Cleveland Fall 2006
Corporate law exists to resolve conflicts between:
1. Management and Shareholders
2. Shareholders and Debt holders (security holders)
3. Controlling and Non-controlling Shareholders
Shareholders are “residual claimants”
1. 216 – elect directors
2. 141K – remove directors
3. 242[ – fundamental governing document – certificate of incorporation a.k.a. articles of incorporation, corporate constitution, charter – SHHs vote to amend
4. 251 – corporate mergers
5. 271[ – sale of all of substantially all assets
6. 275 – dissolution of corporation
Closely held – few shareholders, may hold many positions such as officers or directors
DGCL 142 – choose officers and remove officers
Typically not employees of the corporation, there to monitor officers
Full time employees
Trending to yes
· Formalities are required to create (DGCL 102)
· Limited liability exists (with one narrow equity exception – DGCL 102(b)(6))
· Centralized management – SHHs do not control (DGCL 141(a))
· Free transferability of shares – default, but in the charter restrictions can be imposed on their transferability (DGCL 202)
· Maintain a perpetual existence (DGCL 102(b)(5))
· Double taxation – imposed both as corp. income and dividend income to SHHs
· No formalities required to create – all that is required is an agreement
“The receipt by a person of a share of profits of a business is prima facie evidence that he is a partner in the business, but no such inference shall be drawn if such profits were received…” P. 724-725
· No limited liability of SHHs
· No centralized management – SHHs control day-to-day operations – every partner is an agent of the partnership, all partners can bind the business to contracts
· Shares are not freely transferable – no transfers of partnership interests without the consent of the other partners
· Not a perpetual existence – when partners die, partnership dies – trending to having a perpetual existence
· Taxed only as income to investors – no business entity tax – downside is that gov’t may impute income to us that is not actually income, i.e. still taxed as income even if the money is reinvested in the business
Limited Partnership (LP):
· Formalities are required for formation
· General partners are subject to unlimited liability, but limited partners are more like SHHs and enjoy limited liability.
· There is centralized management b/c the general partner will operate the business and the LPs have no day-to-day control, have a limited voice in the business – if LPs take too much control then they can be changed to general partners and be subject to liability (See list bottom of P.823-824)
· General partner cannot transfer interests without consent, but Limited partner can
· Perpetual existence
· Only investor level taxation
Limited Liability Company (LLC):
· Formalities are required
· There is limited liability
· Default is that there is no centralized management, but it can exists – Code P. 1101 §18-402 – can be either member managed or manager managed, the first is decentralized and the later is centralized
· No free transferability of business interest – Code P. 1095 §18-301 – must have consent to transfer any operation interest
Limited Liability Partnership (LLP):
· Formalities are required to create
· Limited liability exists
· Generally not freely transferable
Forming the Corporation
1. Selection of State of Incorporation
a. If business is to be conducted within a single jurisdiction, incorporate in that jurisdiction…otherwise must pay additional taxes, be subject to suit, etc.
b. A resident of any other state can organize in any other state.
c. If business is to engage in multistate business:
1. Rates of Franchise fees
2. Tax rates
3. Corporation statutes
a. choice-of-law rule states that the law of the state of incorporation will govern the corporation’s internal affairs
b. b/c DE’s statutes are permissive, it is the favorite state in which large businesses are incorporated
4. Is state competition for corporations beneficial?
a. Permissive statutes allow managers to run corporate affairs with little interference from SHHs or the courts and thus diminish mgmt’s responsibility and accountability
b. The best system of corporate governance emerges from competition among the states
c. Diverse state corporation laws allow each firm to choose the state with the best mix of laws, considering its operating policies, organizational structure, and management preferences
d. The status quo is desirable b/c it is capable of generating a variety of sets of legal rules from which corporate participants may choose in a value maximizing manner
2. Compliance with State Requirements
a. Preparation of Documents – DGCL 102 – Must contain name, address, nature of business, stock info, name and address of incorporators…may contain provisions for mgmt, stock provisions, limitation on duration of existence, imposing liability on SHHs
b. Meeting Statutory Formalities – After articles are prepared, must be signed and verified or acknowledged…delivered to appropriat
of the would-be corporation.
b. Corporations by Estoppel: Under the doctrine of corporations by estoppel, one who deals with a corporation in such a manner as to recognize its corporate existence (i.e., one who believes he is dealing with a valid corporation), which could be shown by the fact that the plaintiff executed an agreement with the corporation as a party (i.e., the only signature line on the contract or note was for the corporation), is thereby estopped from denying the corporation’s existence. [Thompson & Green Mach. Co. v. Music City Lumber Co.] Rationale: Without the doctrine of corporation by estoppel, the plaintiff would essentially be getting something (personal liability for a corporate debt) that he could have bargained for, but failed to do so. If the plaintiff knew he was dealing with a corporation at the time the contract was formed, if he wanted to hold the promoter personally liable for the debt, he should have required a guarantee.
Requires Innocent Noncompliance: Most courts that have applied the doctrine of corporation by estoppel also seem to require that the shareholder who is asserting the defense must not have known that the incorporation was defective. Thus the doctrine is most often used where the shareholder in good faith relies on some third party (a promoter or lawyer) to handle the incorporation, and based on assurances from this third person, falsely, but honestly believes that a corporation has been formed.
Doesn’t Apply in Tort Cases: Because of the requirement that the estoppel doctrine applies only where the plaintiff has dealt with the business as a corporation and agreed solely to look to the corporation’s credit, the doctrine is essentially limited to contract cases, and is virtually never applied against tort plaintiffs. Obviously, a person who is injured by the act of a business or its employee has not agreed to deal with the business as a corporation.
6. No Corporate Liability under Agency Theory: When the corporation is not technically/legally formed, it cannot be held liable for the acts/agreements of the promoter or the purported officers, directors, and employees under agency theories because there was no principal at the time the acts/agreement occurred (i.e., there was no agency). Promoters and incorporators cannot legally bind the defendant corporation under agency principles if the contract was entered into prior to the existence of the corporation.
Adoption/Ratification by the Corporation: If the corporation