Business Organizations Fischel Fall 2013
PUBLICLY HELD CORPORATIONS
I. The Publicly Held Corporation
A. A corporation is a business venture, registered with the state that is organized in order to efficiently optimize a business and maximize profits.
B. A publicly held corporation is one that has shareholders who can freely buy and sell their stocks in the market. The alternative is the closely held corporation.
C. Corporations are a way to aggregate capital in order to pursue bigger ventures.
D. “Cast of Characters” in a Publicly Held Corporation
1. Investors (people supplying capital)
a. Shareholders are equity holders, which means they own a portion of the business.
b. Creditors include lenders like banks, bondholders, and others, who lend money to the corporation at an interest rate, rather than owning a piece of it.
2. Corporate Managers
a. Officers run the corporation on a day-to-day basis – presidents, CEOs, CFOs etc.
b. Directors are the people entrusted by shareholders, through shareholder voting, to run the corporation
a. Inside Directors are employees of the corporation
b. Outside Directors are not.
E. Basic Principles that apply to all corporations:
1. Corporations must be incorporated.
a. Papers must be filed with the state, and a corporation is incorporated, and subject to the laws, of whatever state it files its papers in.
b. There is no need for physical presence in order to incorporate in a given state – there is total choice of law.
2. Shareholders have limited liability.
a. Shareholders are only liable up to the amount of their investment in the corporation
b. This means that creditors can only reach the assets in the corporate treasury: they cannot reach personal assets.
c. Limited Liability allows shareholders to invest and not put their full personal finances at risk.
3. Corporations have indefinite life.
a. Their existence does not depend on the status or identity of any investor, director or manager.
b. So, large-scale economic projects can easily outlive their founders.
4. Corporations can sue and be sued in their own name. Its own entity
a. This prevents the inefficiency of having to name each investor in a suit, and protects the efficiency created by aggregating capital.
II. Responsibilities of Corporations to Shareholders
A. In general, corporations pay their shareholders dividends pro rata to their shareholders, based on the equity stake in the corporation.
B. The separation of ownership and control.
1. Although it was probably originally true that shareholders and officers running the corporation were one in the same, that is less and less the case
2. Problems with the separation
a. Directors are essentially bargaining with other people’s money at stake. Therefore, it arguably removes that basic economic check on corporate abuse (Brandeis dissent, Liggett v. Lee)
3. Good things about the separation
a. We see it as a kind of specialization – shareholders do not necessarily want to be involved in day-to-day business.
b. It allows corporate ventures to be larger and more ambitious because there can be a huge number of non-officer shareholders.
C. Dodge v. Ford Motors holds that officers are required to act to maximize the profits of shareholders. They do not have the discretion to choose a non-profit motive at shareholder expense.
1. Ford was not paying stockholder dividends because he felt that cars should be available to more consumers to “spread industrialism and create jobs, so he wanted to decrease the price of the car and increase production, at a loss to the company itself.
2. The shareholders are allowed to get their cash dividends.
3. However, they cannot challenge Ford’s decisions to open and close particular plants. The Secondary holding is that the court is not a business expert and will not second guess the means used to obtain the end of maximizing profits. Therefore, Dodge v. Ford Motors establishes the business judgment rule.
4. Aftermath
a. Dodge mostly means that corporations will need to find some profit maximizing explanation for any action
b. Under Delaware Law, the discretion for how to reach this maximization is extremely broad, and subject basically only to a reasonableness constraint, even in the case of giving to charity.
D. Corporations and Social Responsibility
1. William T. Allen (507) argues that we could view a corporation as a social institution with responsibilities. Since Dodge allows directors to make a wide range of decisions so long as they pay lip service to profit, the line between the strictly private purpose and the public purpose blurs. Champton notes a rise in charity from corporations.
2. Fischel (508) argues that profit maximization isn’t always at odds with the public interest, and is often in line with it.
III. The “Race to the Bottom” (or the Top) and Delaware Corporate Law
A. The Race to the Bottom is the idea that since corporations have full choice of law about where they incorporate and where they do business, states and countries will be motivated to provide laxer and laxer laws to attract business.
B. Frank Rene Lopez (504) points this out on the international level – leads to outsourcing as smaller, poorer countries can simply loosen labor and safety laws to make production cheaper, and will attract business that more highly regulated countries can’t get.
C. The Cary/Winter Debate
1. Background is that more than 50% of all publicly held companies, and more than 63% of Fortune 500 companies, are incorporated in Delaware, giving the state huge power over corporate law.
2. Cary thinks that Delaware law is anti-shareholder.
a. He believes it to be a race to the bottom problem; directors choose where they wish to incorporate, and will pick the set of laws that is favorable to them, rather than favorable to shareholders.
b. Therefore, there should be national minimum standards legislation to prevent the continued relaxing of law.
3. Winter says DE law is necessarily pro-shareholder because of the operation of the market.
a. It is impossible for directors to choose law that is to the detriment of shareholders.
b. From an empirical standpoint, if they were, profits would be lower in Delaware, and they are not.
c. If earnings were lower, fewer shareholders would invest.
d. There will also be an impact on the product market. The general inefficiency of the company and the sale of shares will make it vulnerable to a takeover.
e. A takeover would mean directors lose their jobs.
f. So, directors have incentive, from their own economic interest, to pick shareholder-friendly, profit friendly, law
g. So, we can conclude that Delaware is shareholder friendly because it is being chosen by managers.
LIMITED
3. We are more likely to pierce if there is a sole shareholder, since limited liability is really supposed to protect non-managing shareholders.
4. We are more likely to pierce the veil in tort cases, because, unlike a bank in a creditor situation, a tort victim cannot bargain for a benefit like a creditor can.
5. We may pierce when we think it is the only way to incentivize the parent to implement good policies like safety standards.
a. This might mean we would be less likely to pierce in a subsidiary that had bought insurance to cover losses, even if it is undercapitalized.
b. Caselaw is the taxi case, Wolkofsky v Carlton.
E. Legal Capital Rules
1. Legal Capital rules provide, for each state, restrictions on when a corporation can pay dividends. (DE Code §170).
2. Because dividends deplete corporate coffers, legal capital rules require certain levels of profitability etc to give them out, since corporate coffers must remain full for limited liability to work.
F. Equitable Subordination Doctrine
1. If a shareholder is also a creditor, and, by his actions as shareholder, bumps himself up the preference line as a creditor, that claim will become equitably subordinated, moving them to the bottom of the list when collecting from corporate coffers.
2. Caselaw is Pepper v. Litton.
G. Ultra Hazardous Activities
1. When the possible consequences of liability are huge – like a nuclear meltdown – we don’t want to rely on the relatively weak corporate piercing doctrine to police that
2. So we have external safety regulations.
H. Successor Liability
1. A company, to avoid liability could create a new company, and then buy all the assets of the original except the liability.
2. In general, a buying corporation will NOT inherit the liabilities of the bought corporations.
3. But we do have exceptions to avoid the “sham sale”. Liabilities are inherited if:
a. There is an express agreement to take the liabilities
b. It is a merger
c. The successor entity is a mere reincarnation
d. If the transfer is fraudulent or not made in good faith.
I. The Uniform Fraudulent Transfers Act (UFTA)
1. Some argue that piercing doctrine is unnecessary because the transactions where it is used run afoul of UFTA anyway.
2. Counter argument is that it’s actually good that piercing doctrine is flexible and even unclear because it encourages the purchasing of insurance.
