Business_Associations

Steinbuch 2008 | Business Associations | Steinbuch Spring 2008 | | Chapter 1: Introduction to the Law of Enterprise Organization * Efficiency and the Social Significance of Enterprise Organization, Public policy * Wealth Creation and the Corporate Form of Organization * Corp law deals with the creation and governance of the private legal entities that are the principal economic actors in the modern world * Dominates in all instances where technology creates economies of scale * Balancing several goals * Allow parties to do what they want to do in business * Protecting people both inside/outside business enterprise * What do we mean by Efficiency' * economic efficiency: the principal standard by which corporate law should be evaluated; elevation of utility; a subjective perspective * the ‘American way of business’ is accepted argument today, but not whole argument for this nature * address problems of having a small group of people run a business that effects thousands * Pareto Efficiency: a given distribution of resources is efficient when, and only when, resources are distributed in such a way (within a given group or territory) that no reallocation of resources can make at least one person better off without making at least one other person worse off * Happens only through voluntary exchange * These transfers are those that are certain to increase social welfare starting from a fixed starting point; legitimacy of this distribution is often contested * Bad way to evaluate/criticize law of ent org. * Kaldor-Hicks Efficiency: what we refer to when say ‘efficiency’ * Actual payment of any compensation is NOT stipulated in this def * Because information is imperfect and transactions are costly, it is generally impossible to compensate all persons who are negatively affected by an action * Standard tool for evaluating enterprise law * Law From Inside and Out: Shared Meanings and Skepticism * Fairness and efficiency: both are guesswork, why courts look at policy rationale with business decisions * Development of the modern theory of the firm: lawyer must understand the economics of a problem to find a satisfactory solution to the problem * Don’t focus on hypothetical markets; most of the economic activity accomplished within firms * Ronald’s Coase’s 1937 insight: assumption of neoclassical economics that informed markets cost less and bring together buyers and sellers at an equilibrium price simply ignores many of the problems that real economic activity must solve * Transactions costs theory: owners of various resources are seen as committing to some ‘contractual’ governance arrangement, such as the firm, in order to reduce their transactions costs and share the resulting efficiency gains * Agency cost theory: how the actions of one another (the agent) affect the interest of another (the principal) with whom she is tied by K or otherwise * To the extent the incentives of the agent (the person or interest that possesses discretionary power over some aspect of the principal’s investment in the relationship) differ from the incentives of the principal herself, a potential cost will raise that is termed an ‘agency cost.’ Chapter 2: Acting Through Others: The Law of Agency established by legal fiat and can’t be done through K 1. Introduction to Agency A. widely held public corporation: putative principal—the class of dispersed shareholders—may be entirely unable to monitor its agent—the corporation’s management; part of why agency so vital B. there is a disconnect between the goals of your agent and yourself whenever you have an agent (EX: real estate agent: commission motivates the agent) 2. Agency Formation, Agency Termination, and Principal’s Liability C. Formation (1) Agency: a consensual relationship between the principal, who grants authority to anther to bind her in certain respects, and the agent, who accepts that responsibility (a) Special agent: the agency is limited to a single act or txn (b) General agents: agency contemplates a series of acts or transactions (c) Disclosed principles: when third parties transacting with the agent understand that the agent is acting on behalf of a particular principal (d) Undisclosed principal: when third parties are unaware of a principal and believe that the agent herself is a principal (e) Partially disclosed principal: when third parties understand that they are dealing with an agent but do not know the identity of a principal (f) Employee: an agent because he’s hired by the principal to do the principal’s bidding on certain things; principal exerts more control over agent (this creates more liability in tort) (g) Independent contractor: someone acting in agency that’s not principal or employee; EX: real estate agent (2) at least three parties involved in a principal agent relationship that consummates a relationship (h) principal, (i) agent, and (j) party with whom the agent ultimately contracts (3) Establishing an Agency relationship (k) Done by consent (l) Does not have to be written (m) Does not have to be spoken * HYPO: mother lends coach a car to use one time; POINT: mother told coach the guidelines he must use while in control of the car; mother exerted some control over the car, so an agency relationship was established (4) 5 different ways to prove an agency relationship/authority in an agency relationship (n) Actual express authority: simplest: “I authorize you to hire a landscaper to mow my lawn.” Principal is bound in K for the obligations established; due to the express authority given by the principal and the actual authority given by the principal, the agent. (o) Implied Authority: “go out and hire me a house painter to paint my house purple.” Agency hires house painter and buys 10 gallons of purple paint; principal refuses to pay; court should say purchasing the paint is implied around the actual authority; if the principal doesn’t want the agent to do something, the agent should tell them not to do it; if the court places authority on someone it is more likely that they will be more careful as to what they do—law uses efficiency standpoint to put burden on individual to whom burden costs the least (p) Apparent Authority: communications from the principal to the third party; it can’t be implied when you say “don’t do it,” difference between this one and actual implied authority; you can have apparent authority by saying something to third party, and the third party reasonably relied * Applied apparent authority: EX: someone from Xerox shows up to somewhere for parts for photocopies; he’s a vice president at Xerox; he orders them and they give them and he sues and they say that he wasn’t authorized and third party says that it was apparent that he was authorized * Question becomes: * What did the principal do that gave the agent seeming authority; (here, business card) (q) Ratification: your agent goes out and negotiates an agreement for you that you expressly told agent that she couldn’t negotiate; she did it anyway; this may happen and principal says that isn’t a bad deal after all; ratification means that the principal can adopt this idea; once he ratifies it, he’s responsible * when you ratify by actions rather than expressly is where problem comes from (r) Inherent agency power/inherent authority: principal, even if undisclosed, are responsible for the Ks of their agents; upon his disclosure, the agent can go after his authority; Steinbuch says it doesn’t make any sense at all * Inherent Authority: an undisclosed principal who has prohibited the agent from doing something; EX: “do not buy me the purple paint, I will take care of it;” you can’t have apparent authority here if no one knows that an agent was created * There CANNOT be apparent authority from an undisclosed principal! D. Agency law and agency relationships regarding K: (5) Agent is contracting for the principal; when agent discloses the principal to the third party, there’s no reason for the agent to still be on the hook (no longer agent liability); (s) Old rule: not only must agent identify he’s an agent but the id of the principal also; E. Termination (6) Relationship is contractual and may be terminated at any time; there may still be contractual liabilities/obligations though (if you don’t follow through with these you may have to pay damages) (t) Difference of outcome depends on if there’s a property right or a right to damages; F. Parties’ conception does not control (7) Agency relations may be implied even when the parties have not explicitly agreed to an agency relationship; (u) EX: when creditors ‘assume too much’ is typical example; (8) Jenson Farms Co. v. Cargill Inc.: An agency is created through a course of conduct where the facts, taken as a whole, show that one party (first party) has manifested consent that another party (second party) be its agent; the second party acts on behalf of the first party; and the first party exercises control over the second party; G. Liability in Contract: (9) Actual and Apparent Authority: (v) Agent must reasonably understand form the action or speech of the principal that she has been authorized to act on the principal’s behalf; (w) Scope: that which a reasonable person in the position of A would infer from the conduct of P; (x) INCLUDES: incidental authority: the authority to do those implementary steps that are ordinarily done in connection with facilitating the authorized act; (y) Apparent: is nature of an equitable remedy designed to prevent fraud or unfairness to the third parties who reasonably rely on P’s actions or statements in dealing with A; * Includes if P had explicitly limited the authority of A the precluded A from engaging in that action with third party; (z) White v. Thomas: In the absence of a principal and any indicia that an agent has authority to engage in a specific action on the principal’s behalf, the agent does not have apparent authority to engage in such action merely because the agent asserts she has such authority; (10) Inherent Authority: ({) KNOW: difference between special agent and inherent agent: * HYPO: agent goes out and Ks with third party and doesn’t have any of the authorities; agent didn’t have actual authority (either of the two or the two express) or inherent authority, didn’t have appearance of authority, and the principle didn’t ratify the K once it was discovered; * Right now, 3rd party has no claim against P! P is fully disclosed; * 3rd party still has rights though: * MIN: 3rd party can sue agent for breach of K * MIN: 3rd party can sue agent for deceit; * MAJ: implied warranty of authority theory: 3rd party says to agent that you’ve implied that you have authority, as such, you warrant/guaranteed me that you have authority when you didn’t; you breached that warranty and are therefore liable for that breach; (|) Gallant Ins. Co. v. Isaac: An agent has inherent authority to bind its principal where the agent acts within the usual and ordinary scope of its authority, a third party can reasonably believe that the agent has authority to conduct the act in question, and the third party is not on notice that the agent is not so authorized; (11) Liability in Tort: (}) Send agents out with instructions in K, not to commit tort; (~) Distinction between employee and independent K in terms of liability for tort: * Principal is liable for tortious acts of employee * Not independent K; () Restatement: FACTORS used to determine whether agent is ind K or employee: * Control: how much control do you exert as a principal over the agent and the scope or breadth of that control; * Did you hire someone to mow your lawn that runs a lawnmore business' If you hired a lawnmowing business, you probably hired an independent K; * Degree of Supervision: it’s not the same control; control is your ability to tell people what to do, supervision is your position to observe that they do; * Are you observing what goes on on a day to day basis' Sliding scale standard; * What level of skill is required by that agent' The higher the level of skill required, the less control typically had; * Who supplies the equipment' If you show up with the tools, you’re more likely an independent K than if the principal has those things; * Length of time employed; * How the agent is paid: does the agent receive a salary' (employee) or does the agent get a payment for “services rendered”' (independent K) * Did the principal hire the agent to work the principal’s regular business' * EX: you run a gas station and hire someone to be your gas attendant * You hire someone to mow your lawn; it’s not your business; * Fact that the principal is in business alone might show employer/employee relationship b/c the principal hires employees; * Party’s belief: * Parties don’t necessarily explicitly agree (EX: McD’s would say employees ind Ks) * Third party, in tort, didn’t voluntarily enter into anything; () Humble Oil Refining Co. v. Martin: A party may be liable for a contractor’s torts if he exercises substantial control over the contractor’s operations; * KEY QUESTION: what kind of agent' * Determine this in part by examining the level of control that the principal has over the agent; * 3rd party will go for P b/c deep pocket; * FACTORS: wore P’s uniforms, P scheduled hours, etc; () Hoover v. Sun Oil: A franchisee is considered an independent contractor of the franchisor if the franchise retains control of inventory and operations; * A set own hours, wore own uniforms, etc; () Control over financial matters is factor in determining amount of liability * If principal is forcing agents to perform a certain amount of actions, you get to tell them how to act from moment to moment, the more liable P is * By controlling the economics, you have the incentive to control the tortious behavior more; (address circular reasoning); () Franchise agreement: a company creates a product and that product is usually a combination of goods and services; it sells those goods and services and establishes a good name for itself and then it sells of that name to other people to sell that same grouping of goods and services; goods are typically provided to the franchiser; store is in control of the service; * Franchisee doesn’t collect money from franchisor; franchisee pays the franchisor money for the goods, initially they pay for the name; * HYPO: McDonald’s IS liable for floor mopper b/c they have significant control; () Employer just needs the ABILITY TO CONTROL the employee; () Courts have not managed that the agent get insurance as opposed to going over the agent’s head and making P pay because this is LEGISLATURE’S duty! () Ways to protect the principal when the agent can’t be required to buy insurance: * Waiver: principal pays the agent a little less and buys insurance for them with the remainder (difference is that principal is sure that the agent has insurance in this context) * Third party sues principal and agent tin tort and agent has no money so drops out: if principal buys the insurance, doesn’t have to worry about this; * Independent contractor relationship: puts third party on notice * EX: this hotel is owned and operated by xyz. * EXCEPTIONS: * If a P hires an ind K and then maintains control over that ind K (or an aspect of it) that results in the tort; (could be employee for that function) * Hiring incompetent ind K; * Financially competent ind K' * Inherently dangerous activity strict liability * Scope of employment agreement limits liability to P; * FACTORS: * Purpose of the act: what was the employee doing at the time the torts occurred' * EX: UPS truck on delivery route has wreck; * Question of lunch break; * Whether the act is commonly performed by the employees * Extent of departure from normal methods * Does employer reasonably expect the employee to be engaged in the type of activity that resulted from the tort' * EX: expects employee to drive a truck' (12) The Governance of Agency/The Agent’s Duties: () Agents are forbidden for receiving compensation in relation to the agency agreement unless the principal approves it (must be from principal or approved by P); * Compensation ONLY for agency relationship; () The Nature of the Agent’s Fiduciary Relationship: * Common law: agent is fiduciary of her