Professor Garten – Fall 2011 – Business Associations
I. Introduction to the Corporation
a. Federal law governs publicly traded companies.
b. State corp. law (MAJORITY OF LAWS) governs non-publicly traded companies and publicly traded.
c. Uniform law – model business corporation act…no state has adopted in its entirety.
i. DE – corp. friendly laws, charter shopping is easy…file papers and agree to service of process
d. Why do we need corp. law at all? Maybe we don’t. Collection of people w/ economic interest in the business (shareholders), come together voluntarily to make money.
e. Radol v. Thomas
i. P’s were NY citizens and OH shareholders (minority shareholders) and brought claim against Marathon (inc. in OH, D shareholders held about 80% of stock) in S.D. of OH…claim is seeking to enjoin the merger and purchase of stock at inadequate price as officers and directors owe a fiduciary duty to minority shareholders as majority shareholders.
ii. Mobil announced hostile takeover of Marathon ($85/share), directors believed inadequate so had to find another offer…U.S. Steel offered $125/share for 30 mil. shares with Marathon to become wholly owned…ended up with 80% of stock at end of process (1st part of the transaction).
1. How did tender offer work? (def. when a co. makes a public, blanket offer to purchase all shares at a premium price) à Make offer to every shareholder at once, by mail and publication. At $125/share (needs to be above market price). Want 51% because 49% will be offered a lower value later (voting rights to majority, elect new directors)
a. Even if everyone wanted to sell, only want 51%…fairness? This would discourage small shareholders…BUT to discourage tender offers would affect a way of a number of shareholders to make money and effect U.S. Steel shareholders who have concerns about profitability à law steps in to split the difference…federal law requires proration…must accept some % from each tendering shareholder.
iii. 2nd part of the transaction…merger – remaining shareholders who did not tender cannot now keep their shares because Marathon disappears as a corp. entity.
1. Fair? U.S. Steel votes with it’s 80% of stock for merger. They get the assets of Marathon and minority end up with notes.
a. Potential conflict of interest because shareholders but engineering takeover, but…wouldn’t have bought originally if they couldn’t do it.
b. Why do we need law??? Shareholders always had “a market out”…PROBLEM is that they didn’t necessarily here…what other company is going to pay over $125/share with the lock-up options. (1) option to purchase 10 mil. shares at $90/share à 17% of Marathon stock (newly created shares), if the deal fell through it wouldn’t be hard for U.S. Steel to still get 51%; and (2) option to purchase oil field for $2.8 billion à conditional on any other co. buying Marathon…makes Marathon look less attractive and U.S. Steel might easily be able to sell back to Marathon’s new owners at a premium…both options found illegal in another trial.
i. Who gave these options? Marathon Bd. of Directors (entrenchment…trying to keep their jobs rather than if Mobil took over and they would lose them.
ii. No way that shareholders can benefit from these side-deals…only justification is that maybe $125/share deal was so good that options were fair.
c. The “notes” – in 12 years, U.S. Steel will pay you $100; $12.50/year in interest…sounds great but market rater might have been higher and there is a solvency risk (suspicious that they likely don’t have the money left to pay higher interest value. Note has a market value of $80. Likely no chance to sell on the market anymore because market value drops with share control (5 million shares left so not much voting power!)…P’s argue intrinsic value not reflected in share costs because investments were about to pay off.
iv. D’s claim if left to normal market activity, would have received more than $80/share, stock was artificially capped at a low price. P’s argue that there was no choice for majority not to accept the offer!!!
1. Prisoner’s dilemma: if you tender and maj. sells, you get $12,500 for 100 shares; if you don’t sell and maj. agrees $125/share is too low, nothing changes and U.S. Steel goes away. If you tender and maj. does not, shares are returned to you and U.S. Steel goes away; BUT if you don’t tender and majority does and U.S. Steel gets 51%, you only get $8000. à
a. You will tender out!!! Element of coercion because market price is capped…widely-dispersed so no communication of strategy. It says nothing about the adequacy of the offer…structure of the offer itself left no choice.
2. Solution: SEC plans for communication, but hasn’t worked…institutional holding, but self-interested as well though.
v. Corp. law questions: How do you resolve conflicts…law vs. private contract? How might these conflicts be avoided in the first place? (conflicts exist btw competing raiders, raiders and targeting, mgrs. and shareholders, maj. shareholders and min. shareholders, creditors, customers, etc.)
a. Why would someone want to form a partnership?
i. Hypo: restaurant – $500K to open ($300K of which to buy building)…you have $250K and need another $250K.
