Professor Booth – Fall 2009
Table of Contents
I. Introduction. 2
A. Efficiency and the Social Significance of Enterprise Organization. 2
B. Law From Inside and Out2
C. Approaches to Corporation Law.. 2
II. Agency. 2
A. Agency Formation, Agency Termination, and Principal’s Liability. 2
i. Agency Formation. 2
ii. Agency Termination. 2
iii. Parties’ Conceptions. 2
iv. Liability in Contract2
v. Liability in Tort2
B. The Governance of Agency (The Agent’s Duties)2
i. The Nature of the Agent’s Fiduciary Relationship. 2
ii. Agent’s Duty of Loyalty to the Principal2
iii. Trustee’s Duty to Trust Beneficiaries. 2
III. Partnerships. 2
A. Introduction to Partnership. 2
i. The Governing Rules of Partnership. 2
ii. Partnerships vs. Corporations. 2
iii. Why Have Joint Ownership?. 2
iv. The Agency Conflict among Co-Owners. 2
B. Partnership Formation. 2
C. Relations with Third Parties. 2
i. Third-Party Claims Against Departing Partners. 2
ii. Third-Party Claims Against Partnership Property. 2
iii. Claims of Partnership Creditors to Partner’s Individual Property. 2
D. Partnership Governance and Issues of Authority. 2
E. Termination (Dissolution and Dissociation)2
i. Accounting for Partnership’s Financial Status and Performance. 2
F. Limited Liability Modifications of the Partnership Form… 2
i. The Historical Development of Limited Liability. 2
ii. The Limited Partnership. 2
iii. The Limited Liability Partnership. 2
iv. The Limited Liability Company. 2
IV. Corporations. 2
A. Introduction to the Corporate Form… 2
i. State v. Federal Control over Corporations. 2
B. Creation of a Fictional Legal Entity. 2
i. The History of Corporate Formation. 2
ii. The Process of Incorporating Today. 2
iii. Articles of Incorporation, or “Charter”. 2
iv. Corporate Bylaws. 2
v. Shareholders’ Agreements. 2
C. Limited Liability. 2
D. Transferable Shares. 2
E. Centralized Management2
i. Legal Construction o f the Board. 2
ii. Corporate Officers: Agents of the Corporation. 2
V. Capital – Debt, Equity, and Economic Value. 2
A. Capital Structure. 2
i. Legal Character of Debt2
ii. Legal Character of Equity. 2
B. Basic Concepts of Valuation. 2
i. The Time Value of Money. 2
ii. Risk and Return. 2
iii. Diversification and Systematic Risk. 2
C. Valuing Assets. 2
i. The Discount Cash Flow (DCF) Approach. 2
ii. The Relevance of Prices in the Securities Market2
iii. Leverage. 2
VI. The Protection of Creditors. 2
A. Mandatory Disclosure. 2
B. Capital Regulation. 2
i. Financial Statements. 2
ii. Distribution Constraints. 2
iii. Minimum Capital and Capital Maintenance Requirements. 2
C. Standard-Based Duties. 2
i. Director Liability. 2
ii. Creditor Protection: Fraudulent Transfers. 2
iii. Shareholder Liability. 2
D. Veil Piercing on Behalf of Involuntary Creditors. 2
i. Substantive Consolidation. 2
ii. Dissolution and Successor Liability. 2
iii. Law and Economics of Limited Liability in Tort2
VII. Normal Governance: The Voting System… 2
A. The Role and Limits of Shareholder Voting. 2
i. Stockholder Rights. 2
ii. Stockholder Meetings and Voting. 2
iii. Governance. 2
B. Electing and Removing Directors. 2
i. Electing Directors. 2
ii. Removing Directors. 2
C. Shareholder Meetings and Alternatives. 2
D. Proxy Voting. 2
E. Class Voting. 2
F. Shareholder Information Rights. 2
G. More Voting Basics – Class Notes. 2
i. Shareholders Agreements. 2
ii. Control of Proxy Machinery. 2
iii. Quorum and Majority. 2
iv. Voting for Directors. 2
v. Board of Directors. 2
H. Techniques for Separating Control from Cash Flow Rights. 2
i. Circular Control Structures. 2
ii. Vote Buying. 2
iii. Controlling Minority Structures. 2
I. The Collective Action Problem… 2
J. Board Meetings. 2
K. Committees. 2
L. Amendments. 2
M. Federal Proxy Rules. 2
i. Rules 14a-1 Through 14a-7: Disclosure and Shareholder Communication. 2
ii. Rule 14a-8: Shareholder Proposals. 2
iii. Rule 14a-9: The Antifraud Rule. 2
N. State Disclosure Law: Fiduciary Duty of Candor2
VIII. Duty of Care. 2
A. Introduction. 2
B. The Duty of Care and the Need to Mitigate Director Risk Aversion. 2
C. Statutory Techniques for Limiting Director and Officer Risk Exposure. 2
i. Indemnification. 2
ii. Directors and Officers Insurance. 2
