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

CORPORATIONS

Spring 2012

Dallas

Corporation Structure:

Executive Officers

Board of Directors

Shareholders

If you are a shareholder, who do you sue? Board of Director and Executive Officers

As a shareholder can you sue another shareholder? Not normally, because shareholders have limited liability.

If shareholders don´t like what is done in corporations what can they do? 3 options.

Exit- Wall Street rule- They can sell their shares. Disadvantages for shareholders: they don´t say why they are selling. Economically disadvantage for shareholder: share conveyance loss.

Voice: Remove directors by means of voting of shareholders (shareholders voting).

Loyalty- Remain with the company.

Manager majorship

Shareholders Voice Issue: nominate director.

The corporations are seen in 2 ways: Conception of the Corporation:

1. Public Institution- Look at the corporation as a social institute that says also affects suppliers, employees. Some mandatory rules (ex. For directors) and regard for all constituencies.

2. Private institution- shareholders. Default rules, enabling.

Type of corporations:

Closely held corporation- small company, with few shareholders.

Large Public corporation- large company, lots of shareholders.

Financial crisis: Example of situation where shareholders lost a great deal of money because of risky decisions made by managers.

– What mortgages started the problem? Risky kind of loans. You are not able to pay neither the principal nor interests. Liar loans: you didn’t have to prove your financial situation. Interest Mortgages: you only had to pay the interests not the principal. No down payment.

– Why were these lenders willing to make these risky mortgages? They thought they were going to lend money and then sell those mortgages (to securitizers). Originated mortgages to distribute among other banks. For the fees to be earned.

– Why did the investors buy these securities? The underwriters did not do a complete due diligence, the models were not accurately reflected to the investors, lack of disclosure, false promises, they thought they were going to have great returns.

* File: Borrowing under a securization structure

“Lender” is originator:

– Nondepositary institutions: mortgage bank or mortgage finance company

– Depositary institutions: commercial banks and Thrifts

“Issuer” is market conduit of sponsor: a special purpose entity (SPE) in form of a trust.

Sponsors:

a) Private label sponsors such as investment banks (such as Lehman Brothers, Bear Stearns)

b) Government sponsored entities (GSE) such as Fannie Mae

Underwriters: sell securities for others, they make due diligence. investment banks

Credit rating agencies

Monoline insurance companies such as AIG (providing credit enhancement through CDSs)

CDOs=Complex Collateralized Debt Obligation

In case of default, affected parties:

First, junior equity

Second, mezzanine

Third, senior tranche

What is the role of the board of directors? What were they doing during the financial crisis?

As a result of the crisis, the federal government has got involved.

Corporate Law and internal affairs have been regulated by the States.

INTERNAL AFFAIRS

What are the “internal affairs” of the corporation? Involve things of the corporation, how a corporation is managed, who decides things, procedures for transactions.

What law has traditionally applied to the internal affairs of the corporation? State laws.

Pseudo foreign corporations statute- 50% property, payroll and sales in CA (tax-factor test) and 50% shareholders have addresses in CA (shh-residence test),if both tests are met will apply CA law- notwithstanding if the corp was incorporated elsewhere.

Foreign- means another state, not from other country

Should state law determine the law applicable to the internal affairs of corporation law or should there be a uniform national law?

What law should apply to the corporations? Conflict between certain jurisdictions.

Primarily, where the corporation is incorporated is the law that will govern the corporation.

Does competition among states for corporate charters result in a “race to the top” or a “race to the bottom”?

“Race to the top” (mainly protect shhs)- the state is trying to find balance regarding the interests of the managers and the shareholder.

“Race to the bottom” (mainly protects mgmnt)- protects management side, gives greatest flexibility, because they often choose the state of incorporation.

Ernst L. Folk- Delaware: trying to increase the flexibility of management “pro-management”.

Delaware won the race. Race to the bottom won. Most of corporations are incorporated in Delaware.

First mover advantage in Delaware, they have judges that get expert in corporate law, they have a large body of case law.

Other jurisdictions might just look to Delaware Laws.

Lawyers are an interested party in Delaware corporate law, they want the law to be ambiguous enough to have enough lawsuits.

The federal government law might just come in, because it has influence over corporate law (like disclosure of securities).

Choice of Business Association (diagram)

Corporation

General Partnership

Limited Partnership

LLC- Limited Liability Company

LLP- Limited Liability Partnership

LLLP- Limited Liability Limited Partnership

Connection between management and liability of owners:

Limited Liability- Centralized (because owners not in direct control and managements decisions).

Personal Liability- Direct Control (because they have the control and management decisions).

