DALLAS – CORPORATIONS – SPRING – 2012
Assingment 1 Jan/9:
v Introduction to Corp Law
(Assignment: Text 25-42, 57-66, 72-73, 86-93; CA 2115 (72); P 3-11)
· Money Capital: comes from shh and creditors
· Human Capital: comes from executives and EE’s
(1) What are special characteristics of corporations?
· Default Rule – Corp’s Govern Themselves: a corp is usually a set of default rules that specifies the terms of the parties relationship unless they agree otherwise.
· Special Characteristics: Entity; Centralized Management; LL
· Five Basic Attributes: Corp combines 5 attributes: (1) Separate, perpetual legal personality; (2) centralized management under board structure; (3) shares ownership interests tied to residual earnings and assets; (4) transferability of ownership interests; & (5) LL for all participants.
o 1) Length of investment — (Separate, perpetual legal personality): independent from the money and human capital: The corp, not ppl, own the business assets and is liable for any business debts.
o 2) Who manages the investment – (Centralized management under board structure): BoD. However, BoD delegates power to officers.
§ BoD is subject to fiduciary duty.
· Have limited governance role.
· Powers: Shh’s vote to elect BoD; approve fundamental corp changes; initiate limited reforms.
· Limits on Power: no power to act on held of the corp.
o 3) What is the return on the Investment – (shares ownership interests tied to residual earnings and assets):
§ Business makes money (doesn’t dissolve)
· First: Creditors are first in line and receive a return based on their K’s.
· Then: Shh’s are last in line and receive dividends as declared at the discretion of the Board.
§ If Business dissolves: creditors claims have priority and shh’s are residual claimants.
o 4) How can investors get out – (transferability of ownership interests):
§ Shh’s: shares are freely transferable. Shh’s can sell their shares to other investors.
§ The Corp: has no obligation to repurchase the shares.
§ Managers (Directors & Officers): cannot transfer their positions, but can resign at any time.
o 5) Investor’s Responsibilities to Others (LL for all participants): Generally, the corp is liable for its own obligations, but this is pretty limited.
§ Not Liable à Directors, Officers, Shh’s: are not personally liable to outsiders on corp obligations.
· Investors and managers risk only their investment.
§ Outsiders (i.e., creditors and tort victims) bear the risk of corporate insolvency.
o Shh’s in Closely held corps: can agree to manage the business, pay themselves specified dividends, and limit their ability to transfer their stock.
o The Court’s power: in some situations, ct’s use equitable principles to hold shh’s personally liable for corp debts beyond their investment
o Guarantee’s: lenders may require shh’s to guarantee personally the corps obligations.
(2) What is the Structure of a Corp?
· Shh à elect BoD à choose officers.
o Have a right to vote directors on the BoD.
o Also entitled to remove the directors and fill the vacancies with those they believe are mot suitable.
o Delegate control over their investment to managers.
· Board of Directors:
o Appoints officers (SH’s do not appoint officers)
o No one director has the power: the board has to vote for officers.
o The BoD makes major decisions/policies of the corp – the implementation of those policies are done by the officers.
o They monitor the corp, not really manage. à make major decisions, but the officers in reality are in control and are monitored by the BOD
o BOD can fire officers when ever they want.
· Officers: Implement decisions made by the BoD.
(3) Types of Companies?
· Two Kinds: Public Companies & Closed Corps
· 1) Public Companies: Many owners, millions of shares (i.e., IBM)
o Historically: shh’s are owners of the corp
o Problems w/ Public Companies:
§ Dispersed shareholders: the shareholders are all over the world. à often times own a small amount of shares (i.e., $100 worth of shares)
· Rational Apathy: Don’t care enough about the company to do anything. So it doesn’t make sense for them to be active in SH voting. Most of them don’t care.
· Managerialism: Managers run the company àBoD and officers.
o SH’s aren’t really running the company. They just want to make some money. Managers are the ones that do everything and care.
· Rise of the Institutional Investors: Rather than owning shares in a lot of companies, one person simply puts money in a pension fund and the portfolio manager decides what companies to invest it. In essence, they handle the investments in funds.
o Example: mutual funds à pension funds, hedge funds, banks, insurance cos
o Effect à Shh Primacy: because now you have a lot of money being invested in companies by institutional investors, they have become more active. They are less apathetic. Pressures managers to look to shh’s interests.
· 2) Closed Corps – (Closely Held Corps): a company that has a few shh’s
o Small company owned by a few individuals. They likely started and run the business
(4) Modern State Business Corp Statutes:
· How to form a corp
· Financial Rights of Shh’s
· Governance roles of Shh’s, directors, and officers
· The transferability rights of shh’s
· LL for shh’s
· Structural Changes such as character amends, mergers, and dissolution.
(5) Who Sues Who?
· Shh’s Sue à The management
o R/x: Because if you sue the company, you are suing your self. The corp is injured by the decision of the board of directors.
o The offices and directors make decisions on behalf of the organization – you can sue them.
§ Derivative action: you sue on behalf of the corporation against the officers and directors of the company.
· Can Shh’s Sue each other? All shh’s rely on the BoD.
o Shh’s have LL.
