Corporations: A Contemporary Approach (Palmiter And Partnoy)
Chapter 1. Introduction to the Firm
Meinhard v. Salmon (p. 4)
164 N.E. 545 (N.Y. 1928)
· Salmon (Manager) and Meinhard (Capital Supplier) entered into a joint venture that centered on a 20-year lease for the Hotel Bristol (in Manhattan).
· Before the lease ended, a third party approached Salmon about a new lease. Salmon entered into the new lease with the third-party and did not tell Meinhard. Meinhard sued for breach of duty of loyalty
· Whether Salmon had a duty to extend the new business opportunity that arose from the initial project he and Meinhard were co-adventurer's in?
· Joint adventurers, like co-partners, owe to one another, while the enterprise continues, the duty of the finest loyalty.
o Loyalty and comradeship are not so easily abjured (signed the lease four months before the end of the term)
Dissent: (Andrews, J)
· There was not a general partnership, but a joint venture for a limited object and a limited time, when the joint venture terminated, the relationship terminated
· General partnership – Usually have equal financial and management rights
· Joint venture – “partnership” with a limited duration or scope
A. Risk Allocation in the Firm
1. Nature of Risk
· Two Types of risk:
o Non-Controllable Risks, and
§ Example: U.S. economy, bank interest rates, NYC commercial leasing market.
o Controllable Risks
§ Example: The kind of tenants Meinhard and Salmon would have, quality of the building materials they would use, how the project would be advertised.
2. Methods to Manage Risk
· Insurance – A person or business pays upfront in exchange for the right to payment if a specified event occurs
· Diversification – A person or business participates in numerous ventures, each which involves different risks (doesn't completely eliminate risk, but certainly reduces it)
· Internal Risk Allocation – Risk is allocated to the person who is most willing or best able to bear them, i.e. because they are in a better position to insure or diversify
· Risk Externalization – When a business moves the risk to other people outside of the firm (i.e. Insurance is a form of risk externalization)
o Limited Liability – Participants are liable only up to the amount they invest in the business, thus, OUTSIDE parties that deal with the corporation must bear any loss should the corporation be unable to fulfill its obligations
3. Business Firm as Risk Allocation
· Between Principal (investor/owner) and Agent (manager/employee)
· When a Principal and an Agent join in a business venture, tensions are inevitable
o Principal wants to:
§ Maximize the expected return on his investment, and
§ Have the agent use as much effort as possible to make the venture a success,
§ While retaining the bulk of the profits.
o Agent will also want to:
§ Maximize the expected return on his efforts, given alternate uses of his time.
§ Receive a generous compensation for his effort,
§ Be compensated even if the venture fails,
§ In order to accomplish his goals wants the principal not to interfere
· Note: The difficulty in allocating risk is that the party who bears the consequences of the risk will have a greater incentive to control the risk.
· Example: If Salmon receives a fixed salary he will have little incentive to promote the venture.
o This failure is called Shirking.
§ Shirking – The danger that the person who does not bear the risk will not take steps to control that risk.
§ Essentially, there is no risk to step in because the individual has no interest in the outcome.
4. Role of Law in Business Firms
· To save the participants the costs of contracting, the law of relationships (including agency, partnership, and corporate law), provide off the rack rules, which define the parties relationships.
· Note: These rules are default unless parties otherwise agree in contract
· Agency verses K Law
o Agency reflects the morality of friendship, family responsibility, and authority
§ Governs the morality of a team
§ It's appropriate to sacrifice for the common good
· What's good for me is also good for you
o Contract reflects morality of strangers, markets, fair play
§ If you score I don't, not for the common good
§ One team against another
B. Fiduciary Duties
1. Theory for Fiduciary Duties
· Fiduciary duties seek to protect those who delegate authority (capital suppliers) against the laziness, disloyalty, or worse of those who exercise the authority (managers).
o Essentially, the law steps into define broadly that a fiduciary must exercise, care, diligence, honesty, and loyalty with respect to the firm and its participants.
· (Cardozo, J.): Fiduciaries must a “punctilio of an honor the most sensitive.”
2. Meaning of Meinhard v. Salmon
Chapter 2. Corporate Basics
A. Corporation as Private Constitution
· Corporation – A legal entity that can own property, enter into contracts, sue and be sued.
· The Articles of Incorporation (“corporate constitution”), in general, attempts to allocate the respective roles of shareholders and directors.
Fundamental shareholder rights.
· Right to vote.
o Elect a corporation's directors who have the power to manage and oversee the corporations business.
