Corporations exist to make money. Who knew?

Alexandria, VA – June 9, 2016

Today we’re going to talk about profit. I like profit. Who doesn’t, right?

Seriously, money is not an end in itself; it is a means to an end. It brings a certain level of security. Corporations are formed to raise profits for shareholders. The objective of the corporation is to make money; indeed, that is how a corporation attracts shareholders as investors. Corporations are not formed to be charitable organizations. Charitable organizations are formed to be charitable organizations (in their many forms). Both types of entities, for-profit and non-profit, serve important purposes.

And what happens when a corporation’s Board of Directors decides that the corporation should become a charitable organization? Can the Board do that?

In short, no. Courts generally do not interfere with private companies’ business decisions. For example, whether or not to issue special dividends to shareholders is generally considered to be a business decision. However, in an interesting case involving the Ford Motor Company, shareholders challenged the Board of Directors’ decision not to issue dividends, and won.

Back in the early 1900s, Henry Ford’s company was booming. His company couldn’t fill orders for cars quickly enough. Capital was quickly accumulating and shareholders were making money. In the case, Dodge v. Ford Motor Co., 204 Mich. 459., the Supreme Court of Michigan goes over the numbers and I won’t bore you with them here. Suffice it to say that the company was making tons of money for shareholders, and had a huge surplus. In 1916 Ford Motor Co. turned a $60 million profit.

During this time, Henry Ford decided to withhold dividends from shareholders in order to reinvest in the company. Sounds like a business decision, one in which the courts probably should not get involved. However, two of the largest minority shareholders, John Francis Dodge and Horace Elgin Dodge (yes, THOSE Dodge brothers, Ford’s competitors), filed suit, arguing that Ford Motor Co. should pay out the dividends to shareholders. The plaintiffs’ rationale was that Henry Ford had decided to run the company as a charitable organization, not for the benefit of shareholders, and that such decision was against the company’s charter (this being a corporation that solicited investments from shareholders on the promise that shareholders could make money).

It’s not difficult to see that the Dodge brothers had their own motives here. After all, they took the dividends they eventually received and invested them in their own company. But the record shows that their argument had merit.

The Court stated the general rule in this situation: “…it is for the Directors, and not the stockholders, to determine whether or not a dividend shall be declared.” And, further, “When,…the directors have exercised this discretion and refused to declare a dividend, there will be no interference by the courts with their decision, unless they are guilty of a willful abuse of their discretionary powers, or of bad faith or of a neglect of duty.” The Court then states that proving fraud or a breach of trust is a high bar, as it should be. Trust me; you don’t want the courts policing every business decision made by a private company.

Indeed, the Board of Directors owes a fiduciary duty to shareholders to act in shareholders’ best interest, including making money for them. If shareholders don’t like how the Board makes business decisions, they can vote for a new Board when the time comes.

Generally, a Board can withhold profits to reinvest in the company, again pursuant to business judgment, but the Board “cannot arbitrarily withhold profits earned by the company, or apply them to any use which is not authorized by the company’s charter.” Here, the Court determined that Henry Ford was changing the nature of the corporation, and this was not legally permissible.

When the Dodge brothers brought suit, the Ford company had just had its most prosperous year of business. In other similarly prosperous years, it had been company practice to pay larger dividends. Therefore, the Court called on the Board to justify its refusal to pay dividends in this case. Specifically, the Court asked, how is the capital (from withholding dividends to shareholders) going to be used?

The Court points out that Ford’s business plan as of August 1916 called for a decrease in the sales price of cars. This was inexplicable because Ford had no problem selling its cars at the higher price. Why lower it? With the price reduction, Ford would turn less of a profit, the value of shares would decrease, and shareholder returns would thus be reduced. Why do this?

Because, the Dodge brothers argued, Henry Ford wanted to run the business as a charitable organization, not for profit. Ford’s own statements show this to be the case.

The Dodge brothers showed that Henry Ford dominated Ford Motor Co: “No plan of operations could be adopted unless he consented, and no board of directors can be elected whom he does not favor.”

When asked, Ford stated, “My ambition is to employ still more men, to spread the benefits (read: at shareholder expense) of this industrial system to the greatest possible number, to help them build up their lives and their homes. To do this we are putting the greatest share of our profits back in the business.” To this end, Henry Ford had decided, in the summer of 1916, that no dividends other than regular dividends should be paid “for the present.” When asked during testimony whether he had fixed in his mind any time in the future when he would again pay special dividends, Mr. Ford stated “No.” When pressed on whether that decision was indefinite, Mr. Ford answered, “That was indefinite.”

The Court finds that the record showed that Mr. Ford’s attitude was that the company had made a ton of money for shareholders, and that shareholders should be content to take whatever Mr. Ford chose to give them. His testimony further reflected that he thought Ford Motor Co. made too much money and that, although the company could continue to earn large profits, “a sharing of them with the public, by reducing the price of the output of the company, ought to be undertaken.” In short, the Court found that Mr. Ford was driven solely by humanitarian and philanthropic interests, not by his fiduciary duty to shareholders.

Mr. Ford’s counsel argued that a corporation can undertake charitable works that are incidental to the main business of the corporation. However, here the Court found that Mr. Ford’s strategy was not merely “incidental” to the company’s business:

“There should be no confusion (of which there is evidence) of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders. A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the nondistribution of profits among stockholders in order to devote them to other purposes.” (My italics).

Directors of a corporation exercise their business judgment within the confines of the law:

“There is committed to the discretion of directors, a discretion to be exercised in good faith, the infinite details of business, including the wages which shall be paid to employees, the number of hours they shall work, the conditions under which labor shall be carried on, and the prices for which products shall be offered to the public. It is said by appellants that the motives of the board members are not material and will not be inquired into by the court so long as their acts are within their lawful powers. As we have pointed out, and the proposition does not require argument to sustain it, it is not within the lawful powers of a board of directors to shape and conduct the affairs of a corporation for the merely incidental benefit of shareholders and for the primary purpose of benefiting others, and no one will contend that if the avowed purpose of the defendant directors was to sacrifice the interests of shareholders it would not be the duty of the courts to interfere.” (My italics).

Indeed, most large corporations (thankfully) conduct charitable projects that are incidental to their main business activities. That is different from deciding not to act in shareholders’ best interests which, as stated above, in contrary to the law. Mr. Ford should have established his own charitable company, with a motive different than that of the corporation, to divert his own money to charitable ends. He could then have donated all the money he wanted. He could also have realized that, if the company’s shareholders made more money they would have more disposable income to donate to their preferred charitable causes. What a thought.