Isenbergh
Bus Assoc
Autumn 2011
1) Basics
a) Corporation Overview
i) Economic Aspect of Corporations
(1) Economic rule of corps: to coordinate the elements of productive economic activity
(2) Transaction or contractual nexus
(3) Centralization of management
(4) Allocation of risk and return from economic undertakings
(5) Corps are forms of economic undertakings w/ standardized mechanisms for allocation of risk & return
ii) Legal Aspect of Corporations
(1) Separate person w/ own identity
(a) Pure creation of law: described as a “legal fiction” but it’s real & effective w/ immediate consequences
iii) Ownership and control
(1) Owned and controlled by other persons – shareholders
(2) S/h as beneficial, not titular, owners: S/h do have full titular ownership of their own shares, but shares only represent beneficial ownership of the corporation assets, not direct ownership
(3) Act through agents, representatives, employees and various others
(a) These “others” may be the same – same person may own all the shares and act for the corp as its sole director, officer, employee (known as single owner corporation)
(4) Major constituents
(a) Suppliers of capital (shareholders and debtholders)
(b) Suppliers of labor – the workforce (employees or contract workers)
(c) Managers – operated w/in highly articulated structure; made up of director & high ranking officers
(i) Board of directors: controls corporation; makes large scale decisions and direct its course
(ii) Officers: carry out decisions and operate day-to-day business
(iii) Represent the interest of owners of capital, and adverse to interest of labor
1. In publicly traded company, they control the flow of info to SH à uneasy or even misalignment of interest, compensation based on reported earnings, which is based on control of info flow
2. Agency problem – divergence of interest of manager and owners of capital
3. Manager has strong obligation to s/h – fiduciary obligation, not of agency
iv) Personification of corporations
(1) Courts often impute separate will to corp as though as they acted of their own motive and intention –
(2) Highly distorted b/c underlying interests do not disappear
(3) Demonization of corporations
(a) In reality, corps are neutral vessels for whatever undertaking or objective you put into it
v) Notion of tort dominate over contract b/c relationship btwn manager and s/h is not through contract
b) Background
i) “Corporate functional characteristics” – These are functional characteristics of a corp, not defining elements
(1) Continuity of life/existence
(a) Direct corollary of separate identity of corp separate from destiny of stakeholders
(2) Centralized management
(a) Control resides in ppl with designated role which is diff. from those having a beneficial interest in the corp
(3) (Free) transferability of ownership interest
(a) Shares can be transferred from one person or another w/o affecting identity of internal relations of the corp
(4) Limited liability (of the shareholders)
ii) Legal formation:
(1) What makes a corporation a corporation is the legal recognition by a state or a sovereign authority.
(2) There is no generic federal corporation law
(3) 2 basic forms:
(a) Basic standard form, aka “a corporation”
(i) Identified by word “corp”/“inc” in its name (identifies as a state chartered corp)
(b) Limited liability entity
(i) Less corporate formality (less strict internal hierarchy) and more closely held
(ii) BUT, no matter how informal, still a corp b/c it is a separate legal entity chartered by a state.
(4) International:
(a) Every other commercial/industrial country has a similar state chartered bus. org. but it’s a national charter
(i) U.K. = PLC (limited public company), Spanish = SA, German = AG
(b) Most countries charter a second type of incorporated entity with lesser degree of corporate formality
(5) Another way to classify: Publicly traded v. closely held
(a) Publicly Traded – shares widely owned & freely traded either on Sec Ex or a liquid market by Sec dealers
(i) All iconic corp companies are public (e.g. Microsoft, GE)
(b) Closely Held – owned by a relatively small number of shareholders (sometimes just 1); shares are NOT traded in an anonymous exchange or liquid market
(i) Usually family-owned, but not necessarily small (e.g. Mars, Gallo Wine)
(ii) B/c ownership & control more concentrated, separation between the two is less complete and drastic
(iii) Shares are transferable.
