A.J. Ceberio
Sustainable Corporations
Final Paper
Ford v. Ford
Abstract
On February 7, 1919, the Michigan Supreme Court released one of the most well-known business law decisions in American legal history. For the past century Dodge v. Ford Motor Co. has created an epic battle among legal scholars. On its face, the case stands for the principle of shareholder wealth maximization; I would argue that Henry Ford was never truly fighting with the Dodge brothers, but rather the case’s caption should have read Ford v. Ford.
When I began drafting this paper, my provisional title was “Beating the Dead Horse that is Dodge v. Ford Motor Co.” I had intended to harp on than fact that many students—myself included—hate this case. We read it, think we understand it, then reread it and scratch our heads. To make matters worse, we then turn to generation y’s best friend, “Google,” only to find hundreds of articles debating whether or not the case is even good law. My intention was to discuss the specifics of the case under current laws, but after completing several drafts I recognized that my paper was simply a recreation of the thoughts of others.
In my opinion, the most important question is why Henry Ford lost all those years ago. In this paper I will discuss the history of Henry Ford himself, the history of the Ford Motor Company, and finally how arrogance and/or ineffective counsel led to the outcome in court. Although I suggest that the odds were stacked against Ford, I believe that it was possible for him to come out on top.
The History of Henry Ford
In order to understand what ultimately happened in Dodge v. Ford, we must begin with a brief history of Henry Ford himself. Henry Ford was born on a farm in Michigan in 1863. As a young child Ford did not express an interest in farming but rather enjoyed building water wheels and steam engines. At age 16 Ford took a position as an apprentice with the Michigan Car Company working on railroad cars. After bouncing around for a few years—learning all that he could along the way—Ford returned to the farm. This time, instead of working on water wheels with his childhood friends, Ford began servicing portable steam engines for farmers. During that time Ford also held several odd jobs including cutting and selling timber and working in factories. Although Ford had not developed a definitive career path, one thing was becoming clear; Ford did not like taking orders from anyone else.
In 1891, Ford took a position with the Edison Electric Illuminating Company in Detroit. He knew nothing about electricity, but it only took him five years to become chief engineer. While at Edison, Ford convinced the company’s president to allow him to use a workshop to create a self-propelled vehicle. In return, Ford gave the company’s president a small equity stake in the prototype. In 1896 Ford and a group of friends completed their first prototype, the “Quadricycle.” The Quadricycle, shown in the image to the left, was a step in the right direction, but was in need of improvements. It was steered with a tiller, had only two speeds and no reverse. Ford then turned to investors to assist with the production of his second prototype. In 1899, Ford completed the second prototype. This time the finished product was significantly more polished and attracted the attention of several investors.
A wealthy venture capitalist named William Murphy took an interest in the prototype and conducted an 80-mile test drive. After a successful day on the road, Murphy agreed to fund Ford and organize the Detroit Automobile Company. Murphy convinced his wealthy friends to invest in the company providing Ford with the resources he needed in exchange for significant shareholder equity. At the time, Ford had no money, but had the mechanical skills. As such, he did not contribute any capital to the company, but was given only a minority interest. At the time, this may have seemed like a good deal for Ford, but it would ultimately lead to the peril of the Detroit Automobile Company. He was always improving the design of the prototype and was reluctant to send it through to the production phase. This quickly made the majority shareholders agitated. It would likely follow that the majority shareholders would then begin to insert their own board members and supervisors to push Ford. As we have already discussed, Ford learned at a young age that he did not like listening to others, and this was no different. Ultimately Ford refused to comply with the majority shareholders’ wishes, and the company was dissolved in 1901.
Although the Detroit Automobile Company was dissolved, the prototype and Ford’s vision remained. Ironically, Murphy, the man who provided the funding for the Detroit Automobile Company continued to support Ford. He was willing to give Ford more time with less pressure. Together they formed the Henry Ford Company in November of 1901. Ford had learned that he did not enjoy holding a minority interest, but that did not change the fact that he needed money. This time Ford again agreed to a minority interest—although significantly larger than before—in return for capital contributions. Unfortunately, the new company was even worse for Ford. He was already hesitant, to say the least, about being a minority shareholder, and this time he was the minority shareholder of a company that had his name on the door; it only took three months for Ford to quit.
Henry Ford was quite possibly the best historical example of a person that was either loved or hated. By all accounts he was anti-Semitic, arrogant and stubborn; yet he was generous, philanthropic and a visionary. It is interesting that Ford is not the only corporate executive to be described with these words. In fact, it is fascinating to compare Ford with Apple’s former chief executive officer, Steve Jobs. Like Ford, Jobs was often described as “harsh, arrogant, unkind and impatient.” On the other hand, many loved Jobs as his contributions to world were numerous. Some have gone so far as to call Jobs the Ford of our time. The greatest similarity between Ford and Jobs was their ability to understand consumers and market existing products. Just as Ford did not invent the automobile, Jobs did not invent the computer or the smartphone; he helped make them better and marketed them in a new way.