1. Go to a bank for $250K but pretty volatile industry and you have no experience. What kind of collateral can you offer?…$300K building? Market value on it might decrease though so probably not enough…this would not be good for person seeking loan either because all the assets would be collateral (too risky).
a. Bank – may not be satisfied w/ such security interest and will insist on insurance policy
b. Even if adequately insured – still risk b/c property values vary
c. This is the problem small businesses face – putting together investment
i. 10 yrs ago – if you had a new, high-tech idea you might interest private equity business rather than bank (although they would not be interested in a restaurant)
2. Business partner maybe (friend, relative)…
a. Maybe friend can give $100K as a loan but still too risky for lender because if the business does well only gets interest and if it does badly, subject to foreclosure
b. Friend – should probably take some security interest in business venture (hard to act exactly like bank b/c probably would not want to put friend out of business, etc.)
c. SHARE OF PROFITS???
i. Want to limit losses to $100K lent…BUT bank is not going to like this for lending the other $150K b/c want to be able to go after both (bank would like to see 2 people who are on the line to be liable should business fail)
ii. Want profits if business does well
iii. Want trust in operations…if you’re going to share in losses greater than $100K lent, then want to protect yourself b/c much greater risk. à friend would say, if I have to assume some loss then I want some control over future of the business
3. Are they a partnership?
a. Look to state law!!! – More uniformity than Corporate law because of Uniform Partnership Act [UPA] (adopted in 49 states; two versions: 1914 and 1994 (amended in 1996)).
i. Fairly uniform, but there are different versions
ii. 1914 – some states have adopted this and not changed
iii. 1994 – revised in 1996: various states have adopted various versions
iv. Here let’s look at 1997 version
b. UPA §202(a) – (3 requirements w/ 2 sub-requirements!!!):
i. Association of 2 or more people
ii. To carry on as co-owners a business
1. §202(c)(2) – sharing of returns doesn’t itself establish a partnership…(2 requirements):
a. Sharing of risk – sharing of losses is required!!!
b. Sharing of control – sharing of management!!!
iii. For profit – whether or not persons intend to form a parternship
1. Whether or not parties intended a partnership is formed by “conduct,” not explicit agreement…creates problems. As a practical matter, spell out agreement to avoid problems.
c. Apply to Hypo
i. Sharing profits? – §202(c) sharing profits does not by itself establish partnership
ii. Sharing risk/losses? – ownership means responsibility, therefore sharing of losses is required
iii. Sharing of control? – yes by agreement
iv. Which of the above constitute being a co-owner????
1. Just because two people share profits doesn’t make a partnership arrangement
2. The key to defining partnership is a.) sharing of losses/risk and b.) sharing of control
4. Yes, this is a partnership, so go back to bank…bank wants interest and share of profits as well…this would not be enough to make the bank a partner (202(c)(2))…202(c)(3)(i) – profit sharing presumed to be a partner unless payment received in payment of debt…exclusion which protects banks.
a. What if bank wants control of chef? Is it control under UPA?
i. Probably not – Policy reason: do not want to consider bank partnership because you want to promote lending (especially to smaller businesses).
ii. The bank might have expertise that will help to promote business…banks can exercise some control (Martin)…lenders have leeway to structure agreements.
1. flexibility to structure agreement guarantees bank will be protected
2. don’t want to interfere with lending—so it’s ok to let the bank interfere a bit
iii. Is bank sharing risk? – NO, it has a loan agreement that says its liability is limited
b. Martin v. Peyton – Hall got a loan from friend to use as collateral for struggling business, loaners were to receive 40% of profits until return was made with an option to join the firm if they wanted to…P claimed it was a partnership and that lender friends should share in the losses…ct. disagreed, no control, could veto speculative business but this is normal to safeguard loan, profits were merely compensation for the loan.
c. Subordination—bankruptcy context
i. If bank got so involved into management, that it was part of the reason it was bankrupt, then should “stand last in line of other creditors” (subordination) and held responsible for the debt
5. What is chef that is hired can’t be paid but agrees to accept a share of profits? partner? No share of losses but maybe control b/c chef is central to the business…BUT à
a. 202(c)(ii) – wages or other employee compensation to an employee excluded as a partner.
b. Fenwick: 3 elements!!! losses shared, held out to public as a partnership, control over business…public policy in favor of small businesses because you want people to be able to be employed and for employees to hire w/o holding every employee liable for losses b/c considered a partnership.
i. Fenwick v. Unemployment Comm’n – Employer considered Cheshire a partner of Fenwick and if she wasn’t, he was required to pay into the unemployment compensation fund, they had an agreement that was made when she wanted a raise; said it was a partnership, no cap. contribution, no control, profit sharing, not liable for losses…fact that she had a share in profits was not conclusive here…she did not satisfy the 3 important elements above!…UPA – “two or more persons to carry on as co-owners of a business for profit.”
c. Young v. Jones (PW case) – P invested in SC bank and it disappeared, he relied on audit letter from PW-Bahamas and sued PW-U.S. because on their letterhead and had their trademark, and it was foreseeable that 3rd parties would rely on audit letter issued as a stamp of approval…claimed PW-Bah. and PW-U.S. were a partnership…relying on partnership by estoppel – a person who represents himself to anyone as a partner in an existing partnership or with others not actual partners, it liable to any such person to whom such a representation is made, who has on faith of the representation, given credit to the actual or apparent partnership…here, no licensing agreements in effect, P did not rely on representation, no evidence anyone with PW-U.S. had anything to do with letter.
d. Does it make sense policy wise for a chef to be treated as a partner
6. Partners are formed by conduct, rather than intention
7. What if you approach someone with no money to contribute but a lot of expertise? Partner? Yes, (1) Risk and (2) Control…don’t need to make capital contribution.
