Professor Sawyer – Corporations – UGA LAW – Fall 2011
Overview of Corporate Law (class 1&2)
· Risk: Controllable Risk, Non-controllable Risk
· Expected return → The weighted return based on the probability of risk. 1/3 chance of making $6 and 2/3 $3, then the expected return would be $4. An actual return would be either $6 or $4.
· Three types of risk preference: Risk averse; Risk seeking; Risk neutral → Decisions based solely on expectation returns
· Ways to manage non-controllable risk: Insurance; Diversification; Burden shifting
· Controllable Risks: Difficulty in allocating risk among parties is that the party who bears the consequences of the risk will have a greater incentive to control the risk, but the other party will not.
– Moral hazard → when a person who does not bear the risk does not take the steps to control the risk.
– Allocating the risk to the owner
– Two Components of Monitoring: 1) Determining what is optimal performance, 2) Actually determining if optimal performance is occurring.
– Employment Contract: Owner still maintains the risk but the employee has a clear outline of duties and expectations
– Allocating the risk to the employee: Compensation based on the success or failure of the business. Reputation can be used as an effective monitoring device in some circumstances. Impact of this can vary depending on the demand for that position. More demand then reputation matters less.
– Middle Ground Solution:
– Could form an agreement to split the profits in a mutually agreeable way – Less risk for both sides but also less potential benefits
– Specialization – Employee could gain skills that become more valuable to the owner, but could also make it harder for the employee to go elsewhere.
· Agency is a legal concept when one person agrees to act on the behalf of another. Agents cannot always be excepted to act as if they were the owners. Fiduciary obligation.
· Characteristics that define corporations
– Separate entity: Corps are legal entities separate from their investors and managers.
– Perpetual existence: Corps have unlimited life, although the people in them don't.
– Limited liability: SH liability is limited to amount they paid for their shares, the corporation itself owns the assets and is liable for its debt.
– Centralized management: Separation of ownership and control is a distinctive feature of modern corps. SHs elect BoD, who manage and oversee the corporations' business (they usually delegate daily decision-making to corporate officers).
– Transferability of ownership interests: SHs may transfer stock w/o consent of other SHs.
· Two types of corporations
– Closed → No market for the corporation's securities; Public → Shares are publicly traded
– Two main corporate codes: MBCA, DGCL. Many parts of a state's corporate statute are “default rules” which can be changed with an “enabling law”.
– Organic Documents
– Article of Incorporation: Must be filed with state officials. In essence the “constitution” of the corporation.
– Bylaws: Set forth the details of a corporation's internal governance.
– Corporate Actors: Shareholders, Board of Directors, Stakeholders
– Corporate Securities
– Debt Securities: Least risky but the least return
– Common Stock: Greatest risk but also the greatest potential for return
– Preferred Stock: Less risk than common stock but more risk than debt. Have the right to receive dividend before any common stock
– The articles of incorporation specify how many shares of common and preferred stock the corporation is authorized to issue. Stocks that have been sold and remain in the hands of stockholders are called outstanding stock.
– Fiduciary Duties
– Duty of Care → Requires a director to act in a corporations best interest
– Business Judgment Rule: To rebut this presumption a plaintiff must show that a decision
◦ Was not informed
◦ Lack a rational business basis (waste)
◦ Was made by a director with a personal interest in the decision
◦ Was made by a director who was otherwise not independent
– Duty of Loyalty → Requires director to put the interests of the corporation above their own personal interests.
· Dodge v. Ford
– Minority shareholders were concerned about reinvesting dividends back into the company to make cars cheaper.
– Court viewed the primary purpose of a corporation was to get profits for shareholders, and this was something directors could not change, and as such directors are to be employed to that end
– Henry Ford probably could have won the case if he had said the reasoning for his decision was based on wealth maximization instead of for a social purpose.
What purpose do corporations serve? (class 3)
– Shareholder primacy approach
– A.P. Smith Manufacturing v. Barlow
– Court upheld a corporate donation to Princeton University because it believed that the donation, at least arguably, advanced its long-run business interests.
