Business Associations Outline
Hazen
Fall 2017
Differences b/w shareholders and directors
Issue
Shareholder rule
Director rule
Leaving a meeting early
Does NOT destroy a quorum once it is established. Meeting is valid, shareholder deemed present
Does destroy a quorum, since quorum is measured at the time the vote is taken
Introductory Information:
THEORIES OF THE FIRM:
Fiduciary Model
Traditional view: Managers have “fiduciary” duties that ensure alignment of interests between passive owners and active managers.
Jurists provide discipline for breaches of fiduciary duties by managers.
Contractual Theory (“Nexus of Contracts”)
“Chicago School”: business relationships are governed by contractual agreements and the free market will correct misbehavior of management, rather than judicially created discipline for breaches of fiduciary duties.
Shareholders are assured only of rights they might have under contract with corporation.
Problems Arising from the Separation of Ownership From Control
Basic Problem: Conflict of interest between passive owners and active managers. Managers may work to maximize their own profit rather than maximizing the value of the firm.
Neo-Classical Economists “Chicago School” View : Managers must have “incentive compensation that substantially ties their fortunes to that of the owners.
“Agency Costs”: collective term for the costs of bonding, signaling and monitoring management, as well as the amount of management misbehavior that continues in the face of these steps to deter it.
“Bonding”: Attempt to align the interest of management and passive owners by “bonding” management compensation to the success of the firm.
Stock options or bonuses based on profitability.
“Signaling” : Actions to “link” management’s incentives to those of the firm’s owners “signals” to investors that the firm’s managers will work to maximize profits.
“Monitoring” : devices put in place to police mismanagement. Might include use of “outside directors” or independent accountants.
ADVANTAGES AND DISADVANTAGES OF DIFFERENT TYPES OF ENTERPRISES:
PROPRIETORSHIPS
“Proprietorships” : individually owned businesses that have NO separate legal status apart from their owner.
Advantages:
Direct Control: No separation of ownership and control. Owner of proprietorship directly controls and operates the business
Simplicity: Easy to operate and more flexible because there is NO separate legal entity status. NO registering with the state; NO need to call shareholder meetings, etc.
Expenses: Less expensive in its operations. NO need to comply with expensive reporting and registration requirements under federal securities laws. Accounting is less formal.
Taxes : Proprietorship is NOT taxed separately. Income and expenses are passed directly through to the owner. (In contrast—corporations are “double taxed”).
Disadvantages:
Unlimited Liability : sole proprietor is subject to unlimited liability for any contractual or tort damages caused by business or its agents. Personal assets may be seized by creditors.
Management : Dependent on management of the owner—NOT a professional manager. Death or disability of proprietor can result in loss of business.
Transferability : Ownership of the proprietorship can NOT be readily sold. The entity is usually an integral part of its owner’s personal management and control having NO separate structure that can be easily transferred.
GENERAL PARTNERSHIPS
“Partnership” : an association of two or more persons carrying on a business for profit as co-owners.
General Partnerships are the common law “default” and can be created by conduct.
Advantages
Control : Partnership does NOT separate ownership and control. Ownership and control is dispersed among partners by agreement. Owners directly control business.
Simplicity : The partnership has a separate legal structure, but the partners may agree to conduct their business in almost any manner (flexibility). However, Partnerships must be conducted in accordance with state partnership laws.
Expenses: Less expensive than a corporation b/c there are NO reporting, accounting requirements, etc. However, winding up the partnership may be expensive/complicated.
Taxes : The partnership is NOT taxed separately. Income and expenses are passed directly through to the owners.
Disadvantages
Unlimited Liability : Partners in a General Partnership are subject to unlimited liability (JOINTLY AND SEVERALLY) for any contractual or tort damages incurred by partners or agents in the course of business.
Transferability : A partner can NOT sell his or own ownership interest in the partnership.
LIMITED PARTNERSHIPS (“LP’s”)
“Limited Partnership” : an entity that exists only by statute and has a General Partner that operates the business and one or more “limited partners” that contribute investment capital but do NOT participate in management.
Advantages:
Limited Liability: The liability of the “limited partners” is limited to the amount of their investment thereby protecting other assets. The General Partner has unlimited liability.
Separation of Ownership and Control: “Limited partners” may invest capital without becoming involved in management. This allows limited partners to invest when they don’t have the time or expertise to manage.
Expenses: Simple management b/c business may be structured under the Limited Partnership Agreement. However—LP must file with state upon start of the business and accounting for limited partners may be more complicated than in GP. LP’s might also have more complicated tax structure similar to corporations.
