Commentaries and cases on the law of business organizations connected

Commentaries and Cases on the Law of Business Organizations [Connected Visit to download the full and correct content document: https://ebookmass.com/product/commentaries-and-cases-on-the-law-of-business-org anizations-connected/

To those who taught me: the late S. Samuel Arsht and Andrew B. Kirkpatrick of the Delaware bar; Martin Lipton of the New York bar; Hon. Walter K. Stapleton of the Third Circuit Court of Appeals; and especially to those I teach daily, Joshua, Benjamin and William W. Allen who came late in my life, but in time! Bless you all.

— William T. Allen

To those who have made this casebook possible: especially Victor Brudney, whose generous assistance with materials rescued me during my first year of teaching corporate law, and whose advice and criticism have been invaluable ever since; and especially to my former students whose insights from practice have enriched my own understanding of business organization.

— Reinier Kraakman

SUMMARY OF CONTENTS Contents Preface Acknowledgments Introduction 1. ACTING THROUGH OTHERS: THE LAW OF AGENCY 2. JOINT OWNERSHIP OF A BUSINESS: THE LAW OF PARTNERSHIPS AND LIMITED LIABILITY COMPANIES 3. THE CORPORATE FORM 4. THE PROTECTION OF CREDITORS 5. DEBT, EQUITY, AND ECONOMIC VALUE 6. NORMAL GOVERNANCE: THE VOTING SYSTEM 7. NORMAL GOVERNANCE: THE DUTY OF CARE 8. THE DUTY OF LOYALTY: CONFLICT TRANSACTIONS 9. EXECUTIVE COMPENSATION 10. SHAREHOLDER LAWSUITS 11. TRANSACTIONS IN CONTROL 12. FUNDAMENTAL TRANSACTIONS: MERGERS AND ACQUISITIONS 13. PUBLIC CONTESTS FOR CORPORATE CONTROL 14. TRADING IN THE CORPORATION’S SECURITIES Table of Cases Index

CONTENTS Preface Acknowledgments INTRODUCTION ACTING THROUGH OTHERS: THE LAW OF AGENCY 1.1 INTRODUCTION TO AGENCY 1.2 AGENCY FORMATION, AGENCY TERMINATION, AND PRINCIPAL’S LIABILITY 1.2.1 Formation 1.2.2 Termination 1.2.3 Parties’ Conception Does Not Control Jenson Farms Co. v. Cargill, Inc. 1.2.4 Liability in Contract 1.2.4.1 Actual and Apparent Authority White v. Thomas 1.2.4.2 Inherent Authority Gallant Ins. Co. v. Isaac 1.2.5 Liability in Tort Humble Oil & Refining Co. v. Martin Hoover v. Sun Oil Co. 1.2.6 Liability in Tort Under the Apparent Authority Doctrine 1.3 THE GOVERNANCE OF AGENCY (THE AGENT’S DUTIES) 1.3.1 The Nature of the Agent’s Fiduciary Relationship 1.3.2 The Agent’s Duty of Loyalty to the Principal Tarnowski v. Resop 1.3.3 The Trustee’s Duty to Trust Beneficiaries In re Gleeson

JOINT OWNERSHIP OF A BUSINESS: THE LAW OF PARTNERSHIPS AND LIMITED LIABILITY COMPANIES 2.1 INTRODUCTION TO PARTNERSHIP: WHY JOINT OWNERSHIP? William Klein & John C. Coffee, The Need To Assemble At-Risk Capital 2.2 PARTNERSHIP FORMATION Vohland v. Sweet 2.3 RELATIONS WITH THIRD PARTIES 2.3.1 Partnership Creditors’ Claims Against Departing Partners 2.3.2 Third-Party Claims Against Partnership Property 2.3.3 Claims of Partnership Creditors to Partner’s Individual Property 2.4 PARTNERSHIP GOVERNANCE AND ISSUES OF AUTHORITY National Biscuit Co. v. Stroud 2.5 TERMINATION (DISSOLUTION AND DISSOCIATION) 2.5.1 Accounting for Partnership’s Financial Status and Performance Sample Partnership Balance Sheet Sample Partnership Income Statement Accounting for Partners’ Capital Adams v. Jarvis 2.5.2 Statutory Dissolution of a Partnership at Will 2.5.3 Opportunistic Dissolution and the Partner’s Duty of Loyalty Page v. Page 2.6 AGENCY CONFLICTS AMONG CO-OWNERS: FIDUCIARY DUTIES Meinhard v. Salmon 2.7 LIMITED LIABILITY SUCCESSORS OF THE GENERAL PARTNERSHIP 2.7.1 The Limited Partnership 2.7.2 The Limited Liability Partnership 2.7.3 The Limited Liability Company 2.7.3.1 Taxation of LLCs 2.7.3.2 Contractual Flexibility Pappas et al. v. Tzolis

THE CORPORATE FORM 3.1 INTRODUCTION TO THE CORPORATE FORM 3.2 CREATION OF A FICTIONAL LEGAL ENTITY 3.2.1 A Note on the History of Corporate Formation 3.2.2 The Process of Incorporating Today 3.2.3 The Articles of Incorporation, or “Charter” 3.2.4 The Corporate Bylaws 3.2.5 Shareholders’ Agreements 3.3 LIMITED LIABILITY Frank Easterbrook & Daniel Fischel, Limited Liability and the Corporation 3.4 TRANSFERABLE SHARES 3.5 CENTRALIZED MANAGEMENT 3.5.1 Legal Construction of the Board 3.5.1.1 The Holder of Primary Management Power Automatic Self-Cleansing Filter Syndicate Co., Ltd. v. Cunninghame 3.5.1.2 Structure and Function of the Board 3.5.1.3 Formality in Board Operation 3.5.1.4 A Critique of Boards 3.5.2 Corporate Officers: Agents of the Corporation Jennings v. Pittsburgh Mercantile Co. THE PROTECTION OF CREDITORS 4.1 MANDATORY DISCLOSURE 4.2 CAPITAL REGULATION 4.2.1 Financial Statements 4.2.2 Distribution Constraints 4.2.3 Minimum Capital and Capital Maintenance Requirements 4.3 STANDARD-BASED DUTIES 4.3.1 Director Liability 4.3.2 Creditor Protection: Fraudulent Transfers 4.3.3 Shareholder Liability

4.3.3.1 Equitable Subordination Costello v. Fazio 4.3.3.2 Piercing the Corporate Veil Sea-Land Services, Inc. v. The Pepper Source Kinney Shoe Corp. v. Polan 4.4 VEIL PIERCING ON BEHALF OF INVOLUNTARY CREDITORS Walkovszky v. Carlton DEBT, EQUITY, AND ECONOMIC VALUE 5.1 CAPITAL STRUCTURE 5.1.1 Legal Character of Debt 5.1.2 Legal Character of Equity 5.2 BASIC CONCEPTS OF VALUATION 5.2.1 The Time Value of Money 5.2.2 Risk and Return 5.2.3 Diversification and Systematic Risk 5.3 VALUING ASSETS 5.3.1 The Discount Cash Flow (DCF) Approach 5.3.2 The Relevance of Prices in the Securities Market In re Emerging Communications Inc., Shareholder Litigation NORMAL GOVERNANCE: THE VOTING SYSTEM 6.1 INTRODUCTION: SHAREHOLDER VOTING IN THE NEW CORPORATE GOVERNANCE 6.2 ELECTING AND REMOVING DIRECTORS 6.2.1 Electing Directors 6.2.2 Removing Directors 6.3 SHAREHOLDER MEETINGS AND ALTERNATIVES 6.4 PROXY VOTING AND ITS COSTS Rosenfeld v. Fairchild Engine & Airplane Corp.