principal; * Legal relationship is fiduciary in character means that legal power over property (including formation) held b the fiduciary is held for the sole purpose of advancing the aim of a relationship pursuant to which she came to control that property; * Agencies: advance the purposes of the P; * Corporations: for the directors to advance the purposes of the corp; * 3 Categories Fiduciary Duty: * Duty of obedience to the documents creating the relationship: duty to obey the P’s commands * Duty of loyalty: pervasive obligation always to exercise legal power over the subject of the relationship in a manner that the holder of the power believes in good faith is best to advance the interest or purposes of the principal or beneficiary and not to exercise such power for a personal benefit * Duty of care: duty to act in good faith, as one believes a reasonable person would act, in becoming informed and exercising any agency or fiduciary power; * You have an obligation as an agent to go out and do something and to do it well; () The Agent’s Duty of Loyalty to the Principal * An agent must be loyal to the P; agent must not put his interests ahead of the principal or the interests of anyone else ahead of the principal; * EXs: * When the agent receives some payment from a 3rd party: * Bribes, kickbacks, etc * When the agent secretly transacts with the P * P hires agent to go out and find a 3rrd party with whom to deal and instead of hiring someone else the A hires himself; * A uses his position to make a personal profit from someone who has no relationship with P (uncommon) * Agent uses some authority he has invested in him by the principal to make a profit on his own at no cost to the P, but does it as a function of his A relationship * Case: Brit soldier hired by smugglers to take them through city occupied by Brit at the time; * DISTINGUISH: Moonlighting; * Tarnowski v. Resop: * An agent is liable to a principal for the agent’s profits made during the course of the agency * An agent is liable to a principal for the damages caused by the agent’s breach of his duty of loyalty; * Agent didn’t go out and investigate so breached duty of care; () The Trustee’s Duty to Trust Beneficiaries * In re Gleeson: A trustee of real property who is also a tenant of the trust property must account to the trust for profits made as a tenant; * Trustee is particular kind of A relationship; * A can never have normal relation with P b/c P dead; 3. Chapter 3: the Problem of Joint Ownership: The Law of Partnership: 4. Introduction to Partnership: H. General partnership: jointly owned/managed business; I. Closely follows agency law; J. Property held by partnership is entitled in a tenancy in partnership: provides that the partnership qua firm, rather than the individual partners, exercises true ownership rights over partnership property. (13) Gives creditors of the partnership first priority over the claims of the creditors of individual partners; K. Why have joint ownership' (14) Selling an ownership stake may be a cheaper way to raise capital (15) Klein and Coffee, the need to assemble at risk capital: partnership form assigns ownership rights to the partis who provide capital; () Can make assignments (employees, etc); L. The Agency Conflict Among Co-owners (16) Meinhard v. Salmon: Joint adventurers owe to one another, while their enterprise continues, the duty of finest loyalty, a standard of behavior most sensitive; () Fiduciary duty of loyalty: obligation from the first partner to the second partner; you can’t take for yourself something that belongs to the partnership; * Scope of this duty covered the lease of the part of the property for the new venture; when that opportunity was presented to one of the partners, it must be shared with the partners; M. Partnership Formation: (17) Did individuals intend to become partners: (18) Is there a right among the parties to share among the profits' (19) Is there an obligation to share in the losses' (20) Do individuals share in control of the organization' () Contrast with agency (21) What is the conduct of the parties in that relationship toward third parties' () Partnership tax return, etc (22) Right of dissolution if one of the members leaves' (23) Vohland v. Sweet: For purposes of creating a partnership, one partner’s contribution may consist of labor and expertise; human capital (one person putting up the work) () Court looked almost exclusively at one factor: did the partners share in the profits' * Not always definite, though frequently used, b/c people can share in profits that are not partners (incentives for CEOs, etc); () STEINBUCH POINT: when times are bad, who shares in losses' THIS IS DETERMINING FACTOR ABOVE WHO SHARES PROFITS! N. Relations with Third parties: (24) Creditor rights: () Who is a partner for purposes of personal liability to business creditors' () When can an existing or retiring partner escape liability for a partnership obligation' () Since a partner’s liability on a partnership debt can be satisfied form a partner’s nonpartnership property, how are such claims to an individual partner’s personal assets to be balanced against the claim of other nonpartnership creditors of that person' (25) Who is a partner' () TEST: * If consumer is injured by equipment that company knew was defective, which of the partners are liable or both' (26) Third-party claims against departing partners: () UPA 36(2): releases the departing partner of partnership debts if the court can infer an agreement between the continuing partners and the creditor to release the withdrawing partner; () UPA 36(3): applied to release the departing partner from personal liability when a creditor renegotiates his debt with the continuing partners after receiving notice of the departing partner’s exit; () Strike balance; (27) Third-party claims against partnership property: () If there is no segregated pool of assets available to secure business debts, all of the business and personal assets of investors will be available to both business and personal creditors! () Segregated pool of assets essential for contracting with jointly owned business entities of any significant size; () UPA 25(1): individual partners no power to dispose of partnership property—de facto business property; tenants in partnership; entity ownership; () UPA 25(2): a partner cannot possess or assign rights in a partnership property, a partner’s heirs cannot inherit it, and a partner’s creditors cannot attach or execute upon it; (28) Claims of partnership creditors to partner’s individual property: () Common law/jingle rule: gave partnership creditors priority in all partnership assets and assigned first priority to the separate creditors of individual partners in the individual assets of those partners; * Used if: * The UPA is controlling state law AND * 723 does not apply (partnership is not in chapter 7 or the individual partner is not in bankruptcy) () 723 Bankruptcy Code/modern/parity treatment rule: trustee in bankruptcy first administering the estate of the partnership and then turning to the assets of general partners to the extent of any deficiency; court may order partner not to dispose of property; * (b) when deficiency in partnership assets * (c) the trustee’s claim against the assets of any general partner is on a parity with individual creditors of the partner; * Partnership creditors still have first priority in assets of a partnership; * Partnership creditors though are placed on parity with individual creditors in allocating the assets of an individual partner when the partnership is bankrupt under chapter 7; * Partnership creditors get this if EITHER: * The RUPA is controlling state law OR * 723 applies (the partnership is in chapter 7 and individual partnership is in bankruptcy); () Estate of individual partner is in bankruptcy: * If partnership is sound, typically no problem * Any partnership creditor who has a mature claim could assert that claim in the partner’s bankruptcy case; * UPA follows jingle rule: partner’s creditors priority over partnership creditors * RUPA follows parity treatment