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Business Associations/Corporations
South Texas College of Law Houston
Leahy, Joseph K.

Corporations Outline
Spring 2012
 
I.                   Business Organization
 
A.      The law of enterprise organization
a.        Business organization law focus
                                                               i.      Agents (management/officers)
                                                             ii.      Shareholders (owners of the corporation)
                                                           iii.      Board of Directors
1.       Directors are not agents of the corporation
b.       Bus. Corp. Law Ignores:
                                                               i.      Customers, Employees (lower lever), Suppliers, competitors, independent contractors, the public, communities housing headquarters, the environment.
c.        Underlying purpose:
                                                               i.      shareholder wealth maximization
1.       goal: have board and management operate in a way that maximizes the shareholders wealth
2.       Agency costs are any costs associated with having employees.
a.        Types of Agency Costs:
                                                                                                                                       i.      Monitoring Costs: costs expended for owners to ensure agent’s loyalty; non-compete, hiring good employees (HR), security measures, performance reviews, etc.
                                                                                                                                     ii.      Bonding Costs: a cost of having employees, promoting/ensuring employee reliability, good performance.
1.       salaries, bonuses, benefits, accommodations, training.
                                                                                                                                   iii.      Residual Costs: everything else, misc. costs, etc.
B.       Agency & Partnership
a.        agency is the fiduciary relationship that arises when one person (a principal) manifests assent to another person (an agent) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act.”  – Restatement (Third) Agency §1.01
                                                               i.      Three Elements:
1.       Consent (by principal)
2.       On Behalf of (Agent for Principal)
3.       Subject to Control (By Principal)
b.       Agency is important to the existence of all bus. orgs. because corporations need agents to do any and all work.
                                                               i.      acting on behalf of the organization, subject to the control of the organization.
                                                             ii.      Examples Include: CEO, Mid-Level Managers, All Employees
c.        Partnership: Two or more individuals associated as co-owners to carry on a business for profit.
                                                               i.      Partnership can also be called a “Mutual Agency”
                                                             ii.      Joint Ownership is favorable because: Raise Funds & Avoid Expense (Debt)
C.       Fiduciary Duties (Introduction)
a.        Fiduciary Duties: Legal power over property (including information) held by the fiduciary; held for the sole purpose of advancing the aim of a relationship pursuant to which she came to control that property; one must put the interest of the master above their own.
 
b.       Two Key Fiduciary Duties:
                                                               i.      Duty of Loyalty: A pervasive obligation always to exercise legal power over the subject of the relationship in good faith, to advance the interest or purpose of the principal, and not to exercise such power for a personal benefit.  (monitoring cost).
1.       Tarnowski v. Resop
a.       Agent who gave bad information to Principal, resulted in bad business decision by Principal, Agent worked side deal for himself – Court held that Agent must make principal whole, including the secret commission
b.       Rule: breach of duty of loyalty – must put Principal’s interest before your own.
2.       Meinhard v. Salmon
a.       When one partner entered into a new business deal (long term building lease) and failed to include the other partner, the judge held that because the opportunity stemmed from the business partnership, that the “business opportunity belonged to the partnership.”
b.       Per Judge Cardozo: Protect shareholders from managers taking opportunities for themselves, by causing them to share the wealth maximized by the transaction.
3.       Joint Ventures’, like co-partners, owe to one another (while the enterprise continues) the duty of the finest loyalty.
4.       Certain actions allowed when dealing at arms length are forbidden to those bound by fiduciary duties.
                                                             ii.      Duty of Care: A duty to act in good faith, as one believes a reasonable person would act.  (bonding cost).
 
