Commercial Law: An Historical Account

A Medieval Fair

Commercial Law
Class II
alessandro.pomelli@unibo.it
Subject to copyright. Do not reproduce or circulate without the Author’s consent
 Once Upon a Time…
 The birth of something close to what we today call commercial
law dates back to the XI and XII centuries A.D. (low Middle Ages)
as far as Europe is concerned.
 At that time there was what is dubbed, in Latin words, “lex
mercatoria” or “ius mercatorum” («Merchant Law»).
– It was no State law because States with clear administrative borders
and a legislative sovereign power did not exist yet. At the time there
were only different kinds of scattered-around city-states.
– It was a form of primitive transnational law that started departing
from ancient Roman civil law, which in turn had survived the collapse
of the Empire throughout Europe.
– It was originally made of a number of oral mercantile customs
spontaneously abided by merchants while dealing among
themselves and with customers and clients
– It was later and progressively, though slowly, turned into written,
and thus more certain, statutes held and amended by merchants’
associations.
– Legal controversies were arbitrated by newly established merchants’
courts, which were separate from the official judiciary of the
municipality.
 Principles of Lex Mercatoria
 Freedom of contract
– Contrary to ancient Roman law, which gave birth to European
private law but did not allow unfettered freedom of contract.
– Under Roman law, contracts were limited to a specified and
severely regulated number, and followed sacred forms.
 The first truly commercial contracts were born
– Bank and insurance contracts find their roots in these times.
 Intense creditor protection
– Ex.: Liability of multiple debtors turns from being just
“several” (or “proportionate”), as it was under Roman law, to
becoming “joint and several”
 Governance of multiple contractual relationships in the
interest of all creditors rather than individual creditors
– Prototype of modern bankruptcy proceedings in the name
of the principle of “par condicio creditorum” (equal
treatment of all creditors vis-à-vis their bankrupt debtor)
replacing the ordinary Roman law principle of “prius in
tempore, potior in iure” (the creditor who is prior in time is
stronger in right)
 Development of long-lasting, complex business ventures
– The first prototypes of business partnerships are devised in
order to favor the aggregation of individuals and resources
to carry out business activity collectively
 In the XV century, the first lenders by profession close to what
we today call banks come to exist
– The Italian Monte dei Paschi di Siena claims to be the most ancient
banking institution in the world. It was set up in 1472. Today it still is
among the largest Italian bank by assets.
 Chaotic medieval fairs became organized exchanges of goods
where the first rules being devised would one day become rules
applicable to the modern stock exchanges
– Clearance and settlement of transactions at a later date
– Compensation and netting of opposing entries to lower the circulation
of money and the ensuing risk of loss or theft.
 It is in the XV-century Bruges (today beautiful town of modern
Belgium but earlier belonging to The Netherlands) where the
merchants Van der Burse (of Venetian descent and once named
“Della Borsa”) first organized exchanges of goods in their house
– Hence the name Borsa (in Italian), Bourse (in French) to refer to a
location - once physical, today mostly virtual - where goods and /or
financial securities are publicly traded.
 Formation of National States
 It approximately starts from the XVI century A.D.
 After the “dark” Middle Ages, the resurrection of
Europe leads to the formation of the first national
States, the ascendants of our modern European States.
– United Kingdom, France, Spain and others
 Sovereignty over a territory - requirement for each
State which wants to be as such - means having own
army, currency and law.
– A bunch of transnational mercantile rules were
incompatible with the goal of having state sovereign law
regardless of how efficient they might be.
 States (monarchs, parliaments, etc..) got their hands on
commercial law by issuing their first statutory (written) laws
(however still resembling the customs being followed until then).
 States also set up their own official commerce courts to replace
the old arbitration chambers of the merchants.
– The law cannot be state law if it is not applied by state-appointed
public officials or by officials duly authorized by the State.
 Stock exchanges ceased to be a private affair of illuminated
merchants and became public, state-owned institutions subject
to increasing state regulation.
– The Milan Stock Exchange, for instance, was set up in 1808 by a decree
of the then lieutenant of Napoleon in charge of the kingdom of Italy.
 The Birth of Partnerships and
Companies/Corporations

Commercial Law
Class II continued
alessandro.pomelli@unibo.it
Subject to copyright. Do not reproduce or circulate without the Author’s consent
 Ancient Rome
 There was no such an institution akin to the modern business partnership or
company in Roman times.
 There existed, however, a form of joint ownership over assets to be put to
business uses called societas, from which the modern concept of partnership
and company has derived (hence the Italian “società”, the French “société”,
the Spanish “sociedad” to refer to partnerships and companies).
 Unlike the modern partnerships and companies that would follow in history,
however, this early societas was not conceived as an entity separate from its
members. Besides, It was also used for activities other than economic ones.
 It today survives only in a few jurisdictions as a hybrid between an ordinary
association of individuals and a business partnership and it is regulated by civil
law rather than commercial law:
– France: Société civile; Spain: Sociedad Civil ; Germany: Gesellschaft bürgerlichen Rechts

