CORPORATIONS
SACHS
FALL 2014
I. INTRODUCTION TO CORPORATIONS
A. Major players
1. Board of directors and officers are called the management (most of power)
2. Shareholders
a. Own shares of stock (very little power)
b. When they buy stock, they provide capital dollars for the company to let it grow
c. “owners” is a misnomer
3. Directors (most of power – is it officers or directors?)
a. Inside director = can serve on the board
b. Outside director = someone whose full time job is somewhere else
B. General principles
1. Two ways of thinking about corporations
a. Private property of SH à Purpose is to increase SH wealth
· PREVAILING VIEW – Board should work for the shareholders
b. Social institution à Not strictly private, but tinged with social purpose. Must do what’s best for SH BUT must also take into acct other constituencies (employees, community, etc)
· Board’s duties extend beyond ensuring good return to treating fairly those whom corp affects
· Responsibilities to: Employees, Suppliers, Consumers
2. SACHS. Central problem with corporate law. How to keep managers accountable?
C. Approaches for accountability to corporate law, how to keep managers accountable.
1. Law & Economics, Market Discipline approach à “Non-interventionist”
a. Accountability is not a big deal because managers want what SH want—for the company to succeed.
· SH will sell their stock if bad management and new SH won’t buy in.
· If officer or directed acts poorly, can be removed
· For self-interested reasons, managers will act appropriately.
b. Fallback argument to idea of a “few bad apples:” Because some managers are bad, SH can minimize risk by diversifying, not putting all your money in one company.
c. However, there may be benefits of not diversifying.
· May have enough shares to control and have influence.
· Company loyalty
· Careful monitoring of managers
d. Rule – Role of law under this approach is minimal. Because the interests of managers and SH are aligned, little need for regulation. Still, SH should diversify.
2. Interventionist, Regulatory, Traditional. Substantial legal intervention needed to protect SH. Enact laws and regulations to do so.
a. Different views of regulation
· A) Respond by shareholder interests
o Problem: not all SHs are alike (institutions are full of many SH). Shareholders not a monolith, many are not knowledgeable and it’s a diverse group
· B) Have control that makes it more likely that decisions will favor public good (employees, customers, etc.) – use regulation to maximize flexibility of the board
b. Types of legal protection employed
· Fiduciary duty
· Efficient market hypothesis
· SH participation
· SH voting
D. Dual systems of law.
1. Corporate law is a creature of both state and federal law. When there is uncertainty, two approaches (law & economics v. regulatory) may inform whether there is more or less legal intervention.
2. Size of the company (number of SH) can affect the types of protection.
3. Model Act adopted in 30 states (including GA)
4. State law
a. For the most part, this consists of default rules
b. Default rule: the rule that governs in the event that the parties have not provided otherwise
c. Mandatory rule: some state laws that are mandatory (corp HAS to do it that way)
5. Federal Law
a. Most fed law is mandatory
b. Gapfilling proposition that fed law performs
· If state law did not enter an area
· Or did not do a good job
II. INTRODUCTION TO FIDUCIARY DUTY
State law – judge made law
Fiduciary duty is a central feature of corporate law.
CCS v. Reilly – Sales rep starts own fundraising business while at old firm. Former employer sues for breach of fiduciary duty & seeks fees rep got from those campaigns. No contractual violation here though
1. Rule – For P. During course of employment, must prefer employer’s interests to your own. Ct applies principle of fid duty, finding obligation to act for corp & not solicit future business.
NOTE that breach of fiduciary duty does not require a specific violation of K. Independent of contractual duties, there is a duty implied in an employment K.
1. Employee’s action was not in express violation of any employment K.
2. Too inefficient to require parties to contract for every contingency.
3. Duty of loyalty is too wide to be contained in a single K, thus the duty becomes part of the employer/employee relationship.
Two alternative ways of looking at where fiduciary duty comes from:
(1) Fiduciary duty amounts to an ad hoc notion of fairness.
1. Blackburn v. Witter – Financial advisor tricked old lady (made up stock) & pocketed $.
a. Rule – For P. D (advisor’s company) is liable based on a fairness approach. Principle of ostensible authority: if the agent appears to have been given authority by the principal, then the agent binds the principal in what he does. For this to apply, P must have been acting reasonably and must be a reasonable outsider
2. NOTE. Ct comes to this conclusion even tho evidence that widow did not act reasonably.
(2) Look to the expectations of the parties. What would parties have bargained for if they had bargained?
1. Requires making various assumptions about what they knew, or thought they knew, the bargaining process, financial world, etc. (PROBLEM)
2. We could look at these parties or similarly situated ones
III. THE BASIC CHARACTERISTICS OF THE CORPORATION (Sachs’ “Four Key Characteristics”)
(1) Separation of Ownership and Control
SH have no right to run the corp. Typically very little power as the Board manages the business.