– Rule: Corporations are meant to make money for shareholders
– ALI Principles of Corporate Governance § 2.01
– Corporates are meant to enhance corporate profit and shareholder gain, but
◦ Corporation still has to act in the bounds of the law;
◦ May take into considerations that are reasonably appropriate to the conduct of business; and
◦ May devote a reasonable amount of resources to public welfare, humanitarian, educational, or philanthropic purposes.
– Social responsibility / stockholder approach
◦ Pennsylvania Business Corporations Law allows for corporate consideration of shareholders, employees, suppliers, customers, creditors, and their community in making decisions, as well as the past conduct of any person seeking to gain control of the corporation and the short-term and long-term interests of the corporation.
▪ No one factor has to be considered dominant
– Some states requires one model or the other, while other states are permissive.
Corporate Charity (class 4)
– MBCA § 3.02(13)
– “to make donations for the public welfare or for charitable, scientific, or educational purposes.”
– Most charitable donations by a corporation will be allowed under this provision as long as the donation is reasonable.
– Theodora Holding v. Henderson
– DGCL § 122(9) allows for charitable donations by a corporation
– “Make donations for the public welfare or for charitable, scientific or educational purposes, and in time of war or other national emergency in aid thereof.”
– No limits placed on donations but it has been construed “to authorize any reasonable corporate gift of a charitable or educational nature.”
– Reasonableness – Compare loss v. benefit. Court will look at factors like: 1) Size of gift (in relation to income); 2) If it's a real charity; 3) Possible tax benefits here, the gift was less than 5% of the income, so it was w/in IRS charitable contribution deduction limit of 10% of their taxable income); and 4) Long-term benefits corp may receive over potential short-term loss.
– Kahn v. Sullivan
– CEO of corporation wanted to use corporate money to build a museum for his art collection.
– Rule: because of the protection of the BJR, a charitable contribution should only be overturned when the decision amounts to corporate waste or breach of DoL.
– Not every charitable contribution is a valid corporate action, but due to the express statutory permission and BJR, many are. Also, here the corp made a special committee of independent and disinterested outside directors to review the action, which helps shield BoD from self-interest allegations (DoL).
– Shows that there is broad discretion in applying the Theodora Holding test.
Choice of Entity (class 5)
Management structure
· Corps are legal entities distinct from their owners, and mgmt is centralized in the BoD.
· General partnership partners have an equal voice in management.
· Limited partnerships, limited partners have no voice in active management (like SHs in corps), general partners have equal voices in management.
· LLCs are also legal entities distinct from their owners (“members”), and management can be decentralized (members) or centralized (managers).
Liability provisions
· Corps SH liability is limited to whatever amounts they agree to contribute, and does not extend to any debts of or liability that the corp incurs.
· General partners in general partnerships have unlimited liability, and have authority to act as agents for the partnership and incur obligations that will bind all the partners.
· Limited partnerships general partners have unlimited liability but limited partners are limited to their contribution for liability purposes.
· LLCs members receive the benefit of limited liability.
Formation
· Corporation – begins upon required filing of articles of incorporation, which must contain certain info (name, # of shares corp is authorized to issue, names and founders etc), and may contain other info, including provisions regulating the management of the corp or limiting its powers and that of SHs, officers, or BoD (see MBCA § 1.20. Reqs for Documents; Extrinsic Facts).
· General Partnership – Requires no filing with the state, but is generally formed by K, and may also be formed by operation of law (forming non-consensual partnerships). See UPA § 202. Formation of Partnership.
· Limited Partnership – Requires filing w/state of a certificate of partnership, which must be amended if new gen partners are added. See ULPA § 201. Formation of Lim Partnership; Cert of Lim Partnership).
· LLC – reqs filing of articles of organization w/ appropriate state agency, must include name of LLC and its registered agent. Also, members enter into an operating agreement that sets forth members' rights and duties (see ULLCA § 103. Effect of Operating Agreement; Non-waivable Provisions).