– Italy: Existing in the past, it disappeared in 1942 with the entry into force of the new
civil code.
 Middle-Ages
 “Compagnia”
– It is the ascendant of the modern, worldwide-existent general
partnership
– This institution was born in the Italian mercantile cities (Pisa,
Florence, Venice, Genoa) of the XII – XIV centuries upon the
initiative of the wealthiest merchants’ families of the time.
– Its primary goal was to carry out trades in goods.
– It is the first example of an aggregation of individuals and
resources for the collective pursuit of a business activity with the
aim of dividing the profits among its members in proportion with
the resources contributed by each member.
– It gave birth to a few basic legal features that have accompanied
partnerships and companies until today. What are they?
1. Autonomous legal capacity
 It is the first example of an aggregation of individuals enjoying a legal
capacity by itself - though not yet a full-blown legal personality - which is
distinct and separate from that of its individual members.
 The individuals to whom management is delegated have the power to bind
the firm in contract, i.e. sell and buy assets in the name of the firm rather
than in their own.
2. “Weak form” entity shielding (or weak “affirmative asset partitioning”)
 Creditors of the firm have a priority over the creditors of the individual
members against the assets of the firm. Their claims are senior to any
other competing claim.
 The assets of the firm are a segregated pool available to secure business
debts first. In case of insolvency, i.e. in case the firm stops paying off its
debts, the firm’s creditors may attach (or execute) on the assets of the firm
(i.e. “get their hands” on them for their benefit) before anyone else.
3. All members could exercise managerial powers
• Power to run the firm, make investments, buy and sell goods, etc.
4. All members of the partnership bore unlimited liability for
partnership’s debts and obligations
• No distinction was made between active partners, actively
involved in management decisions, and “sleeping” partners, i.e.
those left outside of an active involvement in management
decisions.
• All of them would bear the same unlimited liability.
• Should the firm fail to pay the counterparty to the contract or the
creditor, the partners would be called for to pay instead. All of
their personal assets were at risk of loss.
• Partners were automatically made guarantors of the firm’s debts,
i.e. by the mere fact they did take managerial decisions or could
have done so on behalf of the firm, regardless of their will or
awareness in this regard.
 “Commenda”
– It is the ascendant of the modern, worldwide-existent limited
partnership
– This institution, too, was born in the Italian mercantile cities (Pisa,
Florence, Venice, Genoa) of the XII – XIV centuries upon the initiative of
the wealthiest merchants’ families of the time. Its goal was once again
to carry out trades in goods.
– The Commenda exhibited all the contractual features of the Compagnia
seen above except for the existence of two different categories of
partners:
1. Those that managed the firm and incurred unlimited liability for
partnership’s debts and obligations
2. Those that just contributed capital to the firm expecting to make a
profit, refrain from managing it and were awarded the privilege of
limited liability for partnership’s debts and obligations
 Managing partners/members bore unlimited liability for
partnership’s debts and obligations
• Only those partners who run the firm, i.e. making investment
decisions, sales and purchases and so forth (ship captains,
travelling merchants), would be personally liable for all debts
and obligations incurred by the firm in its name
• Should the firm fail to pay the counterparty to the contract or
the creditor, the managing partners, and they alone, would be
called for to pay instead.
• They, and they alone, were automatically made guarantors of
the firm’s debts, i.e. by the mere fact they were in charge of
taking decisions on behalf of the firm and regardless of their
will or awareness in this regard.
 Non-managing owners/members bore limited liability
for the firm’s debts and obligations
– While managing partners would put all of their personal
assets at risk of loss….
– …..Non-managing partners, as passive “sleeping” investors,
would not and could not risk losing more than the amount
of money or other resources they freely decided to
contribute to and ultimately invested in the firm
– They did not have that portion of personal wealth not
directly invested in the firm at risk of loss.
– Their personal assets were therefore fully shielded from the
claims of the firm’s creditors, who could not attach and/or
execute on them due to the firm’s failure.
XV and XVI Centuries leading up to a Corporate
Revolution: The Joint-Stock Corporation
 Europe-led colonialism and imperialism of the time spurred
investments in commercial expeditions into remote locations in
search of profits
 Such commercial expeditions in far-flung territories might also
be very risky though, not only because of the usual dangers of
piracy, disease and shipwreck, but also because changes in
demand and supply of many goods, such as spices, could make
prices tumble at just the wrong moment, thereby ruining
prospects of profitability.
 To manage such risk the forming of a cartel to control supply
would seem logical.
 But something else was needed: Extensive personal limited
liability in case of loss and a more modern corporate
governance.
 This first occurred to the English, who bundled their
forces into a monopoly and military enterprise, the East
India Company in 1600,
 In 1602, the Dutch government followed suit, sponsoring
the creation of a single United East Indies Company that
was also granted a monopoly over the Asian trade.
 Both Companies were created by royal charter (an act of
the monarch), which defined the legal status of the new
entity as well as rights and duties of their participants.
 British and Dutch East India Companies are the
ascendants and prototypes of the modern joint-stock
corporation that would one day make its way into every
other developed jurisdiction.
 Some Basic Corporate Features of the Joint-Stock
Corporation that Sailed Through Corporate Law History
1. Creation of a legal entity/person separate from its
owners
 The British/Dutch royal charter granted full-blown legal
personality (not just mere legal capacity) to the company,
making possible for it to act in its own exclusive name,
acquire rights and take on obligations in its own name, have
its own patrimony fully separate from that of its members,
by means of its “formal incorporation”
2. “Strong form” entity shielding (or strong “affirmative
asset partitioning”)
 The assets of the company were available for seize solely by
the firm’s creditors.
 Personal creditors of the members were altogether barred
from attaching the firm’s assets
3. Protection against liquidation of individual investments
at will
 The capital commitment was made permanent during the
lifetime of the company. Owners could not generally
withdraw from the company, i.e. liquidate their
investments at will until dissolution of the company.
4. Limited liability extended to all owners (“defensive asset
partitioning”)
 The investments made by the owners formed the equity
capital of the company, which the company used to do
business and pay off its debts.
 No investor in the company risked losing more than the
amount invested in the company in case the company run
losses and became insolvent.
 Their investment risk, i.e. their personal liability, was
capped at what effectively invested and no more. They did
not have all of their personal wealth at stake.
5. Management formally separate from the ownership
base.
 Formal distinction and separation between a collegial
body comprised of the owners on the one hand, and on
the other hand a professional managerial body
comprised of directors and a chief manager in charge of
managing the company on behalf of the owners.