rule () In all cases, partnership creditors get first priority in the assets of the partnership; O. Partnership governance and issues of authority (29) National Biscuit Co. v. Stroud: The acts of a partner, if performed on behalf of the partnership and within the scope of its business, are binding upon all co-partners; () Partners have equal rights to participate in the management of partnerships; () CAN BE CHANGED: by agreement of the partners; for ordinary business decisions, you need a majority to agree; () Any agent of a partnership can bind the partnership; () Within partnership, if it’s an ordinary business decision, a majority gets to make the rules; () If a partner acts outside the scope of his authority b/c he’s a minority, then he’s liable to other partners; * AVOID: make agreement before hand; * AVOID: dissolve partnership; PROBLEM: you must do this fast; (30) Tax benefits: () In a partnership, when a partnership makes money, it goes to the partners and they pay individual tax returns; () CONTRAST: when corp makes money, the corp is a legal fiction and it makes money; it gets taxed, then whatever left over goes to owners; * Money given to shareholders (owners) is taxed; * If corp keeps that money, shares go up; when you sell that stock you have to pay tax on rate at which sold; () In the end, you have more money in partnership; P. Termination/Dissolution and Disassociation (31) Accounting for Partnership’s Financial Status and Performance () Evaluation looks at: * Balance sheet: statement of assets it holds, * Liabilities it owes—Difference between a and b = equity that partners have in the firm; * Income statement: reflects results of txns that firm engaged in over set period; * Capital account: report that records the effects on the partners’ capital of the operations of the business over a year; () Adams v. Jarvis: A partnership agreement which provides for the continuation of the firm’s business despite the withdrawal of one partner and which specifies the formula according to which partnership assets are to be distributed to the retiring partner is valid and enforceable. * you can contract around virtually any rule in partnership; * you can K around termination upon the withdrawal of a partnership; () Dreifuerst v. dreifuerst: A partnership at will is a partnership that has no definite term or particular undertaking and can rightfully be dissolved by the express will of any partner. () Page v. page: A partnership may be dissolved by the express will of any partner when no definite term or particular undertaking is specified; * Must be in good faith; * If you dissolve the partnership to go on opportunities on your own, you’re breaching fiduciary duty to partnership; you’d be held liable and unable to dissolve entity without compensation to the others Q. Limited Liability modifications of the partnership form: (32) The limited partnership: all partners can have managerial responsibilities; can have everybody off the hook; () Depends on state statute: sometimes you can only limit certain things; () Business creditors cannot proceed against the personal assets of some or all of a firm’s equity investors; business assets are only assets that creditors can rely! () Share in profits without incurring personal liability for business debts; () Uniform Limited Partnership Act: if limited partners make managerial decisions, they lose limited liability protection; () When limited partners held liable for partnership debts: * Limited partner who participates in the control of the business is liable only to persons who transact business with the limited partnership reasonably believing, based on the limited partner’s conduct, that the limited partner is a general partner; (33) Limits of limited liability: () K: if business goes bad, you don’t owe a penny; creates corp, sign lease, is business ends, walk away from lease; if did it as a partnership, you’d be personally liable for that lease for the rest of the lease; (34) Limited liability partnerships and companies () The limited liability partnership: general partnership where partners retain limited liabilities for certain liabilities and limited periods; * Liability limited only with respect to partnership liabilities arising from the negligence, malpractice, wrongful act, or misconduct of another partner or an agent of the partnership not under the partners’ direct control; () The limited liability company: * Investors/members to be governed by general or limited partnership law; * Members may operate the firm and serve as its agents or elect managers; * Tax driven: taxed like corporation if possess at least 3: * Limited liability for the owners of the business * Centralized management * Freely transferable ownership interests * Continuity of life (LLCS must involuntarily dissolve upon happening of specified events) * Transferees not approved obtain only the distribution rights of the transferor; * Check the box rule: allow all new unincorporated businesses to choose whether to be taxed as partnerships or corporations; 5. Chapter 4: The Corporate Form: 6. Introduction to the Corporate Form: R. Make the most money by far; doesn’t make up the majority of businesses though; biggest businesses; S. 5 basic characteristics corporations: (35) Legal personality with indefinite life () Different from partnership b/c when a partner pulls out the partnership dissolves; * Can be written in to where it doesn’t automatically dissolve now; () Corporation continues () Fraudulent conveyance: since it’s a legal entity with assets, the assets travel with the entity and when it dies, you can sue the estate to get the money * Since you have a fictional entity, what you can’t do is take all the assets and put into another company or entity or in your pocket; (36) Limited liability for investors: most important aspect!! () Primary driving force behind why corporations have evolved; () Liability of each investor is limited to her investments; so the max that can happen to you is that the value of your investment becomes 0 rather than they can come after you; the money you lose is the money you already gave; () Upside to having limited liability in addition that you don’t have to pay anymore if the company has a lawsuit against it; * You don’t have to worry that if you put money in a particular business that you can be liable for more * Share price stays the same regardless of who owns it; () If you give a business entity limited liability, they’re more likely to sell shares; customers more likely to buy shares; () Extends in tort, not K; (37) Free transferability of share interests (38) Centralized management () Once you put control in the agents, there’s potential problem that they start acting on their own behalf rather than that of their owners; * Typically on cost of shareholders () Management: BOD elected by shareholders acts as an agency and the officers hired by the BOD, and a chief financial officer (employees and act as employees and are agents of the corp); * DISTINGUISH: agents of corp, NOT shareholders; (39) Appointed by equity investors (owners’ control over corp is by mergers) T. Closely held corporations: not traded publicly on the stock market; (40) Looks a lot like a partnership; U. Publicly Held Corporations: fungible; usually controlled by management that’s detached from the shareholders; (41) Nasdaq is cheaper stocks (42) NY Stock exchange for bigger money 7. Creation of a Fictional Legal Entity: V. Because its principal investors need not execute the txn or even agree to it, the information and coordination costs of closing the txn are minimal; W. Reduces the cost of K for credit; X. Delimits the pool of assets upon which corp creditors can rely for repayment; Y. Indefinite life enhances stability of corp form; Z. A note on the history of Corporate formation: internal affairs doctrine: law of the state of incorporation governs the internal affairs of a corporation, including who votes, on what, and how often; [. The process of incorporating today: seen in Revised Model Business Corporation Act (RMBCA) (43) Incorporator signs docs and pays