CORPORATIONS Fall 2013 Professor Frank Partnoy
I. Introduction to the Firm
a. Attributes of Corporations:
– Separate entity with perpetual existence
1. Legal artifice—entirely creature of the law
2. Existence and attributes arise from state statutes & private law (Ks)
– Limited Liability (incorporating limits liability to assets)
1. Corporate insiders (directors, management, etc.) are not liable for business debts.
2. Outsiders bear the risk of corporate insolvency.
3. Investors and managers risk only the amount of their investment
– Centralized management (ownership & control separated)
1. Board is locus of corp power, responsible for managing & supervising bus.
a. S/H elect board, but otherwise have limited management role.
i. S/H have no power to bind/act for corp; only vote on fundamental changes.
2. Board usually delegates power to officers who can then act for/bind corp.
– Transferable ownership interests (ability to sell/buy shares)
1. Ownership shares freely transferable; S/H can sell: realize investment value
b. Corporation = Person
– Corp can own property, enter into Ks, sue and be sued, and be held liable for debt
– Corp has CON rights; 14th Am. protection and commercial rights
c. Sources of Corporate Law:
– Model Business Corporation Act—uniform set of rules from ABA; adopted by some states
– State Statutes—mandatory, default rules, and penalty rules
1. Delaware General Corporation Law
a. Choice state
b. Management flexibility by statute
i. E.g., § 102(b)(7) DCC: Corporations can exculpate directors for duty of care—no liability when breached.
c. Courts are experienced; strong case law—certainty
2. California Corporations Code
– ALI Principles—corporate governance project produced a set of laws drafted
– Judge-made Law
– Private Law:
1. Articles of incorporation (charter, certificate); bylaws (interpretation of the articles)
– Federal Law
1. No federal corporation laws, but securities regulation
– RISK: Probabilistic outcomes you can put a number one (quantifiable)
– Controllable Risks: relates to specific business choices/activities
1. E.g., what kind of tenant to have.
– Non-controllable Risks: outcomes that cannot be affected by business choices/activities
1. E.g., weather, wars, etc.
– Risks vs. Uncertainties: Uncertainties are unquantifiable; can’t put probabilities on.
– Expected Returns: Weighted average: E.g., 1/3 chance of $6; 2/3 chance of $3 = expected return of $4 (1/3 * 6 + 2/3 * 3 = 4)
– Risk Tolerance:
1. Risk Averse: dislikes risk; needs high expected return
2. Risk Seeking: likes risks; doesn’t need high expected return
3. Risk Neutral: ambivalent to risk
4. Endowment Effect: the value of the good increases when it becomes part of a person’s endowment; the person demands more to give up the object than they’d be willing to pay to acquire it; if it’s theirs, they will assume greater risk.
– Risk Management:
1. Insurance: it’s a bet (option); rooting for utilization of coverage; good for pooling risks and protecting against non-controllable.
a. Moral Hazard: strategic behavior (taking on additional risk) in the presence of insurance—e.g., arson & fire insurance.
2. Diversification: investing in multiple markets/ventures.
3. Risk Allocation:
a. Principal vs. Agent: i.e., Shareholder vs. Manager
i. Separation of ownership (S/H )& control (agent)
ii. Principal wants maximum return on investment; bulk of venture profits agent to put S/H interest above all else.
iii. Agent wants maximum return for his efforts; compensation even if venture fails; expend as little effort necessary to succeed; discretion to accomplish goals w/o P interfering or blaming if venture fails.
b. AGENCY COSTS: With diverging interests, P will want to monitor A, and discipline if A does not do as expected. A will still shirk.