· Right to sue (private/derivative claims).
· Right to sell and exit the corporation.
o Transferability of ownership interests, usually accomplished on a stock exchange for larger companies.
B. Basic Corporate Vocabulary
1. The Corporation
· Corporate categories.
o Public vs. Close; Tax Status; For Profit vs. Non-Profit.
o Most public corporations are also known as “C Corporations,” based on the provision of the IRC that applies to them.
o Many closed corporations are formed as “S Corporations,” based on a different IRC provision.
· Corporate characteristics.
o Separate entity – Every Corporation is a legal entity that is separate from the investors who provide it with money and the people who manage its business.
o Perpetual existence – A corporation has a perpetual existence and an unlimited life.
o Limited liability – A corporation's shareholders have limited liability and cannot lose more money than what was invested.
Corporate Purpose [MBCA 3.01]: Every corporation incorporated under this Act has the purpose of engaging in any lawful business unless a more limited purpose is set forth in the articles of incorporation.
2. Organic Documents (Articles of Incorporation and Bylaws)
· Anyone can create a corporation by filing “articles of incorporation” with relevant state officials
o These documents serve as the Constitution for the corporation
· Bylaws are also drafted and include: powers of directors and officers, procedures for election, required notice periods and details for calling and holding meetings of shareholders and directors.
3. Corporate Actors
· Shareholders – Contribute capital to the corporation in exchange for “common shares” which represent a divided ownership stake in the corporation.
· Directors – Individuals who are elected by the shareholders to be responsible for managing and supervising the corporations business.
o Delaware General Corporations Law § 141 – The business and affairs shall be managed by or under the direction of a board of directors.
o Note: Directors are supposed to act in the best interests of the corporation, they are not employees of the corporations
· Officers – Corporate employees who run the day-to-day activities of the corp
shareholders in the subsidiary (also occurs in close corporations).
6. Corporate Law vs. Other Areas of Law
· Internal Affairs Doctrine
o In general, the law of the state of incorporation governs the “internal affairs” of the corporation.
o The relationships between the owners (shareholders) and managers (directors and officers) are governed by the corporate statutes and case law of the state where the corporation is incorporated.
C. Basic Corporate Law Question: Changing the Annual Meeting
· Under what circumstances may the board change the timing or location of the annual shareholders' meeting?
o If a shareholder has persuaded other shareholder's to vote to replace the board, the incumbent directors might find it to their advantage to change the date of the annual meeting
· General Rule—Using the corporation's own assets to perpetuate yourself in office for your own purposes is breaching a fiduciary duty
o DGCL §211—Meetings of Stockholders: Can be held within or out of state, designated in a manner provided by the certificate of incorporation, the bylaws, or if not designated by the B of D
o DGCL §222—Notice of Meeting and Adjourned Meetings: When shareholders are required/ permitted to take action written notice of the meeting must be given which shall state the place, date and hour of the meeting
o Written notice shall be given not less than 10 nor more than 60 days before the date of the meeting to each stockholder entitled to vote at such meeting
· Case Law Conclusion
o Schnell: board has power — but it's inequitable to change meeting date and impede voting insurgency
o Stahl: board has power — and it's equitable to not set meeting date and thus impede insurgency/tender offer
Schnell v. Chris-Craft Industries, Inc. (p. 44)
285 A.2d 437 (Del. 1971)
· Simply because management followed the correct procedure does not mean the action of changing the annual shareholder's meeting is acceptable when the intent was to obstruct efforts for a proxy contest.
· When there is a voting insurgency (rebellion), the shareholders can just elect a new board of directors and accordingly a new corporation.
· Power vs. Duty
o “… Management has attempted to use the corporate machinery and the Delaware Law for the purpose of perpetuating itself in office … for the purpose of obstructing the legitimate efforts of dissident stockholders … These are inequitable purposes, contrary to established principles of corporate democracy.” Schnell v. Chris-Craft Industries, Inc. (Del 1971)
· Delaware's “Product”
o Board timeline – 1971
§ Sep 17 – Shareholder insurgent group forms
§ Oct 18 – Board meeting amending bylaws
§ Oct 27 – Shareholder group learns of new meeting date
§ Dec 08 – Proposed new date for meeting (Cortland, NY)
§ Jan 11 – Original date for meeting (bylaws)
o Court action – 1971
§ Nov 1 – Shareholders group files action
§ Nov 10 – Chancery Court grants access to shareholders' list
§ Nov 18 – Chancery Court denies preliminary injunction
§ Nov 29 – Supreme Court remands case to postpone meeting