Select Page

Business Associations/Corporations
University of Oklahoma College of Law
Cleveland, Steven J.

Corporations
Professor Cleveland
University of Oklahoma College of Law
Fall 2013
Overview
 
Glossary:
·         BoD = Board of Directors
·         C = corporation
·         CC = close corporation
·         Cert. of inc. = certificate of incorporation
·         DGCL = Del. Gen. Corp. Law
·         P’ship = partnership (if used alone, a general partnership)
·         SHH = shareholder
 
Corporate law is state law: Any C can incorporate in any state it likes, but it is bound by the law of the state of incorporation.
·         Most major Cs are incorporated in Delaware and other states look to Delaware when their own precedents do not cover a particular case. This is because Delaware has a court of chancery.
 
The Players
·         Corporations
o   The goal of any corporation is to ‘maximize shareholder’s value’
o   DGCL 242: Cs must have a cert. of inc. (also known as a constitution, as charter, or the articles of incorporation)
§  In their cert of inc., the C states the rules it will operate under, including any rules it will use in lieu of the default (DGCL 102(b))
o   Cs can engage in charitable giving (DGCL 122)
§  But: The statute has no limits and is unclear as to who should benefit.
·         SHHs
o   The SHHs are the owners of the C; owning shares confers bundles of economic rights and bundles of voting rights
o   Voting Rights
§  DGCL 216 + 141(k): SHHs have the power to elect and remove the BoD.
§  Any ‘fundamental change’ in the C must go to the SHHs for a vote (e.g., mergers, sale of assets, dissolution)
·         BoD
o   Governed by DGCL 141 & 142
o   The job of the BoD is to create a map/blueprint of the C’s goals and then make decisions toward meeting those goals.
§  Often, the BoD will be comprised of executives from other Cs and presidents of universities
o   Only 1 director is needed
o   Types of directors:
§  ‘Inside’: A member of the BoD who is an employee/officer of the C
·         There is a concern that inside directors may be biased toward their own interests, and the expense of the SHHs.
§  ‘Outside’ (aka ‘independent’): A member of the BoD who is not connected to the C in any other way.
·         Officers (aka ‘Executives’)
o   These are the people who are hired to make the day-to-day decision of running the C.
§  Analogy: The SHHs are the mom, the C is the baby, the officers are the babysitter.
o   The concern is that, like inside directors, execs’ interests will not align with the SHHs’ interests.
§  ‘Bonding’: An attempt to make the execs’ interest align with SHHs by offering them incentives (e.g. stock options) that increase as their performance and the C’s performance increases.
§  ‘Monitoring’: SHHs will hire third-parties to verify statements made by the executives.
 
Types of Businesses Formed
·         Differences between publicly-held C and a P’ship
 
Publicly-held C
Gen. P’ship
Limited P’ship
Formalities Required for organization
Yes, there are numerous (easy) procedural hoops
No; as long as the members have intent, nothing else is needed
Yes, though the barrier is low.
Investor liability is limited to the investment
Yes (exception: piercing the corporate veil)
No, partners are subject to unlimited liability
General partners are subject to unlimited liability, but limited partners have limited liability
Perpetual existence
Yes
No
No, if a general partner is lost, the partnership is lost
Freely transferable
Yes (subject to DGCL 202)
No
No for general partners, yes for limited partners
Centralized management
Yes – executives
No, every partner is an agent of the p’ship
Yes, the Ltd. P’ship is generally put in the general partners’ hands
Tax requirements
Two levels of taxation; individual and corporate
Individual taxation only
Individual taxation only
 
