Business Associations/Corporations Outline

 
 
Corporations Outline
Professor Sawyer
Fall 2015
Introduction to Corporate Law
Economics of the Firm (1-15)
1.       Risk
a.       2 Types of Risk
                                                               i.      Controllable – risk influenced by 1 or more parties
                                                              ii.      Non-Controllable – risk parties can’t control after all reasonable efforts
1.       Dealt with by insurance (pool), diversification (can’t diversify human capital), and placing burden on person best able to handle it
b.       Risk= quantifiable uncertainty
                                                               i.      Expected return = weighted avg. return based on p
c.        Ppl generally highly risk adverse w/ gains and risk seekers w/ loss
2.       Allocating Risks to the Owner – employment
a.       Reduced by monitoring (directly, through agent, employment K) and disciplining E to align incentives with O’s
b.       If fixed salary, worried about shirking
3.       Allocating Risks to the Employee – tenancy
a.       O can allocate risk to E by basing compensation on success or failure of the business
b.       Gives E more incentive to maximize success (less shirking)
4.       Middle Ground Solution
a.       Fixed salary with % of profits
b.       Look to who is best able to control risk and who is willing to bear the risk
c.        Tenancy vs. employment – look at risks, incentives, and monitoring costs
                                                               i.      Risk averse E would prefer employment while risk averse O would prefer tenancy
Overview of Corporate Law (16-38)
1.       Basic Terms and Concepts
a.       Firm – a legal entity used to assemble, organize and manage resources to carry on some economic activity. Structure of firm avoids costs of creating numerous separate, detailed contracts with independent contractors and allows for the creation of long term employment contracts
                                                               i.      Principle reason firms exists is that they reduce the information, transaction, and agency costs that would exist in a theoretical fee market
b.       Separate entity – corp is a legal entity, separate from Owners and Managers
c.        Perpetual existence – corp has unlimited life
d.       Limited liability – SH’s liability limited to amount they paid for shares; corp owns assets and is liable for debt
                                                               i.      3 Major Exceptions to Shareholder Limited Liability
1.       Shareholders will be personally liable where the corporation is not properly formed
2.       For unpaid capital contributions they have agreed to make
3.       Where the veil of limited liability is pierced for equity reasons
e.        Centralized management – don’t have to have a meeting with 100,000s of Os
f.        Enabling laws – enable participants in a business to structure that business in a way that seems best for them
g.        Choice of location of corp
h.       Easy transferability of shares – public corp more liquid than CC
                                                               i.      CC harder to exit bc no market for shares; typ same ppl O and M
i.         Characteristics make it easy to raise capital
2.       Corporate Statutes
a.       No federal law; basic governance through state law
b.       MBCA – outline for states to use
c.        DGCL – more than half of NYSE incorp in DE and DE courts have greater expertise
d.       Always created under the laws of a particular state
                                                               i.      Internal affairs doctrine – dispute btw O and M governed by law of state of incorp
3.       Basic Hierarchy
a.       SH elect BOD who appoint officers
                                                               i.      Outside stakeholders – creditors, employees, customers, etc.