D. Judicial Protection: The Business Judgment Rule. 2
i. Understanding the Business Judgment Rule. 2
ii. The Duty of Care in Takeover Cases. 2
iii. Additional Statutory Protection: Authorization for Charter Provisions Waving Liability for Due Care Violations. 2
E. Delaware’s Unique Approach to Adjudicating Due Care Claims against Corporate Directors. 2
F. The Board’s Duty to Monitor: Loses “Caused” by Board Passivity. 2
G. “Knowing” Violations of Law.. 2
H. Indemnification and Insurance. 2
IX. Duty of Loyalty. 2
A. Duty to Whom?. 2
B. Self-Dealing Transactions. 2
i. The Disclosure Requirement2
ii. Controlling Shareholders and the Fairness Standards. 2
C. The Effect of Approval by a Disinterested Party. 2
i. The Safe Harbor Statutes. 2
ii. Approval by Disinterested Members of the Board. 2
iii. Approval by a Special Committee of Independent Directors. 2
iv. Shareholder Ratification of Conflict Transactions. 2
D. Director and Management Compensation. 2
i. Option Compensation Plans. 2
ii. Executive CompensationToday. 2
iii. Regulatory Responses to Executive Compensation. 2
E. Corporate Opportunity Doctrine. 2
i. Determining Which Opportunities “Belong” to the Corporation. 2
ii. When May a Fiduciary Take a Corporate Opportunity?. 2
F. Duty of Loyalty in Closely Held Corporations. 2
X. Shareholder Lawsuits. 2
A. Basic Requirements. 2
B. Dismissal & Compromise. 2
i. Special Litigation Committees. 2
C. Other Issues. 2
D. Derivative Action in Closely Held Corporations?. 2
XI. Transactions in Control2
A. Sales of Control Blocks: The Seller’s Duties. 2
i. The Regulation of Control Premia. 2
ii. Looting. 2
iii. Tender Offers. 2
XII. Securities Fraud & Insider Trading. 2
A. Common Law of Directors’ Duties when Trading in the Corporation’s Stock. 2
B. The Corporate Law of Fiduciary Disclosure Today. 2
C. Exchange Act § 16(b) and Rule 16. 2
D. Exchange Act § 10(b) and Rule 10(b)(5)2
i. Historical Development2
ii. False or Misleading Statement2
iii. Omissions. 2
iv. Fiduciary Duty/Misappropriation Theory. 2
v. Materiality & Reliance. 2
vi. Congressional Response to a Rise in Securities Fraud Class Actions. 2
– Types of business organizations:
o (1) Agency
§ Simplest form of business organization
§ Can be terminated at any time by principal or agent
o (2) General Partnership
§ Simplest form of jointly owned business firm, “firm” being a form of business relation that has a temporal dimension, a social identity, and a separate pool of dedicated business assets
§ Generally simple joint enterprises of individual partners, subject to dissolution at the whim of any partner if no contrary agreement exists
o (3) Corporate Firm
§ Most stable, complex, and socially important form of business organization
– Efficiency is the dominant criterion for academic evaluation of corporate law doctrines, but judges frequently incorporate notions of fairness into their opinions.
– Two overarching questions:
o (1) What are the responsibilities that business owners have towards third parties and to what extent can they be held liable fo that?
o (2) What are the responsibilities of owners of the business to one another?
A. Efficiency and the Social Significance of Enterprise Organization
– Pareto Efficiency – a given distribution of resources is efficient when, and only when, resources are distributed in such a way that no reallocation of resources can make at least one person better off without making at least one other person worse off (“Pareto Optimal”)
o Utility is a subjective state of well-being
§ Need voluntary exchange for both parties to experience a utility gain
o Only when all parties affected by a transfer experience a net utility gain (or at least one party experiences a gain and no part loses) can we be certain that there is a net utility gain from the transaction overall (“Pareto Efficient”)
o Poorly suited to evaluating or criticizing the law of enterprise organization à somebody is almost always worse off
– Kaldor-Hicks Efficiency – an act or rule is efficient if it leads to an overall improvement in social welfare – at least one party would gain from it after all those who suffered a loss as a result of the transaction or policy were fully compensated.
