Sawyer/Corporations/Fall2012
BASICS OF CORPORATE LAW
Economics of the firm
in theory, parties share interest in max return at min cost, but may allocate risks differently to achieve this; parties self-interest not always same as interest of whole venture
types of risk (quantifiable):
controllable risks: can be influenced by >1 party by action or inaction
risk management: monitoring/disciplining devices; align agent's incentive w/ principal's incentive
non-controllable risks: parties can't control
risk management: insurance, diversification of investment (hard to do for labor), allocation to party who can best bear it
uncertainty: not the same as risk b/c unquantifiable
approaches to risk:
risk averse: more often for gains; people will take the sure thing rather than risk for more
risk neutral
risk seeking: more often for losses; people will risk for no loss rather than take small guaranteed loss
allocation of risk (expenditures):
to owner: makes sense b/c owner has rights to profits; but requires greater monitoring (e.g. supervising, employment contract provisions); works if risk the main concern
middle ground: divide profits; employee gets (lower) fixed salary + some cut of profits; but employee may ask for more power
to employee: allow employee to get all profits in exchange for rent but base compensation on success (e.g. no pay if business flops); works if shirking the main concern
problem: employee and employer may have different goals (e.g. short term vs. long term)
fiduciary duties: legal solution to inefficiency caused by hiring underlings
Choices of organizational form
Partnership
General partnership: each partner has unlimited liability, equal voice in mgmt, authority to act as agent for partnership and incur obligation that will bind all partners
partners can be jointly/severally liable (unlike corp)
can be at will or for definite period of time
transferability: default rule: all partners must consent to transfer of interest; but can transfer economic interest while retaining governance interest
can be dissolved at any partner's will by default
taxes: treated as aggregate of individuals, not separate entity (unlike corp which pays taxes)
Limited partnership: each partner has unlimited liability, equal voice in mgmt, authority to act as agent for partnership and incur obligation that will bind all partners
combo of general partnership and corp: general partners' liability same as in general partnership, limited partners' liability limited to their investment as long as they don't participate in mgmt
partnership agreements specify latest date upon which partnership must be dissolved
transferability: can transfer economic interests, but assignee can only exercise limited partner's governance rights w/ all other partners' consent
Corporation
Limited liability company
Member-managed: all members have authority to make management decisions and act as agents
Manager-managed: members are not agents, only make major decisions; managers need not be members
liability same as limited partnership, but members can still participate in management
exists in perpetuity unless operating agreement or AoI provide otherwise
transferability: originally similar to general partnerships; modern trend to allow free transferability
taxes: can decide whether they want to be taxed as corp or partnership
Conceptions of corp:
property conception: primary purpose of corp to advance shareholders' interests (dodge v. ford)
under this conception, unlawful for BoD to conduct corp affairs for primary purpose of benefiting non-shareholders w/ only incidental benefit to shareholders
managerialist conception: corp has public purpose as social institution
law justifies expenditures not directly related to short-term value maximization (e.g. charitable gifts) by saying it arguably takes into account long term business interests (AP smith mfg. v. barlow)
DGCL 122: every corp can make donations w/o statutory limitation
corp gifts evaluated by courts on reasonableness standard; whether loss of short-term income to shareholders outweighed by long-term goodwill from overall benefits of corp gift
BJR applies to charitable donations; shareholders must prove waste (kahn v. sullivan)
MBCA 3.02(13): corp has unlimited statutory power to make donations
Characteristics of corp:
Separate entity (separation from investors and people who run it)
Taxed as separate entity after deducting salaries as business expense
S-corp: interest on loan
increases potential profit but also potential risk
bankruptcy: highly leveraged company may have debt treated as equity by bankruptcy court
Deep Rock Doctrine: subordinates shareholder creditors' claims to other creditors if company is inadequately capitalized; shareholders won't be repaid for debt they hold
Responsibilities
Fiduciary duties: directors must be responsible/loyal to corp
duty of care
duty of loyalty: place corp interests above one's own
responsibility is proportionate to facts of situation
must use similar judgment that one would use for one's own affairs; need more than mere honesty, but extraordinary care not necessary
liability for breach extends to losses caused to corp
fiduciary duties generally don't apply in partnerships or LLCs, other than maybe good faith/fair dealing
Business judgment rule: courts defer to BoD judgment absent highly unusual circumstance
rebuttable (by P) presumption that directors act in good faith and honest belief of best interests of company; P must rebut before court considers merits of action
how to rebut? show that decision was uninformed, didn't have rational business purpose, or that directors either had personal interest or were not independent in making decision
once presumption is rebutted, directors have burden to prove that decision was fair
Enforcement:
Derivative suit: shareholder sues on corp behalf against 3rd party (e.g. bad director or manager)
DE: must first either a) present allegations to corp directors and show that they wrongfully refused to bring suit, or b) plead particular facts showing that demand on board would be futile
particularized facts must create reasonable doubt that BoD can exercise independent business judgment
Limitations on limited liability
Veil piercing: equitable remedy allowing recovery for creditors from shareholders
applied when corp doesn't have enough assets (e.g. undercapitalized subsidiary) or tactical reasons (e.g. creditor forum shopping)
veil pierced more often for tort (involuntary) creditors than contract (voluntary) creditors
problems with enforcement: inconsistent criteria (may be allowed b/c corp is “sham” w/o
ism (MBCA 7.31)
lawyer as director:
positives: gives attorney inside knowledge and ability to give better advice; attorney can address problems sooner; fosters trust b/w counsel & mgmt; attorney's analytical skills make him good director; law firm gets paid
negatives: loss of independent professional judgment and objectivity, potential conflict of interest
restrictions on board discretion
shareholder agreements
common law: big 4 cases
manson v. curtis: agreement invalid when fundamental/dominant intent/purpose is to transfer mgmt authority from board to shareholder; can't have agreement that tries to let stockholders create BoD to their wish since law gives directors power to manage corp
mcquade v. stoneham: agreement invalid when shareholders attempt to use best efforts to elect each other as directors/officers; can combine to elect but power is limited to that and doesn't extend to contracts that limit directors' power to manage corp by selecting agents
clark v. dodge: agreement valid when one shareholder to elect another as director b/c no attempt to sterilize BoD; can infringe on statutory BoD authority slightly if unanimous shareholder agreement and if invasion of director power is negligible
long park inc. v. trenton-new brunswick theaters: agreement invalid when it called for 1 shareholder to be mgr w/ full authority b/c this sterilized director power over mgmt
statutory authorization
MBCA 7.32: agreement that modifies traditional corp structure is valid even if it eliminates BoD or restricts board discretion
must be set forth in AoI/bylaws and approved by all shareholders or in written agreement
limited by public policy, and purchaser who didn't know about it has rescission remedy
NY: 1963 amendment allows restriction on BoD as long as all shareholders authorize and anyone acquiring shares knows/consents
may even be allowed if it doesn't comply entirely w/ close corp statute
high voting requirements (veto rights): supplement control devices to protect minority shareholders' interests
supermajority/unanimous approval may be required to approve specified actions
limitation: can be struck down if it creates substantial risk of deadlock, but trend is to allow
MBCA 7.27
fiduciary duties: shareholders who assume mgmt/control functions undertake fiduciary duties of whoever they replace (MBCA 7.32e)
shareholders in close corp owe each other substantially same fiduciary duties as partners in partnership
contractual transfer of ownership provisions (MBCA 6.27, DGCL 202)
2 purposes: balance control among shareholders, create market for illiquid shares (e.g. so shareholder's estate can pay personal debt by selling shares upon death)