Business Associations/Corporations Outline

Corporations Notes
Spring Semester 2009

– Statutory supplement contains Model Business Act, adopted in some form by 35 states, including GA
o We focus on Model Act, but also look at Delaware and Common law
o Casebook refers to Model Act and Delaware, but at this stage, only worry about Model Act
– Class Participation:
o Can raise grades
o No taping allowed
– Exam: All essay, graded blindly
o Can bring statutory supplement, casebook, class notes, an outline that you yourself prepared
– Focus on the form of the business enterprise known as the corporation.
o Possible new trend seen where Enron and World Com directors pay out of their own pockets for fraud.
§ Question to ask our selves concerns the monitors on these corporations.
· SEC: overworked
· Board of Directors. They did not speak up or did not understand. There was enormous deference to the CEOs
· Accountants.
· Lawyers
· Financial experts.
o Congress has acted to address these abuses. In the wake of all these scandals, there has bee a sea change of attitude of the board members b/c of the new laws. Asking questions is the new attitude.
o We look briefly at certain other forms, such as LLC, limited partnership, etc.
§ But almost exclusive focus on corporation
– Main players in corporations
o Shareholders – owners of corporation
o Board of directors – oversight role
o Officers (managers) – run corporation; handling the day to day affairs.
o Much of corp law is devoted to who gets to do what
– Two inconsistent views about corporation that have co-existed for a long time
o 1) Corporation is private property of shareholders
§ Purpose is to increase shareholders’ wealth – this is the predominate view.
§ Managers’ purpose is to bring that about
o 2) Corporation is a social institution
§ Corporation not strictly private – tinged with a social purpose
§ Board’s duties extend beyond simply ensuring a good investment – have a duty to treat fairly everything corp. affects – buyers, suppliers, community, etc.
o When these views come head-to-head, the tendency is to paper over problems
o Central problem of corporate law è How do we keep the officers accountable to the owners (shareholders)?
§ There’s a big debate about how
– Various answers to that question: 2 positions to that debate:
o 1) Non-interventionist approach
§ Accountability is not a problem
· Managers want same thing the shareholders do – for corporation to do well
· Motivation is this: If managers do bad things, shareholders will sell stock and no one else will want to buy in.
§ Proponents of this approach have to concede that sometimes bad management occurs
· Fall-back argument: Shareholders should diversify portfolio to minimize risk
· If a shareholder has a diversified portfolio, she won’t have too much money tied up in one company
§ But consider the possibility that some good things may come about when shareholders have bulk of wealth invested in one company:
· Effective monitoring b/c shareholder only monitors one company.
· Loyalty to company since most money tied up in it – so they’ll watch carefully what those managers do
o Therefore, managers motivated to do right thing and fall back is shareholders can diversify to minimize risk
§ Role of law in this view is relatively minimal
· When law does come into picture, it’s a rather distinctive view
o 2) Regulatory or Traditional Approach
§ In order to protect shareholders, substantial legal intervention is necessary
§ Legal intervention can take various forms in protection
· 1.Can protect shareholders by giving them a voice
· 2. Can give shareholders various procedural protections
o Voting rights to elect board of directors
o Information disclosure
· 3. Can impose on the managers so-called fiduciary obligations, the violation of which creates liability. Central aspect of corp law.
§ Managers/ Board, however, have enormous power to manipulate these protections.
– Preliminary questions about various types of legal questions
o 1) How does size of corporation affect need for protections?
o 2) Should regulation of corporations be more a matter of federal law than it is? Fed law v. State law.
§ Most of law is state law – mainly model act and Delaware this semester
§ Would shareholders benefit from greater control by Congress?
– Who cares about these two approaches?
o As lawyers, in terms of understanding cases we read and one day litigate, how should a court resolve an issue not covered by prior case law or statutes
o From standpoint of Congress or state legislature, how should they tackle these issues?
§ See these two approaches at work in much of the material this semester
o Focus now on fiduciary duty Fiduciary Duty is a control feature of corporate law
– Congress has become more involved in Corp law
o Why with the recent scandals did States do nothing?
§ States may have thrown in the towel when it comes to these large corps.
§ Also, preemption by Fed gov. may have been a deterrence

– CCS v. Reilly, p. 15
o Not a shareholder – manager case, but raises basic question involving fiduciary duty
o Reilly – regional sales representative, for a fundraising firm which raised firms for charities and non-profits
§ Decided to start his own fundraising business before he left CCS
§ CCS sued, claiming Reilly had breached fiduciary duty. CCS sought an accounting
§ CCS wants the money Reilly earned with his start up claiming the money belonged to CCS
o Reilly’s K: Nothing mentioned in K about this; so he didn’t violate his contract.
o What did Reilly violate?
§ Duty of loyalty
· During course of his employment, can cannot solicit future clients while employed by CCS
§ Why didn’t court tell CCS that it needed to have contracted with him that this sort of conduct was out of bounds?
· Difficulty to do that: Even assuming good faith on part of employer, this would be a very tall order – how can you anticipate all the things an employee would do within bounds of law that employer wouldn’t want him to do – Cannot anticipate everything that might come up
· Thus, fiduciary duty becomes part of employment K and eliminates the need to see into future
o Spares employer and employee the need to enter into such contracting
– Where do Courts get the idea or content of fiduciary duty?
o How does a court determine what the fiduciary duty is?
o from an ad hoc notion of fairness
· Ad hoc notion of fairness is approach that the regulatory, traditional approach (#2 above) takes
· Regulatory, Traditional Approach looks at fiduciary duty as far as what is fair
o What alternative approaches does the reading suggest?
§ Figure out what parties would have bargained for had they bargained
· Page 19, 1a and 1b lays these two approaches out
· Look at these individuals or these types of parties in general
– That approach raises a number of questions:
o How are we going to go about identifying this hypothetical bargain?
§ We focus on CCS v. Reilly or focus on expectation that similarly situated individuals would have
o Either way, how would we know what agreement would have been?
§ Turns on what we assume about parties’ knowledge, Parties’ character, state of business world, etc.
§ A lot of assumptions would have to be made.
§ Which view is better?
o Do many judges take Law and Economics approach into account?
§ Significant proportion (1/3 – ½) of federal judges are familiar with these Law and Economics principles
– Another question: Can a fiduciary duty (there are many types that managers have) be waived or modified by K? Can we contract around it?
1/12/2005
o Cannot be answered globally – look at which fiduciary duty we’re talking about
§ One way of reformulating this question is this: Is fiduciary duty a mandatory rule or a default rule?
· A lot of the material this semester may be either one of these
o Default rule – rules that parties can change by K
o Mandatory rule – no change is permitted
o Be aware of which category rules fall into and how mandatory rules differ by their very nature from other rules…
– One more distinction need to know:
o To what extent does a given rule make it more likely that a dissatisfied shareholder will sell his stock (exit the corporation) or stay and try to fix it (use his voice)
o Need appropriate balance between exit and voice
o How does size (close corporation or large corporation) affect the need to establish different exit and voice mechanisms