6.5 CLASS VOTING 6.6 SHAREHOLDER INFORMATION RIGHTS

6.7 TECHNIQUES FOR SEPARATING CONTROL FROM CASH FLOW RIGHTS 6.7.1 Circular Control Structures Speiser v. Baker 6.7.2 Vote Buying Frank Easterbrook & Daniel Fischel, Voting in Corporate Law Schreiber v. Carney 6.7.3 Controlling Minority Structures Lucian A. Bebchuk, Reinier Kraakman & George G. Triantis, Stock Pyramids, Cross-Ownership, and Dual Class Equity 6.8 MITIGATING A COLLECTIVE PROBLEM TODAY: ACTIVIST INVESTORS Marcel Kahan & Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control 6.9 THE FEDERAL PROXY RULES 6.9.1 Rules 14a-1 Through 14a-7: Disclosure and Shareholder Communication 6.9.2 Activist Investors and the Short Slate Proxy Contest 6.9.3 Access to the Company’s Proxy Statement: Rule 14a-8: Shareholder Proposals 6.9.4 Rule 14a-9: The Antifraud Rule Virginia Bankshares, Inc. v. Sandberg 6.10 FIDUCIARY SUPERINTENDENCE OF SHAREHOLDER VOTING Schnell v. Chris-Craft Industries, Inc. NORMAL GOVERNANCE: THE DUTY OF CARE 7.1 INTRODUCTION TO THE DUTY OF CARE 7.2 THE DUTY OF CARE AND THE NEED TO MITIGATE DIRECTOR RISK AVERSION Gagliardi v. TriFoods International, Inc. 7.3 STATUTORY TECHNIQUES FOR LIMITING DIRECTOR AND OFFICER RISK EXPOSURE 7.3.1 Indemnification

Waltuch v. Conticommodity Services, Inc. 7.3.2 Directors and Officers Insurance 7.4 JUDICIAL PROTECTION: THE BUSINESS JUDGMENT RULE Kamin v. American Express Co. 7.4.1 Understanding the Business Judgment Rule 7.4.2 The Duty of Care in Takeover Cases: A Note on Smith v. Van Gorkom 244 7.4.3 Additional Statutory Protection: Authorization for Charter Provisions Waiving Liability for Due Care Violations 7.5 THE BOARD’S DUTY TO MONITOR: LOSSES “CAUSED” BY BOARD PASSIVITY Francis v. United Jersey Bank Graham v. Allis-Chalmers Manufacturing Co. In the Matter of Michael Marchese In re Caremark International Inc. Derivative Litigation In re Citigroup Inc. Shareholder Derivative Litigation 7.6 “KNOWING” VIOLATIONS OF LAW Miller v. AT&T THE DUTY OF LOYALTY: CONFLICT TRANSACTIONS 8.1 DUTY TO WHOM? 8.1.1 The Shareholder Primacy Norm A.P. Smith Manufacturing Co. v. Barlow 8.1.2 Constituency Statutes 8.1.3 Defining Corporate Purpose in the Charter: Benefit Corporations 8.2 SELF-DEALING TRANSACTIONS 8.2.1 The Disclosure Requirement State ex rel. Hayes Oyster Co. v. Keypoint Oyster Co. Melvin Eisenberg, Self-Interested Transactions in Corporate Law

8.3 THE EFFECT OF APPROVAL BY A DISINTERESTED PARTY 8.3.1 Early Regulation of Fiduciary Self-Dealing 8.3.2 Judicial Review of Self-Dealing Today: The Limited Role of Safe Harbor Statutes Cookies Food Products v. Lakes Warehouse 8.3.3 Judicial Review When Transaction Has Been Approved by a Disinterested Majority of the Board Melvin Eisenberg, Self-Interested Transactions in Corporate Law Cooke v. Oolie 8.3.4 Approval by a Minority of Directors: Special Board Committees 8.3.5 Shareholder Ratification of Conflict Transactions Lewis v. Vogelstein 8.4 CORPORATE DIRECTORS AND THE DUTY OF GOOD FAITH 8.5 CONTROLLING SHAREHOLDERS AND THE FAIRNESS STANDARD 8.5.1 Different Treatment for Controlling Shareholders?

Sinclair Oil Corp. v. Levien Weinberger v. UOP, Inc. 8.5.2 Approval by a Board Minority of “Independent” Directors: Special Committees 8.6 CORPORATE OPPORTUNITY DOCTRINE 8.6.1 Determining Which Opportunities “Belong” to the Corporation 8.6.2 When May a Fiduciary Take a Corporate Opportunity?

8.7 THE DUTY OF LOYALTY IN CLOSE CORPORATIONS Donahue v. Rodd Electrotype Co. Frank Easterbrook & Daniel Fischel, Close Corporations and Agency Costs Smith v. Atlantic Properties, Inc. EXECUTIVE COMPENSATION 9.1 INTRODUCTION 9.2 THE CHALLENGE OF EXECUTIVE PAY

9.2.1 Creating Incentives That Align Managers With Investors 9.2.2 Political and Regulatory Responses to Executive Pay 9.3 ARE U.S. CEOs PAID TOO MUCH? Lucian Bebchuk & Jesse Fried, Pay Without Performance: Overview of the Issues Bengt Holmstrom, Pay Without Performance and the Managerial Power Hypothesis: A Comment 9.4 JUDICIAL REVIEW OF COMPENSATION 9.4.1 The Law of Executive Officer Compensation In re The Goldman Sachs Group, Inc. Shareholder Litigation 9.5 JUDICIAL REVIEW OF DIRECTOR COMPENSATION Calma v. Templeton SHAREHOLDER LAWSUITS 10.1 DISTINGUISHING BETWEEN DIRECT AND DERIVATIVE CLAIMS 10.2 SOLVING A COLLECTIVE ACTION PROBLEM: ATTORNEYS’ FEES AND THE INCENTIVE TO SUE Fletcher v. A.J. Industries, Inc. 10.3 STANDING REQUIREMENTS 10.4 BALANCING THE RIGHTS OF BOARDS TO MANAGE THE CORPORATION AND SHAREHOLDERS’ RIGHTS TO OBTAIN JUDICIAL REVIEW 10.4.1 The Demand Requirement of Rule 23 Levine v. Smith Rales v. Blasband 10.4.2 Special Litigation Committees Zapata Corp. v. Maldonado In re Oracle Corp. Derivative Litigation Joy v. North 10.5 DEALING WITH AN ABUNDANCE OF SHAREHOLDER SUITS: EXCLUSIVE FORUM BYLAWS 10.6 SETTLEMENT AND INDEMNIFICATION 10.6.1 Settlement by Class Representatives

10.6.2 Settlement by Special Committee Carlton Investments v. TLC Beatrice International Holdings, Inc. 10.7 WHEN ARE DERIVATIVE SUITS IN SHAREHOLDERS’ INTERESTS? TRANSACTIONS IN CONTROL 11.1 SALES OF CONTROL BLOCKS: THE SELLER’S DUTIES 11.1.1 The Regulation of Control Premia Zetlin v. Hanson Holdings, Inc. Perlman v. Feldmann 11.1.2 A Defense of the Market Rule in Sales of Control Frank H. Easterbrook & Daniel R. Fischel, Corporate Control Transactions In re Delphi Financial Group Shareholder Litigation 11.2 SALE OF CORPORATE OFFICE 11.3 LOOTING 11.4 TENDER OFFERS: THE BUYER’S DUTIES Brascan Ltd. v. Edper Equities Ltd. 11.5 THE HART-SCOTT-RODINO ACT WAITING PERIOD FUNDAMENTAL TRANSACTIONS: MERGERS AND ACQUISITIONS 12.1 INTRODUCTION 12.2 ECONOMIC MOTIVES FOR MERGERS 12.2.1 Integration as a Source of Value 12.2.2 Other Sources of Value in Acquisitions: Tax, Agency Costs, and Diversification 12.2.3 Suspect Motives for Mergers 12.2.4 Do Mergers Create Value?