Disadvantages:
Unlimited Liability: The General Partner in a LP is subject to unlimited liability for any contractual or tort damages occurred in the business. However, this can be limited by making the general partner a corporation.
Transferability: A “limited partner” can NOT usually readily sell ownership interest UNLESS it is registered under (or exempt from) the federal securities laws with all their attending expenses, etc.
Dissolution: Upon the death of a general partner, not of a limited partner though
LIMITED LIABILITY COMPANIES (“LLC’s”)
“Limited Liability Company” : An entity that exists only by statute that is basically an incorporated partnership that allows members to actively participate in management OR be passive if they so wish.
Advantages:
Limited Liability: The liability of members is limited to the amount of investment.
Separation of Ownership and Control: LLC members may invest capital without being involved with management OR members can manage the company if the operating agreement permits, without incurring unlimited liability. Maximum flexibility.
Expenses: Simplicity in management in an LLC because biz may be structured freely under the operating agreement. However, a charter must be obtained from the state. Accounting may be more complicated than a partnership.
Disadvantages:
Transferability: Ownership interest may be transferred, but transfer may be restricted by operating agreement. Sale of ownership interest may be subject to fed securities laws.
LIMITED LIABILITY PARTNERSHIPS (LLP’s”)
“Limited Liability Partnership”: Another form of incorporated partnership that exists only by statute. Particularly popular with law firms.
Advantages
Limited Liability :
Liability of members of the LLP is limited to the amount of their investment.
For a law firm
Unlimited liability for your own acts
Protection from personal liability for acts of other partners BUT not partnership interest (may be seized by creditors of the partnership)
Expenses : LLPs may structure their operations as they deem fit under the agreement.
Taxes: Taxes may be passed through to members directly, avoiding double taxation
Disadvantages
Transferability : ownership interest in an LLP is NOT eas
o enter into mortgages, purchase stock, or sell dividends w/ out Cargill’s approval 5) Cargill’s correspondence and criticism regarding Warren’s finances, officer’s salaries, and inventory 6) Cargill’s determination that Warren needed strong paternalistic guidance 8) Financing of all Warren’s purchases of grain and operating expenses 9) Cargill’s power to discontinue the financing of Warren’s operations.
Manifestation of Consent; Apparent Authority
Warren used Cargill labeled business forms: “Holding themselves out” to third parties that Cargill was in control and backing up the business’ obligations.
Benefit:
Cargill is getting 90% of the benefit of Warren G & S’s business . . . and all of the financing came from Cargill
Warren was NOT free to become a competitor of Cargill.
Thus: Warren was acting on behalf of and under the control of Cargill. Cargill is liable for Warren’s debts as the de facto “principal”. NOT LIMITED LIABILITY to the investment
FIDUCIARY OBLIGATIONS OF AGENTS:
An agent is a “fiduciary”: an agent is held to extraordinarily high standards of behavior–“not honesty alone, but the punctilio of an honor the most sensitive” [Meinhard].
Two Categories of Fiduciary Duties:
Duty of Care (common law negligence)
Duty of Loyalty
Basic “Duty of Care Obligations of Agents:
You must use reasonable care to carry out your functions
Basic “Duty of Loyalty” Obligations of Agents:
Unless otherwise agreed, the agent:
Must act solely for the benefit of the principal (Duty of Undivided Loyalty)
May NOT deal with the principal as an adverse party (Conflict of Interest)
If an agent makes a profit while working, agent must give profit to the principal
Duty not to compete ; and
Duty not to appropriate opportunities belonging to the principal.
Agent that acquires “confidential information” while working and gains a profit on that info must give that profit to the principal (Insider trading)
LIABILITY of third parties dealing with Agents:
A 3rd party is bound to the principle when dealing with agents, sometimes even when they don’t know
But, a 3rd party will not be bound if the Agent misrepresents the relationship and otherwise there would have been no agreement
AUTHORITY OF AGENTS
“Authority”:
General Rule: Authority must come from the principle, an agent cannot create authority
Determines which of an agents acts falls within the ambit of agency relationship binding the principle
An agents acts bind the principal ONLY if the agent acts within the scope of his authority.
Three Types of Authority (all are binding on the principle):
Actual Authority (express or implied) : runs from the principal to the agent and can flow from a contract, title, job description, past course of dealing, etc.
Express Authority: specific authorization of agency (Principle tells agent what to do)
It might be in the contract
Implied Authority: flows from an express grant of authority
Implied from the job
Whats reasonably necessary to do the job
Apparent Authority : can exist in the absence of actual authority where the principal (NOT the agent) gives a third party reason to believe that actual authority exists.