a. Share of profits? if no agreement, share equally if not specified. (UPA)
ii. Hypo alteration: 3 investors now…the original, the investor, and the expert…B ($100k friend) buys 10 dozen chairs but A (original entrepreneur) and C (new expert) already bought…can A reject delivery??? No –
1. §301 – if partner’s actions are within the scope of the business, each partner is an agent of the partnership and thus has power to bind the entire partnership; EXCEPTION:
a. No authority to act and
b. 3rd party knew it or received notification that partner lacked authority
2. Purpose: society who K’s with partnership benefits…still have rights against B but if B has no $$$ then you can go after the partnership…It protects 3rd party’s expectations (if a person thinks they’re dealing with a partnership, respect it). Look through the eyes of the 3rd party!!!!!!!!!!!!
i. Issue: do you want to bring them in as general partners? No, would have to give them control b/c they will demand it if they have liability.
1. Limited Partnership – share of profits
a. No control
b. Losses limited to initial capital contribution – if they put in $100k, that’s all they can lose
ii. What about a Limited Partnership? (L.P.) à good if you want to be a passive investor.
1. Limit of liability is amount invested, BUT no control.
2. If limited partner exercises too much control, she becomes a general partner…liable for all losses.
a. Holzman v. DeEscamilla – Farm was ltd. partnership with one general partner and two ltd. partners, went bankrupt and general partner brought this action against ltd. partners to declare them general partners…a ltd. partner shall not become liable as a general partner, unless, in addtion to the exercise of his rights and power as a ltd. partner, he takes part in the control of the business…here, involved in crop decisions, and ltd. partners could draw on bank acct. funds with both signatures, w/o general partner approval and they did.
i. Revised UPA – ltd. partner is only liable to those who transact business with ltd. partnership AND who reasonably believe, based upon ltd. partner’s conduct, that the ltd. partner was a general partner.
b. What is control? How much do you have to do to have exercised it?…traditionally, you couldn’t do or say anything…some state have altered…DE allows limited partners to (1) vote to remove general partners, OR (2) to change nature of the business.
3. Always need at least ONE general partner.
a. ex. B and C could become limited partners if A consented, but legal steps required…need to file declaration of limited partnership.
4. Limited partnership solves the partner/agency problem b/c you don’t have to worry about everyone going around and buying chairs. Seems like a good idea so why not more…for example, no law firms are allowed???
a. Public policy – it limits the number of people responsible to creditors which is true of any limited partnership but since it is a professional practice, you want attorneys being more responsible for their actions and not risk taking.
i. LIMITED PARTNERSHIP – NO Law firms or Accounting firms
ii. LLP – different than Limited Partnerships
1. law firms and accounting allowed
b. As a result, new hybrid partnership (law firms and acct. firms)…L.L.P.…as a result of malpractice suits. Difference from LP:
i. It allows individual partners to limit liability to 3rd parties from negligence or misconduct by other partners!!!…not involved in malpractice, not responsible, but still responsible for capital losses.
1. Still responsible in K actions (LLP aimed only at tort cases).
2. Can exercise as much control as they want w/o becoming a general partner.
3. Requires minimum insurance coverage and funds set aside for malpractice liability.
4. Must file w/ state and identify designation in every deal.
c. ex. chair dealer wants $$$…general partnership – money will be there, can go after anyone and partnership’s assets; limited partnership – can’t go against B alone, only up to liability responsible for; L.L.P. – can go after any like it were a general partnership b/c it’s a K action.
c. With new investors, maybe switch to corp. form? Most procedural steps b/c offers many legal situations not available to partnerships…in corp. form, all investors have limited liability (regardless of control)!!!! Only entity responsible for repayment to chair dealer is ABC Corp. à
III. THE CORPORATE ENTITY (advantage is limited liability b/c its own entity and responsible for its own debts!!!)
i. What about a partnership switching to the corp. form? What would you do if you were a bank who loaned money and now were going to be limited in liability?…Personal assurances, more insurance…w/ small corp.’s not likely to make much difference b/c likely to get individuals backing small corp. anyway.
ii. Tax differences???
1. Corp. is taxed, not individuals…double-taxed on dividends but can get around by dispersing $$$ through employment K’s…individuals can’t write-off as corp. losses.
a. L.L.C. formed for tax purposes for tax advantages (need more info. on L.L.C.)
2. Partnerships pay their own taxes, losses flow through too, so can be written off on taxes by individuals.
iii. What if partners entering into partnership are worried about being able to sell their share? Corporate advantage is that corp. shares are liquid.
1. Why is there a better corp. trading market? Legal component – when you get a share of stock, you get a voting right, right to dividends…makes it fungible b/c you know your rights à contrast to partnership interests which give different rights to control and profits…they all differ!
2. Corp. form might allow you to appeal to outside investors…may to go if you want to grow; whereas partners would likely have to resell to others.
3. Old cases – corporation is a person and is liable for its debts and torts (why should individuals be liable for another person’s actions?
a. Only the corporation can sue for its rights and only the corporation be sued for its liability