fees (44) Incorporator drafts and assigns articles of incorporation or certificate of incorporation () ‘charter’ () State purpose and powers of corp and define all special features with flexibility to designer of firm’s legal structure () Purposes typically included in broad statement () Typically generic () Ids office; (45) SOS issues corp’s charter where copy articles attached with cert of good standing signed by SOS; (46) First act of business is electing BOD; \. The articles of incorporation or ‘charter’: can contain any provision not contrary to law; (47) Voting stock, BOD, shareholder voting; (48) Special purposes will be stated here; (49) Orig incorporators, name, business, fix capital structure; (50) May include size of BOD, etc; ]. The corporate bylaws: must conform to corporation statute and corp’s charter; (51) Fix operating rules for governance of corporation; (52) Establish annual meeting date or formula ^. Shareholders’ agreements: courts will specifically enforce these agreements where all shareholders are parties as well; 8. Limited liability: shareholders cannot lose more than the amount they invest; _. Corps have unlimited liability; shareholders have no liability for the debts or obligations of the corp; `. Point: to encourage investment in equity securities and to make capital more available for risky ventures; 9. Transferable shares: a. Share interest: something distinct from any part of the corporation’s property; personal legal property of holder; freely transferable (default provision) b. How to restrain transferable shares: (53) Means of separate statute (EU) (54) Provision for restrains as option under single general corporation statute (US); (55) Antitakeover defenses: limit the ability of shareholders to sell their stock to would be acquirers (controversial b/c restrict power of market to new management team); 10. Centralized management: designated board directors manage day-to-day c. Government’s role in helping corporation: collective action problem specify when shareholder votes are required, what information shareholders must be given and shareholders must be able to vote in convenient ways that do not require physical attendance at meetings; d. Default rule: management be appointed by a BOD that is elected by the holders of common stock; centralized directorate structure; e. Power of the board given by corp law: (56) Makes the centralization of management power in the board a strong default option for firms organized as corporations; (57) Vests more power in board than large partnerships do; f. Corporate officers are agents of the company; board appoints officers; BOD treated by corp law as quasi-principal of the company & economic agent of shareholders; g. BODs typically much better informed of company’s doing than shareholders (public companies) h. Usually elected by shareholders; i. Legal construction of the board (58) The holder of primary management power () Board members do not have duty to follow wishes of majority of shareholders; () Automatic self cleansing filter v. Cunningham: Where a company’s charter requires a 75% vote of the shareholders, made as an ‘extraordinary resolution,’ to override a board of directors’ decision, a mere majority resolution made at an ordinary shareholders meeting may not override the board’s decision that is contrary to the majority’s wishes; * Shows that board is not agent directly of shareholders; once elected, shareholders do not dictate what board does; * Way for Management to protect themselves: * Create staggered boards: elect 1/3 of board every three years; * ASK! HOSTILE TAKE OVER PREVENT ISSUE! (59) Structure of the board: charter sets forth general terms; () All directors have one vote on matters before the board; () Board has inherent power to establish standing committees for the effective organization of its own work, and it may delegate certain aspects of its task to these committees or to ad hoc committees; * Advisory committees may include nondirectors; * If exercise any part of the board’s power, must be composed entirely of directors; * Independent directors; (60) Formality in board operation: () Corporate directors are not legal agents of the corporation; * Powerless to act with respect to the corporation’s affairs; * In board room they have all power created by firm’s constitutional documents; * Quorum must be present at board meetings; proper notice; () Formality in meetings is way to discourage manipulation of board decision making; (61) A critique of boards: center of energy and power of corporate enterprise with BOD; () Only meet for few hours three or four times a year; j. Corporate officers: agents of the corp (62) DE: has law that’s most favorable to management; management makes the initial decision of where to incorporate; better protected here than in most states; () Race to the bottom: race to the least amount of restrictions on corporations; right now is DE; (63) Jennings v. Pittsburgh: A corporation’s executive officer does not have apparent authority to accept an offer for a transaction that, for the corporation, is extraordinary; 11. Chapter 5: Debt, Equity, and Economic Value: 12. Capital Structure: debt instruments & stocks; k. 2 types of long term claims: (64) Corp can borrow money through the issuance of debt instruments (65) It may sell ownership claims in the corp by issuing equity securities; l. Typically: those who buy corporate debt have a contractual right to receive periodic payment of interest and to be repaid their principal at stated maturity date; (66) Creditor has legal remedies: sue, sheriff seize, contractual right to accelerate payment if debtor defaults (acceleration clause) (67) Debtor must pay creditors amounts due to creditors before debtor can distribute funds or other things of value to equity owners; m. Most equity claims are common stock; n. Legal character of debt: no clear default rules; (68) Legal characteristics of debt generally general patterns of K terms; (69) Maturity date: single most common characteristic; () Legal obligation to repay at a stated date in the future; often to repay principal amount of the bond plus any outstanding interest not yet paid by the maturity date; () Bonds typically have interest at standard rate; * Most pay interest semiannually; * Popular kind: no obligation to pay interest; debtor must pay at maturity an amount larger than the amount the creditor originally lent it zero coupon bonds; * In default if interest/principal not paid when due; * Typically allows credtor to accelerate the payment of the principal from tis original maturity date; (70) Investors choose between investing in debt by lending money to debtor or buying bond of debtor; (71) Advantage bonds: the investor generally faces less risk as a creditor than as an equity holder b/c creditors have legal right to periodic payment of a return (interest) and priority claim over company’s shareholders; o. Legal character of equity (stocks): (72) Common stock: owners of stock can vote to elect directors and that stock carries one vote per share (this can be contracted to be different) () Generally: possesses control rights in the form of the power to elect the BOD; (73) Residual Claims and Residual control: whatever is left over can belong to the stockholders in the sense that it is available for the payment of dividends; (74) Preferred Stock: any equity security on which the corporate charter confers a special right, privilege, or limitation; just as malleable as bonds; () Generally: carry standard dividend, but this is payable only when it is declared by the board; () Can sometimes get votes or designated board seats; () If the corporation fails and plans a close, a designated amount of money must be first paid to the preferred stockholders before the liquidating corporation can distribute any property to holders of common stock; () Typically do not vote while dividend is current; 13. Basic concepts of valuation: p. The time value of money: you get something now but it will cost you more in the future (75) EX: credit cards; (76) If have annuity, you discount it to present