Limited Liability
· Corp: SH's liability is limited to their original investment (see MBCA 6.22, with 3 major exceptions where SHs may be personally liable: 1) Corp is not properly formed; 2) For unpaid capital contributions they have agreed to make; or 3) when veil of limited liability is pierced for equitable reasons). Also, SHs may personally guarantee loans, especially in smaller corporations.
· General Partnership: Partners may be hold jointly or severally liable for partnership obligations. Each partner has power to bind the partnership (and other partners) when acting in the ordinary course of business (see UPA § 301. Partner Agent of Partnership).
· Lim Partnership: Gen partners have unlimited liability as above, limited partners have liability limited to their contributions as long as they do not participate in mgmt (I think this rule has changed so it doesn't matter if they parti
tment). Once election is made, corp income/ losses/ credits flow through to SHs according to # of shares they hold.
– Uniform Partnership Act
– § 202 A partnership is the “association of two or more persons to carry on as co-owners a business for profit forms a partnership.”
– § 301
– Each partner is an agent of the partnership for the purpose of its business.
◦ Business decisions by a partner will bind the partnerships, unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority.
◦ Acts by a partner that are not apparently for carrying out the normal course of business of the partnership will only bind the partnership if authorized by the other partners.
– § 401
– Each partner is entitled to an equal share of the partnership profits.
– Each partner has equal rights in the management and conduct of the partnership business.
– A partner may use or possess partnership property only on behalf of the partnership.
– A person may become a partner only with the consent of all of the partners.
– An act outside the ordinary course of business of a partnership and an amendment to the partnership agreement may be undertaken only with the consent of all of the partners.
– § 502 The only transferable interest of a partner in the partnership is the partner's share of the profits and losses of the partnership and the partner's right to receive distributions.
– § 601 A partner is dissociated from a partnership when: Partnership receives notice of the partner's express will to withdraw as a partner; An event agreed to in the partnership agreement as causing the partner's dissociation; Partner's expulsion pursuant to the partnership agreement; The partner's expulsion by the unanimous vote of the other partners; Judicial determination; Partner becomes a debtor in bankruptcy; Partner dies; Trustee takes over on behalf of a partner
– Uniform Limited Partnership Act
– § 302 A limited partner does not have the right or the power as a limited partner to act for or bind the limited partnership.
– § 303 An obligation of a limited partnership is not the obligation of a limited partner.
– § 406
– Each general partner has equal rights in the management and conduct of the limited partnership's activities.
– Any matter relating to the activities of the limited partnership may be exclusively decided by the general partner or by the majority of general partners.
– § 503 A distribution by a limited partnership must be shared among the partners on the basis of the value, as stated in the required records when the limited partnership decides to make distribution, of the contributions the limited partnership has received from each partner.
– Uniform Limited Liability Company Act
– § 103 Except as provided in the subsection, all members of a limited liability company may enter into an operating agreement, which need not be in writing, to regulate the affairs of the company and the conduct of its business, and to govern relations among the members, managers, and company.
◦ Cannot eliminate the obligations of good faith and fair dealing
◦ Almost anything can be changed in the agreement
– § 303 A member or manager of a LLC is not personally liable for a debt, obligation, or liability of the company solely by reason of being or acting as a member or manger.
– § 404
– Each member has equal rights in the management and conduct of the company's business in a member-managed company.
◦ Any business matter may be decided by a majority of the members
– In a manger-managed company, business matters are decided by the manager, or a majority of the managers.
– § 405 Members have no right to receive a distribution
– § 502 A transfer of a distributional interest does not entitle the transferee to become or to exercise any rights of a member. A transfer entitles the transferee to receive, to the extent transferred, only the distributions to which the transferor would be entitled.
– § 503 A transferee not admitted as member is not entitled to participate in management, require access to information, or inspect or copy company records.