II.               The Corporation
 
A.      The Key Corporate Characteristics
a.        Legal Person with Indefinite Life
                                                               i.      This attribute separates the corporation from the shareholder
b.       Limited Liability
                                                               i.      Corporation is always liable for its debts, but shareholders do not have liability for anything beyond their initial investment.
1.       Absent veil piercing, there is zero liability for the shareholders.
c.        Free Transferability of shares (interest in the corp.)
                                                               i.      no penalty for selling your shares of the corporation.
d.       Centralized Management
                                                               i.      The Board of Directors run the corporation, not the shareholders.
                                                             ii.      Appointed by equity investors (owners appoint management)
e.        Raise Capital
                                                               i.      The corporation permits passive investing by the public (or private)
B.      Types of Corporations
a.        “Close” Corporation
                                                               i.      relatively few shareholders, often incorporated for tax or liability purposes.
b.       Public Corporation
                                                               i.      Federal law requires registration if 500+ shareholders and $10 Mil in assets
c.        “Controlled” Corporation
                                                               i.      Where a single shareholder or a group of shareholders exercise control through its power to appoint the board.
1.       Ex: 50% + 1 share or “legal” control, or some combination that helps you have enough power to control the Corp.
                                                             ii.      When a corporation is controlled, there is one group of people with enough shares to dictate the board; when the corporation is “in the market” there is not a controlling shareholder and the existing management retains (maintains) power.
C.       Mandatory Statutory Rule: Prohibits or forbids corporations from acting in certain ways or maintains a way a corporation MUST act.
a.        ex: “the board of directors shall…..”
D.      Permissive Rules: enables a corporation to act in certain ways.  Corporations can’t do anything they are not allowed to do (they are restricted to doing only what the law allows them to do).
a.        ex: :the board of directors may….”
E.       Default Rules: mean that you can change them. 
a.        ex: “unless otherwise specified in the charter, the board of directors shall consist of 9 persons.”  If the charter states there will be 12 directors, then that is ok and the corporation is permitted to deviate from the “default rules.”
F.       Enabling Laws: Allows for anyone to form a corporation and operate the business.  This is differentiated from Regulatory laws that limited who could form a corporation.
G.       Relevant TBOC & DGCL
a.        TBOC §1.002(18) – Domestic Entity Definition; (22) Filing Entity Defintion
b.       §1.101 – Domestic Filing Entities
c.        §1.102 – Foreign Filing Entities
d.       §1.103 – Entities not formed by Filing Instrument
e.        §1.104 – Law Applicable to Liability
f.         §1.105 – Internal Affairs
g.        §3.003 – Duration
h.       §21.209 – Transfer of Shares & Other Securities
i.         DGCL §102(b)(5)
                                                               i.      (b) ….the certificate of incorporation may also contain any or all of the following matters: (5) A provision limiting the duration of the corporation's existence to a specified date; otherwise, the corporation shall have perpetual existence;
H.      Corporation Statutes
a.        Internal Affairs Doctrine (IAD)
                                                               i.      all affairs of the internal governance of the corporation are handled under the law of the state where the corporation is incorporated.
1.       This includes violations, voting, meeting times/places, etc
                                                             ii.      IAD does not include wrongs by the corporation – these are typically handled under state(s) law where the wrong was committed.
1.       However, if the wrong affected shareholders, then IAD would apply.
                                                           iii.      For Exam: any problem within the facts, consider if it is an Internal Affairs matter

corp. – 10 shares; Andy has 3 share, Bill has 7 shares; C Corp is going to introduce 10 more shares.  Under a pre-emptive right, Bill would have the first option to buy up to 7 shares, Andy would be able to buy three.  This gives each the ability to keep the percentage of shares they initially had.
b.       Under Delaware law: A shareholder has pre-emptive rights, only when it is listed in the charter.  therefore, the Default rule in DE: There are no Pre-Emptive Rights
c.        Under Texas law: A shareholder has pre-emptive rights only when it is listed in the charter, if the charter was formed “today” (after 2003); same as Delware.
                                                               i.      Under TBOC §21.208, if the corp was formed before Sep. 1, 2003, it is presumed that shareholders have pre-emptive rights, unless Charter says they don’t.
E.       Opting for a Statutory Close Corporation
a.        The Charter must state that “this is a Close corporation”  – TBOC 3.008
b.       Statutory Close Corporations can:
                                                               i.      Eliminate the Board of Directors, allowing Shareholders to manage as shareholders.
                                                             ii.      Shareholder meetings replace board meetings
1.       Here, shareholders are treated, by statute, like directors for the purpose of liability (fiduciary duties)
                                                           iii.      no bylaws required
                                                           iv.      Note: There is no maximum number of shareholders to be a statutory close corporation in Texas.  In other states, the max is 35 shareholders.
c.        Shareholder Agreements in Texas
                                                               i.      Not restricted to close corporations – can be in almost any type of corp.
1.       This is not effective for publicly traded corps – (listed on the NYSE)
                                                             ii.      an agreement is valid for ten years unless it says otherwise.  TBOC §21.102
                                                           iii.      Allow corporations to opt out of some otherwise mandatory rules of TBOC
1.       i.e., restrict discretion of board of directors (TBOC 21.101(a))
                                                           iv.      Must be
1.       in Charter or Bylaws or
2.       agreed upon and signed by shareholders,
3.       made known to the corporation, and
4.       amended only by the shareholders – TBOC 21.101(b)
                                                             v.      If you were not originally subject to the shareholder agreement, you are not bound by it.
                                                           vi.      Must be disclosed on the corporation’s stock certificates (But, if not, does not affect the enforceability)
                                                         vii.      Cannot improperly restrain the board or be illegal vote buying
F.       Formation: Restrictions on Transfer of Shares
a.        Transfer restrictions are more desirable in a close corporation because you can keep the shareholders to a minimum, like within a family or a small group of shareholders.
b.       TBOC 21.210 – Ways to Restrict Transfers
                                                               i.      may be imposed by:
1.       the corp’s cert. of form.
2.       the bylaws
3.       written agreement – two or more holders of the securities
c.        TBOC 21.211 – Types of transfer restrictions
                                                               i.      To be valid, restrictions must be:
1.       reasonable
2.       noted on the share, or in a notice sent to the holder
a.        Also enforceable if transferee for value has actual knowledge of the restriction at the time of transfer.