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Business Organizations
Rutgers University, Camden School of Law
Beckerman, John S.

Beckerman BizOrgs Spring 2010
I.        Financial crisis
A.      Reasons
1.       Mortgage fraud
a)       Sub prime mortgagesàgiven to people who had below average credit rating
(1)     Mortgage originator problem
(a)     Many mortgage originators did not keep the loan, but rather sold it
(b)     Got fees from borrower and people they sold it toàhad little risk
(2)     Types of loans
(a)     Interest only loans, ARMs, no down payment
(b)     NINJA—no income, no job or assets
(3)     Packaged together became “toxic assets”
2.       how is a mortgage an asset
a)       mortgageoràperson taking loan
b)       mortgageeàlender
c)       mortgage backed securityàCDO (collateralized debt obligations)
(1)     periodic payment derived ,from mortgage payments
(2)     pool of mortgages are collateral
(3)     offered high rate of return
3.       shadow economyàinstitutions acted like banks but weren’t regulated like banks
a)       leverage—incurring debt to purchase assets
(1)     if assets apprtiate > interest, you make money
b)       liquidity crisis—cash was not available b/c banks weren’t lending money b/c they weren’t getting paid
c)       credit default swap—shadow economy insurance K for CDO’s that did not make payment
(1)     no regulationsàdid not have to meet credit requirements of normal insurance companies
4.       deregulation
a)       federalist societyàthe less ,gov’t regulation, the better
(1)     started w/Reagan
(a)     made gov’t agencies reluctant to issue regulations
II.      Corporate Basics
A.      Economics of the firm
1.       Risk
a)       can be quantified—“quantifiable uncertainty”
b)       two types
(1)     Non-controllableàcannot be controlled or completely eliminated
(a)     Insurance is best method to reduce risk
(b)     diversification
(2)     controllableàthey might be able to influence
(a)     compensation structure
(i)       employment modelàemployee gets basic salary, employer gets all profits
(a)     incentive plansàbonuses, stock options
(b)     sanctionsàreduce pay for poor performance
(c)     best efforts/reasonable practicesàminimize transaction costs
(ii)     tenancy modelàlease land, worker gets all profits
c)       uncertainty—cannot be quantified
d)       expected return
(1)     weighted average return based on the probabilities of events
e)       ways to manage risk
(1)     insurance
(2)     diversification – participating in numerous ventures each which involves different risks
(3)     allocate
2.       allocating risk
a)       principal – the investor/owner wants
(1)     to maximize return on investment
(2)     agent to use as much effort as possible to make the venture a success
(3)     the bulk of the profits
(4)     agent to put the principle’s interest above the interest of others, even the agent’s own interest
b)       agent – manager/employee wants
(1)     compensated for its effort, even if the business does not succeed
(2)     expended little effort is necessary to make the venture a success
(3)     discretion until college goals of the venture without interference
c)       agency costs
(1)     monitoring costs
(a)     cost to make sure employees are doing what they should
(2)     bonding costs
(a)     put up insurance $ incdase of embezzlement/theft
(3)     residual loss
(a)     due to decisions by agent that does not maximize profit for principal
3.       The Role of Law and Allocating Risks
B.      Introduction to corporate law
1.       Overview
a)       Corp. definitions
(1)     A legal entity that can own property, entry into contracts, sue and be sued
(2)     A team of people, including suppliers of money and labor, to work together to earn a return on their investment
(3)     A web of contracts among investors, employees, customers and community
(4)     An investment vehicle that can be used for good or for ill
(5)     A drama where the corporate actors worked through conflicts that arise from their different incentives, investments and goals
b)       Characteristics of a corporation
(1)     Separation of ownership and management
(2)     legal entity that is separate from the investors to provide money, people who manage business
(3)     Perpetual existence
(4)     Limited liability
(a)     Shareholders can only lose the money they have invested
(b)     Corporations own the assets of the business and are liable for the debts
(5)     Centralized management