§ Only liable for what they put in, and what they get from their profits
· Corp is a Nominal P: If you bring action against a corp for breach of fiduciary duty, the recovery goes to the corp.
(6) What are the shareholder options of exit, voice and loyalty?
· Other ways shh’s can discipline the BOD besides suing:
· 1) Exit – “Wall Street Rule”: Sell their shares = Exit
§ If enough ppl leave: it will impact the company bc it will drive price of shares down.
· Will this result to new management? If prices are down, some may buy it.
o “Market for Corporate Control”: when companies don’t do well, the shares go down, so others buy it, and put their own people in the company, and try to fix it.
· Hopeful Effect: results to take overs
· Lose money & probably wont change anything in the company bc the shh is just leaving.
· Problems w/ “Market for Corp Control”: may not discipline management the way shh’s want.
o The prices many not be efficient, they may not go down, it might be a time where the market is doing really well, and the price of the stock is going up
§ Its possible that other factors are dictating the stock à unlikely someone will take over.
o The price is truly not reflecting the value of the company: If shh sells shares, the market might not be as informed to why they are selling their shares.
o Managers may be manipulating the information.
§ When shh’s sell their shares, the BoD is not sure why the shh sold their shares, so the BoD will manipulate why the sold their shares.
o Price might also have to go down really really low to attract some one à there are a lot of transaction costs when purchasing a company
o Other Reasons: Often times, ppl take over companies other than the reason the management is doing poorly
· 2) Voice Option: remove directors/officers through shh voting à Activism
o Shh institutional ownership: more concentrate power
o New managerialism: more powerful shh managers more concerned with stock prices
§ ex. of short-termism – goal is short term stock price
· 3) Loyalty: Not do much and just hope for the best – be loyal to the corp
o Intangible but important to shh decision-making
(7) Financial Crisis — SHH Activism & Its Effect
· The Problem:
o Shh Activism:
§ Tender Offers: Investors were critical of management. The interests of managers are different from the SH’s (at times) à SH’s created tender offers
· SH’s felt they should be able to sell out to those trying to take over the company at a premium when the management didn’t want that.
§ Rise of Institutional Investors: more shares are now put into these funds. Institutional investors can go to experts (“Institutional Investor’s Association”) and ask what they should do à leads to more shh’s activism
o Effect à Managers Change Behaviors: corp laws tells managers to look into the interests of the shhs, but they were doing it, now they are.
§ New Managerialism:
· Positive: new management is engaging in shh primacy à they care about stock price & the interests of the shhs
· Drawbacks: they focus too much on stock price à may not be focusing on long term interest of shhs. They become very focus on the casino theory of the stock market.
§ Managerial Myopia: engaged in behavior that showed the appearance of things, rather than true value. Made investments that made their companies look good, but the investments were actually toxic à some claim it was the SH’s that made this happen because they were forcing the BoD to make the stock higher right now.
§ Result – Stock Options: shh activists wanted to align the interests of management w/ the shhs w/ stock options.
· Management became so intoned to stock price, they did things that were illegal, and ultimately damaged their companies and shh’s/
· Dallas Solution:
o Short-term (Transient) institutional investors VS. Long-term (institutional) investors
§ Studies: Misreporting and earnings management and manipulation of numbers is caused by having transient inviting owners –
· But when you have long term investors à these problems don’t arise.
§ Proposal: “Time-Phase-Voting”
· Long Term investors are given greater voting rights than transient investors who come in and out à Then you would see shh activism only by the long term institutional investors.
(8) What are the competing conceptions of the corporation and what implications do they have for the role of law?
· Do Shh’s have a say in managerial decisions?
o Depends on the conception of the Corp:
§ Social Conception: The corp serves a public purpose and has a duty to promote the general welfare of state
· Fiduciary duties apply.
§ Private Conception: the corp is the private property of the shhs and its purpose is to further the financial interests of the shh’s by following the default and enabling laws.
· There is an agreement that certain ppl have control over the partnership à the SH’s are the owners and have control over the company thru centralized management
· Role of Law: Facilitate Private K’ing
o Enabling Statutes (disciplines management) à enable private parties to get together in set of default rules
§ Private K + Market Discipline
o Default rules can be altered by way of bargaining
§ Can make fiduciary duties mandatory
o Instances of Market failure – too costly for parties to negotiate and come up w/ private K rules (i.e., financial Crisis)
· Role of Judge Made Law: Judicial gap-filling involves fiduciary duties of managers and controlling shhs.
(9) What are securities?
· Securities: financial instruments representing financial value
o Debt Securities: debt of corp (i.e., bank notes, loans, bonds)
§ These are paid back before equity securities
o Equity Securities: paid in capital to the corp (i.e., common stock and preferred stock)
o Derivative K’s: futures, options, swaps, forwards
(10) Choosing Where to Incorporate:
· A corp can be formed in any state, no matter where it does business.
· Where should a Corp incorporate and Why?
o Balance the benefits of incorporating in a state that provides flexibility in managing the business against the costs of incorporating elsewhere and then qualifying to do business as a foreign corp in other states where business is to be conducted.