6. Issuance of shares
 Paper certificates (shares) representing an ownership
interest in the company were issued to each member in
proportion to the amount of capital contributed.
 They might circulate between buyers and sellers as if
they were movable goods.
7. Free transferability and public trading of the shares
 Owners that wished to liquidate their interest before
the dissolution of the company could only do this by
selling their shares to others on a stock market
 The Amsterdam Stock Exchange was precisely
established in 1602 by the Dutch East Indies
Company for dealings in its printed stocks (and
bonds).
 It is considered the first to formally begin trading in
securities and thereby establishing the modern
concept of stock exchange.
 Transferability and negotiability of shares on a public
stock market could for the first time earn their owners
positive (or negative) returns by way of their sale at a
higher (or lower) price than the original purchase price
8. Periodic distribution of profits
 Joint-stock companies paid out divisions of profits, so
called “dividends”, to their shareholders by dividing up
the profits of the voyage in proportion of the shares
held in the company.
 Divisions were usually in cash, but when working
capital was low and it was detrimental to the survival
of the company, divisions could be paid out in kind,
such as the remaining cargo, which could then be sold
by shareholders for profit.
 Evolution of Joint-Stock Companies
 For a long time incorporation was only possible by an
individual, tailored Royal charter or Act of Parliament for
the benefit of some privileged, powerful merchants, owing
to the government's jealous protection of the privileges
and advantages thereby granted.
 As a result of the rapid expansion of capital intensive
enterprises in the course of the industrial revolution in
Britain, many businesses came to be operated as
unincorporated associations or extended partnerships, with
large numbers of members.
– Nevertheless, membership of such associations was usually
short term and unstable, so their nature was constantly
changing and unsecure for the development of businesses with
a long-term horizon.
 Consequently, a general rule of registration and
incorporation of companies in the form of a joint-stock
company was eventually introduced in Britain by the
Joint Stock Companies Act of 1844.
 Initially companies incorporated under this Act did not
automatically award their members limited liability,
although it became common for companies to include a
limited liability clause in their internal rules of operation.
– In the case of Hallett v. Dowdall (1852) referring to
partnerships, the English Court of the Exchequer held
however that such clauses only bound creditors who had
prior notice of, and agreed to such clauses.
 Four years later the Joint Stock Companies Act of 1856
provided for limited liability for members of all joint-stock
companies provided, amongst other things, that such
companies included the word "limited" in their company
name.
 Now all merchants and businessmen could set up a joint-
stock company. It was no more a special, arbitrary grant
from the Monarch. It was made a legitimate right for
everybody provided that all legal requirements were met.
– In the landmark case of Salomon v. A Salomon & Co Ltd
(1897), the British House of Lords conclusively established
that a limited liability company, by being as such, also enjoyed
a formally distinct legal personality, separate from that of its
individual members.
 The United States
 The world's first modern limited liability law was however
enacted by the state of New York in 1811 and joint-stock
companies came onto the scene there in the same
century:
– The Unites States of the time was far from what it is today.
Half of today’s territories, those in the far west, were still
unreachable.
– Because of political and economic reasons, there was the
need to connect the East to the West and give new lands to
the migrants from Europe and the rest of the world. To get
there, railways were required.
 The first large-scale enterprises in need of large capital for
investments to appear in the US in the 19th century were
indeed railway companies.
 In order to finance their ambitious plans of massive
railways construction, they were turned into joint-stock
companies and started raising money from the retail
public by selling them shares and making them tradable
on stock markets.
 The stock market on Wall Street had opened on May 17, 1792
 24 brokers had signed the Buttonwood Agreement outside 68
Wall Street in New York underneath a buttonwood tree
 This successful scheme for the financing of much-needed
infrastructure fueled the conquest of West and, most
importantly, lay the foundations of what today are one of
the world-largest market for goods and services and still
the world-largest financial securities markets