value (77) Balance credit card interest v. borrowing (78) Positive net present value: if you can invest your money and earn more money on that than you would if you paid off your credit card with that money; q. Money has cost: net present value: how much it costs you to get that money; (79) As we increase the value of money, then we are less apt to buy something and decreases inflation; r. Risk and return (80) No risk investment: government bond: give certain amount and in certain amount of time you’ll get that back plus interest earned; no risk b/c government can always pay you back; risk is of revolution or complete economic bust; (81) Banks: take your money and you pay for it; they lend it to others for a higher interest rate than they charge you; (82) Zero coupon bond: doesn’t pay out until the end; () Bond that pays out is better if you need cash now; (83) Less risk in buying bonds than stocks, but bonds make less money; () You can sell bonds before they cash out; () With stocks you aren’t limited to certain cash out; (84) SPLITTING MEANS NOTHING IN TERMS OF A STOCK’S VALUE (85) Inflation: too many buyers; demand outstrips supply; no such thing as a shortage; s. Preferred Stock: (86) It’s a cross between a debt, bond and common stock (87) Written into the charter of the corporation, they get a payment under certain circumstances, and those circumstances are greater than for common stock. (88) Board still ultimately decides under certain principles set forth in the docs, but you get less of an ownership interest. (89) By getting less of an ownership interest, you risk getting less of the upside than a common stock shareholder (90) Preferred stock holders often do not vote or have more limited voting rights than common stock shareholders. t. Diversification and systematic risk (91) 2 investments with equal risk and different payout; you invest in one with highest payout; (92) Expected return = value of success x likelihood (percentage) of success + value of failure x likelihood of failure + risk premium (93) If you buy a little of each, if one fails, others may not; (94) less of a good deal, but less of a bad deal too; (95) there’s a point to where you diversify too much and might as well buy a mutual fund (bundle of stocks that mimic the S&P 500) u. EFFICIENT MARKET HYPOTHESIS: Academic theory on how markets work: 3 forms: (96) Weak—if you look at fundamental data of stocks (historical growth rates, P/E ratio, etc.) you can predict if the company will make money in the future. The problem with the weak version is it is not true. Meaning just by looking at the fundamental data, you can’t tell if it’s going to make money next year. The price doesn’t reflect all of the outside information—public or private. (97) Semi-strong—none of the info that is out on the market can affect the price of the stock or can be used to predict the price of the stock. That price for which it’s selling accurately reflects all of the publicly available info. (98) Strong—inside information. Someone in the company may know something that hasn’t been disclosed yet. That info can be used to better predict the performance of the company. No one knows this except for the insiders. Insiders are not allowed to trade those stocks. the price of the stock you see reflects all info known in the universe about that company—both inside information and public information. Problem is that it is a violation to conduct business based on inside information. 14. Valuing assets v. The discount cash flow (DCF) approach: (99) Highest level: DCF valuation requires a preduction of all future cash flows and a discount rate to bring those cash flows back to the present to yield a net present value; (100) Used by investment bankers in valuing takeovers and small businesses; (101) STEPS: () Estimation of all future cash flows generated by the asset; () The calculation of an appropriate discount rate; * Capital asset pricing model: risky ventures are required to pay a higher price for their capital in order to compensate investors for their risk aversion; w. The relevance of prices in the securities market: (102) In re emerging communications inc, Shareholder litigation: () It is appropriate to apply a small stock premium in determining the cost of capital where doing so is shown to be appropriate in a particular case. () It is not appropriate to apply a supersmall size premium in determining the cost of capital where although the company is very small it is also insulated from risk through several advantages () It is not appropriate to apply a weather-related premium in determining the cost of capital where such a premium is unsupported by valuation literature or empirical evidence () The market price of a publicly-traded stock does not corroborate fair value where there are factors that indicate the market price is below fair value; 15. Chapter 6: The Protection of Creditors: 16. With limited liability, we talk more about protecting creditors; doesn’t mean we offer them more protection; x. Limited liability opens for more misrepresentation in transactions with voluntary creditors y. Also makes it possible and sometimes attractive to shift assets out of the corp after a creditor has given credit; z. Large creditors are ok b/c take SI and contract for specific assets; {. 3 ways corporate law tires to protect creditors: (103) Mandatory disclosure duty on corporate debtors (104) Promulgate rules regulating the amount and disputation of corporate capital (105) Impose duties to safeguard creditors on corp participants/managers/shareholders; 17. Mandatory Disclosure: helps the creditors; |. Imposed by fed securities law (106) Audited financial statements annually, etc; }. POINT: if the information is disclosed, it gives the creditor the opportunity to make an informed judgment; (107) Efficient market: if you require disclosure, the efficient market (the middle and strong form) says the prices of stocks and bonds will accurately reflect what is going on in the corporation it will get out to the market even if you don’t know the right price on the bond; () EX: pricing bonds: buy a bond with a fixed rate of return at 5%; at end of 10 years you get $50. They pay more than the government because they want to attrack people; the higher interest rate they offer is typically inversely related to the risk; * You’re being paid a risk premium: something additional that reflects the possibility that the company will default on its loan; this is part of the price of the bond; ~. Disclose information to companies and they write up reports and tell how well the bond will pay off and the likelihood if the bond will pay off; (starts at AAA and goes down); (108) Bonds: trade like stocks with a price; price reflects () the effective interest rate that you’ll get on payout and () the financial health of the company; (value of bond will go down as risk increases) (109) Junk Bonds: very low rated bonds; they look very much like stock—bug upside potential, traded, low trade out; (110) Zero coupon bonds; . Permissive disclosure by the corporations: . Mandatory disclosure by the corporations: . Marking to market: you buy or acquire an asset and that asset has a value when you buy it (presumably the value you pay for it) and over time the value of that asset changes; 18. Capital regulation: regulation of the capital committed to the corporation; . EX: requiring investors to contribute a minimum amount of capital to the corp and restricting the removal of capital from the firm; . Financial statement: usually presented representing over 2 or more years to show how fluctuated; (111) Balance sheet: represents the financial picture of a business organization as it stands on one particular day in contrast to the income statement; (112) Income statement: presents the results of the operation of the business over a specified period; . Distribution of constraints: (113) Legal capital/stated capital account: ‘permanent capital’ not to be distributed to shareholders and is to be used for creditors to lend on; control of is weak; . Minimum capital and capital maintenance requirements: America does not have, so there’s no guarantee that a creditor will get paid b the corporation because there’s no guarantee that the corporation will have the ability to pay the creditors; (114) K liability: ARGUMENT: the entity contracting with the corp knows this up front and takes the risk; BUT: tort victims example of not knowing up front/involuntary; () ARGUMENT: liability insurance requirement as an alternative to require minimum capital and capital maintenance; corps in US aren’t required this either; (115) Min capital isn’t really issue in large companies; . 