from a trustee’s unsecured creditors. To see how the mechanics of a business trust worked, consider the structure of a real-life water supply company that appeared at the dawn of large-scale, investor-owned business trusts in England in the late 1600s. The details come to us through judicial reports from the Chancery and House of Lords in the case of To my knowledge, recent historians have never analyzed this case, presumably because previous historical work on the history of business organizations has focused on books, newspapers, and contractual documents rather than on specifically legal sources such as case law and legal treatises. Scott, The Progress of the Law 1918–1919—Trusts, 33 Harv. My focus here is on judicial doctrine and what it achieved. The Lords agreed that the city’s claim was against the trustees, rather than the shareholders for whom the trustees had acted because it was the trustees who held the lease. No historian has yet shown that in fact the trust was almost as strong as the corporation as a matter of judicial doctrine. The most famous example is the set of death taxes and military obligations that modern historians call the “feudal inci­dents.” The feudal incidents essentially taxed the land a man owned when he died, and they provided the primary source of revenue for the English crown during the later stages of feudalism. The evidence for this is somewhat hard to see at first, but it grows increasingly clear over time, becoming unambiguous by the early nineteenth century. Additional evidence comes from Professors Freeman, Pearson, and Taylor’s recent survey of eighteenth- and early-nineteenth-century joint-stock companies. Lescure 1847) (“Where, as is frequently the case, a precise time is fixed for the duration of the partnership, it is dissolved by the expiration or effluxion of that time, if it do[es] not meet with an earlier legal termination.”); Joseph Story, Commentaries on the Law of Partnership 403 (Bos., Charles C. This doctrinal shift probably first appeared around the 1820s, since this was the time when courts in England and the United States first began treating contractual arrangements as partnerships even when the partners did not want to do so. See generally Ribstein, supra note 25 (surveying the history of business forms with little discussion of the trust). The basic principle behind the trust’s popularity was that by giving property to a trustee, a landowner could avoid a set of obligations that applied to himself. For many centuries, the central function of bankruptcy law was to undo the effect of these fraudulent-transfer statutes in certain circumstances by making private compositions binding even on the creditors who did not agree to them. — When the trust first appeared in joint-stock companies in the late 1600s, it brought its asset-partitioning features along with it. suggests that even from the very dawn of trust-based joint-stock companies, something like entity shielding was widely expected. Indeed, the whole point of treating a business as a partnership was usually to make the partners personally liable for the partnership’s debts.

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