12.3 THE EVOLUTION OF THE U.S. CORPORATE LAW OF MERGERS 12.3.1 When Mergers Were Rare 12.3.2 The Modern Era

12.4 THE ALLOCATION OF POWER IN FUNDAMENTAL TRANSACTIONS 12.5 OVERVIEW OF TRANSACTIONAL FORM 12.5.1 Asset Acquisition Katz v. Bregman 12.5.2 Stock Acquisition 12.5.3 Mergers 12.5.4 Triangular Mergers 12.6 STRUCTURING THE M&A TRANSACTION 12.6.1 Timing 12.6.2 Regulatory Approvals, Consents, and Title Transfers 12.6.3 Planning Around Voting and Appraisal Rights 12.6.4 Due Diligence, Representations and Warranties, Covenants, and Indemnification 12.6.5 Deal Protections and Termination Fees 12.6.6 Accounting Treatment 12.6.7 A Case Study: Excerpt from Timberjack Agreement and Plan of Merger 12.7 THE APPRAISAL REMEDY 12.7.1 History and Theory 12.7.2 The Appraisal Alternative in Interested Mergers 12.7.3 The Market-Out Rule 12.7.4 The Nature of “Fair Value” 12.7.5 Discounted Cash Flow Analysis 12.7.6 Current Developments in Appraisal 12.8 THE DE FACTO MERGER DOCTRINE Hariton v. Arco Electronics, Inc. 12.9 THE DUTY OF LOYALTY IN CONTROLLED MERGERS 12.9.1 Cash Mergers or Freeze-Outs Kahn v. Lynch Communications Systems, Inc. Kahn v. M&F Worldwide Corp et al.

11.9.2 Do Controlling Shareholders Have a Duty to Offer Only a Fair Price on the First, Tender Offer Step of a Two Step Freeze-Out? 520 In re CNX Gas Corporation Shareholders Litigation

PUBLIC CONTESTS FOR CORPORATE CONTROL 13.1 INTRODUCTION 13.2 DEFENDING AGAINST HOSTILE TENDER OFFERS Unocal Corp. v. Mesa Petroleum Co. 13.3 PRIVATE LAW INNOVATION: THE POISON PILL 13.4 CHOOSING A MERGER OR BUYOUT PARTNER: REVLON, ITS SEQUELS, AND ITS PREQUELS Smith v. Van Gorkom Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc. 13.5 PULLING TOGETHER UNOCAL AND REVLON Paramount Communications, Inc. v. Time, Inc. Paramount Communications, Inc. v. QVC Network, Inc. 13.6 REGULATION OF TAKEOVERS IN OTHER LEGAL SYSTEMS 13.7 BRINGING TAKEOVERS LAW DOWN TO DATE Lyondell Chemical Co. v. Ryan C&J Energy Services, Inc. v. City of Miami General Employees and Sanitation Employees Retirement Trust 13.8 PROTECTING THE DEAL 13.8.1 “No Shops/No Talks” and “Fiduciary Outs” 13.8.2 Shareholder Lock-ups Omnicare, Inc. v. NCS Healthcare, Inc. 13.9 STATE ANTITAKEOVER STATUTES 13.9.1 First- and Second-Generation Antitakeover Statutes (1968-1987) 13.9.2 Third-Generation Antitakeover Statutes 13.10 PROXY CONTESTS FOR CORPORATE CONTROL Blasius Industries, Inc. v. Atlas Corp.

TRADING IN THE CORPORATION’S SECURITIES

14.1 COMMON LAW OF DIRECTORS’ DUTIES WHEN TRADING IN THE CORPORATION’S STOCK Goodwin v. Agassiz 14.2 THE CORPORATE LAW OF INSIDER TRADING POST-GOODWIN Freeman v. Decio 14.3 §16(b) AND RULE 16-b UNDER THE 1934 ACT 14.4 EXCHANGE ACT §10(b) AND RULE 10b-5 14.4.1 Evolution of Private Right of Action Under §10 14.4.2 Elements of a 10b-5 Claim 14.4.3 Early Rule 10b-5 Insider Trading Liability: The Equal Access Theory SEC v. Texas Gulf Sulphur Co. Santa Fe Industries, Inc. v. Green 14.4.4 The Equal Access Theory of Rule 10b-5 Liability 14.4.5 Elements of 10b-5 Liability: The Fiduciary Duty Theory Chiarella v. United States 14.4.6 The Problem of Tippees after Chiarella Dirks v. SEC United States v. Newman 14.4.7 Note on Regulation FD 14.4.8 The Introduction of the Misappropriation Theory United States v. O’Hagan 14.4.9 Civil Liability, Civil Fines, and Criminal Penalties for Security Fraud Violations Elkind v. Liggett & Myers, Inc. 14.5 THE OTHER SIDE OF 10B-5: FRAUD-ON-THE-MARKET CLASS ACTIONS 14.5.1 Materiality and Reliance in FOM Class Actions Basic Inc. v. Levinson 14.5.2 Loss Causation in 10b-5 Class Actions 14.5.3 The Role of Class Certification in Recent Challenges to FOM Actions 14.6 INSIDER TRADING AND FOM CLASS ACTIONS: THE ACADEMIC POLICY DEBATES 14.6.1 The Insider-Trading Debate 14.6.2 The Academic Policy Debate over FOM Class Actions

Table of Cases Index

PREFACE TO THE FIFTH EDITION This book represents our effort to assist students and non-specialist lawyers to achieve an understanding of the basic principles of law that undergird the legal structures within which business is conducted in the United States. Our approach in this effort is premised upon a functional perspective of law. Thus, we attempt to ask how these legal structures function to produce desired benefits to parties who enter into agreements and relationships, or how legal structures (or rules) add costs and can impede sensible business organization. In this second aspect, the analytical or critical perspective, our point of view is informed through our understanding of basic principles of economics. The book, however, requires of its readers no formal training or understanding of economics.

The concepts are for the most part quite intuitive and easily grasped.

We have organized the book into two segments. The first (and shorter) of these segments — the Introduction and Chapters 1-3 — deals with the fundamentals of organizational law in a business setting. Chapter 1 focuses on agency law, which is no less a predicate for modern enterprises functioning in a market economy than contract or property law. Chapter 2 addresses the partnership form and its modern variants: the limited partnership, limited liability company, and limited liability partnership.

Chapter 3 introduces the corporate form, explicitly contrasted against the partnership and its variants, such as the LLC. The larger segment of the book, Chapters 4-14, addresses the legal regulation of a variety of actions, decisions, and transactions that involve or concern the modern public corporation. Chapter 4 explores relationships among shareholders, corporations, and corporate creditors.

Chapters 5 provides a basic primer on applicable finance concepts useful in understanding issues respecting estimating costs of funding a business and estimating asset values. Chapters 6 and 7 explore what we term “normal governance” — that is, the legal framework that regulates the vast majority of the corporation’s ordinary business activities. Chapter 6 addresses the routine functioning of the voting system, including the proxy rules and some current issues in corporate governance. Chapter 7 explores the duty of care, together with the multiple legal devices that insulate

corporate officers and directors from shareholder liability, including, most notably, the business judgment rule.

Chapters 8 and 13 are devoted to particular classes of corporate actions and related shareholder transactions that are subject to more specialized regulation by corporate law. Chapter 8 addresses self-dealing and other potential duty of loyalty issues arising from the conduct of corporate officers, directors, and controlling shareholders. Chapter 9 focuses on the particular challenges of executive compensation. Chapter 10 reviews the law and practice of shareholder derivative suits. Chapter 11 examines transactions in corporate control, including sales of control blocks of shares and tender offers. Chapter 12 addresses the specialized legal treatment of so-called fundamental corporate actions, with special attention to merger and acquisition transactions. Chapter 13 turns to the dramatic topic of conflicts for corporate control, including hostile tender offers and proxy contexts. And finally, Chapter 14 examines the regulation of transactions in shares on the public markets, including such topics as insider trading and fraud on the market.

Throughout, the fifth edition contains substantial updating from the fourth edition, especially respecting the topics of corporate finance, corporate governance, mergers & acquisitions and securities regulations.

The basic structure and insights of the book remain unchanged, however.

These materials continue to be structured in a way that conforms to the simple insight that much of corporate law can be divided into general governance, on the one hand, and discrete areas of specialized governance on the other. We expect some teachers will present the materials in a different sequence. We have taken care to facilitate alternative approaches by recapping in later chapters points more exhaustively made in earlier ones and by supplying cross-references for further review.

The book contains a number of notes that are perhaps a bit longer and more openly explanatory than other authors prefer. In this we have been motivated by our experience as teachers to want to provide a rather full textual basis for a general understanding of each subject. Our aim is to provide for those happy occasions when class gets deeply involved in an interesting discussion. In this event we are comforted by the knowledge that we can move on to the next class knowing that all of the basic information and insights have been made available to the class in the reading assignment.