(a)     Separation between shareholder ownership and managerial control distinctive feature of modern corporations
(6)     Transferability of ownership interests
c)       How shareholders can ensure managers will be accountable
(1)     Exità Simply sell your shares
(2)     Voiceà Try to influence managers by speaking out, influence other shareholders
(3)     Loyaltyàintangible, typically stronger in social or political innovations
d)       Conceptions of corporations
(1)     Property conception – corporation is the probably the stockholders, function is to advance the financial interests of the owners a lot
(2)     Managerialist/institutionalized/social entity conception
(a)     Corporation is not strictly private, as public purpose – advancement of general welfare
e)       rights and responsibilities
(1)     shareholders
(a)     right to residual profits
(2)     creditors
(a)     K established rate of return for investment
(3)     managers
(a)     incentives for running company well
f)        articles of incorporation
(1)     fundamental
(2)     on file w/ state
(3)     where statute provides minimum stds, they are in control
g)       by laws
(1)     how company is run
(2)     not on file
h)       stocks
(1)     types of stocks
(a)     common stock
(i)       vote on mergers, changes in articles of inc, sale of assets, board of directors
(b)     preferred stock
(i)       intermediate debt instrument t between common stock and bond
(ii)     paid off before common stock
(iii)    paid dividends before common stock
(c)     Authorizedàupper limit set by articles
(i)       Usually more than what is issued b/c can be used for mergers
(d)     Issuedàstocks on the market
(i)       Outstandingàissued stock not controlled by company
(ii)     Treasuryàissued stock bought back by company (no voting rights)
(2)     Options
(a)     Payment to hold an offer open (to buy) at a predetermined price for a specified time period (call options)
(i)       Ex. employee stock options
(b)     Payment to hold a particular price to sell to someone (put options)
(c)     Strike Price/Grant Price/Exercise Price
(i)       Price at which the option may be exercised to purchase the stock
(d)     Incentive Compensation
(i)       Ability to buy/sell stock at when stock market is favorable
(a)     In the money-Market price is higher than strike price
(b)     Underwater-Market price is below the strike price
(e)     Can use it to reward managers or employees for their performance
(f)      May have options that have vesting schedules
(i)       Keeps employees from using options right away, provides incentive to keep maximizing profits/performance
(3)     pre-emptive rights gives opportunity to purchase newly issued stocks
(4)     dilution
(a)     economic dilution
(i)       new stock issued at fair market price, there is no dilution
(ii)     new stock issued at a lower price would dilute value of original stock (preferential price)
i)         Debt v. Equity
(1)     Debt-outstanding financial obligation that can have a fixed rate of interest
(a)     Creditors will not have equal claims on the debt owed to them
(b)     Secured debt- debt that has been collateralized
(i)       Ex. Mortgage
(ii)     Secured creditors would take what is owed before unsecured creditors
(c)     Unsecured debt-
(d)     Net worth=assets-liabilities
(i)       In corporate world- assets=liabilities + owner’s equity
(a)     If a business incurs a debt that liability is a claim on the assets of the business, if it is not paid off in liquidation the claims are the first to be paid
(b)     Owner’s equity is the residual share after all the liabilities are paid off
(2)     Equity-
(a)     Preferred stock holders take claims before common stock owners during liquidation (liquidation preference)
(i)       Preferred stock is usually non-voting
(a)     Dividends are paid to preferred stock owners first, no dividend is paid to common stock owners until the preferred stock owners are paid
(b)     Common stock owners have residual claim on assets after the others are satisfied (after the debt is paid)
(3)     Order of liquidation
(a)     Secured debt, Unsecured debt, Preferred stock, Common stock
j)        Acts
(1)     Securities Act of 1933
(a)     Dealt with initial issuance of securities (stock)
(i)       Ex. initial public offering of stock
(b)     State and federal courts have concurrent jurisdiction with claims brought under this act
(2)     Securities Exchanges Act of 1934
(a)     Deals with trading of stocks, etc on secondary markets like NYSE