It was no secret that Ford had a deep hatred of board members—whom at the time held their positions solely by virtue of their ownership interests—viewing them as “elitists and speculators who knew nothing about machines, cars, or manufacturing.” Ford was vocal about his distrust and hatred of elitists and Jews. In an interview he said, “The Jew is a mere huckster, a trader who doesn’t want to produce, but to make something out of what somebody else produces.” It was not just board members that Ford disliked; it was all investors. Ford viewed them as “parasites.” Again, it is important to understand his reasoning. Right or wrong, Ford was fed up with answering to others. He had big ideas and was tired of being held back. Most people believe that Ford simply preferred those who made things over those who made money off of those that actually put in the hard work. I think the motive is more innate than that; Ford was jealous. He was a gifted engineer with visions that most people could not dream of. Unfortunately, businesses need two things to succeed: a good idea and money. Ford only had one of the two. He was forced to take the money of others and subordinate his interests to theirs. As a result, he was taking orders from people whose only contribution was money. Ford had a difficult time coping with this dynamic, but a century later it seems capitalists still call the shots.
Ford Motor Company
By Christmas of 1901 Ford had learned that he truly could not work under the control of others. He was quoted as saying, “From here in, my shop is always going to be my shop… I’m not going to have a lot of rich people tell me what to do.” Unfortunately, Ford was still forgetting about a very crucial piece; he needed money! In early 1902, Ford partnered with Alexander Malcolmson. Malcolmson agreed to provide Ford with the resources he needed to create another prototype, but to allow Ford to run the show.
This time Ford had a different plan. In the past Ford had built excellent prototypes, but when it came down to it, he could not stop tinkering long enough to send them through to production. As a result, Ford made the decision to outsource the manufacturing process. The process would work beautifully, and in just one year Ford had his best prototype yet, ten new investors, and he and Malcolmson started the Ford Motor Company. Although I find it to be significant, scholars do not often discuss the Dodge’s path to ownership. The Dodge brothers were originally contracted by Ford to build the engines and transmissions for the prototype, but by virtue of Ford’s inability to make timely payments on the notes for the purchased engines, the Dodge brothers were given a 10% interest in the company. I purpose that Ford hated the Dodge brothers’ demands even more than he hated typical elitists. Elitists made money by investing money; the Dodge brothers procured ownership interest in the Ford Motor Company by default.
Within a short amount of time, the Ford Motor Company became incredibly profitable. It was paying dividends that were almost incomprehensible. In 1904, just one year after the Ford Motor Company came into existence, the company made profits of $300,000 paying dividends of nearly $100,000. In 1910 the company made $4.5 Million in profits distributing $2 Million in dividends to its shareholders. The annual dividends continued to grow each year and in 1915 amounted to $16.2 Million on profits of $24.6 Million. To put these numbers in perspective, the Dodge brothers owned 10% of the Ford Motor Company. Their capital contribution was $10,000. That means that their dividend in 1904 repaid their initial investment in full. Their dividend in 1905 provided them of a return of 100% within two years. Over the course of the first 13 years of the Ford Motor Company, the Dodge brother’s investment of $10,000 returned more than $35 Million.
The Lawsuit
The issue that led to this suit came about in 1916. During that year the Ford Motor Company made $60 Million in profits but decided to pay only $3.2 Million in dividends. Instead, Ford decided to put 95% of the profits back into the company in order to increases wages and build a new factory known as the River Rouge factory. The new factory would feature innovative technology, such as a new method for manufacturing iron and would employ thousands of additional workers. According to Ford, the factory was necessary to meet demand as he expected to nearly double the number of sales from 1916 to 1917.
The Dodge brothers filed suit seeking an injunction on the construction of the River Rouge factory and a court order for the payment of special dividends. The Dodge brothers won at the trial court level, and Ford timely appealed.
The Michigan Supreme Court faced two issues on appeal. The first was the injunction on the construction of the River Rouge factory. With regard to the injunction the court was overturned and the injunction was lifted. Ultimately the factory was built and remains one of the largest automobile manufacturing plants in the world. (A photograph of the plant is found to the right)
The second issue on appeal—and the one that we continue to argue about—was Ford’s decision to not pay special dividends and to reinvest the earnings in the company. The court stated “[t]he management of the corporation and its affairs rests in the board of directors, and no court will interfere or substitute its judgment so long as the proposed actions are not ultra vires or fraudulent. They may be ill advised, in the opinion of the court, but this is no ground for exercise of jurisdiction. The board has full power over the matter of investing the surplus and as to dividends so long as they act in good faith.” They court continued that “[t]he judges are not business experts,” and stated “[t]he experience of the Ford Motor Company is evidence of capable management of its affairs.”
Although the phrase does not appear within the court’s opinion, today we know the standard the court applied to be a variation of the “business judgment rule.” Under this standard, a court will not second-guess the decisions of a director as long as they are made (1) in good faith, (2) with the reasonable belief that they are acting in the best interests of the corporation. The key elements of the rule are “good faith” and “reasonable belief.” The existence of those two terms creates a very low bar for directors to overcome.
Typically, in corporate law, when you see the court say the phrase “business judgment rule” you can nearly stop reading because it is extremely likely that the directors will not be found at fault. However, here the Michigan Supreme Court focused on “good faith” and came out the other way. So, why did this court use all of the right language, but come out the other way?