1/18/00
– On Board:
o Separation of ownership
o Limited Liability
o Transferability of Interests
o Continuous Existence
– A shareholder doesn’t manage
– Board of Directors have ultimate responsibility for managing the business
– 1) Separation of ownership and control gives us the fundamental problem of corporate law that we talked about last time – how to keep managers responsible to owners
o Separation helps promote investment
§ Why?
· Two standpoints:
o 1) Individual shareholder – average individual shareholder is probably not a good manager, or if they are, they probably don’t want to spend their time running the business
§ Don’t have to devote all working hours to running business
§ Allows shareholders to invest
o 2) Corporate shareholders
§ Corporations have other things to do, too
§ Most corporate shareholders carefully watch only a fraction of the stocks in their portfolios
§ Even corporate shareholders are watching carefully only a fraction, and not paying attention to many of them
– Other distinctive features that also encourage investments:
– 2) Limited Liability – all shareholder can lose is the price of the shares
o Even if the corporation is in debt, shareholders won’t lose their house, etc.
o Limited liability makes it possible for person or corporation to not feel like house is on line, so makes it easier for corporation to raise money
– 3) Transferability Of Interests
o If shareholder in X corporation wants to stop being a shareholder of X corp, he can sell shares to someone else
§ Don’t need corporation’s approval
o Free transferability helps people invest because don’t feel locked in
– 4) Continuity of Existence
o Hard to dissolve a corporation
o When shareholder sells his shares, that doesn’t bring corporation to an end
o Relative permanent entity
§ By minimizing potential for disruption, corporation becomes an attractive investment – stable
– All of these characteristics can be abused
o We’ll look at abuses – see how law deals with them
– Some of these characteristics will not necessary apply in case of a close corporation
o We’ll treat close corporations differently
§ Small # of shareholders who tend to be involved in operations
o Not all of these characteristics are necessarily applicable to close corps.
– Formation of a Corporation
o Organizers need to pick a state
o That chosen state’s laws will govern corp’s internal affairs
§ Fiduciary duties
§ Relationship between people within corporation, etc.
· Called Internal Affairs Doctrine
o State chosen for incorporation doesn’t have to do business in which state previously operated
§ Could have no connection
· Example: GM incorporated in Delaware
§ A corporation that will do the majority of its business in only one state will choose that state to incorporate in. Why?
· Local attorney for corporation may know law of that state only
· Cost – a corporation pays taxes to its state of incorporation and also to state doing business, so a savings
o With large corporations, doing business in a number of states, so a different calculus prevails
§ Cost drops out
§ Delaware is the favored state for big corporations to incorporate
o Two competing reasons why Delaware is favored state
§ 1) Race to Bottom – page 165, Delaware has won a race among the states for the very worst corporate laws – worst because gives manager power to shareholders’ detriment
· Only solution is for Congress to intervene and there to be a federal corporate law
o Favorite example:
§ Once upon a time there was a vote law in DE where the board approves and the shareholders had a vote as well – needed to be a 2/3 majority of shareholders to approve
§ DE Leg. amended to say all need is majority of shareholders
· Race to bottom – because if we require 2/3, means a low # can block a deal
o Keep lowering standards – makes it easier for managers to reach their goals
o But it also keeps a small number from dictating corp direction
o Put another way: Hard to know what amounts of shareholder participation and control is actually good for shareholders
o Race to Bottom Approach is part of traditional approach
§ 2) Race to the Top Approach challenges this
· DE’s laws are best laws
o Race to have good corp. laws and DE is leading the way – giving shareholders flexibility
· Race to Top is from Law and Economics School
o Managers want to do right thing because their reputations and jobs are on the line
o Want what’s good for corp. And giving them flexibility to do
o Some evidence to support Race To Top theory
§ Based on corporations that used to be incorporated outside DE (can change state of incorporation), there was no decline in price of stock when corps made switch
§ That’s evidence for Race To Top because shareholders still want to invest in that corp.
· Therefore, investors are satisfied
§ What’s wrong with that analysis?
· It assumes all shareholders would be aware of the move or may not be sensitive to what it means to reincorporate in DE
· Or it may be hard to place a value on what it means to reincorporate in DE
· The corps. We’re talking about here are corps that reincorporated in DE – what caused them to reincorporate?
o Perhaps expanding the business or maybe the increased profits of expansion sent price of stocks up and then the reincorporation in DE sends prices down, and the result is a wash
o Possible that there is some truth in both Race to Top and Bottom theories
§