(b)     Also regulates proxy disclosures (public disclosures)
(i)       Ex. Concerned with false and misleading disclosures of employee stock options
2.       Types of Business Entities
a)       Sole proprietorship
(1)     Not limited liability
b)       Partnership
(1)     GP general partnership
(a)     Not limited liability, each partner can be liable for debts
c)       LP
d)       LLP limited liability partnership
e)       LLLP limited liability limited partnership
f)        Types of corporations
(1)     For-profit or not for-profit (non-profit)
(2)     Public – stocks are publicly traded on NYSE or NASDAQ
(a)     “C”àprofits

ally permissible, it is inequitable and therefore the court will not permit it
(a)     Legal but inequitable to move up meeting to help keep board of directors entrenched
(i)       Clearly self dealingàtriggers “most stringent scrutiny”
(b)     Board actions that manipulate shareholders right to vote also triggers scrutiny
c)       Chesapeake Bay Part II problem
(1)     Merger plan does not need shareholder approval and therefore gets around super majority requirement in articles
(2)     Sale is only 20% of assets which does not violate §12.02 (retain at least 25%)
(3)     Problemsàunwise and unfair
(a)     Lambert family is allowed to buy, but Apple is not (unfair)
(b)     2,000 shares are worth $375k or $187.50 per share (Chesapeake assets)
(c)     1,500 shares (750 to Lambert family) are being sold at $100 per share
(i)       This is a self dealing transaction and will be subject to “rigorous scrutiny” b/c possible breach of duty of loyalty
(ii)     Follow the money
(a)     Shipyard gets $375k in assets and $150k in cash
(b)     There are 3,500 shares outstanding
(c)     Each outstanding share is worth $150 ($525k/3,500)
(d)     Lamberts 750 shares are worth $112,500 (750 x $150)
(i)       Lamberts are paying $75,000 for the stock
(e)     Shipyard is paying $300k for Chesapeake’s $375k assets (2,000 x $150)
(d)     To fix the problem
(i)       make stock sale to all Chesapeake shareholders (includes Apple)
(ii)     raise price of stock to $187.50 per share
(iii)    sell at lower price, but do not allow any board member to buy
C.      Corporate Federalism
1.       if no corporate statutes
2.       The Internal Affairs Doctrine
a)       Jayhawk problem
(1)     Shareholder derivative suit
(a)     Recovery would go to corp. (Jayhawk) who no longer exist
(2)     Microcircuits takes over assets and liabilities
b)       Background
(1)     Choice of law rule
(a)     Law of the state of incorporation should govern disputes regarding that corporation’s internal affairs
(b)     Why have it? Easy and convenient test to apply (bright-line test)
(2)     Internal affairs
(a)     Matters that are particular to the relationships among the corp and its officers, directors and shareholders
(i)       Shareholders right to vote
(ii)     Include duties managers owe to shareholders
(iii)    Action by boardàindemnify officers, issue stock, merge w/companies
(3)     External affairs
(a)     Governed by law of the place where activities occur and state or fed statute
(i)       State labor laws govern conditions of employment
(ii)     Local income and real estate taxes
(iii)    K, tort, and property laws
c)       view of internal affairs (CA and NY)
(1)     CA law exercise their power over corporations if majority (>50%) of shareholders or most of the activities (property, payroll, and sales) are in the state
(2)     Wilson v. Louisiana-Pacific (1982) CA impose law §2115 of cumulative voting when co is domiciled elsewhere but has significant contacts w/ CA is greater
(a)     Incorporated in UT which allowed straight voting unless in charter
(b)     CA court upholds statuteàit regulates even handedly
(c)     Straight voting-for each share you get one vote (ex. you have 100 shares and can vote 100 times for each directors)
(d)     Cumulative voting (CA)-how many positions times number of shares (ex. 100 shares, 5 positions, 500 votes can vote 500 to one director)
(e)     Tries to protect minority shareholders of closely held corp.
d)       majority/Delaware view
(1)     McDermott v. Lewis (1987) DE corp became a 92% owned subsidiary of Panama corp after merger, held 10% voting power in parent
(a)     DE conflict of Laws principle
(i)       Laws of jurisdiction of incorporation govern
(ii)     Allows for a single, constant and equal law to avoid fragmentation of continuing, interdependent internal relationships