1. But SHs may contractually enter an agreement to limit transfer
2. Practically, transferring shares of CHC can be very difficult since corp is run to the benefit of majority SHs. Someone would have to step in as a minority SH which has many disadvantages.
iii) Other Business Organization Choices
(1) General Partnership:
(a) No centralized management. Important actions need a high degree of consensus between partners
(b) Lack of Transferability: Partnership interests are not transferrable without unanimous consent
(c) Unlimited liability: Partnership obligations become the individual obligations of the partners. Including tort liability where one partner may be entirely innocent
(d) Does not require the agreement of the state. Can form just by private agreement
(2) Limited Partnership (LP): hybrid where some are general partners and some are limited partners
(a) Formation: Must be created w/ written agreement among partners; certificate must be filed w/ state official
(b) Dissolution: Lasts as long as partners agree or, absent agreement, until a general partner withdraws
(c) Firm Governance: (2 kinds of partners)
(i) General Partner (there must be at least 1) – unlimited liability
(ii) Limited Partners – liable only to extent of their investment; no participation in control
1. General partners have authority to bind partnership to ordinary matters
2. Limited partners have voting authority over specified matters, but CANNOT bind the partnership
3. Sometimes the general partner is itself a corporation with small assets where people try to combine these two forms to limit liability.
(d) Transferability of Ownership Interests:
(i) General partner: cannot transfer interest unless ALL remaining partners agree OR partnership agreement permits it
(ii) Limited partner: freely assignable; partnership not destroyed when limited partners shares transferred
(iii) BOTH can assign their rights to profits & distributions
(3) Limited Liability Partnership (LLP):
(a) Limited liability is achieved by filing a document with a state official.
(b) Different from LP in that there is no need for a general partner.
(c) Delaware has a broad limitation on liability covering both tort and contract.
(d) LLP interests are NOT freely transferable
(4) Limited Liability Company (LLC): alternate form of business org that combines certain features of the corporate form with others more closely resembling general partnerships
(a) Formation: requires some paperwork and filings with a state agency (like a corp.)
(b) Investors are called “members”
(c) Like the traditional corp, the LLC provides a liability shield for its members.
(d) Allows somewhat more flexibility than the corp in developing rules for management and control
(i) May be managed by all its members (as in a partnership) or by managers, who may or may not be members (as in corp).
(e) Advantageous tax treatment as compared to corp à investors in an LLC are taxed, like partners, only on its profits, as those profits are earned.
(5) S Corporation:
(a) Only one class of stock
(b) Limited number of shareholders allowed
(c) All shareholders must be US citizens
(d) Can’t be publically traded because amount of shareholders may be exceeded or foreigners can buy.
(e) Typically been supplanted by LLC’s.
iv) How to Select Business Organization-Type
(1) Issues to consider:
(a) Distribution of risk and return among the venturers
(b) Defining and limiting the individual liability and obligation of each venturer
(c) Form of control and management
(d) Possibility of transferring ownership interest
(i) Esp in event business is successful, and possibly restructure through M&A, recapitalization
(2) BUT taxation cuts against the choice of corporate form though b/c treated as separate entity for tax purposes
(a) Double taxation of corporate earnings – taxed by corp and then s/h on its dividend
(b) Partnership is not a separate taxpayer, thus partners taxed as if they are direct legal owners of the business; they don’t get taxed twice on fully distributed earnings
(3) Tax Ramifications:
(a) For closely held businesses, they have all the advantages of the corporate form and the tax benefit of being fiscally transparent
(i) Can use LLC (most desirable), limited partnership or S-corp
(b) All but publicly traded business can avoid two level taxation: 2-level taxation can be understood as a kind of surtax on doing publicly-traded business
(c)
2) Formation of Corporations
a) Starting a Corporation
i) Formation – Overview
(1) Present Form:
(a) Arises from private initiative, but the state must acknowledge the existence of a corporate charter
(b) The state doesn’t ration the amount of corporate charters. The state has no power of review either.
(c) Entirely self-executed. Just have to file the papers.
(d) You can form a corporation in any one of the 50 states
(i) No inherent reason why your corporation must be formed in the state that it does business in.
(2) Place of corporation
(a) Dominance of Delaware: More that 50% of publicly traded corps incorporate in DE; state generates 20% of its income from incorporation fees alone. This is followed by NY with 5%.