                                                              ii.      SH  vote on specified matters – alter AIC, fundamental transactions, remove dirs., dissolve corp
b.       AIC (articles of incorporation) – filed with state officials (like “constitution”); publicly available
                                                               i.      Requirements:
1.       Name of the corporation and business purpose
2.       Name and address of each incorporator and the registered agent
3.       The number and types of stock that may be issued
4.       Any preferences or restrictions on particular classes of stock, and the par value of each
5.       After incorporation there must be a meeting to select board members
                                                              ii.      Other things to consider adding:
1.       Voting requirements for certain actions
2.       Limitations on the corporation’s duration
3.       Limitations on director liability
4.       Corporate/Franchise Tax Rates
5.       Ease of Operation
6.       Regulation of the sale of stock and payment of dividends
c.        Bylaws – set forth internal governance (like “statutes”); easier to change
                                                               i.      Contain date/time/place of SH meeting, number of dirs., voting for dirs., list of officers and their duties, and what constitutes a quorum
4.       Corporate Securities
a.       Raise $ by issuing securities
b.       Distributes risk from corp to ppl who own corp or own rights to income streams
c.        Stakeholders – creditors, employees, customers of the corporation
d.       Debt (bonds, notes, debentures)
                                                               i.      More secure (least risky); lowest rate of return – typ fixed payment with interest and principal returned after x yrs; paid first
                                                              ii.      Can be secured or unsecured
                                                            iii.      Ex: Bonds
                                                            iv.      Temporary contributions of capital
                                                             v.      Have priority in terms of payment if the firm becomes insolvent or liquidates voluntarily
e.        Equity
                                                               i.      Securities that represent permanent commitments of capital to a corporation
                                                              ii.      Returns generally depend on the firm earning a profit
                                                            iii.      The rights of equity securities are subordinated to the other claims of the creditor, including those who hold the corporation’s debt securities
                                                            iv.      Holders typically exert more control over the conduct of the corporation’s business and risk it incurs
                                                             v.      Common stock – greatest risk of success or failure of firm; greatest expected return
1.       Residual claim to income and assets (often paid through dividend at discretion of BOD)
2.       Get to vote for BOD
3.       Get what’s left after corp has satisfied all claims (to creditors and debt securities)
                                                            vi.      Preferred stock – risk level btw debt security and common stock
1.       Preferred bc receive dividends (usually fixed) before common stock and get $ before common stock in case of insolvency
2.       Limited or no voting rights
f.        Can also have hybrids of debt and equity
5.       Fiduciary Duties
a.       Duty of Care – requires dir to act in corp’s best interest and exercise reasonable care in making business decisions
                                                               i.      Huge deference given to dir under BJR (bus. Judgment rule) unless court finds conflict of interest or gross inattention
                                                              ii.      BJR allows dirs. to escape personal liability absent highly unusual circum, such as conflict of interest or gross negligence
                                                            iii.      BJR presumes dirs. act on informed, good faith, and honest belief that actions were in the best interest of the co
1.       To rebut, P must show decision was:
a.       Not informed
b.       No rational business purpose (ie waste)
c.        Made by the director with personal interest in the decision
d.       Made by dir who was not independent
2.       If P rebuts presumption, burden on dir to prove decision was fair to the corp
3.       Rationale: don’t want to paralyze BOD w/ threat of liability, hindsight 20/20, J has limited info on bus, LL and diversification should already account for and factor out unsystematic risks
b.       Duty of Loyalty – must act with the corp’s interest above their own; in good faith
c.        Penalties for violating fiduciary duty
                                                               i.      Dirs liable for any losses they cause corp
                                                              ii.      SH can’t sue dir bc can’t act directly for the corp and don’t want to sue actual corp (ie themselves)
                                                            iii.      Solution 1 – Derivative Suit
1.       Action brought by SH in equity on behalf of the SHs
2.       Corp is nominal defendant (w/ breaching dir)
3.       Recovery belongs to the corporation
                                                            iv.      Solution 2 – Class Action
1.       Can sue in class action alleging breach of duty against corp and dirs.
2.       However, most corps have agreed to indemnify or insure Ms against suit so they rarely have to pay
d.       Bayer – dir approves $1M in radio advertising; wife is hired; Ps sue dirs on behalf of the corp (der suit)
                                                               i.      No breach of fiduciary duty (DOC or DOL) bc court didn’t want to violate BJR
                                                              ii.      Personal interest (promoting family in co) examined with scrutiny but not a per se violation of DOL
1.       No violation of DOL bc was a prof singer, not paid more, others involved in hiring decision, K was std form, and no evidence another commercial would be better
Basics of Corporate Law
Whose Interests do Corporations Serve? (75-91)
1.       Shareholder Primacy
a.       Decisions must “primarily” pursue interests of SH (i.e. max stock prices)
b.       Corps should focus on what they do best – make $$; leave charity to SH
c.        Can justify nearly any decision, even charitable donations, as potentially in best interests of corp in long run
2.       Corporate Social Responsibility
a.       About 30 states (not DE or MBCA) have said explicitly that in addition to SH val max, BOD can consider the following at its discretion:
                                                               i.      Interests of corp’s employees, suppliers, creditors, and customers
                                                              ii.      Economy of the state and nation
                                                            iii.      Community and so