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

Corporations Leahy Spring 2018

Business Organization

The law of enterprise organization = In all events, the modern law of organizational forms—most notably corporation law—is premised on the idea that facilitating individuals’ efforts to create wealth is wise public policy—search for efficiency is, and should be, at the core of organizational law—FAIRNESS in this policy refers to fairness to SHs

Groups that Business organization law focuses on

Agents (management/officers)
Shareholders (owners of the corporation)
Board of Directors

Directors are not agents of the corporation

Bus. Corp. Law Ignores:

Customers—Employees (lower lever)—Suppliers (Creditors, sometimes)—competitors—independent contractors—Govt/Municipality— Consumers/Clients/Customers—environment.
Is bus org law unjust or unfair b/c it ignores these groups and their concerns?

No. Its amoral, it ignores them. Mergers can affect people- ex if factory shuts down, but they can seek remedies in other areas of law
Environmentalists can seek remedies in environmental law, suppliers in K or bankruptcy law, employees in employment law, consumers in consumer law, competitors in anti-trust law

Underlying purpose:

Transactions Costs Theory = the firm as a set of transactions cost-reducing relationships (or “governance structures,” in Williamson’s terminology).

In this view, 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.

shareholder wealth maximization

goal!!!!!: have board and management operate in a way that maximizes the shareholders wealth
Agency costs are any costs associated with having employees. (of having someone do it for you)

Types of Agency Costs that owners have to pay:
Loyalty Costs: To ensure agent loyalty EX: Prevent EE from stealing; security cams

Monitoring Costs: costs expended for owners to ensure agent’s loyalty; non-compete, hiring good employees (HR), security measures.

Due Care Costs: To ensure agents work diligently/skillfully

EX: Give bonus for better performance…protects against laziness/shirking

Bonding Costs: a cost of having employees, promoting/ensuring employee reliability, good performance.

salaries, bonuses, benefits, accommodations, training.

Residual Costs: everything else, misc. costs, etc.

Agency Cost: The CEO & the Jet Plane; CEO flys a lot & needs convenience to work while traveling. Leasing private jet costs $1.5 million vs. $500K to fly first class, same comfort/convenience. – There’s a $1 million difference in cost. The extra $1 million to fly on a private jet is the agency cost. If CEO owns 100% of the corp, it would cost her $1 million, but if she only owns .01% it would only cost her $1,000 – this is an agency cost. How can you govern them? Say don’t do anything that’s not in the shareholders best interest. Put it the onus on the fiduciary (the CEOs)

Agency & Partnership

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

Three Elements:

Consent (by principal)
On Behalf of (Agent for Principal)
Agent is Subject to Control (of Principal)

Agency is important to the existence of all bus. orgs. because corporations need agents to do any and all work.

acting on behalf of the organization, subject to the control of the organization.
Examples Include: CEO, Mid-Level Managers, All Employees

Partnership: Two or more individuals associated as co-owners to carry on a business for profit.

Partnership can also be called a “Mutual Agency”
Joint Ownership is favorable because: Raise Funds & Avoid Expense (Debt)

Agency: Agreement + A acts on behalf of P + P controls A

Partnership: 2+ co-owners + in business + for profit

When might a bus org w/ joint ownership be superior (from the founder’s perspective) to a sole proprietorship?

A founder might bring in a co-owner b/c sometimes sharing the risk is cheaper than borrowing…. BUT also, must share profit

***After a certain point, selling an ownership stake may simply be a cheaper way to raise capital than attempting to borrow more funds.

Fiduciary Duties (ARE IMPORTANT!!!!)

Fiduciary Duties: one must put the interest of the master above their own…cannot take side deals during fid transactions….duty of finest loyalty…encourages passive investment Fid duties control agency costs

These relationships are more efficient than specific rules bc they place the onus for deciding how to act on the fiduciary


Federal law requires registration if 500+ shareholders and $10 Mil in assets

“Controlled” Corporation

Where a single shareholder or a group of shareholders exercise control through its power to appoint the board.

Ex: 50% + 1 share or “legal” control, or some combination that helps you have enough power to control the Corp.

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.

Mandatory Statutory Rule: Prohibits or forbids corporations from acting in certain ways or maintains a way a corporation MUST act.

ex: “the board of directors shall…..”

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).

ex: :the board of directors may….”

Default Rules: mean that you can change them.

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.”

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.
Relevant TBOC & DGCL

TBOC §1.002(18) – Domestic Entity Definition; (22) Filing Entity Defintion
§1.101 – Domestic Filing Entities
§1.102 – Foreign Filing Entities
§1.103 – Entities not formed by Filing Instrument
§1.104 – Law Applicable to Liability
§1.105 – Internal Affairs
§3.003 – Duration
§21.209 – Transfer of Shares & Other Securities
DGCL §102(b)(5)

(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;