Business Entities and State Law
Corporate Law is State Law
Each state can create its own partnerships, corporations, and other business organizations. Our focus will be on state law.
Private bodies of law may also be important. Corporations often subject themselves to private organizations (NYSE, for example; country clubs, HOA, etc.).
You can organize in one jurisdiction and operate in another. You pay a fee in the state to organize and you pay fees to operate.
States as Laboratories (External vs. Internal Matters)
Whose law governs which matters? Chipped tooth at Sonic? Most likely Oklahoma law will govern because this is an EXTERNAL AFFAIR.
Internal Affairs Doctrine (IAD)–disputes among shareholders and directors go to the law where the organization was incorporated. MATTERS INTERNAL are resolved by the law of the jurisdiction where the company was organized.
Delaware copied NJ code many years ago and continues to update and improve. OK updates corporate code every couple of years. There is a rich body of common law in Delaware.
Delaware has judges specialized in corporate law matters and have developed a particular expertise in that area.
OK adopted DE corporate code in 1986.
Focus will be on Delaware Corporate Law. (Oldest corporate code.)
Model Business Corporation Act (MBCA) was drafted by the ABA. A majority of the states have adopted something similar but this is not as influential as the DGCL.
Devon is a foreign corporation, incorporated in Delaware but operating/headquartered in Oklahoma. So, Oklahoma passes a statute saying “you’ve gotta pay us money to be here.”
Size matters. If you have a SMALL corporation, you don’t want to organize in DE and operate in OK because you’ll have to pay two fees, as opposed to just one. As corporations get larger and larger, they pay the fee to every state and incorporate in DE because corporate law is so good.
Certificate of Incorporation (charter), DGCL 102
Bylaws, DGCL 109
Example: The U.S. Constitution vs. U.S. Code
There are things that HAVE to go in the corporations’ charter. You cannot put anything in the U.S. Code that is not consistent with the Constitution. Same with bylaws–you can put what you want to that deal with how corporation will be managed, but you can’t put anything in them that is inconsistent with the charter or state statute.
It’s easier to amend the bylaws than it is to amend a corporate constitution/charter.
Delaware: Only shareholders can amend the charter. More difficult. (See book.)
Board of Directors–in charge of the big decisions
Chosen by the shareholders.
A corporation’s power is given to the BOD, who then delegate to the CEO and other Senior Management.
For small corporations, there may be only one person wearing multiple hats.
As corporation get larger and larger, BOD are not employees of the company. They are usually composed of outside directors having no employment relationship and little percentage of the shares. For smaller corporations, this can be lots of tim
These directors could make $250k, but the downside could be tremendous liability.
Board could make committees and delegate responsibilities that way.
MBCA Section 8—Directors and Officers (majority of states follow MBCA)
8.01–Requirements for and duties of Board
8.02–Qualifications of Directors (prescribed by Articles of Incorp.
8.03–Number and election of directors
Must consist of one or more individuals
Number may be increased or decreased
Elected at the annual SHH meeting
8.04–Election of directors by certain classes of SHH
8.05–Terms of directors generally
8.06–Staggered terms for directors
8.07–Resignation of directors
8.08–Removal of directors by SHH
SHH may remove one or more with or without cause
Can only be done in a meeting for that purpose
Removal of directors by judicial proceedings
8.10–Vacancy on board
Compensation of directors (fixed/set by BOD)
All participating directors must be able to simultaneously hear each other
Teleconference and video conferences are okay
Email real time not okay (cannot hear)
8.21–Action without meeting
Each director must sign consent
Consent can be revoked by a signed revocation sent prior to all consents being received
8.22–Notice of meeting
Regular meeting—okay without notice (boards oversee these all the time so it’s regular and not everyone needs to be there)
Special meeting—2 days notice (purpose not required in notice)
Doing something outside the norm so we need all directors there to have an opportunity to participate
8.23–Waiver of notice
Waiver must be in writing and signed by director (filed with the minutes)
8.24–Quroum and Voting
Quorum = majority
Articles of Incorporation can make a quorum = 1/3
(e)(2)–Committees cannot approve or make proposals to SHH that have to be approved by SHH
Officers described in bylaws or appointed by the board
BOD may elect individual officers. Officer may appoint other officers if okay by bylaws or BOD.
BOD or Bylaws assign one officer responsibility to prepare minutes of directors and SHH meeting and for maintaining records
Can hold more than one office
8.41–Functions of officers: officers have the authority to perform duties set forth in the bylaws or prescribed by the BOD
Ex: Mark Zuckerberg is officer/employee and director of Facebook, so he is an inside director.
Ex David Boren is not officer/employee of American Airlines but is director, so he is an outside director.
Ex Attorney that is also on the BOD, but reps a client the corporation works with, so he is not independent because he has another outside relation that could taint decision-making process.
Managers/Officers/Employees–the people running the operations of the company
Officers are appointed and can be removed by the BOD. Top of the hierarchy is the CEO. CEO’s goal is to please the board.
Shareholders–at the pinnacle of decisions, while officers/employees are at the bottom. Shareholders elect directors and can remove them in the middle of their term (DGCL 141(k)). Directors are accountable to shareholders. Shareholders are also the investors of the corporation.
Shareholders also have voting rights that have an effect on fundamental changes within the corporations Board can only initiate these changes but must get Shareholders’ approval.
Quorum and Required vote for stock corporations—DGCL 216.
Fundamental changes in or to the corporation also require shareholder approval:
Election of Directors: DGCL 211 and 216.
Shareholder must approve an amendment to the Constitution/Fundamental Change to the Nature of the Business: DGCL 242.
Merger: DGCL 251.
Sell all or substantially all of the assets: DGCL 251.
Dissolution of the Corporation: DGCL 275.
Ex: Invest in guns or butter? If I invest in butter, and Butter Corporation is going to sell all of its butter-making assets to get gun-making assets, this would fundamentally change the nature of the business. (DGCL 242)
SHAREHOLDERS MUST APPROVE. This means I get a vote in whether or not Butter Corporation can do this. We can do the exact same thing in mergers (DGCL 251)
Ex: Babysitter Hypo: SHH (mom) owns the kids, but BOD manages the kids.
Mom (Shareholders)–wants kids to do homework, eat healthy, go to bed on time, etc. Tons of rules for the kids and for the babysitter.
She goes on her date and “the rules go with her.” Babysitter (Board of Directors) orders Domino’s, TV instea
. I’m a driver for FedEx. I run into school bus and children die. Parents go after FedEx and try to get me as a shareholder. I’m safe. Parents sue me for negligence. I’m not safe. I’m liable for my own acts.
Courts may, under some very narrow circumstances, pierce the corporate veil and sue shareholders. But as a general rule, shareholders are not liable.
Are ownership interests freely transferable? Yes
I call my broker, say “sell” my shares are gone.
Once again, if we don’t like the default rule we can deviate from it my imposing restrictions on the transfer of stock.
Example: No transfer without approval of non-transferring shareholder. If you, the non-transferring shareholder, don’t approve of the transfer of shares to the three stooges, you have to deviate from the default rule.
These are known as “closely-held corporations” where there are very few shareholders.
I’m a shareholder of Exxon and don’t know a thing about oil and gas. I can still make money off of it even though I am ignorant about it. I’m not going to run Exxon, but will still make money, because it is centrally managed.
Tax–Yes, corporations are subject to double taxation.
Corporation subject to 30% tax, individuals subject to 30% tax. Partnerships not subject to a tax.
Ex: Corporation makes $100. Tax leaves $70 to go to two owners. Individuals own 30% on their $35 and each walk with $25. Partnership makes $100, no tax, so each owner gets $50. Tax on individual income leaves them with $35.
S corporations (small corporations) are only subject to one level of taxation. All others subject to double taxation.
These feed into and flow with one another.
General Partnerships (AKA “partnership”)
Formalities to Organize–No
I shake your hand, we agree to A, B, C.
Sharing of gross returns (revenue) does not evidence a partnership. However, if you agree to share PROFITS (the revenue – expenses), you are a partnership. No formalities required, unless those profits are being paid as compensation to employees. Those employees are not partners.
Vohland v. Sweet
Owner agrees to give 20% of the net profits to an employee. The employee then wanted to be considered a partner so he could have access to additional money. Partner said nah, this is an employee.
Rev – Exp = Profits
Sharing revenue is not evidence of a partnership. BUT sharing of profits IS, unless the profits were paid as employee wages.
Court held it WAS a partnership, based on the evidence and factors evaluated by the court.
Perpetual Existence–Historically, no.
Viewed as an aggregation of partners.
If aggregation altered, then the partnership ended and the remaining partners would form a new partnership.
Fairway Dev. Co. V. Title Ins. Co. Of Minn.
Two partners go away, now we have partners A and D. A and D make claim on insurance company and insurance says “I don’t know who you are. I knew ABC partnership, not AD partnership.”
This is the problem with long-term contract.
If someone dies, you’ve got a new partnership.
Exception: If partnership is a stand-alone entity.