In the end, what makes this branch of law so interesting (and frustrating) to students, practitioners, and scholars alike is the vital role played in it by the open-textured concept of fiduciary duty. From the early study of agency, to its conclusion with corporate mergers and acquisitions, the field and these materials offer myriad puzzles arising from the admixture of morality and efficiency that is often encountered when courts are required to fill in the specifics of a fiduciary’s obligations. In approaching this subject, the book places primary emphasis on the Delaware statute and decisions, as that law grows in its dominant importance for publicly financed corporations in the United States.

Opinions by the Delaware Court of Chancery and the Delaware Supreme Court tend to outnumber cases from other jurisdictions.

We must offer very real thanks and appreciation to colleagues and friends who have taught from these materials for some years and who have been generous in their comments, contributions, and suggestions. First among these is Guhan Subramanian, our talented coauthor on several prior editions of this Book. Needless to say, we are grateful for his numerous contributions in the past and, like loyal continuing partners, we are fully prepared to hold him intellectually harmless for the novel content of the 5th Edition. Next among those to whom we owe deep gratitude are Victor Brudney, whose teaching materials provided the starting point for this book, and Henry Hansmann, who has commented so richly and so long that it would be difficult to exaggerate our gratitude. Other colleagues have made useful comments and supplied detailed guidance. Among these are Jennifer Arlen, Ryan Bubb, Lucian Bebchuk, Bernard Black, John Coates, Rob Daines, Jill Fisch, Jesse Fried, Jon Hanson, Hon. Jack B. Jacobs, Marcel Kahan, Ehud Kamar, Vic Khanna, Stephen J. Lubben, Mark Roe, and Hon. Leo Strine. We acknowledge gladly our debt to them. In addition, numerous anonymous reviewers made very helpful comments, and we hope that they will find the book improved because of their efforts.

Finally, we each owe a debt of gratitude to student researchers and secretarial associates. Among students, some especially stand out for their glad assistance: Alison Gooley, NYU, 1999, of the Bar of New South Wales; Ronnie Deutch, NYU, 2002, of the New York bar; Melissa Anderson, HLS, 2009; Jeffrey Young, HLS, 2010; Maria Parra-Orlandoni, HLS, 2015 and Divya Suwasin, NYU 2016. Susannah Atkins, Carol Bateson, Cara R. Conlin, Linell Hanover, Annie Hard, Barbara Karasinski,

Kimberly Peterson, and Paula Prather offered cheerful and highly competent assistance. Our gratitude extends to them all.

William T. Allen Reinier Kraakman

February 2016

ACKNOWLEDGMENTS We thank the authors and copyright holders of the following works for permitting their inclusion in this book: Bebchuk and Fried, Pay Without Performance: Overview of the Issues, 30 J. Corp. L. 647 (2005).

Bebchuk, Kraakman, and Triantis, Stock Pyramids, Cross-Ownership, and Dual Class Equity, 295ff. in Randall K. Morck, ed., Concentrated Corporate Ownership (2000).

Easterbrook and Fischel, Close Corporations and Agency Costs, 38 Stan. L. Rev. 271 (1986). Stanford Law Review by School of Law, Stanford University, Copyright © 1986. Reproduced with permission of Stanford Law Review via Copyright Clearance Center.

Easterbrook and Fischel, Corporate Control Transactions, 91 Yale L. J. 698, 715-719 (1982). The Yale Law Journal by Yale Law School, Copyright © 1982. Reproduced with permission of Yale Law Journal Company, Inc. via Copyright Clearance Center.

Easterbrook and Fischel, Limited Liability and the Corporation, 52 U. Chi. L. Rev. 89, 94-97 (1985).

Easterbrook and Fischel, Voting in Corporate Law, 26 J.L. & Econ.

395, 409-411 (1983).

Eisenberg, Self-Interested Transactions in Corporate Law, 13 J. Corp.

L. 997, 997-1008 (1988). The Journal of Corporation Law, published by University of Iowa, College of Law, Copyright © 1988. Reproduced with permission of The Journal of Corporation Law via Copyright Clearance Center.

Eisinger, Jesse, Long & Short: Icahu Cries Foul at Perry’s No-Risk Play in Takeover Fight, Wall Street Journal, Eastern Edition, Dec. 15, 2004. Copyright © 2004 by Dow Jones & Company, Inc. Reproduced with permission of Dow Jones & Company, Inc. via Copyright Clearance Center.

Hansmann, Kraakman, and Squire, Law and the Rise of the Firm, 119 Harv. L. Rev. 1333 (2006). Harvard Law Review by Harvard Law Review Publishing Association, Copyright © 2006. Reproduced with permission of

Harvard Law Review Publishing Association via Copyright Clearance Center.

Holmstrom, Bengt, Pay Without Performance and the Managerial Power Hypothesis: A Comment, 30 J. Corp. L. 503 (2005).

Holzer, Jessica, A “Yes” in Say on Pay, Wall Street Journal, July 8, 2011, Copyright © 2011 by Dow Jones & Company, Inc. Reproduced with permission of Dow Jones & Company, Inc. via Copyright Clearance Center.

Kahan and Rock, Hedge Funds in Corporate Governance and Corporate Control, 155 U. Pa. L. Rev. 1021 (2007). University of Pennsylvania Law Review by University of Pennsylvania Law School, Copyright © 2007. Reproduced with permission of University of Pennsylvania Law School via Copyright Clearance Center.

Markon, Jerry, and Robert Frank, Five Adelphia Officials Arrested on Fraud Charges, Wall Street Journal, Eastern Edition, Jul. 25, 2002.

Copyright © 2002 by Dow Jones & Company, Inc. Reproduced with permission of Dow Jones & Company, Inc. via Copyright Clearance Center.

Roe, Mark J., Corporate Strategic Reaction to Mass Tort, 72 Va. L. Rev. 1, 32 (1986). Virginia Law Review Association by Virginia Law Review, Copyright © 1986. Reproduced with permission of Virginia Law Review via Copyright Clearance Center.

Staff Writer, Doing Good and Doing Well at Timberland, Wall Street Journal, Eastern Edition, Sept. 9, 2003. Copyright © 2003 by Dow Jones & Company, Inc. Reproduced with permission of Dow Jones & Company, Inc. via Copyright Clearance Center.

Thompson and Thomas, The New Look of Shareholder Litigation: Acquisition-Oriented Class Actions, 57 Vand. L. Rev. 133, 166-69 (2004).

INTRODUCTION Like much of civil law, the law of business enterprises is concerned with facilitating voluntary economic relationships. Property law and contract law are the legal bedrock of market economies, but other bodies of law are also important. Among these are the laws of security interests, money and credit, bankruptcy, intellectual property, agency, and enterprise organization. This book deals primarily with the last, but hardly the least, of these fields: the law of enterprise organization. In particular, we address the laws of agency, partnership (and related limited liability entities), and corporations.

Because cooperative economic relationships frequently raise the same recurring problems, the law provides a useful menu of standard forms to address these problems. Thus, the laws of agency, partnership, noncorporate limited liability entities, and corporations can be seen as offering parties a set of standard legal forms from which to choose the form most suited to their needs. The choice of a standard form is implicitly a contractual choice. Moreover, these forms themselves are more or less contractual insofar as they may be customized or fine-tuned by the parties by express agreement — and, of course, with the assistance of expert lawyering. As we shall also see, the laws of agency, partnership, and corporations are not entirely malleable because fiduciary duties grounded in equity — a principal focus of this course — limit the opportunistic use of contractual and even statutory rights. Finally, agency law as well as the law of all business entities have a “property” dimension in addition to a contractual dimension, insofar as they may alter the legal rights of third parties as well as the rights of the parties who enter into these enterprise relationships.

We begin by examining the law of agency. The agency relationship can be imagined as the simplest form of business organization. Alternatively it may be seen as the legal glue that contours the boundaries of a legal enterprise: Which persons have the power to bind the entity contractually and in tort or criminal law, and which persons act outside the entity?

Agency law also prefigures many of the most basic and difficult problems of corporation law, most particularly those arising from the so-called

fiduciary duty of loyalty. From agency, we move to the general partnership — which we may think of as the simplest form of a jointly owned business firm. (For our purposes, a “firm” is a form of business relation that has a temporal dimension, a social identity, and a separate pool of dedicated business assets.) And from partnership and other noncorporate forms, we move to our principal subject — the corporate form — which is the most stable, complex, and socially important form in the menu of business forms that the law provides.