o A transaction is efficient if the aggregate monetary gains to the winners exceed the aggregate monetary losses to the losers – that is, the total wealth of the affected parties increases
§ Actual payment is not stipulated, it is hypothetical
o Sometimes termed the rule of “wealth maximization”
o Vastly more workable than Pareto efficiency as a yardstick, even though it also says little about the legitimacy of initial distributions of wealth
B. Law From Inside and Out
– If one seeks to understand the operation of the legal system, one must master both perspectives on law: the interior, which is rooted in history, authority and consistency, and the exterior, which is rooted in the practical need to produce a “good” society in a changing world.
o Interior Perspective – internal processes of law clarify legal meaning as well as determine their provenance in “authority” and the consistency of the entire body of meanings.
o Exterior Perspective – Subjective observations by social scientists and empiricists who are officially agnostic about all normative issues apart from their belief in science
– Fairness and Efficiency in the Courts
o Courts often avoid using exterior concepts like efficiency to justify their choices]\, and often do not provide policy rationale for their decisions
o However, fairness is considered with respect to the shareholders, not the general public, so often court decisions will be Kaldor-Hicks efficient even without that stated purpose
C. Approaches to Corporation Law
– Until the 1970’s, the internal organization and functioning of firms were largely ignored
o Coase’s Theory – Suggested that firms exist because, in a world of positive transaction costs, it is sometimes more efficient to organize complex tasks within a hierarchical organization – with its established authority and compensation structures – than on the market.
– Two schools of thought regarding how we approach corporation law – trying to reduce:
o (1) Transaction Costs – maybe part of the point is to help people make deals that they would otherwise have difficulty making on their own
§ Why are we making it so easy to get limited liability?
· If we didn’t have limited liability, nobody would invest in stock because they might have to pay if the company gets sued or goes bankrupt.
· Everybody would otherwise have to depend on non-failure every time they invested
· We are facilitating deals that otherwise wouldn’t get made
o (2) Agency Costs – when you hire somebody else to take care of your business, it is difficult to find somebody that will care about the business as much as you do. How do we control these agents and ensure that they work as hard as they should and don’t take things that belong to principals they work for?
§ Agency Cost Theory – Basic assumption that economic actors are rational, informed, utility maximizers [of their own interests] § Basic insight is that to the extent the incentives of the agent differ from the incentives of the principal, a potential cost will arise, termed “agency cost”
§ Three general sources of agency costs:
· (1) Monitoring Costs – costs that owners expend to ensure agent loyalty
· (2) Bonding Costs – costs that agents expend to ensure owners of their reliability
· (3) Residual Costs – costs that arise from differences of interest that remain after monitoring and bonding costs are incurred
§ Two particular types of agency costs:
· Shirking – an agent is not going to be as enthusiastic about making you money as you would be. You can fix this by including incentives (i.e. stock options for CEO’s) in order to make them care as much as you do.
· Opportunism – What do we do about the fact that agents are difficult to monitor? How much can we hope to know that they are paying everything they owe us as shareholders and not earnings sweatheart deals?
– Three major problems arising from agency relationships that are relevant to corporate law:
o (1) Formation and Termination – How are agency relationships formed and how are they dissolved?
o (2) Principal’s Relationship to Third Parties – What is the principal’s responsibility for the agent’s authorized and unauthorized contracts and for torts committed by the agent during the course of her service?
o (3) Nature of the Duties that the Agent Owes to the Principal
– How Agency is Unique
o There is no contract, no consideration
o They are completely at will – as a principal you can always fire your agent, and as an agent, you can always quit.
A. Agency Formation, Agency Termination, and Principal’s Liability
i. Agency Formation
– Agency – Agency is the fiduciary relationship that arises when one person (a principal) manifests assent to another person (an agent) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act. R3d Agency § 1.01.
o Agent Types
§ Special Agents – agency is limited to a single act or transaction
§ General Agents – agency contemplates a series of acts or transactions
o Principal Types
§ Disclosed Principal – third parties transacting with the agent understand that the agent is acting on behalf of a particular principal
§ Undisclosed Principal – third parties are unaware of a principal and believe that the agent himself is a principal
§ Partially Disclosed Principal – third parties understand that they are dealing with an agent but do not know the identity of the principal
§ This is a consensual relationship
§ The principal’s right to control the agent is an essential aspect of an agency
· Employee/Servant – when a principal has a right under his deal with the agent to control the details of the way in which the agent goes about her task
· Independent Contractor – when the principal’s rights of control are significantly less extensive (i.e. agent provides independent judgment)
ii. Agency Termination
– Agency can be terminated at any time by either the principal or the agent
o Courts will not enforce irrevocable agency agreements – they are by nature revocable
o If there is a contract between them fixing a set term of agency and the principal decides to revoke or the agent decides to renounce, there will be a claim for damages for contract breach.