§ Usually comes down to home state vs. Delaware
o Effect of Choice: determines how much in franchise tax the corp pays to the incorporating state.
a) What is the Internal Affairs Doctrine?
· International Affairs Doctrine: The law of the state of incorporation governs all shh/manager matters in multistate corps.
o How do we determine what state a Corp is in? à where they file
o They can file them in any state.
o Its not necessary to do business where you do most business or where your head quarters is.
b) What law applies to the international affairs of the corporation?
· A corps “Internal Affairs”: relate to the legal relationships btwn the corp participants, rights of shhs, fiduciary duties of directors, and the procedures for corp action.
· State Cts Bound: state cts are bound to accept the corp law rules of the incorporating state.
c) Exception: What are “pseudo
e personally liable à GP’s have unlimited liability for partnership obligations.
o Each person is individually liable for partnership obligations
§ They are fully responsible for partnership debts. Personal assets are at risk for partnership obligations.
· Claims on Income + Firms Assets:
o Partners share equally in profits and losses, unless there was an agreement otherwise.
o A Partner may enforce the right to profits in an action for an accounting.
o Partners have no right to compensation for their services, unless otherwise agreed.
o On dissolution, profits and losses are divided among the partners.
· Management & Control: Partners have equal managerial authority à direct control. General Partners have direct control. The owner directly controls the business and can act on behalf of the business and can bind the business.
o Each partner can bind the GP à either (i) by transacting business or (ii) by appearing in the eyes of 3rd parties to carry on a partnership business.
o Majority vote of partners decides ordinary partnership matters
§ Addition of a new partner: can require unanimous consent.
o Profits: Equally divided
o Fiduciary Duty: partners have fiduciary duty to act in good faith.
· Transferability of Ownership Interests:
o Free Transfer rights to profit.
o NO free transferability of control rights à Partner cannot transfer their interest in the GP unless the remaining partners agree or the partnership agreement permits it.
o Partner may withdraw at any time.
§ Effect of With drawing: business is liquidated and the partner is entitled to payment in proportion of his shares.
· Continuity of Life: Its not continuous. The life is ended if there is a Dissolution by a GP or death.
o At Will Partnership (A GP w/out definite term): the GP dissolves upon the with drawl of any partner
§ Absent any agreement, the withdrawing partner can demand that the business be liquidated and the net proceeds be distributed to the partners in cash.
o When a partner dies: the surviving partners may choose o continue the GP and buy out the deceased partners interest, w/out liquidation.
o Default: partnership tax à flow through
o Or Check The Box for corp tax treatment.
b) Limited Liability Partnerships (LLP)
· Generally: its really a GP, but some partners get LL.
o Limited: limited to professional organizations.
o Insurance Requirement: some statutes require that LLP’s have insurance to cover malpractice or require them to have some form of liquidated assets to cover some of the liability.
· Formation: registration or applications
· Liability of Owners:
o GP has PL
o LP has LL à in a GP, LLP partners avoid personal liability for partnership obligations unless:
§ The partners own conduct makes him personally liable.
o Full shield: complete liability even though you are a GP.
o Partial shield: Not liable for anything other than your own malpractice. Not liable for acts against the malpractice of other partners.
· Control and management:
o LP à No Direct Control: LLP’s don’t have direct control à unless they participate in management.
§ If they do participate, they lose LL status
§ If you manage it directly à may lose LL status
· No bright line rule to how much management is ok.
o GP à Direct Control.
· Transferability of Ownership interests:
o Free Transfer rights to profit
o Cannot transfer manager interest w/out unanimous consent for management rights, unless otherwise provided.
· Continuity of life: Dissolves upon withdrawal or death, unless the K’ed for something different.
· Tax: Default or check the box for corp treatment.
c) Limited Partnerships (LPs)
· Generally: Combines tax advantages and LL
o Possible Scenarios: Could have some partners be LPs and others be GPs.
· Formation: Certificate must be filed w/ a state official.
· Liability of Owners:
o GP’s are personally liable à at least one partner must be a GP w/ unlimited liability.
o LP’s have Limited Liabilityà Liable only to the extent of their investment so long as they do NOT participate in the control of the business.
§ No Bright Line Rule: LP’s can still be officers, directors, or shhs of a corporate GP, can still vote and advise GP’s
· Claims on Income + Firms Assets:
o LP and GP’s share profits, losses, and distributions according to their capital contributions.
o Pre-Dissolution distributions are by agreement, as is compensation of the GP.
· Management & Control:
o General Partners: Manage and Control.
§ GP’s have authority to bind the LP as to ordinary matters.
o Limited Partners: have no control. If they begin to exercise some control, they can lose the protection of limited liability.
§ LP’s have voting authority over specified matters, but cannot bind the LP.
o Fiduciary Duties: GP’s have fiduciary duties like those in a GP.
· Transferability of Ownership Interests:
o Freely Transfer rights to profit.
o No free transferability of control rights à GP cannot transfer his interest unless all the other GP’s and LP’s agree or if they K’ed for it.
· Continuity of Life: No continuous life à Lasts as long as the parties agree or, absent agreement, until a GP withdraws or death.