Before beginning, we will address here two very general themes that run throughout this book. The first is a policy theme: How does one evaluate and critique enterprise law, and what are the goals of enterprise law? The second theme concerns the role that the morally charged language of enterprise law (it is law, after all) plays in its legitimation and enforcement.

We begin with the policy theme. It goes without saying that the fundamental objective of enterprise law — indeed of all law — is to increase social welfare. Yet, this abstract formulation tells us little about how enterprise law should contribute to social welfare or how it might be tweaked to do a better job. Like many other modern commentators on enterprise law, we sometimes assert that good law is “efficient” law, meaning that it maximizes the size of the economic pie (even if the pie’s pieces are allocated quite differently according to whether one is, say, an investor or an employee).1 At other times we assert that the goal of the business corporation is to maximize long-term shareholder wealth.

Needless to say, there is a gap of some distance between innocuously stating that enterprise law should increase social welfare and asserting that this means furthering the interests of shareholders or other investors of risk capital.

Some commentators argue that large enterprises such as public corporations should not privilege shareholder interests over those of other constituencies such as creditors, employees, suppliers, customers, or even the interests of society as a whole. We explore these alternative goals in Chapter 4 (The Protection of Creditors), Chapter 7 (Conflict Transactions: The Duty of Loyalty), and Chapter 12 (Public Contests for Corporate Control). Elsewhere, we take the primacy of shareholder interests for granted. This is not because we believe that shareholder ownership of corporations is an indisputable and sacred property right, or that it is an

obvious principle of natural law. Rather, it is partly because we believe that shareholder/investor welfare is a workable if imperfect proxy for social welfare in most situations, and partly because the primacy of shareholder/investor welfare dominates American enterprise law as a matter of pure empirics. The objective of maximizing shareholder welfare runs so deeply through the relevant statutory and case law that it is rarely questioned or even stated, except when the conflict between the interests of shareholders and those of other corporate constituencies grows too acute to ignore.

Once shareholder/investor welfare is identified as the principal objective of enterprise law, it follows easily that economic efficiency is the logical criterion for evaluating enterprise law. Shareholders/investors are the “equity holders” or “residual claimants” of business entities — a fancy way of saying that they don’t get paid until everyone else is paid first, including business creditors, employees, and suppliers. Any factor that increases residual value of the enterprise to its shareholders (or other equity investors) is “efficient” by this criterion — at least if it does not impose uncompensated costs on third parties such as tort victims. And any factor that reduces the costs of capital, labor, supplies, and the like adds to the residual value of the enterprise. Put differently, efficient law adds to the value of the firm just as any other factor might do, by reducing the costs of the firm’s inputs and increasing the value of its outputs.

There are at least three specific ways in which enterprise law can enhance the efficiency of enterprises. The first is by providing standard platforms for business entities as well as agency contracts and creditor protections. Where negotiating parties are involved, these platforms are often an integrated set of default terms open to contractual modification.

Where third-party rights are at stake, the analogous standard terms are often mandatory. In both cases, however, standard platforms save time and effort by allowing parties to do business in shorthand, without reinventing the legal wheel. Second, enterprise law adds value by permitting business actors to modify third-party property rights in circumstances when contract alone cannot do the job. We address this function in Chapters 2 and 3, where we demonstrate how legal entities permit investors to divide their assets among different buckets that serve as collateral for different groups of creditors. This power to assign specific assets to support

business creditors is enormously useful and yet, as we will argue, cannot be achieved by contract alone.

Finally, enterprise law provides a variety of rules and standards — collectively termed “fiduciary duties” — that are intended to either prevent or remedy self-interested opportunism by parties within enterprises. The simplest example is that of an agent who agrees to act loyally on behalf of his principal, but is economically motivated to act against his principal’s interests in numerous ways, from colluding with third parties in negotiating contracts on the principal’s behalf to expropriating the principal’s property or private information for his own benefit. This genre of opportunism is a chronic problem in every sort of enterprise, from simple agency relationships to publicly traded corporations. In the academic literature, it is referred to generically as the “agency problem” and the costs that inevitably arise from the fact that agents rather than owners themselves are at work in the enterprise are referred to as “agency costs.” This problem and the costs that it produces are not specific to the law of agency at all. Indeed, these are not legal terms of art. But addressing them lies at the core of the understanding and critical analysis of much of enterprise law.

As the problem of mitigating agency costs implies, evaluating the efficiency of a particular legal rule or a particular reform in enterprise law requires a good deal of knowledge about institutional context and enforcement. Research in the social sciences can be helpful here. But at the very least, clarity is essential about one’s empirical assumptions about the institutional context as well as the weights assigned to particular costs and benefits. In the end, and over time, the balance of costs and benefits generally determines the survivorability of legal doctrine here, as in so many other areas of the law.

However, policy-oriented analysis is certainly not the only aim of the study of organization law by lawyers. If it were, enterprise law would be nothing but a pastiche of applied social sciences — mostly economics and finance perhaps, but with a dash of psychology and organization theory tossed in. The meaning of this imaginary law would be wholly captured in phrases such as “efficiency,” “transaction costs,” “collective action problems,” and the “prisoner’s dilemma.” Its rules and standards would be understood as more or less well-supported hypotheses. Individual plaintiffs and defendants would occupy roughly the same status as

laboratory animals behaving in accordance with the vector of their selfinterest and the law’s calibration of incentives. Judges would be the investigators-in-chief.

Needless to say, this Orwellian account of enterprise law is not the real thing by a long shot, even if traces of applied social science occur in the case law and large deposits of it may be found in the academic literature.

The principal statutes of enterprise law, including the statute that will play the most important role in this book — the Delaware General Corporation Law (DGCL) — read like an integrated set of self-contained rules that erect a legal entity, and describe its governance mechanisms. In the aggregate, they seem to rest on social science no more than the blueprints for large buildings do. Similarly, if one reads an opinion handed down by the Delaware Court of Chancery or the Delaware Supreme Court concerning an issue in corporate law, the number of references to “efficiency” or “transaction costs” is vanishingly small in comparison to that of legal terms of art such as “entire fairness” and the “business judgment rule.” Moreover, the language of these opinions is often morally charged and didactic. The authorities cited are statutory provisions and prior case law. This is, in short, law as we know it. The attention to policy concerns is often here, but it resides in the melody rather than in the words. The only remotely “scientific” piece of the typical opinion is the careful attention paid to the facts and institutional context at the outset of the decision. And this resembles anthropology or history more than economics.

Phrased more directly, judges and lawyers occupy a different role than social scientists do. Judges and lawyers are understood to be believers in the language of law. Indeed, they are the high priests and the deacons of the faith. For them, the articulated reason for some judicial act is not simply a concurrence with good policy, but a legally derived cause in itself. In this faith, law is all about the meaning of legal doctrines: statutes, court rules, administrative procedures, judicial precedents, and the rich body of professional learning that allows experienced lawyers to perform their professional functions. These meanings may be unclear at times, but the internal processes of law — canons of construction, rules of authority and judicial processes of discovery, trial and appeal, and even much scholarship — are about clarifying legal meanings as well as their application. This is the “interior” perspective on law.

How, then, can faith and science freely coexist in the study of enterprise law — and perhaps even in its creation?2 Our long answer to this question lies in the discussion of the materials in this book. The short answer comes in several pieces.

The most obvious piece is that the interior perspective on enterprise law comes first in time. The law’s basic entity forms, its morally charged categories, and even the forerunners of today’s business statutes long predate the normative claims made by modern economics. Indeed, some fundamental concepts in organizational economics were inspired by enterprise law. Examples include entire subfields of microeconomics such as “the principal-agent problem,” the idea of “transaction costs,” and the distinction between production by a principal’s agents within a legal entity as distinct from acquiring goods or services from independent contractors in the market.

