1) Introduction to the Firm
a) Agency and Corporate Form
i) College dropout wants to develop software in garage. Buys computer, hardware, etc. Develops code, markets and sells. Collects all revenue and pays bills. Keeps the rest. What is he being compensated for? What has he done to earn these returns?
(1) Developed the idea
(2) Managed the company
(3) Financed the investment
ii) Business grows and he can’t keep doing everything himself. He’s behind on the new version of the software, orders for existing software are backing up and nobody’s manning tech support. He’s in danger of losing the business.
(1) What can he do?
(a) Developmentà needs to bring in people to work on the new version to bring in new ideas, make compatible with other software, etc
(b) Managementà hire someone to come in as employee, outsource to another company such as accountant to manage as aspect of business
(i) Employees will have legal duty to employer whereas outsourced work will typically be strictly contractual
(ii) Will have less control of business and will be forced to rely on others to complete tasks
(iii)Employees may not have incentive to make business as profitable as possible if employees interests are not aligned with the company’sà agency problem
(c) Financingà may want to expand business into new areas but needs money to do so
(ii) Private investorsà may demand some control of the business
(iii)Public financing (IPO) à downside of reporting requirements as large expense
b) Meinhard v. Salmon, (p. 4)—Duty of Loyalty
i) Background – lease entire building for 20 years and then want to sublet the building
(1) Salmonàputs in half of the money needed for lease; entrepreneur and the manager of the investment
(2) Meinhard à puts half of the money into the investment but has no management duties
ii) What are the respective duties and rights of Meinhard and Salmon in the joint venture?
(1) Meinhardà purely financial; Put in half of the funds necessary to operate property, bearing losses equally with Salmon
(2) Salmonà same financing role as Meinhard, sole power to manage the building
iii) How did the joint venture perform during the term of the lease before 1921? Initially lost money, but turned it around and now very profitable enterprise
iv) What happened near the end of the initial lease term?
(1) Landlord went to Salmon because is the face of the joint venture and speaks of opportunity to become a part of a new building
(2) Salmon signs new lease by his own corporation, Midpoint Realty, and not through the joint venture—rent will be increased substantially
(3) New lease requires Salmon to put up a personal guaranty, which makes him personally on the hook for an deficiency in the future even though through his company
(4) Meinhard does not know anything about this new lease and does not find out about the new lease until the previous lease expires
(a) Demands to be a part of the new lease and is willing to continue his investment role as in the initial lease, including guarantee
v) What does the court say about Salmon’s conduct?
(1) Did the court conclude that Salmon was attempting to defraud Meinhard?
(a) No—Salmon did not have the conscious purpose to defraud and likely that he assumed in good faith that with the approaching end of the venture he might ignore Meinhard and take the new lease for himself
(2) What are his duties in this context?
(a) Has a duty of loyaltyà “joint adventurers, like copartners, owe to one another, while the enterprise, the duty of the finest loyalty”
(b) If we allow this to happen here, then this important obligation is being eroded away, and courts should not let this occur—By preventing these erosions, can keep this standard so high
(c) There would be no advantage in having an agent, if the principal constantly was looking over their shoulder to make sure that they were not being cheated
(d) Meinhard was denied the chance to participate in the new lease, and this violated the duty of loyalty
(i) Meinhard had a right to know the full details of the new opportunity as an integral part of the initial venture
(3) Does it appear that Gerry (property owner) knew about the joint venture?
(a) No—because would have required Meinhard to become a guarantor in the new lease because he had substantial money to back the lease
(4) What if the new opportunity did not arise as a result of Salmon’s management of the joint venture?
(a) Could go either way—under modern conceptions would not be a violation, but under the Cardozo conception might be a closer call
vi) What remedy does Cardozo fashion?—gives Meinhard shares in the realty corporation, but gives Salmon one more share in the company so he can maintain control
c) Overview of Risks and Duties in Corporate Law
i) Types of risk
(1) Non-Controllable Risksà risks the parties in a business firm cannot control—NYS commercial leasing market
(a) How did the parties in Meinhard allocate this risk?
