BUSINESS ASSOCIATIONS
Prof. Butler – Fall 2016
A Bit of History – Introduction to Business Enterprises
Corporations and other business associations are the structures through with business is conducted – profits distributed and losses allocated
“joint-stock company” – England 1553
Dutch East India Co., English East India Co., Hudson Bay Co.
Ownership interests = shares that could be transferred
Allowed each investor one vote, regardless of the amount of their investment
Investor’s liability for the company’s debt was unlimited
Managed by a committee of directors and employed officers who acted as professional managers
Business associations colonized America
England sought to exploit and settle America through the use of joint-stock companies
King sought system of trade in which JSC would provide “a method of returning to the original investor their capital and interest in the form of dividends on their investment.”
“Adventurers” were stockholders who supplied funds (capital) to the enterprise
“planter” were those who went to America to found the Jamestown settlement
Given a share of the company’s stock plus land in America
Pilgrims sent to America by Plymouth Co were given a share in the company’s stock and double shares if they supplied their own tools.
Most businesses in America operated as proprietorships or partnerships
South Sea Bubble in England in 1720 caused large losses to investors
Parliament required a royal charter for companies seeking investment funds from the public.
Imposed on American colonies in 1741
Dispute over who could authorize such charters – Royal governors or the colonial legislatures
Few charters were issued – mostly to charitable societies, libraries, universities
Constitution adopted after the Revolution – gave power to issue corporate charters to the states
1784 – limited liability of shareholders had been generally accepted
By 1800 – over 350 commercial corporations had been chartered in US
States gradually moved toward laws that freely allowed businesses to be formed as corporations
NY – first American incorporation act
Allow any person to incorporate by compliance
Incorporation by special act – manufacture of various commodities
Corporate existence limited to 20 years
Capital could not exceed $100K
1835 – general incorporation laws – general acts permitting incorporation by signing and filing articles of incorporation
1888 NJ – creation of holding companies – corporations were allowed to purchase and hold shares of stock in other corporations
1896 NJ – “Mother of Trusts” – enacted first permissive modern incorporation act
Conferred broad power on corporations
could set up almost any kind of corporate structure they desired
granted broad powers to corporate directors and managers
provided great protection against liability for corporate directors and managers
1913 – Delaware – under Woodrow Wilson, governor – permissive corporate laws
DE is now the venue of choice for public corporations
Today, all states have broadly permissive enabling corporation statutes with very little regulatory or paternalistic provisions.
Since 1960s – Legislatures embraced philosophy of allowing corps broad framework of local law, to tailor the governance structure to accommodate their own special needs and relationships
Choosing the State of Incorporation
1950 – publicized Model Business Corporation Act (“MBCA”)
2/3 of states have adopted some version
Internal affairs rule (“choice of law” rule) – the law of the state of incorporation will govern all matters relating to the internal affairs of the corporation
State of incorporation = Legal regime that that will govern many aspects of a corporations existence.
the court hearing the case must refer to the law of the incorporation state to resolve the issue
ensures uniform treatment of a corporation’s internal affairs regardless of where a lawsuit is brought
R2 – virtually every issue that relates to the management of a corporation
Rights of shareholders
Duties of corporate directors
Followed by all states – EXCEPT CA
Corp law of CA shall govern the internal affairs of corps that have certain minimum contacts with CA, even if incorporated in another state
Have states have resisted CA’s attempt to expand its scope of corp law
Race to the bottom – corp managers (not SH) decide where to incorporate and states compete by enacting laws that cater to managers at SH expense
SH protection is eroded.
Scholars argue for federal statutes providing for minimum corp law standards
Race to the top – companies tend to incorporate in states that maximize SH value
Generates extra wealth for shareholders
Most robust legal protections for SH
NV – 2nd to DE – imposes virtually no liability upon corp officers and directors
Corp law that is as lax as possible
DE – Delaware General Corporation Law (“DGCL”)
Corporations venue of choice for incorporation
More than half of all public companies are incorporated in DE
Studies show increase in firm value when reincorporated in DE
Benefits to State:
High franchise tax
Provide substantial business to attys (corp law / litigation)
2015 – permitted exclusive forum selection clausesfor all SH lawsuits
NO “fee shifting” allowed – corp cannot recoup litigation expenses from unsuccessful SH Pls.
DE Court of Chancery – hears all corporate disputes
5 judges – widely regarded as experts on corp law
Special commercial division
20 other state have “business courts” that hear corporate and commercial law cases (primarily or exclusively).
Agency Problems in the Modern Corporation
“race” debate is due to separation of ownership from control
Conflict between those who own the corp (SH) and those who manage it (corp officers)
Corp officers make virtually all decisions relating to the conduct of the business
Utility maximization – Manager will advance their own interests at expense of the SHs
Managers’ quest to maximize their utility does not naturally lead to decisions that also maximize the value of the firm.
The Chicago School – neoclassical economist view
Managers must have an incentive compensation arrangement that substantially ties their futures to that of the owners:
the manager to serve the SHs’ interest thru stock option plan or bonuses based on firm profitability;
best features of all other business associations
Has become the most popular form of business entity, especially for start-up businesses.
Limited Liability – Liability of members is limited to amount of investment
in management – business can be structured freely under operating agreement.
Separation of ownership and control – Allows members maximum flexibility in management and operation of business. Can invest without becoming involved in management, or can manage company (if operating agreement permits) w/out incurring unlimited liability.
–A charter must be obtained from state upon commencement of the business of the LLC;
accounting might be more complicated than in a simple partnership.
– “pass through”
– Ownership interest of a member is transferable but might be restricted by terms of the operating agreement, and subject to state and federal securities laws.
Professional Corporations (PC) & Professional Associations (PA)
Created in Texas in 1969
Tax advantages of a corporation and at least some limitation of liability for the conduct of other partners
Not-for profit corporations – charitable enterprise
Unique tax issues
Federally chartered corporations – National Banks – regulated by federal govt
Separate ownership and control
Legal structure – SH meetings, reports, registered with state
Limited Liability – Liability of investors (SH) is limited to amount of investment = encourages risk taking
Separation of management and control – Stockholders may invest w/out becoming involved in management, which allows an efficient allocation of capital and professional management of the company’s operations.
– Stockholdings are transferable,
may be subject to requirements of federal securities laws
might not always be ready market for the stock
Perpetual Life – continues to exist until dissolved (death of owner doesn’t terminate life of corp.)
Double taxation –profits are separately taxed.
SH are then taxed again if remaining income is distributed to them
This may be avoided in smaller corporations through subchapter S status which allows a pass-through of profits directly to SH in smaller corps.
– Managers can manage for their own interests (e.g., higher salaries, perquisites) instead of seeking to maximize shareholder wealth.
– More than other enterprises.
Publicly held corporations must comply w/expensive reporting and registration requirements under federal securities law.
Accounting and legal issues will be more frequent and more complicated.