A second aspect of the coexistence of “faith-based” legal analysis and economically oriented policy derives from the policy-making role of the judiciary. Even a judge who is a strict constructionist finds that policymaking choices are inescapably thrust upon her. Linguistic ambiguity alone often requires a judge to make choices. To be sure, in such situations — and they arise frequently in the law of enterprise organization — courts avoid using concepts like “efficiency” to justify their choices, even if these concepts are central to evaluating the wisdom of the outcome reached. However, this may change over the years as more lawyers trained in economic analysis enter the profession. Even today, one should not underestimate how many lawyers and judges — especially those who are frequently involved in business-related cases — are, if not fully bilingual, able to discourse in the language of economics as well as that of traditional enterprise law. In business law, the lawyer who fails to understand the economics of a problem usually fails to find a satisfactory solution to the problem.

Finally, we hasten to add our prediction that today’s coexistence will never result in policy analysis supplanting enterprise law as we know it.

There are two reasons. The first is that the vice of microeconomic theory cannot completely close on the complex institutional structures and transactions encountered in enterprise law. Markets and contracts are incomplete, and information is noisy in the real world. Judgments based on the situational insights of sophisticated lawyers and judges, as

expressed in the language of the law, will ordinarily dominate judgments mechanically derived from an abstract policy framework. Second and even more important, business actors are not two-dimensional puppets entirely controlled by economic concerns. They are moral individuals (albeit more or less imperfect ones) whose actions often reflect ethical notions as well.

In many cases, the soft prodding of conscience or reputation may elicit more legal compliance than will the threat of monetary sanctions. The morally charged language of business law takes aim directly at conscience and reputation. For most of us, it is one thing to be scolded by a court for acting inefficiently and quite another to be charged with acting disloyally or in bad faith. Arguably, in fact, some obligations imposed by enterprise law are enforced exclusively by these soft sanctions. And arguably, this is the way it should be.

1. Those familiar with the literature addressing various definitions of efficiency will recognize that by “efficiency” we mean “Kaldor-Hicks efficiency.” This form of efficiency looks to increasing the size of the value pie. In principal, a larger pie is divisible in a way that makes all participants in an enterprise better off. Yet efficient law increases Kaldor-Hicks efficiency by increasing the size of the pie, regardless of how the increased pie is divided. Kaldor-Hicks efficiency is to be contrasted with “Pareto efficiency,” under which a change is efficient only if the pie increases and every constituent’s piece of pie is also increased. The latter criterion is too demanding to serve as a useful norm in enterprise law.

2. We ask the reader to excuse this phrasing, which borrows from another, more venerable discussion.

Another random document with no related content on Scribd:

DANCE ON STILTS AT THE GIRLS’ UNYAGO, NIUCHI

Newala, too, suffers from the distance of its water-supply—at least the Newala of to-day does; there was once another Newala in a lovely valley at the foot of the plateau. I visited it and found scarcely a trace of houses, only a Christian cemetery, with the graves of several missionaries and their converts, remaining as a monument of its former glories. But the surroundings are wonderfully beautiful. A thick grove of splendid mango-trees closes in the weather-worn crosses and headstones; behind them, combining the useful and the agreeable, is a whole plantation of lemon-trees covered with ripe fruit; not the small African kind, but a much larger and also juicier imported variety, which drops into the hands of the passing traveller, without calling for any exertion on his part. Old Newala is now under the jurisdiction of the native pastor, Daudi, at Chingulungulu, who, as I am on very friendly terms with him, allows me, as a matter of course, the use of this lemon-grove during my stay at Newala.

FEET MUTILATED BY THE RAVAGES OF THE “JIGGER” (Sarcopsylla penetrans)

The water-supply of New Newala is in the bottom of the valley, some 1,600 feet lower down. The way is not only long and fatiguing, but the water, when we get it, is thoroughly bad. We are suffering not only from this, but from the fact that the arrangements at Newala are nothing short of luxurious. We have a separate kitchen—a hut built against the boma palisade on the right of the baraza, the interior of which is not visible from our usual position. Our two cooks were not long in finding this out, and they consequently do—or rather neglect to do—what they please. In any case they do not seem to be very particular about the boiling of our drinking-water—at least I can attribute to no other cause certain attacks of a dysenteric nature, from which both Knudsen and I have suffered for some time. If a man like Omari has to be left unwatched for a moment, he is capable of anything. Besides this complaint, we are inconvenienced by the state of our nails, which have become as hard as glass, and crack on the slightest provocation, and I have the additional infliction of pimples all over me. As if all this were not enough, we have also, for the last week been waging war against the jigger, who has found his Eldorado in the hot sand of the Makonde plateau. Our men are seen all day long—whenever their chronic colds and the dysentery likewise raging among them permit—occupied in removing this scourge of Africa from their feet and trying to prevent the disastrous consequences of its presence. It is quite common to see natives of this place with one or two toes missing; many have lost all their toes,

or even the whole front part of the foot, so that a well-formed leg ends in a shapeless stump. These ravages are caused by the female of Sarcopsylla penetrans, which bores its way under the skin and there develops an egg-sac the size of a pea. In all books on the subject, it is stated that one’s attention is called to the presence of this parasite by an intolerable itching. This agrees very well with my experience, so far as the softer parts of the sole, the spaces between and under the toes, and the side of the foot are concerned, but if the creature penetrates through the harder parts of the heel or ball of the foot, it may escape even the most careful search till it has reached maturity.

Then there is no time to be lost, if the horrible ulceration, of which we see cases by the dozen every day, is to be prevented. It is much easier, by the way, to discover the insect on the white skin of a European than on that of a native, on which the dark speck scarcely shows. The four or five jiggers which, in spite of the fact that I constantly wore high laced boots, chose my feet to settle in, were taken out for me by the all-accomplished Knudsen, after which I thought it advisable to wash out the cavities with corrosive sublimate. The natives have a different sort of disinfectant—they fill the hole with scraped roots. In a tiny Makua village on the slope of the plateau south of Newala, we saw an old woman who had filled all the spaces under her toe-nails with powdered roots by way of prophylactic treatment. What will be the result, if any, who can say?

The rest of the many trifling ills which trouble our existence are really more comic than serious. In the absence of anything else to smoke, Knudsen and I at last opened a box of cigars procured from the Indian store-keeper at Lindi, and tried them, with the most distressing results. Whether they contain opium or some other narcotic, neither of us can say, but after the tenth puff we were both “off,” three-quarters stupefied and unspeakably wretched. Slowly we recovered—and what happened next? Half-an-hour later we were once more smoking these poisonous concoctions—so insatiable is the craving for tobacco in the tropics.

Even my present attacks of fever scarcely deserve to be taken seriously. I have had no less than three here at Newala, all of which have run their course in an incredibly short time. In the early afternoon, I am busy with my old natives, asking questions and making notes. The strong midday coffee has stimulated my spirits to

an extraordinary degree, the brain is active and vigorous, and work progresses rapidly, while a pleasant warmth pervades the whole body. Suddenly this gives place to a violent chill, forcing me to put on my overcoat, though it is only half-past three and the afternoon sun is at its hottest. Now the brain no longer works with such acuteness and logical precision; more especially does it fail me in trying to establish the syntax of the difficult Makua language on which I have ventured, as if I had not enough to do without it. Under the circumstances it seems advisable to take my temperature, and I do so, to save trouble, without leaving my seat, and while going on with my work. On examination, I find it to be 101·48°. My tutors are abruptly dismissed and my bed set up in the baraza; a few minutes later I am in it and treating myself internally with hot water and lemon-juice.

Three hours later, the thermometer marks nearly 104°, and I make them carry me back into the tent, bed and all, as I am now perspiring heavily, and exposure to the cold wind just beginning to blow might mean a fatal chill. I lie still for a little while, and then find, to my great relief, that the temperature is not rising, but rather falling. This is about 7.30 p.m. At 8 p.m. I find, to my unbounded astonishment, that it has fallen below 98·6°, and I feel perfectly well. I read for an hour or two, and could very well enjoy a smoke, if I had the wherewithal—Indian cigars being out of the question.

Having no medical training, I am at a loss to account for this state of things. It is impossible that these transitory attacks of high fever should be malarial; it seems more probable that they are due to a kind of sunstroke. On consulting my note-book, I become more and more inclined to think this is the case, for these attacks regularly follow extreme fatigue and long exposure to strong sunshine. They at least have the advantage of being only short interruptions to my work, as on the following morning I am always quite fresh and fit.

