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Business Associations/Corporations
University of San Diego School of Law
Dallas, Lynne

Dallas

Corporations

Fall 2011

v Special Characteristics of a Corporation:

o Separate Entity:

§ The corporation is a legal entity that is separate from the investors who provide it with money and the people who directly manage its business.

o Perpetual Existence:

§ Unlimited life; While the individual corporate actors inevitably change (i.e., shareholders sell shares, employees quit, retire, are fired, or die), the corporation remains.

o Limited Liability:

§ A shareholder’s liability is limited to the amount of money she paid for her shares.

o Centralized Management:

§ Shareholders elect a corporation’s directors, who have the power to manage and oversee the corporation’s business and owe a duty to act in the best interest of the corporation.

o Transferability of Ownership Interests:

§ Shareholders are free to transfer their stock without obtaining the consent of other shareholders.

v Corporate Actors:

o Stockholders:

§ Said to “own” the corporation, although this is not technically correct; they own the corporation’s stock, which carries residual financial rights and basic voting rights.

§ They do not directly control the corporation. Instead they elect a board of directors which is responsible for managing and supervising the corporation’s business.

§ They have the right to vote only those matters that are specified in the statute:

· Including: (1) Certain (but not all) fundamental transactions such as merger or the sale of all or substantially all of the corporation’s assets, (2) amend the articles of incorporation, (3) remove directors, or (4) dissolve the corporation.

o Directors:

§ “Inside Directors” – those who are corporate employees or officers.

§ “Outside Directors” – those who generally have no other affiliations with the corporation.

§ ALL directors are required to act in the best interests of the corporation and are not considered employees of the corporation.

o Officers:

§ Selected by the Board; typically, a president, one or more vice-presidents, a secretary, and a treasurer.

§ Have the primary responsibility of running the corporation’s day-to-day business, with specific duties described in the bylaws.

o Stakeholders:

§ Those who do not fit the legal categories above, but who nevertheless have an interest in the actions of a corporation (i.e., creditors, employees, customers, and the community)

v Corporate Securities:

o The Articles of Incorporation specifies how many shares of each stock the corporation is authorized to issue.

§ More can only be issued in the event the Articles are amended (i.e., by shareholder vote)

o Debt:

§ Least risky; lowest expected return.

§ Holder of debt may expect to receive fixed payments of interest over time (whether the corporation does well/poorly) and the return of the principal on the maturity date of the debt.

§ In the event of insolvency, these securities have priority over equity securities.

o Equity:

§ Common Stock:

· Assumes the greatest risk of the success or failure of the corporation but also has the greatest expected return.

· Holders have a residual claim to the corporation’s income and assets (i.e., after the corporation has satisfied all its claims, the holders of common stock are entitled to what is left).

· Dividends: Paid at the discretion of the Board of Directors.

· Also gain from any increase in the market price of the stock.

· In the event of insolvency, common stockholders are paid last and, in many cases, will receive nothing.

§ Preferred Stock:

· Less risk than common stock but more risk than debt; lower expected return than common stock, but higher than that of debt.

· Holders will receive a fixed dividend payment (but at the discretion of the Board)

· Preferred stockholders receive dividends before common stockholders and receive distributions in liquidation before common stockholders.

v Shareholder Options of Exit, Voice and Loyalty:

o Exit: The person can sever her connection with the organization.

§ Favored by economists; either exit will force the organization to eliminate the inefficiency or it will b replaced by a more efficient competitor.

o Voice: A person can remain within the organization and attempt to remedy the situation.

§ A participant’s willingness to rely on voice depends heavily on her estimates of the prospects for success.

o Loyalty: Intangible; how an organization is structured and what strategy the organization employs to deal with participants’’ dissatisfaction can have powerful influence over their feelings of loyalty and whether they ultimately choose voice or exit.

v Internal Affairs Doctrine:

o Choice of Law Rule: The law of the state of incorporation, with rare exceptions, governs the “internal affairs” of the corporation.

o The choice of where to incorporate is made by the directors of the corporation, not the shareholders.

§ This could potentially lead to a choice to incorporate in a state where the case law favors them rather than shareholders if there is a conflict.

o The “external affairs” of the corporation are generally governed by the law of the place where the activities occur and by federal and state regulatory statutes rather than by the place of incorporation.

o Competition for Corporate Charters:

§ Does this lead to a “race for the bottom” (i.e., laws that systematically favor management) or a “race for the top” (i.e., produce a corporate law that reflects the optimal bargain between shareholders and managers)?

