The Governance of the Company's Contract and the Unexplored Dimension of Property Rights

In this paper, I try to escape from any sort of contractual determinism. I want to provide a normative account of articles of association of private limited liability companies (PLLCs) which is able to accommodate the introduction of contractual clauses establishing restrictions on transfers of shares of these companies. I define the articles of association or the company’s contract as a 'contract for the governance opportunity' provided by legislators. In other words, restrictions provided by default rules are tools that legislators use to adapt property rights in shares to the nature and purpose of the PLLC. I have equated this with a process of artificial selection by which legislators enable corporate constituencies, in particular shareholders, to maintain the closed nature of their business, and to make sure that transfers or changes in the company’s ownership structure are approached from an entitlements perspective. At the same time, these restrictions influence market agents’ behavior as to the way they perceive their investment in the company, and the relationships of power between members and directors of the company. All in all, restrictions are contractual mechanisms of governance. The questions that pose themselves are the following.What is this governance of? What is this governance for? This paper stresses the contractual nature of company law. I say, however, that it has to be mitigated with the right approach to property rights. That includes their governance by contract. Against this background, the work lawyers do in shaping fundamental legal institutes is of undeniable importance. Lawyers, by acting as gatekeepers, can engineer the company’s contract through well-crafted and clever solutions based on Pareto efficiency. However, default rules informing the contractual choices taken by market agents and their lawyers are designed by the legislator. In many circumstances, these rules have revealed weak enforceability. They also do not create incentives for market agents to change, particularly when the legal framework no longer fulfils their interests. The legal framework may be outdated. Market agents may also be ill-advised. In this context, I explore the alternatives lawyers have, from a contractual and property rights point of view, to (re)adjust the relationships between corporate constituencies. The circumstances that guide this creative endeavor are equivalent to those of an engineering drawing. Here the lawyer, just like an engineer, is aware that it is important that all relevant information be effectively communicated upon the incorporation of the company and drafting of its constitutional documents. She is aware of the need for ‘conventions of engineering drawing’ to be understood and functional throughout the life of the firm. This paper is about drafting the company’s contract. It proceeds as it follows. Section 1 tries to explain the importance of the company’s contract by taking into account two aspects. First, I consider the approach to corporate law and the ‘corporate contract’ taken in the literature. Second, I treat some of the proposed views about the relationships and interactions between individuals that try to explain why firms are thought to be more beneficial than markets.Section 2 is an attempt to create a scheme of governance of the company’s contract. This scheme is mostly based on the analysis of property rights in different circumstances. Lawyers are defined as 'reflexive intermediaries' who look at the reality as it is to create the best possible solutions. Part of creating a scheme of governance of the company’s contract is also to create mechanisms that strengthen property rights through contract. Again, not only lawyers play a special role, but also legislatures are important in this framework.Section 3 focuses on the definition of property rights ex-ante. It proposes two solutions to strengthen property rights at this stage – the dissolution of the company at will and the inclusion of lock-in clauses in the company’s contract. Section 4 concludes. It is inherent to this normative construction the interaction between property rights, transaction costs and economic and political aspects as they were seminally put together by Ronald Coase. However, it tries to go further and investigate the unexplored dimension of property rights in shares of PLLCs. I submit that property rights have a complex dynamics which cannot be sufficiently tackled within the framework of transaction costs economics. There is an unexplored dimension which has to do with their form and composition and the way they react to contractual measures, namely restrictions on their transfer. This calls to the fore the theoretical framework of new institutional economics. Nevertheless, there is a particular aspect. It is important to analyze the molecular composition of property rights (claims, duties, privileges) and how the relevant elements interconnect in the context of company law.