2 other sources/ways to get recovery by creditors (either contractual or tort) (116) Fraudulent conveyance: idea that a corporation has some assets and it becomes a situation where the company… () Solvency: you owe more than you have, then you solvent; () Obligation is what they have use to get the maximum value and use that maximum value to pay off the creditors (that’s their obligation when going through solvency); () If they do not get the max value, that is a fraudulent conveyance; (117) Equitable subordination: if an insider becomes a creditor b/c he loaned money to an outsider and an outsider is a creditor and the insider somehow behaved unfairly, then he won be able to collect before the insider collects; you subordinate the recovery from the insider to the outsider; you can’t do this by K; 19. Standard-based duties: . Director liability: (118) Uniform Fraudulent Transfers Act: directors owe an obligation under certain circumstances to creditors not to render the firm unable to meet its obligations to creditors by making distributions to shareholders or to others without receiving fair value in return. . Creditor protection: fraudulent transfers: law imposes on effective obligation on parties contracting with an insolvent debtor to give fair value for the cash or benefits they receive or risk being forced to return those benefits to the debtor’s estate; . How to maintain a corporate identity if you are one person: (119) Make a board of directors (made of friends/family) (120) The one person will be the president and can serve as the president and the secretary (121) Got o the bank and open a bank account in the name of the corporation; you have corporate checks with the corp’s name (IMPORTANT) (122) The president should take his own money out of his pocket and put in the corps account as working capital. The money is no longer a personal asset; (123) Sign all Ks in the name of the corp (124) File your charter and do all the other necessary paperwork to do so; file with the state; list the name of the copr and specify that you’re a corp; . Shareholder liability: will have loans subordinate/be liable to corp creditors under: (125) Equitable subordination: courts invoke when they feel compelled by considerations of equity to recharacterize debt owed by the company to its controlling shareholders f equity; () Deep rock doctrine: rarely invoked outside bankruptcy context; () Means of protecting unaffiliated creditors by giving them rights to corporate assets superior to those of other creditors who happen to also be significant shareholders of the firm; () To be invoked: creditor be an equity holder and typically an officer of the company also, the insider-creditor must have behaved unfairly or wrongly toward the corporation and its outside creditors; () Costello v. Fazio: Where, in connection with the incorporation of a partnership, and for their own personal and private benefit, partners who are to become officers, directors, and controlling stockholders of the corporation, convert the bulk of their capital contributions into loans, taking promissory notes, thereby leaving the partnership and succeeding corporation grossly undercapitalized, to the detriment of the corporation and its creditors, their claims against the estate of the subsequently bankrupted corporation should be subordinated to the claims of the general unsecured creditors. (126) Piercing the corporate veil: covers both corporations and LLCs; () When veil is pierced, no longer is liability limited to the amount of money that’s been invested; if someone is successful at piercing the veil, they can go after your home, car, etc; you can go get the assets of the shareholders; * Tests (are vague and vary by jurisdiction): * Lack of corporate separation (lack of corporate identity) * EX: absence of corporate formalities; no ann meetings * Big point! * (less essential) unfairness, some sort of wrong doing) () You will never be able to pierce the veil on a publicly listed big company; legally you can, but it’s unlikely; () Passive shareholders in even closely held corporations aren’t typically held liable; () Also very unlikely against minority shareholders; () Once veil pierced, you can go for the good shareholder and the ‘bad’ shareholder; () RULE: * Corporate formalities (very very important!) * Element of unfairness; * Applied to LLCs as well; () Egregious under capitalization can increase the likelihood of piercing the corporate veil, but on the other hand is NEVER a sufficient factor alone; () Sea land services inc v the pepper: this is really a reverse-veil piercing * the corporate veil will be pierced where there is a unity of interest and ownership between the corporation and an individual and where adherence to the fiction of a separate corporate existence would sanction a fraud or promote injustice; * reverse veil piercing: you go after a shareholder who holds stock in corporation 2 in addition to corporation 1; the law can go back down to corp 2 and pierce its and go for the assets of it and its shareholders; * not very likely; * you go past the shareholder and back into another corp that the shareholder is also invested in and get at the corp; * issue of state law; * STANDARDS TO WHICH WE LOOK AT VEIL PEIRCING HAS NOTHING TO DO WITH THE INJURY TO THE P! * DEFENSE: something to look at to say this rule doesn’t apply; () Kinney shoe corp v Polan: In a breach of contract, the corporate veil will be pierced where a unity of interest and ownership blends the two personalities of the corporation and the individual shareholder, and where treating the acts as those of the corporation alone would produce and inequitable result; * Court requires min level of capitalization; allows this to pierce; 20. LLCs: members (not partners or shareholders) control it; they can structure it in virtually any way they want; . Usually looks more like a partnership; . Corporate veil can be pierced like in corporation; 21. Veil piercing on behalf of involuntary (tort) creditors: . Walkovsky v. Carlton: Whenever anyone uses control of the corporation to further his own rather than the corporation’s business, he will be liable for the corporation’s acts. Upon the principle of respondeat superior, the liability extends to negligent acts as well as commercial dealings. However, where a corporation is a fragment of a larger corporate combine which actually conducts the business, a court will not ‘pierce the corporate veil’ to hold individual shareholders liable. (127) Insurance coverage is not a decision for the courts to regulate but for the legislature. If there was no insurance, some courts have found that would be sufficient; purchasing a minimal amount of insurance protects the shareholders from piercing; (128) Enterprise liability/substantive consolidation/horizontal veil piercing: distinct from piercing veil: () All of these corps are acting as one enterprise and as such their liability should reflect that; the entire enterprise should pay; () FACTORS: * Do the corporations have common employees' * Common record keeping' * Separate accounting' * Does any one corp pave the way for any of the others' * Common business name among the corps' * Undocumented transfers of assets' * Is there an unclear allocation of profits/losses among the corps' * Do the corps share common officers' Partially or completely * Do the corps share shareholders' Is there only one who is common among all of the corps' * Other iding commonalities such as sharing common phone number; () Here, you pierce from