LLP

Exactly like a GP, except that the general partners have limited liability.

Need to proof the company have substantial assets.

File gov. document

LLLP

o Is as a LP, but the general partners also have some form of limited liability.

o Professional corporation use this.

o Need to proof the company have substantial assets.

o File gov. document

LLGP

o Is as a GP, but the general partners also have some form of limited liability.

o Professional corporation use this.

Two ways to exit a business:

1.- Transfer ownership interest

2.- Dissolve company

Corporation

Co., Corp., Inc.

Concession theory- concession from the State

General Partnership GP

Limited Partnership LP

Limited Liability Company LLC

Formation

Gov’t Organization Document Filing

*before secretary of state

*articles of incorporations

No Gov’t Organization Document

*no public filing

Gov’t Organization Document Filing

*certificate of limited partnership

Gov’t Organization Document Filing

*articles of organization

Liability of Owners

Limited Liability

-shareholders

Personal Liability of GP

-partners

Personal Liability of General Partners

-general partners and limited partner

Personal Liability of Limited Partners only if they “participate in management”

Limited Liability

-members

Management and Control

Centralized: Inverted Triangle

1.- Shareholders

2.- Board of Directors

3.- Executive officers

General Partners

(direct control)

General Partners

But Limited Partners have under RULPA voting rights similar to shareholders

Centralized like Corporation: Manager-Managed Or

Like GP: Member-Management (direct control, but still limited liability)

Transferability of Ownership Interests

Free Transferability

Because of centralized management

No Free Transferability of Control Rights

No Free Transferability of Control Rights

Free Transferability under some statutes

*depending manager or member-management

Continuity of Life

Yes, Perpetual Life

No, Dissolution by GP withdrawal or death

No, May

hat can be made)

*****Results can be the same in both, the statutes are different in each.

o Transferability of ownership interest

§ Bernie might want to transfer his share to son Bill.

§ PT might need new capital

*** CORP and LLC, might be advisable to enter into an agreement that involves restriction on transfers. By controlling transfers might arise a liquidity issue (how can people get out to convert shares in cash), that can also be treated by a buy-sell agreement (under certain circumstances a person can get out).

o Tax Treatment- might be losses

§ CORP: corp or subchapter s

§ LLC: corp, partnership, subchapter s

4-5 FORMING THE CORPORATION

A. THE PROCESS OF INCORPORATION

1. FORMAL REQUIREMENTS

· Is simple and quick.

· MBCA (Model Business Corporation Act) illustrates the procedure generally required.

· The organization is formally accomplished by an “incorporator”= signs and files the articles of incorporation with the Secretary of State.

· The filing is accompanied by the payment of a fee (usually calculated on the basis of the number of authorized shares or the aggregate legal capital).

· In MBCA jurisdictions, formal corporate existence commences with the filing of the articles of inc. In other, with the issuance of a certificate of incorporation from the Secretary of State (ex. Delaware). It is important to know when the existence of the corporation begins, because of the limited liability.

· Statutory required information for the articles of incorporation (must) 2.02 MBCA:

o Name of the corporation (make sure the name is clear)

o Number of shares it is authorized to issue

o Name and address of each incorporator (who are these incorporators? Person who does the filing of the articles of inc., there are no further requirements)

o Name and address of registered office and agent (receive service of process or other official notices)

· Other provisions (not required) that can be added to the articles (may) 2.02 MBCA:

o Managing the business and regulating affairs of the corporation

o Defining, limiting and regulating powers of the corporation, its board of directors and shareholders (3.02 MBCA- corp has the same powers as an individual) (3.04 MBCA-ultra vires- powers beyond its capacity/invalid)

o Purpose of the corporation (3.01 MBCA-has the purpose of engaging in any lawful business unless a more limited purpose is set forth in the articles of incorporation) (Historically, companies could not: hold stock in other corporations, could not be a general partner, grant pensions, make charitable contributions)

o Provision limiting the liability of directors for money damages in certain circumstances.

· Difference between purpose and powers: purpose (activities of the corporation) and powers (ex. entered into an agreement, purchase real estate, etc)

· After a legal existence, an organizational meeting must be held, either by the incorporators, who select the first members of the board of directors, or by the board of directors if they were named in the articles of incorporation.

· First (organizational) meeting, the incorporator/board sees:

o Election of additional directors (if any)

o Adoption of by-laws

o Appointment of officers

o Adoption of corporate seal

o Designation of a bank as depositary for corporate funds

o Sale of stock to the initial shareholders

· The organizational meeting may be taken without a meeting if the action taken is evidenced by one or more written consents describing the action taken and signed by each incorporator.