Select Page

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

Professor Cleveland
University of Oklahoma College of Law
Fall 2013
·         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
No, if a general partner is lost, the partnership is lost
Freely transferable
Yes (subject to DGCL 202)
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 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).

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.