o If no term is stated, general agency terminates at the end of a reasonable term, and special agency terminates when the specific contemplated act is performed or after a “reasonable” time has elapsed.
iii. Parties’ Conceptions
o Agency relations may be implied even when the parties have not explicitly agreed to an agency relationship
o Jenson Farms Co. v. Cargill, Inc. (Minn. 1981)
§ Facts: Cargill financed Warren’s grain operations and was to oversee and consent to big financial operations, and Warren became Cargill’s agent when the company was seeking growers because Cargill had Warren carry out its orders. Cargill supervised Warren’s daily operations because it was concerned about losing money – had right of first refusal, initiated restrictions on spending and borrowing dividends, maintained right of inspection, corresponded and criticized, financed, had power to yank financing. Warren got into serious financial trouble and owed money to Cargill and plaintiffs who it had dealt with individually. Jury below determined that Cargill was liable as principal on Warren’s contracts with plaintiffs.
· In order for there to be an agency relationship, there must be an agreement.
· This agreement can be formed even though the parties did not call it an agency and did not intend the legal consequences of the relation to follow.
o The existence of the agency can be proved by circumstantial evidence of control (i.e. right of entry onto premises, providing of strong “parental guidance”)
o Factors cannot be considered in isolation but must be viewed in light of all of the circumstances surrounding the relationship and financing of the company
§ Holding: There was sufficient evidence from which the jury could find that Cargill was the principal of Warren
§ Booth’s Thoughts:
· They reached this conclusion because one guy said “we financed them b/c we wanted the grain.” This seems like a really thin read to base such an EXTRAORDINARY OUTCOME on.
· We are piercing the corporate veil here between two otherwise unrelated corporations (kind of like disregarding limited liability to hold shareholders liable for a corporation’s debt)
· Other doctrines probably would have fit this case a lot better than agency – seems strange and unnatural. They could have said that they were really in partnership with each other and focused more on the fact that Warren didn’t stand to make any profits or to be able to pay the loan back – in those circumstances, they aren’t really acting like a creditor. Because it’d probably come out that way if considered it in partnership context, no real reason to question the outcome.
· They are really focusing here on the fact that the “creditor” was not acting like a creditor – you can’t maintain your status as a creditor when you act this way
iv. Liability in Contract
– Typically, the agent is not bound and assumes no liability even though they are negotiating agreements for the principal (except if the principal is undisclosed)
a. Actual and Apparent Authority
o A written or verbal agreement to establish an agency relationship is not necessary. What is necessary is for the agent to reasonably understand from the actions of the principal that she has been authorized to act on the principal’s behalf.
§ Actual Authority – The scope of authority the person in the position of A would infer from the conduct of P. Typically arises then P specifically gives A permission to do something.
· Includes incidental/implied authority – the author
vering a fraud, has rescinded the contract and recovered that with which he parted. R3d Agency §407(2)
· If an agent has received a benefit as a result of violating his duty of loyalty, the principal is entitled to recover from him what he has so received, its value, or its proceeds, and also the amount of damage thereby caused, except that if the violation consists of the wrongful disposal of the principal’s property, the principal cannot recover its value and also what the agent received in exchange therefore. §407(1)
· The principal is entitled to be indemnified by the agent for any loss which has been caused to his interest by an improper transaction not carried out in good-faith
· Plaintiff had an absolute right to the secret commission recovered by the agent, irrespective of any recovery he got against the sellers for the rescission.
· Attorney’s fees and expenses of suit were directly traceable to the harm caused by defendant’s wrongful act, so they are recoverable.
§ Booth’s Thoughts:
· The important thing is that we do not allow agent to keep the fruits of their faithless behavior. This was classic shirking.
· It was a bit of a stretch to award him all attorney’s fees as well.