(i) Both took on the same risks with equal investments
(b) Was Salmon compensated for additional risk? YES, was given additional incentive in the first five years of the property (10%)
(2) Controllable risks.
(a) How did they allocate responsibility for controllable risks in Meinhard?
(i) Salmonà types of tenants brought into the building
ii) Financial risk management in Corporations (protecting agents from liability)
(1) Enterpriseà insurance, diversification (participating in numerous ventures)
(2) Investorsà losses limited to the extent that the invested in the enterprise; very rare that liable for losses beyond this point
(3) Managers and Employeesà fixed salary so as long as company continues to pay, risk very limited; also protected as long as they abide by their duties to the corporation
(4) Boardsà insurance for certain alleged violations of their obligations
iii) How does the book suggest parties clarify their respective rights and obligations in principal/agent scenarios?
(1) Provide default rules so that parties know their rights and responsibilities
1) Who are the key players? Hierarchy
a) Shareholder—equity holders (important to note that debt holders not a part of the hierarchy and relations are strictly contractual, also have priority in bankruptcy, no fiduciary responsibility)
c) Company officers
2) How does corporate law frame the rules for governing corporations?
a) Indefinite term for corporation
b) Bylaws: informal constitution for the government of the corporation
i) Discretion and responsibility of the agents
ii) How the board of directors can delegate authority to corporate agents
iii) What board must do to take action binding on corporation
iv) Power to supervise and control (shareholder)
c) Articles of Incorporation
d) State law/ common law dictates much of corporate governance
3) Republican Democracy Overview
a) Officers are not directly answerable to the shareholders individually
b) Indirectly they are and have duties that flow to the benefit of the shareholders
c) Want shareholders to have the ultimate say over corporation but too much control would cause a problem with micromanagement, etc.
4) Shareholders take on role of citizens in the corporation
10) Stahl v. Apple Bancorp, Inc. (p. 47)
i) November 1989à board met to discuss what action, if any, should be taking with respect to Stahl’s accumulation of stock. Stahl delivered to the board a proposal to be submitted to a vote at the next annual meeting calling for an amendment to the company’s bylaws increasing the number of directors of the company from 12 to 21, whereas he would be able to nominate 13 of the directors. In order for Stahl to gain control needed to increase the size of the board, because the board election was staggered.
ii) March 19, 1990àboard fixed April 17, 1990 as the record date for determining the shareholders entitled to vote at the company’s 1990 annual meeting (thus latest day for annual meeting would be June 16)
iii) March 28, 1990à Stahl, holder of 30% of the outstanding stock Apple announced a public tender offer of the remaining shares
iv) April 10, 1990àboard of directors withdrew the record date and elected to defer the company’s annual meeting, which had been intended for mid-may and announced it would explore the advisability of pursuing an extraordinary transaction, including the possible sale of the company. Because record date withdrawn there was no requirement that meeting must take place
v) April 12, 1990—Stahl files suit
vi) May 9—Stahl sends out proxy solicitation materials to stockholders even though no meeting scheduled
b) What relief is Stahl seeking? An order requiring the directors to convene the annual meeting on or before June 16, 1990, as if record date was not withdrawn
i) What legal theory did Stahl advance in support of his case?
(1) Did not argue that board violated the Delaware General Corporation Law (DGCL)
(2) Argues that this action uses the corporate machinery to end of unjust result
(3) That the directors had intended to convene an annual meeting in May or June and had gone so far as to fix April 17 as the record date for the meeting but dropped that plan when it appeared that a proxy contest by plaintiff was likely to succeed
c) What was the Board’s response?
i) That in not scheduling the 1990 meeting in the spring of the year as had been the practice; they are behaving responsibly in the best interests of the corporation and its shareholders. Claims that the decision to delay the annual meeting was not a response to a proxy contest by plaintiff but was a response to the announcement of plaintiff’s tender offer which they conclude is coercive and at an inadequate price. Can justify this response by the two day meeting they just had to see if the tender offer was correct
d) What is the “fundamental question” of the case?
i) Whether defendants have exercise corporate power inequitably? Whether they have taken action for the purpose of impairing or impeding the effective exercise of the corporate franchise and if they have whether the special circumstances are present warranting such an unusual step?