·         Corporations
o   Transferability: A C can opt-out of being fully transferrable. But doing so could deter investment because it locks the money into the C (i.e. SHHs prefer flexibility)
o   Centralized management:
§  Encourages diversification within the C, because the C will have the resources to engage in wide projects beyond the capabilities of the individual but will have limited liability to protect investors
§  Gives SHHs control over the C’s direction – If the C is underperforming, they can vote in a new BoD who can hire new execs.
·         ‘Human Capital’: The idea that the personnel within the company are part of the C’s investment portfolio.
·         Partnerships
o   A p’ship is an aggregation of individuals, and if that aggregation ever changes (death, sale, move, etc.) then the original p’ship ceases.
§  Perpetual existence, free transferability, and limited liability are all linked to one another.
§  P’ships, for understandable reasons, often have trouble getting insurance for themselves.
o   If the profits (not the gross revenue, the profits) of the enterprise are shared, that is prima facie evidence of a p’ship.
§  But: This rule does not apply if the money is paid as wages to the employees of the enterprise.
o   Each partner in the p’ship is considered an agent of the p’ship
§  Any act of a partner carrying on the business of the p’ship in the usual way binds the p’ship.
·         Exceptions: The partner was not carrying on the business in the ‘usual way’; the partner does not have the authority to act and the vendor knows that fact.
·         Limited Partnerships
o   Uses a dual-investor system – general partners have all of the control but fact unlimited liability; limited partners have no control but their liability is limited to their investment.
o   The general partner need not be a person – a C could be the general partner of a limited p’ship, which would add another layer of limited liability.
·         LLC = Limited Liability Company
o   Investors (‘members’) in an LLC enjoy limited liability
o   Default rule: investment interests are not freely transferable.
§  Just like in general p’ships, each of the members has a say in the management of the entity.
o   Default rule: Everyone is equal as to profits and voting power
§  But: Voting power changes with profit.
·         LLP = Limited Liability Partnership
o   General idea: Allows some of the benefits of a p’ship while giving some members limited liability.
o   But: personal assets may be at risk for contract suits involving the LLP as a whole (as opposed to individual members), depending on the state.
 
THE BOARD OF DIRECTORS (BoD) AND FORMALITIES
 
The BoD must abide by any required formalities in order to ensure that their actions remain legal.
 
Hierarchy of Authorities
·         State statute: Contains the default rules (many of these defaults can be contracted away from, but not all of them can)
·         Constitution: Document that governs the business; can contain anything, as long as that anything does not conflict with statute.
·         Bylaws: the ‘rules of the road’ for the C; can contain anything, as long as that anything does not conflict with statute.
o   These are initially created by the BoD but thereafter amended by the SHHs, unless of cert. of inc. allows the BoD to amend also (DGCL § 109).
 
Notice
· 

rity SHH)
·         Duty of Care
o   Directors owe a duty of care to the C, and in performing that duty they must do what a prudent person would do.
o   Business Judgment Rule (BJR): Absent fraud, illegality, or self-interest, courts will defer to decisions of the BoD, presuming the BoD is informed and acting in good faith the further the best interests of the C/SHHs.
§  Reasoning: The courts will not second-guess the in/actions of the BoD, because part of being in business/investing is taking risks. Thus, it would be massively unfair to hold the BoD responsible for failed risks but not reward them for successful risks.
§  There’s no standard for business judgments, so there’s no structure for making negligence claims in business (unlike in law or medicine)
o   Fraud/Illegality: If the plaintiff can prove either of these, the rule will not apply, but the burden of proof is on the plaintiff (Miller v. AT&T).
§  Policy: The Court does not want to promote efficient breaches of contract.
o   “Informed”: Courts are looking for a rational process by which the BoD arrived at their decision (the court will not review the substance of the board’s decision).
§  Factors the court will consider: the BoD’s prior knowledge; number and length of BoD meetings; all available information (including reliance on expers); ability to and result of negotiations.
§  DGCL § 141(e): Committee members are justified in relying on information provided by third-party experts (hired in good faith with reasonable care) or on other committee members.
o   “Good Faith”: Failure to act in good faith only results in liability when the BoD has either 1) intent to harm or 2) a conscious disregard of a known duty to act.
§  If a director has some “special skill,” they may be held to a higher standard if they did not employ that skill for the corporation.
·         Scenarios
o   Considered (in)action – The plaintiff must prove that the BoD was grossly negligent in its decision-making process.
§  Important: A BoD can be negligent (unreasonable) without being liable. Otherwise, the courts would be too close to second-guessing the BoD (In re Walt Disney Co.).
§  Test: BJR
§  DGCL § 102(b)(7): A corporation can, in their cert. of inc., limit or eliminate a director’s personal liability for breach of fiduciary duty.
·         Exceptions: Breach of the duty of loyalty; acts not in good faith; illegal payment of dividends; self-interest.
·         SHHs routinely approve these provisions as amendments, as they can be crucial to hiring talented directors.
o   Failure to Monitor – The plaintiff must prove that the BoD failed to safeguard itself against harmful in/action (Stone v. Ritter).
§  Caremark Test: The plaintiff must show one of the following:
·         The directors utterly failed to implement any monitoring system
·         The directors, having created a monitoring system, consciously failed to monitor what was happening.