(i) Explaining DE’s popularity:
1. First state to provide a flexible and efficient corporation law
2. First state to weed out the older legal baggage associated with corp., esp doctrine of ultra vires
3. Abandoned the mandatory requirement of par value of issued stock
4. Posture: All these are advantageous to s/h
5. Posture: All these are advantageous to managers (and disadvantageous to s/h)
(b) Choice of Laws Consequences:
(i) The law of the state of incorporation governs when there is a di
some obligation.
1. Equitable notion: Someone who dealt w/ association as though it were valid suffers no surprise à outside transactional counter-party is no worse off b/c of the defect
(ii) Corp is estopped to deny its own existence to the end of evading its obligations to some other party
(iii) Estoppel can arise even when principal acting for corp knows of defect; what matters is whether outsider party was aware of defect
(iv) Corp by estoppel only good against the person who had dealt with the corp.
(v) Cranson v. International Business Machines Corporation (CoA of MD 1963) M 12 corp by estoppel
1. HOLDING: Cranson not liable. Although b/c Bureau failed to file its certificate of incorporation, this prevented if from being a corp de jure or de facto, IBM having dealt with the Bureau as if it were a corp and relied on its credit rather than that of Cranson, is estopped to assert that the Bureau was not incorporated at the time the typewriters were purchased.
(c) De Facto shields only those who have acted in ignorance, but it is good against the world; Estoppel can apply to both, but it is NOT good against the world
(d) MBCA §2.04 – does it limit the estoppel doctrine?
(i) Added a knowledge requirement: “all persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this Act, are jointly & severally liable for all liabilities created while so acting.”
(4) No limited liability for LLC members who fail to disclose existence of their business organization to 3rd parties
(a) Water, Water & Land, Inc d/b/a Westec v. Lanham (Colo 1998) CB 282
(i) RULE: Under the common law of agency, an agent is liable on a contract entered on behalf of a principal if the principal is not fully disclosed.
1. If both the existence and identity of the agent’s principal are fully disclosed to the other party, the agent does not become a party to any contract which he negotiates. . . But where the principal is partially disclosed (i.e. the existence of a principal is known but his identity is not), it is usually inferred that the agent is a party to the contract. CB 284
(5) Partnerships
(a) Partners compared with employees – Fenwick v. Unemployment Compensation Commission
(i) RULE: Uniform Partnership Act defines partnership as an association of two or more person to carry on as co-owners a business for profit.
1. Several elements courts have taken into consideration in determining existence of partnership
a. Intention of the parties
b. Right to share in profits
c. Obligation to share in losses
d. Ownership and control of the partnership property and business
e. Power in administration
f. Language in the agreement
g. Conduct of the parties toward third parties
h. Rights of the parties on dissolution
(b) Partners compared with lenders – Martin v. Peyton (NY 1927)
(i) FACTS: Creditors of KNK claim “loan” agreement was actually a partnership agreement.
(ii) ISSUE: Partnership formed? No, all features of the agreement consistent with loan agreements
(c) Partnership versus contract – Southex Exhibitions, Inc v Rhode Island Builders Assn
(i) ISSUE: Partnership exist? No
(ii) REASONING: Whether a partnership exists is normally assessed under a “totality of the circumstance” test. Here, while the agreement contained some terms common to partnerships, there was ample evidence that one did not exist: (1) the 1974 agreement was entitled “Agreement” not “Partnership Agreement” (2) agreement was for a fixed term as opposed to an indefinite duration (3) SEM was responsible not only for advancing all money required to produce the shows but also for indemnifying D for all show-related losses (4) SEM was responsible for the majority of management decisions (5) P entered into contracts and conducted business with 3rd parties in its own name (6) P never filed a federal or state partnership tax return (7) evidence as to whether either contributed any corporate with the intent that it become partnership property is highly speculative. Finally, SEM’s president testified that he regarded SEM as simply produce of the shows, and D’s executive director testified that SEM specifically disclaimed any ownership interest in the home shows in 1974.
