I. Introduction to Corporation Law
A. Special Characteristics of Corporations
1. Separate Entity: corporations are legal entities separate from (1) investors who provide the corporation with money and (2) the people who manages the corp’s business.
2. Perpetual Existence: corporations have an unlimited life.
3. Limited Liability: shareholder’s liability is limited to the amount of money paid for shares. The corporation owns assets and is liable for its debts.
4. Centralized Management: shareholders elect corporate directors. Directors have power to manage and oversee the corporation’s business.
(a) Directors delegate responsibility for daily decisions to corporate officers.
(b) Directors owe a duty to act in best interest of the corporation, not their own interest.
(c) Key feature of modern public corp is separation between ownership and managerial control.
5. Transferability: Shareholders can transfer ownership of stock w/o need for approval from others.
6. Types of Corporations:
(a) “for-profit” & “non-profit”
(b) Close Corp (private corp): no real market for the corporation’s securities and there is a substantial overlap of ownership and management
(1) majority shhs are also active in the management of the business
(c) Public Corp: there is an available market for trading the corporation’s securities.
(1) governance structure separates ownership from control and shareholders generally do not play an active role in the management of the business
B. Competing Conceptions of Corporation
1. Property: corporation is the private property of the shhs. Corporate purpose is to advance the shh interest (maximize shh wealth). Directors, as agents of shh, advance financial interests of owners.
(a) aka contract model
(b) “Nexus of Contract”: corporation is a nexus of contractual relationships. