Corporations (Skeel, 2016 fall). Multiple-choice exam: 50 Qs, 3.5 hrs.
Enterprise Forms and Incorporation (Location & Reasons)
Traditional forms (no need to register):
Sole proprietorship (the simplest form)
No fees or filing requirements
Personal responsible (unlimited)
General Partnership – joint ownership
1 or more investors (e.g. bakery)
No fees or filing requirements
Joint and several liable
NOTE: can be altered by contractual arrangement. “Free of opt-out” default rules (exception: personal liability, but can i) contract around it to say some partners provide additional guarantee, ii) side agt. to allocate liability/ liability waiver from 3rd party, and iii) buy insurance policy).
Partnership property: “tenancy in partnership” – property held by the partnership. Creditors of partnership have priority over creditor of individual partners. Benefits: lower the agency costs. i) creditors do not need to look into the financials of the partners or the creditors of the individual partners, ii) partners do not need to worry about the financials of other partners.
Similar Q: whether to put a new biz as one sector or a separate entity? Pros and cons co-exist.
Q: In bankruptcy, do creditors need to go after partnership before going to partners? In most states, yes.
LP and GP (De facto matter: permit using LL entity as GP, then GP is actually LL in essence)
Need to register
“Control” test (as an exception to LP’s LL):
– Sec. 303 of 1976 RULPA
– 303 of the 2001 RULPA: abolish. Currently, distinctions b/t GP and LP have been breaking down and it is now harder to lose limited partner status. However, most LP agreements vest complete control of the entity in the hands of the general partner.
(Low cost; preferential taxation – no double taxation, “pass-through” taxation; not freely tradable)
Transferability of Ownership Interest: Generally not transferable unless other partners agree or partnership agreement permits it
Corporations , its attributes are:
Governance structure: members/shareholders, board
Closely held corporations: Corporation is held by a limited number of shareholders (usually, also managers). There is generally no readily available market for trading the shares.
Why organize as a closely held corporation? (1) Tax purposes, rather than capital raising purposes (E.g., Shareholders may take return as tax-deductible salary); (2) Fewer transaction costs to organize as no-frills corporation b/c corporation has more elaborate set of default provisions
New fangled entities: all get flow-through taxation upon a check.
S-Corp. (satisfy the requirements under subchapter S. of the IRC, 1st form to have all the attractive attributes)
Gets pass-through taxation
No clear definition
Ownership restriction: max 100 shareholders (limit the S corp to a closely held corp., usually less than 20 – small family business); only one class of stock; shareholders be individuals.
Difference with LLC: generally, it is difficult to fulfill the requirements for S Corp. LLC would be much easier and common.
LLC (a default choice for most small-medium businesses)
Members rather than shareholders
Pass through taxation
Operating agt. (Delaware: certificate, equivalent to the Bylaws of corporation)
LLP (normally for professional biz, pay attention to the Quiz of Wachtell&Lipton)
Similar to GP, but provide LL for all partners for the malpractice of other partners (malpractice protection).
Liability for Obligations of Business: Limited liability for partnership obligations, except that a partner cannot eliminate his own liability from malpractice
Not liable: Ordinary torts claims
Liable: If you commit malpractice or have supervisory authority over someone who commits malpractice
treated as if limited partnership that had limited liability. Has all the same attributes of LLP, except your general partners get limited liability as well.
[PA: also have a special form called professional corporations.
Non-profit corporations: Delaware do not have a separate section for non-profit corps, though the relevant provisions regarding non-profit corp scattered in the sections of for-profit corps. Other states do have special chapter/section for non-profit corp.]
Q – Big companies: tend to be corporations rather than LLC. Why?
IRS history of pass-through treatment requirements:
At first, corporate resemblance test (LLC fails in i) free transferability, and ii) continuity of life).
In 1997, IRS change. “Check the box” regulations.
Lost of flowthrough taxation status: if actively traded, must be double taxation regardless of corporate form. So, big companies take Corp. form because they could not enjoy passthrough any way. (Exception: Blackstone went public as a limited partnership, but retained flowthrough taxation b/c investments considered “passive”.)
Familiarity (people more familiar with Corp.)
Wachtell & Lipton (few law firms that use general partnership: why? Marketing & Culture)
Facebook, corporations. Public traded in stock exchange.
Baby Blues, LLC (one private company, small business).
Hedge Fund, LP: real estate firms also frequently use LP. Hedge fund sometimes use LLC or other forms. (Short time period investment, looking for profits in specific projects (differ from equity fund); Set up to avoid regulation to the extent possible.)
Why not LLLP? 1) no debt, not necessary. If LL for GP required, can establish corp. 2) treated as general partner, then no partner is protected. GP involved in management. There is a risk of being treated as general partnership. 3) division between LP (investment) and GP (management). If LLLP, risk of LP in management being categorized as GP is low, so may have LP interfere with the management.
State of Incorporation – why DE, and why not?
Incorporating locally (esp. for small business):
Convenience, less expensive than go to DE in respect of fees.
Tax: DE collect tax based on authorized shares and other states may not; Double tax bill: otherwise pay separate franchise tax and doing business tax; when together cheaper. Tax not overlap.
Home State Effect.
Local legal knowledge: local lawyers know local law.
Specific corp. law provision – for example, on whether to allow Bylaws to have loser pays clause for attorney fees. DE supreme ct. said it could be ok. One year ago, DE legislature reverse it. So if concerned about this, people go to other state (such as PA).
Incorporating in DE (esp. for big business)
Network& Signaling benefits: DE name is valuable, like everyone using MS Word.
More “favorable” laws – friendly to managers/ mindful of managers’ interests: benefits directors.
Contested by scholars:
Race to bottom? Bad thing. DE pays attention to managers, but not to other constituencies, cause issues regarding policing on managers. (Sab-OX & Dodd Frank Act) [Harvard] Race to the top? Good. First, shrs have a saying in the place of incorporation. Second, even if the managers choose to DE, there is a consideration of market forces. If DE has a bad law & just for managers’ benefits, then the market will treat DE corp.s as companies not worth investing. Then company will change the incorporation location.
Most people in the middle.
A new angel: DE’s most serious competition/concern not come from other states, but from D.C.’s stringent regulations (such as Sab-OX & Dodd Frank Act).
Deep precedent & comprehensive corporation law.
Qualified judges: the judges mostly have expertise in corporation law.
Efficiency of DE judicial system re corporation law: 2 courts and 10 judges.
(Chancellery court (5 judges, the trail court – equity court, no juries) & appellant court (5 judges)), decide very fast.
(P.S.: for predictability of DE corp. law, maybe true in statute but not case law.)
Some other states, for example, Virginia: anti-takeover measures, protect local firms from being taken over.
listed in national exchange. The fact no LLC in national exchange may change only if IRS changes the tax rules.
Case 1: Dodge v. Ford
Facts: Action by John F. Dodge and Horace E. Dodge (hold 10%) against the Ford Motor Company (a corporation, organized and existing under Act No. 232 of the Public Acts of 1903) and others to compel the declaration of dividends and for an injunction. Authorized capital stock of Ford is $2,000,000. No special dividend having been paid after Oct. 1915 (since 1914 Ps have not been represented on the board and thus Henry Ford dominated). Henry declared the settled policy of the company not to pay any future special dividends (other than 5% regular dividends), but to put back all earnings into the business in future [for reducing car prices to benefit working man].
[John F. Dodge and Horace E. Dodge (hold 10%, approx. 200 shares) against the Ford Motor Company (58%) for stop of distributing special dividends & business expansion plan of the company.
[Hard to sell minority shareholding at the expected consideration since Ford is the controlling shareholder. There is liquidity issue & shareholding structure issue. They want to get special dividends first and then sell the 10% shares.
Similar examples in Silicon Valley: Microsoft – no dividends for a long time, shrs ok with it via increase of share price (good businesses). Amazon.]
Dodge brothers supply most components of the Ford cars, Ford played a hard role in the re-negotiation phase and Dodge decided to start their new companies. But Dodges need funds for that and Ford then stops the special dividends distribution (try to monopoly in the car market). [Part of the reasons that drive the judgement – anti-trust concerns]
Procedural History: P’s decree rendered, defendants appeal. Affirmed as to dividends and reversed as to the injunction.
Issues: Whether the court should interfere with the board’s dividend distribution policy? Whether the court should interfere with the proposed expansion?
Holding: Affirmed in part (paying dividend of $19 million (half of its cash surplus as of the start of the suit)) and reversed in part (reversed the lower court’s injunction of Ford from expanding its plants).
1. A business corporation is organized primarily for the profit of the stockholders, and the discretion of the directors is to be exercised in the choice of means to attain that end, and does not extend to the reduction of profits or the nondistribution of profits among stockholders in order to benefit the public, making the profits of the stockholders incidental thereto.
2. The directors of a corporation, and they alone, have the power to declare a dividend of the earnings of the corporation, and to determine its amount. Courts of equity will not interfere in the management of the directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds, or refuse to declare a dividend when the corporation has a surplus of net profits which it can, without detriment to its business, divide among its stockholders, and when a refusal to do so would amount to such an abuse of discretion as would constitute a fraud, or breach of that good faith which they are bound to exercise towards the stockholders.