My treasure of a cook is suffering from an enormous hydrocele which makes it difficult for him to get up, and Moritz is obliged to keep in the dark on account of his inflamed eyes. Knudsen’s cook, a raw boy from somewhere in the bush, knows still less of cooking than Omari; consequently Nils Knudsen himself has been promoted to the vacant post. Finding that we had come to the end of our supplies, he began by sending to Chingulungulu for the four sucking-pigs which we had

bought from Matola and temporarily left in his charge; and when they came up, neatly packed in a large crate, he callously slaughtered the biggest of them. The first joint we were thoughtless enough to entrust for roasting to Knudsen’s mshenzi cook, and it was consequently uneatable; but we made the rest of the animal into a jelly which we ate with great relish after weeks of underfeeding, consuming incredible helpings of it at both midday and evening meals. The only drawback is a certain want of variety in the tinned vegetables. Dr. Jäger, to whom the Geographical Commission entrusted the provisioning of the expeditions—mine as well as his own—because he had more time on his hands than the rest of us, seems to have laid in a huge stock of Teltow turnips,[46] an article of food which is all very well for occasional use, but which quickly palls when set before one every day; and we seem to have no other tins left. There is no help for it—we must put up with the turnips; but I am certain that, once I am home again, I shall not touch them for ten years to come.

Amid all these minor evils, which, after all, go to make up the genuine flavour of Africa, there is at least one cheering touch: Knudsen has, with the dexterity of a skilled mechanic, repaired my 9 × 12 cm. camera, at least so far that I can use it with a little care.

How, in the absence of finger-nails, he was able to accomplish such a ticklish piece of work, having no tool but a clumsy screw-driver for taking to pieces and putting together again the complicated mechanism of the instantaneous shutter, is still a mystery to me; but he did it successfully. The loss of his finger-nails shows him in a light contrasting curiously enough with the intelligence evinced by the above operation; though, after all, it is scarcely surprising after his ten years’ residence in the bush. One day, at Lindi, he had occasion to wash a dog, which must have been in need of very thorough cleansing, for the bottle handed to our friend for the purpose had an extremely strong smell. Having performed his task in the most conscientious manner, he perceived with some surprise that the dog did not appear much the better for it, and was further surprised by finding his own nails ulcerating away in the course of the next few days. “How was I to know that carbolic acid has to be diluted?” he mutters indignantly, from time to time, with a troubled gaze at his mutilated finger-tips.

Since we came to Newala we have been making excursions in all directions through the surrounding country, in accordance with old habit, and also because the akida Sefu did not get together the tribal elders from whom I wanted information so speedily as he had promised. There is, however, no harm done, as, even if seen only from the outside, the country and people are interesting enough.

The Makonde plateau is like a large rectangular table rounded off at the corners. Measured from the Indian Ocean to Newala, it is about seventy-five miles long, and between the Rovuma and the Lukuledi it averages fifty miles in breadth, so that its superficial area is about two-thirds of that of the kingdom of Saxony. The surface, however, is not level, but uniformly inclined from its south-western edge to the ocean. From the upper edge, on which Newala lies, the eye ranges for many miles east and north-east, without encountering any obstacle, over the Makonde bush. It is a green sea, from which here and there thick clouds of smoke rise, to show that it, too, is inhabited by men who carry on their tillage like so many other primitive peoples, by cutting down and burning the bush, and manuring with the ashes. Even in the radiant light of a tropical day such a fire is a grand sight.

Much less effective is the impression produced just now by the great western plain as seen from the edge of the plateau. As often as time permits, I stroll along this edge, sometimes in one direction, sometimes in another, in the hope of finding the air clear enough to let me enjoy the view; but I have always been disappointed.

Wherever one looks, clouds of smoke rise from the burning bush, and the air is full of smoke and vapour. It is a pity, for under more favourable circumstances the panorama of the whole country up to the distant Majeje hills must be truly magnificent. It is of little use taking photographs now, and an outline sketch gives a very poor idea of the scenery. In one of these excursions I went out of my way to make a personal attempt on the Makonde bush. The present edge of the plateau is the result of a far-reaching process of destruction through erosion and denudation. The Makonde strata are everywhere cut into by ravines, which, though short, are hundreds of yards in depth. In consequence of the loose stratification of these beds, not only are the walls of these ravines nearly vertical, but their upper end is closed by an equally steep escarpment, so that the

western edge of the Makonde plateau is hemmed in by a series of deep, basin-like valleys. In order to get from one side of such a ravine to the other, I cut my way through the bush with a dozen of my men.

It was a very open part, with more grass than scrub, but even so the short stretch of less than two hundred yards was very hard work; at the end of it the men’s calicoes were in rags and they themselves bleeding from hundreds of scratches, while even our strong khaki suits had not escaped scatheless.

NATIVE PATH THROUGH THE MAKONDE BUSH, NEAR MAHUTA

I see increasing reason to believe that the view formed some time back as to the origin of the Makonde bush is the correct one. I have no doubt that it is not a natural product, but the result of human occupation. Those parts of the high country where man—as a very slight amount of practice enables the eye to perceive at once—has not yet penetrated with axe and hoe, are still occupied by a splendid timber forest quite able to sustain a comparison with our mixed forests in Germany. But wherever man has once built his hut or tilled his field, this horrible bush springs up. Every phase of this process

may be seen in the course of a couple of hours’ walk along the main road. From the bush to right or left, one hears the sound of the axe— not from one spot only, but from several directions at once. A few steps further on, we can see what is taking place. The brush has been cut down and piled up in heaps to the height of a yard or more, between which the trunks of the large trees stand up like the last pillars of a magnificent ruined building. These, too, present a melancholy spectacle: the destructive Makonde have ringed them— cut a broad strip of bark all round to ensure their dying off—and also piled up pyramids of brush round them. Father and son, mother and son-in-law, are chopping away perseveringly in the background—too busy, almost, to look round at the white stranger, who usually excites so much interest. If you pass by the same place a week later, the piles of brushwood have disappeared and a thick layer of ashes has taken the place of the green forest. The large trees stretch their smouldering trunks and branches in dumb accusation to heaven—if they have not already fallen and been more or less reduced to ashes, perhaps only showing as a white stripe on the dark ground.

This work of destruction is carried out by the Makonde alike on the virgin forest and on the bush which has sprung up on sites already cultivated and deserted. In the second case they are saved the trouble of burning the large trees, these being entirely absent in the secondary bush.

After burning this piece of forest ground and loosening it with the hoe, the native sows his corn and plants his vegetables. All over the country, he goes in for bed-culture, which requires, and, in fact, receives, the most careful attention. Weeds are nowhere tolerated in the south of German East Africa. The crops may fail on the plains, where droughts are frequent, but never on the plateau with its abundant rains and heavy dews. Its fortunate inhabitants even have the satisfaction of seeing the proud Wayao and Wamakua working for them as labourers, driven by hunger to serve where they were accustomed to rule.

But the light, sandy soil is soon exhausted, and would yield no harvest the second year if cultivated twice running. This fact has been familiar to the native for ages; consequently he provides in time, and, while his crop is growing, prepares the next plot with axe and firebrand. Next year he plants this with his various crops and

lets the first piece lie fallow. For a short time it remains waste and desolate; then nature steps in to repair the destruction wrought by man; a thousand new growths spring out of the exhausted soil, and even the old stumps put forth fresh shoots. Next year the new growth is up to one’s knees, and in a few years more it is that terrible, impenetrable bush, which maintains its position till the black occupier of the land has made the round of all the available sites and come back to his starting point.

The Makonde are, body and soul, so to speak, one with this bush.

According to my Yao informants, indeed, their name means nothing else but “bush people.” Their own tradition says that they have been settled up here for a very long time, but to my surprise they laid great stress on an original immigration. Their old homes were in the south-east, near Mikindani and the mouth of the Rovuma, whence their peaceful forefathers were driven by the continual raids of the Sakalavas from Madagascar and the warlike Shirazis[47] of the coast, to take refuge on the almost inaccessible plateau. I have studied African ethnology for twenty years, but the fact that changes of population in this apparently quiet and peaceable corner of the earth could have been occasioned by outside enterprises taking place on the high seas, was completely new to me. It is, no doubt, however, correct.