· Officers have the ultimate responsibility to run corporation, management. Board does big-picture management. SH do not manage (even though SH called owner)
“How do we keep the board and officers working in the firm’s best interest?”
· Sep of ownership and control helps encourage investment. People and institutions to buy shares. The diversity of SH helps this
Two types of SH
· Individual SH. – The avg one is not a good potential manager for the company or doesn’t want to manage. Can buy stock knowing they can have a life
· Institutional SH. Have the resources & could manage their investments more efficiently, however, these SH do so with respect to only a fraction of the shares in their portfolio. Willing to invest bc they don’t have to spend all their energy watching the corporation.
(2) Limited Liability. SH will only lose the amt invested in buying the shares. Personal assets of SHs are safe.
No matter what sorts of debts the corporation incurs, the SH is not personally responsible.
Allows SH to invest w/o worry of risking much. Doesn’t have to evaluate creditworthiness of other SH.
POLICY. Makes it easier for corp to raise capital. Gives rise to modern corp à encourages investment
(3) Transferability of Interests. SH can sell shares easily and end ownership without approval of the corporation. Shares are fungible (easily replaced, interchangeable)
Free transferability of ownership interests makes one willing to invest bc no feeling of being locked in.
(4) Continuity of Existence. Relatively permanent entity, hard to dissolve. Stability of corporation
No matter who sells or resigns, the corporation is still in place.
Makes investment stable, more attractive – encourages investment
NOTE: Not all of these characteristics apply to close corps (they do public corps)
Additionally, all can be abused by managers, even when not closely held.
Close corporation characteristics (i.e., Mom & Pop Jewelry Store):
· (1) Small number of SH (1, 10, 35…typically no maximum)
· (2) No public mKt for shares (not traded): public you can sell at drop of hat. Close, can’t
· (3) SH are actively involved in operation of business.
(merge), die (dissolve), and have its limbs severed (sell assets).
o Other things SH can’t decide, though, and many are just as “fundamental.”
o E.g., expand into emerging markets, fundamentally change nature of business, buy tremendous assets (inverse of § 12.02), incur enormous debt to finance things.
V. GOVERNING DOCUMENTS—Articles, bylaws, shares
A. * these show how director-centric the model act is and corporate law is
B. Articles of incorporation are the corporation’s constitution.
· Also known as “charter.” Lays out basic relationship bt board, SH, and directors. It is a K bt the corp and the state & the corporation and its SH. The Board manages, subject to any limitations in the charter.
· Must be filed with state (default rule – MBCA 10.03)
· Charter is more difficult to change.
o Changes must be initiated by directors. Directors are gatekeepers of the charter.
· SH may suggest changes to charter, but cannot propose. Must seek support of director.
o Proposed amendments to charter must be adopted by directors and then SH have to approve it as well.
· Technically a default rule which corporation could K around with charter, but practically speaking, few board members would initiate an amendment to curb its own powers.
· Minimal requirements à 2.02(a) tells us what charter has to have incl. in it (bottom line = not very much)
o (1) Under 2.02(a)(1) – Corporate Name
· Satisfy the requirements in MBCA § 4.01 (MANDATORY RULE)
· Need: Incorporated/Limited/Corporation/ or company
· Justification: name must satisfy “corporateness” requirement so consumer knows he’s dealing with an artificial entity where liability is limited.
o (2) Number of shares corporation is authorized to issue. § 2.02(a)(2).
· Spelled out in 6.01(a) – “the charter must authorize”
· Must amend charter to issue more shares
· May include par value, floor below which shares may not be sold by company, but not required. § 2.02(b)(2)(iv)
· Shouldn’t authorize way more shares than you need
o It looks strange to investors and some states tax on # of shares
o (3) State address of corp’s initial registered office & name of its initial registered agent at that office. 2.02(a)(3)
· Bc corp is an artificial entity w/ obligs, registered agent is person who will receive process
o (4) 2.02(a)(4) Name and address of incorporator. Incorporator may be other corp entity.
· MAY rules – Permissive inclusions in charter set out in § 2.02(b).
o (1) Purpose of Corporation
· This is a MAY rule under 2.02(b)(2)(i) – can be left out of charter if want
· Language may not be included stating or implying that corporation is organized for purpose other than that permitted by § 3.01 and its articles.
o Purpose under § 3.01 is to engage in any lawful activity, unless more limited purpose articulated in charter.
o Have the option of contracting around it and limiting the purpose of the charter
o Why limit corporate purpose?
· Banks, insurance companies, other specifically regulated types of businesses are required to articulate a more limited purpose. Need purpose language that comports with regulatory obligations.
· Sometimes businesses are uncomfortable not articulating—want to level expectations. Provides sense of identity according to personal preference.
· Serves as a defense mechanism amongst owners who may not necessarily trust each other’s intentions w/r/t the nature of the future business (esp in close corps)