· It used to be that prior to 1983, the DE courts would say as long as the price is fair, it’s probably good enough. DE then decided that there was a much more genuine fiduciary responsibility that the majority shareholder owes to the minority shareholder. You would be liable for what you should have paid and any gaint hat you enjoyed in the meantime – recissory damages – monetary equivalent of recission (i.e. what you would have if the merger hadn’t happened) – not so much a duty of loyalty sort of thing – bit it is that the Agent should cough up the improper gain.
iii. Trustee’s Duty to Trust Beneficiaries
o The private trust is a legal device that allows a trustee to hold legal title to trust property, which the trustee is under a fiduciary duty to manage for the benefit of another person, the trust beneficiary.
o However, a trust is different from an agency relationship because the trustee is subject to the terms of the trust and not the control of the beneficiary.
o In Re Gleeson (Ill. 1954)
§ Facts: Mary Gleeson died intestate in 1951, petitioner was a lessor of the land and also appointed as trustee of the will. The death happened fifteen days before the new farm year, so it may have been difficult to find a good leasor. However, he continued to lease the property to his partnership. Although he was co-tenant of the trust real estate, he failed to account for the share of profits received by the trustee as co-tenant, which should have been repaid by him to the trust estate.
· A trustee cannot deal in his individual capacity with the trust property. He cannot deal with himself.
· The good faith and honesty of the petitioner or the fact that the trust sustained no loss on account of his dealings therewith cannot serve as justification for a decision to deal with himself in trust
§ Holdings: Petitioner should have been required to recast his first semi-annual report and to account therein for all money he received personally s a profit by virtue of his being a co-tenant of the trust property during the 1952 crop year and to pay the amount of that profit to the trust.
§ Principles Established:
· The court can determine whether the transaction was fair:
o Burden on fiduciary to prove terms were fair
o On the other hand, if you get the ratification, the burden flips to plaintiffs to show it was unfair
§ So defendant bears the burden unless there was ratification
§ Booth’s Thoughts: This is definitely NOT a good rule for all of agency (damned if you do, damned if you don’t theory)
– Class Discussion
o The Jerry Maguire Paradox
§ Agents generally have the duty not to compete with the principal
§ So how can a real estate agent/sports agent represent more than one client?
§ Why aren’t these breaches of fiduciary duty
· A real estate agent with many clients will also have more people to attract you to your home, and a sports agents with more clients will be contacted more often
· Section 8.04 – throughout the relationship, the agent must not compete with the principal or assist the principal’s competitor (but can plan to compete later)
· BUT Section 8.06 – No breach if the principal consents to the conduct provided there is good faith disclosure of material facts.
§ The law recognizes that certain kinds of agents come with baggage – not a plain agency relationship – you are generally favored when your agent has more clients under these circumstances.
A. Introduction to Partnership
– Partnership – two or more people in business together in operation for profit. Can end up in one without meaning to – just have to be in business with somebody else.
– The general partnership is the easiest and simplest form of a jointly owned and managed business
– Partnership is the default form of organization – can have one even if you haven’t entered into some form of agreement to form one
– Property held by the partnership is entitled in a special form: “tenancy in partnership” – belongs to the partnership, not the individual partners
– The primary agency problem is not the conflict between the agent or manager and the owner, but potential conflicts among joint owners.
o This is a form of mutual agency – every partner is a fiduciary for the other.
i. The Governing Rules of Partnership
– Partnerships are free to have own written agreement governing management; it is pretty foolish to rely on provided acts.
– Two widely followed acts:
o UPA – 15 states follow this old act, including PA and NY. Provides a barebone set of partnership rules:
§ Very few rules are mandatory under UPA, except that there has to be some level of fiduciary duty among the partner (and some of the fiduciary relationship can even be waived by express agreement)
§ Liability is joint for contracts (creditor would have to go after each individual partner for their share. Each partner has to kick in their share of interest) and joint & several for all other obligations
§ If a disagreement re: how partnership should be run, each partner gets one vote
§ All partners must agree to fundamental changes i.e. adding a partner
§ No partner entitled to pay in exchange for efforts and connections with the partnership, but it forwards funds to the partnership
· Entitled to be repaid anything that you forwarded, and when partnership dissolves, you get back whatever money was advanced, then what is invested in capital, and then split what is left equally (profits and losses are shared EQUALLY only at the end when partnership dissolves.
§ In the absence of rules to the contrary, any partner can insist on dissolution at any time, but can’t wrongfully dissolve
§ If a new person joints partnership, he is only liable for losses from time of admission on.
§ No limited liability – can’t hide under the veil of the partnership – have to pay individually
o RUPA – language a bit more modern, followed by majority of states
§ Joint & Several liability everywhere
§ Defines a lot more fiduciary duties among partners
§ Under this new act, a partner’s exiting does not automatically cause dissolution and does not trigger the right to liquidate – triggers rights of other partners to buy out (dissociation)