II. Corporate Federalism
a. HORIZONTAL FEDERALISM
– Internal Affairs Doctrine:
1. Corp can choose where (no matter where it operates) to incorporate
2. Laws of state of inc govern internal affairs, with rare exceptions
a. Parties can choose governing law regardless where litigation is brought
b. Internal Affairs: Standard: peculiar to relationship between S/H, managers, and officers.
i. Manager-S/H relationship
ii. Rights of S/H (voting for board)
iii. Fiduciary duties of board
iv. Procedures for corporate action
v. Issuance of stock
vi. Mergers with other corps
c. External Affairs: governed by state where occurred or feds:
i. Corp enters in K; commits torts; deal in property
ii. State tax law on corp real estate and income
iii. State/Federal employment laws
iv. Federal securities laws
d. Overlap: Some acts governed by both internal & external rules:
i. E.g., state law governs right to merge and procedures, but feds regulate antitrust and securities.
e. CA—rare exception to IA doctrine:
i. If a foreign corp has at least 51% of its property, sales, payroll, and outstanding voting shares in CA, CA law will apply regardless of state of incorporation
3. Effects of Internal Affairs Doctrine:
a. Forum shopping
b. Corps confident, knowing rules applying to acts & decisions
c. Competition between states for business incorporation
d. States receive money for the chartering of the corp as well as increased business market
i. Race to the bottom
1. Corporate law of state favors management to detriment of S/H
2. Managers prefer broad deference; insulation for decisions from derivative suits
ii. Race to the top
1. Corp law of state favors S/H
b. VERTICAL FEDERALISM
– Absent a clear federal statutory invention, federal courts assume corporate law is governed by state law.
1. But interference in commercial transactions occurring outside the state such sales of shares on national stock exchanges can violate the dormant Commerce Clause.
– STATE ANTITAKEOVER REGULATION:
1. Hostile Takeovers: Bidder makes tender offer (offer by bidder to buy shares, usually at a premium, on certain conditions for a specified period); allows bidder to buy voting control, and gain control of corp w/o dealing with managers; bidder can replace board with its nominees and negotiate a backend merger, which does not require the vote of the minority that didn’t sell to bidder. Thus, S/H may feel coerced to sell and get premium, rather than face an uncertain fate in the backend merger.
2. First Generation Antitakeover Law:
a. Set of fairly aggressiv
duct of business activities with a view to enhancing corporate profit and shareholder gain.
b. Even if the corp profit and S/H gain are not thereby enhanced, the corp, in the conduct of its business:
i. (1) Is obliged, to the same extent as a natural person, to act within the boundaries set by law;
ii. (2) May take into account ethical considerations that are reasonably regarded as appropriate to the responsible conduct of business; and
iii. (3) May devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes.
5. State Constituency Statutes
a. Generally, nearly 20 state leg have adopted statutes permitting (one requires) a BOD to consider the effect of any corp action on non-S/H interests. Such interests include: corp’s employees, customers, creditors, suppliers, the economy of the state/region/nation, community and societal interests, and long-term or short-term interests of the corp.
i. DE and MBCA have not adopted a constituency statute; DE has limited the extent to which a BOD may consider non-S/H constituencies in the context of a hostile takeover.
6. CORPORATE CHARITABLE CONTRIBUTIONS
i. Tax deductions; additional goodwill; CEOs can have some perks
b. RULE—the general test is reasonableness as to amount and purpose (similar to BJR analysis; broad discretion to corps)
c. DGLC § 122(9) Every corporation created under this chapter shall have the power to make donations for the public welfare or for charitable, scientific, or educational purposes, and in the time of war or other national emergency, in aid thereof.
d. Theodora Holding Corp. (Permissible charitable gift): Ex-wife of the CEO of Dawson Inc., brought suit to enjoin a charitable gift to build a youth camp approved by the BOD. CH: Court upheld charitable gift—it was reasonable in light of the type of donation, the amount in relation to the corp’s assets, and the tax deductions permitted under the IRC (the gift was well within the limitation % of the relevant tax code.
e. Kahn v. Sullivan (Great deference given to Charitable corporate gifts): After talks with the LA Museum failed the CEO of Occidental influenced BOD to make a large donation to build a Museum to house works of art held by a foundation in the CEO’s name. S/Hs challenged the gift because it was so large in relation to any benefit to the corp. A settlement changing some of the aspects of the donation was reached with the dissenting S/Hs. CH: Charitable donations approved by independent directors are subject to review under BJR. Not every charitable gift is a valid corp action, yet given the net worth of the corp and the associated tax benefits, the gift was reasonable despite its large size—much deference.