Choice of Organizational Form

Corporate Characteristics

Corporation

General Partnership (GP)

Limited Partnership (LP)

Limited Liability Company (LLC)

Formation

Requires an organization document filing with the state*

No filing with the state required

[Rather, formed when two or more persons enter into a partnership agreement]

Requires an organization document filing with the state* (including the list of General Partners)

Requires an organization document filing with the state*

Liability of Owners

Limited liability (i.e., shh liability limited to original investment in the corporation)**

Joint and several liability for partnership’s obligations.

General partners have same unlimited liability as partners in a GP.

Limited Partners liability is limited to the amount of their investment, so long as they do not participate in management.

Limited liability for all, even those who participate in management.**

Management & Control

Centralized; inverted triangle

[Shh elect Bd, Bd appoints officers]

General partners have direct control (can bind the partnership where they act in the ordinary course of business); Equal voice regardless of the amount contributed; Decisions generally made by a majority vote. Can be modified (i.e., voice = to capital contribution)

General Partners responsible for most management decisions. Limited Partners cannot participate in management without losing their limited liability status, but maintain right to vote on major decisions (i.e., dissolution, changing nature of bus., removal of general partner)

Member-managed: all members can make management decisions. Manager-managed: members not agents, but can participate in major decisions. (Managers need not be members)

Transferability of Ownership Interest

Free transferability (with no consent of other shh)***

No free transferability of control rights (must gain consent of all other general partners)

No free transferability of control rights (i.e., can transfer pecuniary interest, but not control)

Free transferability under some statutes.

Continuity of Life

Unless the AofI provide otherwise (i.e., condition precedent or stated time), life is perpetual.

Dissolves at the death (option to elect to continue), bankruptcy or withdrawal of any partner (at will).

Unless contrary provision, dissolved when a general partner withdraws.

Unless specified otherwise, life is perpetual.

* Th

, it is not always easy to determine whether each of the parties is a client, whether the corporation is (or will be) a client, and whether the lawyer’s prior representation of one of the parties will raise a conflict of interest in the current representation that will make such representation impossible]

o Multiple Representation and Conflict of Interest:

§ The potential for conflict is present whenever there is multiple representation.

· Multiple representation means that no party will have her own advocate in that process.

· Where a lawyer’s independent professional judgment for a client is materially limited due to anything or anyone, a conflict may exist.

§ Arguments in favor of multiple representation:

· Although divergent interests exist, the parties state with a common goal: going into business together.

o Divergent interests do not always rise to the level of conflicts of interest.

· In an effort to keep transaction costs low, the cost of each party retaining her own lawyer at this stage may seem excessive.

o Model Rule 1.7: Requires a lawyer to get informed consent before representing one or more clients who may have a conflict of interest or to decline the representation altogether.

§ A concurrent conflict of interest exists if:

· The representation of one client will be directly adverse to another client.

· There is a significant risk that the representation of one client will be materially limited by the lawyer’s responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.

§ Regardless of these conflicts, a lawyer may still represent a client if:

· The lawyer reasonable believes that he can provide competent and diligent representation to each client;

· The representation is not prohibited by law;

· The representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation;

· Each affected client gives informed consent, confirmed in writing.

o In obtaining consent, the lawyer should discuss what happens if a conflict arises between two clients. It should also state any potential conflicts.

v Theories of Representation:

o Model Rule 1.13: Entity Theory of Representation:

§ Contemplates that where a lawyer represents the corporation, the client is the corporation, not the corporation’s constituents (although the lawyer may represent both with informed consent).

· The purpose of the entity rule is to enhance the corporate lawyer’s ability to represent the best interests of the corporation without automatically having the additional and potentially conflicting burden of representing the corporation’s constituents.

§ A lawyer can represent an entity that does not yet exist as long as the incorporators understand that they are retaining counsel on behalf of the yet-to-be-formed entity.

§ Jesse by Reinecke v. Danforth: [Text 148]

· Facts: Drs. Danforth and Ulrich hired an attorney to help them form a corporation. Later they were sued as individuals for malpractice. The plaintiff hired the same law firm where the original attorney worked.

· Holding: The corporation in this case, not the constituents, holds the privilege of confidentiality.

· Rule: Retroactive application of the entity rule so that the person who retained the lawyer is given the status of being a corporate constituent during the period before actual incorporation, as long as actual incorporation eventually occurs.