The charming tribal legend of the Makonde—besides informing us of other interesting matters—explains why they have to live in the thickest of the bush and a long way from the edge of the plateau, instead of making their permanent homes beside the purling brooks and springs of the low country.

“The place where the tribe originated is Mahuta, on the southern side of the plateau towards the Rovuma, where of old time there was nothing but thick bush. Out of this bush came a man who never washed himself or shaved his head, and who ate and drank but little.

He went out and made a human figure from the wood of a tree growing in the open country, which he took home to his abode in the bush and there set it upright. In the night this image came to life and was a woman. The man and woman went down together to the Rovuma to wash themselves. Here the woman gave birth to a stillborn child. They left that place and passed over the high land into the valley of the Mbemkuru, where the woman had another child, which

was also born dead. Then they returned to the high bush country of Mahuta, where the third child was born, which lived and grew up. In course of time, the couple had many more children, and called themselves Wamatanda. These were the ancestral stock of the Makonde, also called Wamakonde,[48] i.e., aborigines. Their forefather, the man from the bush, gave his children the command to bury their dead upright, in memory of the mother of their race who was cut out of wood and awoke to life when standing upright. He also warned them against settling in the valleys and near large streams, for sickness and death dwelt there. They were to make it a rule to have their huts at least an hour’s walk from the nearest wateringplace; then their children would thrive and escape illness.”

The explanation of the name Makonde given by my informants is somewhat different from that contained in the above legend, which I extract from a little book (small, but packed with information), by Pater Adams, entitled Lindi und sein Hinterland. Otherwise, my results agree exactly with the statements of the legend. Washing?

Hapana—there is no such thing. Why should they do so? As it is, the supply of water scarcely suffices for cooking and drinking; other people do not wash, so why should the Makonde distinguish himself by such needless eccentricity? As for shaving the head, the short, woolly crop scarcely needs it,[49] so the second ancestral precept is likewise easy enough to follow. Beyond this, however, there is nothing ridiculous in the ancestor’s advice. I have obtained from various local artists a fairly large number of figures carved in wood, ranging from fifteen to twenty-three inches in height, and representing women belonging to the great group of the Mavia, Makonde, and Matambwe tribes. The carving is remarkably well done and renders the female type with great accuracy, especially the keloid ornamentation, to be described later on. As to the object and meaning of their works the sculptors either could or (more probably) would tell me nothing, and I was forced to content myself with the scanty information vouchsafed by one man, who said that the figures were merely intended to represent the nembo—the artificial deformations of pelele, ear-discs, and keloids. The legend recorded

by Pater Adams places these figures in a new light. They must surely be more than mere dolls; and we may even venture to assume that they are—though the majority of present-day Makonde are probably unaware of the fact—representations of the tribal ancestress.

The references in the legend to the descent from Mahuta to the Rovuma, and to a journey across the highlands into the Mbekuru valley, undoubtedly indicate the previous history of the tribe, the travels of the ancestral pair typifying the migrations of their descendants. The descent to the neighbouring Rovuma valley, with its extraordinary fertility and great abundance of game, is intelligible at a glance—but the crossing of the Lukuledi depression, the ascent to the Rondo Plateau and the descent to the Mbemkuru, also lie within the bounds of probability, for all these districts have exactly the same character as the extreme south. Now, however, comes a point of especial interest for our bacteriological age. The primitive Makonde did not enjoy their lives in the marshy river-valleys.

Disease raged among them, and many died. It was only after they had returned to their original home near Mahuta, that the health conditions of these people improved. We are very apt to think of the African as a stupid person whose ignorance of nature is only equalled by his fear of it, and who looks on all mishaps as caused by evil spirits and malignant natural powers. It is much more correct to assume in this case that the people very early learnt to distinguish districts infested with malaria from those where it is absent.

This knowledge is crystallized in the ancestral warning against settling in the valleys and near the great waters, the dwelling-places of disease and death. At the same time, for security against the hostile Mavia south of the Rovuma, it was enacted that every settlement must be not less than a certain distance from the southern edge of the plateau. Such in fact is their mode of life at the present day. It is not such a bad one, and certainly they are both safer and more comfortable than the Makua, the recent intruders from the south, who have made USUAL METHOD OF good their footing on the western edge of the CLOSING HUT-DOOR plateau, extending over a fairly wide belt of country. Neither Makua nor Makonde show in their dwellings anything of the size and comeliness of the Yao houses in the plain, especially at Masasi, Chingulungulu and Zuza’s. Jumbe Chauro, a Makonde hamlet not far from Newala, on the road to Mahuta, is the

most important settlement of the tribe I have yet seen, and has fairly spacious huts. But how slovenly is their construction compared with the palatial residences of the elephant-hunters living in the plain.

The roofs are still more untidy than in the general run of huts during the dry season, the walls show here and there the scanty beginnings or the lamentable remains of the mud plastering, and the interior is a veritable dog-kennel; dirt, dust and disorder everywhere. A few huts only show any attempt at division into rooms, and this consists merely of very roughly-made bamboo partitions. In one point alone have I noticed any indication of progress—in the method of fastening the door. Houses all over the south are secured in a simple but ingenious manner. The door consists of a set of stout pieces of wood or bamboo, tied with bark-string to two cross-pieces, and moving in two grooves round one of the door-posts, so as to open inwards. If the owner wishes to leave home, he takes two logs as thick as a man’s upper arm and about a yard long. One of these is placed obliquely against the middle of the door from the inside, so as to form an angle of from 60° to 75° with the ground. He then places the second piece horizontally across the first, pressing it downward with all his might.

It is kept in place by two strong posts planted in the ground a few inches inside the door. This fastening is absolutely safe, but of course cannot be applied to both doors at once, otherwise how could the owner leave or enter his house? I have not yet succeeded in finding out how the back door is fastened.

MAKONDE LOCK AND KEY AT JUMBE CHAURO

This is the general way of closing a house. The Makonde at Jumbe Chauro, however, have a much more complicated, solid and original one. Here, too, the door is as already described, except that there is only one post on the inside, standing by itself about six inches from one side of the doorway. Opposite this post is a hole in the wall just large enough to admit a man’s arm. The door is closed inside by a large wooden bolt passing through a hole in this post and pressing with its free end against the door. The other end has three holes into which fit three pegs running in vertical grooves inside the post. The door is opened with a wooden key about a foot long, somewhat curved and sloped off at the butt; the other end has three pegs corresponding to the holes, in the bolt, so that, when it is thrust through the hole in the wall and inserted into the rectangular opening in the post, the pegs can be lifted and the bolt drawn out.[50]

MODE OF INSERTING THE KEY

With no small pride first one householder and then a second showed me on the spot the action of this greatest invention of the Makonde Highlands. To both with an admiring exclamation of “Vizuri sana!” (“Very fine!”). I expressed the wish to take back these marvels with me to Ulaya, to show the Wazungu what clever fellows the Makonde are. Scarcely five minutes after my return to camp at Newala, the two men came up sweating under the weight of two heavy logs which they laid down at my feet, handing over at the same time the keys of the fallen fortress. Arguing, logically enough, that if the key was wanted, the lock would be wanted with it, they had taken their axes and chopped down the posts—as it never occurred to them to dig them out of the ground and so bring them intact. Thus I have

two badly damaged specimens, and the owners, instead of praise, come in for a blowing-up.

The Makua huts in the environs of Newala are especially miserable; their more than slovenly construction reminds one of the temporary erections of the Makua at Hatia’s, though the people here have not been concerned in a war. It must therefore be due to congenital idleness, or else to the absence of a powerful chief. Even the baraza at Mlipa’s, a short hour’s walk south-east of Newala, shares in this general neglect. While public buildings in this country are usually looked after more or less carefully, this is in evident danger of being blown over by the first strong easterly gale. The only attractive object in this whole district is the grave of the late chief Mlipa. I visited it in the morning, while the sun was still trying with partial success to break through the rolling mists, and the circular grove of tall euphorbias, which, with a broken pot, is all that marks the old king’s resting-place, impressed one with a touch of pathos.

Even my very materially-minded carriers seemed to feel something of the sort, for instead of their usual ribald songs, they chanted solemnly, as we marched on through the dense green of the Makonde bush:—