Common Law

Common Law is a legal system built not on a giant rulebook written by politicians, but on centuries of judicial decisions. Think of it as law created by judges, case by case. Originating in England, this system is the legal foundation of countries like the United States, the United Kingdom, Canada, and Australia. Unlike its counterpart, Civil Law, which relies on comprehensive, codified statutes, Common Law is dynamic. It evolves as judges interpret past rulings—a concept known as precedent or stare decisis—and apply them to new, unique situations. For an investor, this is hugely important. A strong Common Law tradition is often linked with robust protection of private property rights, enforceable contracts, and safeguards for investors, creating a more predictable and secure environment to grow your capital. It’s the legal bedrock upon which many of the world's most successful capital markets have been built.

At the heart of Common Law is the principle of stare decisis (Latin for 'to stand by things decided'). This means that courts are bound by the decisions of previous, higher courts in similar cases. When a judge faces a new dispute, they look back at the historical case law—the collection of past rulings—to find a 'precedent'. If a relevant precedent exists, the judge is generally required to apply the same legal reasoning. If the case is entirely new, presenting facts or issues never seen before, the judge's decision effectively creates new law, setting a precedent for all future cases. This makes judges powerful figures who not only apply the law but also actively shape its evolution. This is a key difference from Civil Law systems, where a judge's role is primarily to investigate the facts of a case and apply the specific provisions of a pre-written, exhaustive legal code.

For a long-term investor, the type of legal system a company operates under is not just an academic detail; it's a fundamental risk factor. Common Law systems tend to create a much friendlier environment for shareholders.

Landmark academic studies have shown a strong correlation between common law countries and better protection for minority shareholders. There are two main reasons for this:

• Judicial Flexibility: Judges can address new forms of corporate abuse or complex financial trickery much faster than a legislature can draft and pass a new law. They can interpret broad principles like fiduciary duty—the legal obligation for management to act in shareholders' best interests—and apply them to novel situations, preventing managers from exploiting legal loopholes.
• Empowered Shareholders: Common Law often provides more powerful legal tools for shareholders to sue directors for misconduct, holding management directly accountable. The credible threat of a lawsuit is a powerful deterrent that helps keep corporate insiders honest and protects the value of your shares.

This might sound like a contradiction, but Common Law delivers both.

1. It's flexible because it can adapt to changing economic realities and new technologies without waiting for parliamentary action.
2. It provides certainty because the deep respect for precedent allows investors and businesses to have a reasonable expectation of how a court will rule on a contract dispute, based on a long history of similar cases.

This is why contracts in common law countries are often incredibly long and detailed; they aim to spell everything out explicitly, as there isn't a single, comprehensive 'commercial code' to fill in all the potential gaps.

Ultimately, the trust that investors place in a market depends on the reliability of its legal system. Common Law, with its strong defense of property rights and its robust enforcement of contracts, creates fertile ground for capitalism to flourish. It provides the essential framework of trust and predictability that allows individuals and institutions to risk their capital in pursuit of returns, fueling the growth of the world's deepest and most liquid capital markets.

As a value investor, your job is to look beyond the balance sheet. The legal and institutional framework a company operates in is a critical, and often overlooked, part of your investment analysis. When you perform your due diligence, always ask: what legal system is this company subject to? While it's no magic bullet, a company based in a common law country generally comes with a higher degree of built-in legal protection for you as a part-owner. This robust legal backstop acts as a crucial layer in your margin of safety, reducing the risk of your investment being undermined by weak governance, self-dealing management, or legal ambiguity. It's a key qualitative factor that helps separate a good company from a great and safe investment.