side-to-side instead of upwards; . Carter Jones lumber co. v. LTV steel: Mere control of a corporation, no matter how complete, is not insufficient, as a matter of law, to trigger veil-piercing; (129) Court looks at the fraud against the P as well; (130) Individual who committed this tort is liable; if employee, under agency, employer is liable; . Substantive consolidation: equitable remedy in bankruptcy that consolidates assets amount corporate subsidiaries for the benefit of creditors of the various corporate subsidiaries; (horizontal viel piercing); . Doctrine of successor corporation liability: the buyer of the liquidating firm’s product line picks up the tort liability of the seller, at least as that liability relates to the purchased product line; 22. Can Limited liability in tort be justified' . Get insurance for malpractice; . Unlimited shareholder liability for corp torts 23. Chapter 7: Normal Governance: the Voting System: 24. The role and limits of shareholder voting: . Collective action problem faced by shareholders in large public companies is most important factor affecting shareholder voting; . Rational apathy: analysis starts with this power: vote is small and wont have that much of a chance to effect the outcome; even if it did effect the outcome, how big of a difference would it have on me in the end' How much of my time is worth to decide who is the better one and how much return am I getting on all of that effort' (131) Premise: shareholders of a company don’t have any incentive to run the company; it’s disjointed from the management; . Mandatory disclosure is supposed to make shareholders effective monitors, but doesn’t’ always work; (132) ARGUE: motivation on managers: managers are constrained not by shareholder votes but by the pressure exerted by multiple markets; the product market, the market for managerial services, capital market, and market for corporate control; () Market for managers: they aren’t constrained by the shareholders but they have a compensation package (they have options); they make money when the price of the share goes up (b/c of this compensation package); managers are just as worried about their jobs as the price of the stock and success of the company because they’re replaceable; () Capital market: companies need money to run and they raise money all the time; they raise money (sometimes) by issuing stock, this is critical in the success of the company; if the company doesn’t succeed, the manager doesn’t succeed; (another way to raise money besides stock—buy bond) () Market for corporate control: people look at corps and deiced if they think it’s running efficiently; if the stock is low, people are going to want to come in and make the company more efficient—as the stock goes up, it’s retention b/c the company is proven to be doing well; 25. Electing and removing directors: . Electing directors/shareholders vote: can vote at least once per year at annual meeting (required by law); special meeting can be called (typically by BOD) or can be called by the shareholders; (133) Charter says how many directors you have to have; (134) Cumulative voting: you take all of your shares and you get to bundle them during the voting process; you bundle by taking your shares and multiplying by the number of seats that are open and then allocating that total value to any combinations of seats you see; () These aren’t fixed seats; the ones that get the top three votes win; () POINT: so MIN shareholders will have their say; () (S/D+1) + 1 * S = total voting shares * D = number of partners to be elected (135) Classified/staggered board: we don’t elect all the seats at once, every year; it creates longer continuity, so management is better/entrench itself better; () ARGUE AGAINST: don’t have a term that’s too short b/c then people won’t really have a way to evaluate over long term what the best way to go is; () Typically is a 3 year process and you need 2/3 to have majority in that three year process; () Way to disassemble a staggered board: shareholder can pack board with new directors or remove directors without cause and replace with new directors; (136) To have a vote, you have to have a quorum—min number of shareholders show up in person or on paper; typically is 50%; . Removing directors (137) Traditional: directors can only be removed for cause (138) Modern: shareholders can be removed without cause; () Exception: on a cumulative voting scheme; EX: where Y gets one person on the board and X calls a special meting to try to get Y’s person off; can’t do this under cumulative voting schemes b/c there would be no point to cumulative voting; (139) State law in all jurisdictions bar directors form removing fellow directors for cause or otherwise in the absence of express shareholder authorization; 26. Shareholder meetings and alternatives: . Shareholders vote on: (140) Fundamental corporate changes: amendments to the articles of incorporation, voluntary dissolution of the corporation, mergers with another corporation or entity, sale of all of substantially all of the corporations assets; cumulative voting system does NOT apply even if you are cumulative voting system stock; this only applies to directors votes, not to fundamental corporate changes; () Fundamental changes: * tend to be structural (selling off, merging, etc) * procedural (changing the control in documentation) * NOT changing what you sell! . Special meetings: typically only way they can decide something between annual meetings; . Shareholder consent solicitations: statutory provision allowing shareholders to file written consents in lieu of meeting; done in DE; 27. Proxy voting and its costs . Typically these bids are given to existing board members (maybe even some that are up for reelection); they call and ask if you would mind if they have your proxy and you give it to them; . theory of why it’s good to give away the proxy: if you’re truly apathetic, this will be passing along to someone who really knows what’s going on; (141) you’ve been relying on these people to make you money in the first place; there’s no reason not to do it; . proxies can go to anyone, not just managers, including non-owners; . revocable even if you say it’s irrevocable UNLESS it’s coupled with an interest; . cannot sell your proxy! . Rosenfeld v. Fairchild: Directors may make reasonable and proper expenditures from the corporate treasury to persuade stockholders of the correctness of the director’s policy positions and to solicit shareholder support for policies that the directors believe, in good faith, are in the corporation’s best interest. 28. Class voting: if a proposed charter amendment adversely affects the legal rights of a class of stock or disadvantages them in some other respect, then it should be adopted only with the concurrence of a majority of the voting power of that class voting separately; 29. Shareholder information rights: . Common law: shareholders have right to inspect company’s books and records for proper purpose . Stock list: law makes this list readily available to registered owners of the corp’s stock; (142) Problem: court doesn’t consider improper purpose and proper purpose is broad; (143) An order to produce will carry obligation to update and produce second list of stock brokerage firms whose stock is registered and furnish daily trading information; . Inspection of books and records: request puts legitimate interests of corporation at risk; far more expensive; (144) P burden of proof showing purpose and carefully screening P’s motives and consequences of granting the request; (145) You can ask for the list of the company can either give you the list or in according to federal law the company can agree, mail you the list, and charge you for mailing the list; (146) Law balances shareholder’s interest in holding the company accountable with the corporation’s interest in maintaining corporate confidentiality; (147) DE: requires shareholders make written demand; (148) Legitimate purposes: () Need to establish the factual basis () Collecting information for value in shares () To have a proxy fight