Business Associations Aviram Fall 2016
1. Acting through others
a. Introduction to the BA course
What is corporate law?
Corporate law (organizational law) is the portion of business law that facilitates acting through others (legal issues arising from one person acting on another’s behalf)
This course teaches the foundations of corporate law
The main goal of corporate law is to facilitate acting through others: allowing one person (B, the beneficiary) to have another person (A, the actor) act on their behalf
This often involves A dealing with a third party (T) on B’s behalf
E.g., Bank of America (B) asks Andy (A) (employee or a real-estate agent), to find & buy an office building in Chicago
Acting through others creates two major problems:
The shielding problem: Preventing B from exploiting T by dealing through A (balanced against B’s interest to limit liability from A’s reckless behavior)
E.g. (K), A agrees to buy T’s building for twice the market price. Must B pay?
E.g. (torts), when A negotiates to buy T’s building, she loses her patience with T and punches him. Is B liable to T for damages?
Law & practices dealing with the shielding problem are called corporate compliance (or external governance); will be covered in Chapter 2
The agency problem: Preventing A from shirking or stealing
E.g., Tony (T) offers A $1M if he causes B to buy T’s building. Can A accept this payment?
Law & practices dealing with the agency problem are called corporate governance (or internal governance); will be covered in Chapter 3
1.Types of firms:
Uniform Partnership Act (1997) (“RUPA”) § 202
“Real” firms (allow multiple beneficiaries to conduct business jointly)
Private firm (low cost for Bs to speak in one voice; e.g., few Bs)
Direct control by Bs
Liberal dissolution/dissociation (firm often must accommodate dissenting B’s exit)
Restricted alienability (difficult to sell B’s interest to third parties)
Contractual flexibility (parties can opt out of most rules)
Public firm (high cost for Bs to speak in one voice; e.g., many Bs)
Delegated control (firm controlled by a board that is elected by Bs)
Restrictive dissolution/dissociation (firm rarely needs to accommodate dissenting B’s exit)
Liberal alienability (easy to sell B’s interest to third parties)
Contractual rigidity (most rules are mandatory)
Passive firm (single B or multiple Bs)
Firm owns assets but doesn’t operate a business; firm structure used to benefit from some legal features (e.g., preferable tax treatment; limited liability, etc.)
Proprietorship (a single B)
Operates a business but does not have multiple owners
General partnership (“GP” or “partnership”)
Limited liability partnership (“LLP”)
Limited partnership (“LP”)
Limited liability limited partnership (“LLLP”)[Joint venture] [Joint stock company]
Limited liability company (“LLC”)
Two defaults for governance: member-managed (similar to partnership)
or manager-managed (similar to corporation)
Proprietorship (aka Sole Proprietorship)
An individual operating a business directly (without using an artificial entity); sometimes uses a business name (“doing business as” or dba)
Business trust (based on the common law concept of a trust)
2. Create a firm: RUPA §202
Most of today’s class will be about creating general partnerships…
Why don’t I focus on corporations?
Too easy: The required process is just filling a form
Too hard: The optional (and high value) part of the process – figuring out the firm’s , and the contents of the – requires understanding a lot of issues that come up in corporate governance
We will do this bit by bit, starting with the next class on ConDocs
Martin v. Peyton [NY 1925]
Knauth, Nachod & Kuhne (KNK) was an well-known banking and brokerage partnership (founded in 1839). KNK’s expertise was in German securities… But World War 1 causes this market to collapse… KNK moves into petroleum securities… When the oil company bubble bursts, KNK is in deep financial difficulties… John Hall, a KNK partner, asks friends at investment bank Payton, Perkins & Freeman (PPF) for help. They strike a deal to lend KNK $2.5M:
Do KNK & PPF have the same incentives re managing KNK?
PPF lends KNK $2.5M in marketable securities
What’s the most PPF can expect to lose?
Collateral: KNK’s speculative securities
Dividends on the securities PPF lent to KNK
40% of KNK’s profits for duration of loan, with minimum & maximum caps
Option to join the firm
Inspection & veto rights; duty on KNK to consult with PPF
Hall manages KNK; all other partners must give KNK option to be bought out
PPF should not have trusted John Hall: KNK speculates in foreign currency, loses money & becomes insolvent. KNK’s creditors sue PPF, claiming KNK’s failed business was in fact a partnership between PPF and KNK
If that’s true, PPF has unlimited liability for all KNK’s obligations
That’s a lot more than the $2.5M they thought was the
lk away from firm)
Creating bylaws? No. Dominated by incorporator; no SHs yet (or SHs can walk)
Amending charter? No. Requires both board & SHs to agree; if they don’t agree, amendment fails
Amending bylaws? Yes. Either board or SHs can amend bylaws unilaterally. So if one amends, the other can re-amend, or can challenge the validity of the bylaw
Bylaw must have appropriate subject matter & not conflict with law or charter
Based on Sinchareonkul v. Fahnemann [Del.Ch., 2015] Semperit is a German company that owns the trademark Sempermed for surgical gloves. Sri Trang is a Thai firm that manufactures rubber products. Firms sign an agreement to sell Sempermed-branded surgical gloves in the US. Agreement contemplates creating Sempermed USA (“SUSA”), a Delaware corp., to operate the joint venture.
SUSA will have 8 directors; 4 from Semperit and 4 from Sri Trang
Chairman of the board will be elected from among the Semperit directors, and will have a tie-breaking vote
SUSA is formed, and its charter includes the following:
Board of directors consists of 8 directors
Three classes of shares exist: Class A, Class B and Class C
4 directors are elected by the owners of class B shares, and 4 are elected by the owners of class C shares (no directors elected by owners of Class A)
SUSA’s bylaws state that the chairman of the board will be elected by the board from among the directors appointed by Class C shares, and that the chairman would have a tie-breaking vote in board votes
Class B shares issued to Sri Trang; class C shares issued to Semperit
Semperit signs an agreement giving a license to SUSA to use the Sempermed trademark, initially for just $10, stating it would later be adjusted to “fair market value”
After some time Semperit wants to adjust the royalties. SUSA hires a consultant to decide the fair market value, and consultant determines fair royalties are 2% of sales
SUSA board discusses agreeing to adjust the royalties payments. Semperit’s directors want a change, Sri Trang does not.
Board votes 4-4 to adjust royalties to 1.75% of sales. The chair of the board (a Semperit nominee) casts a tie-breaking vote.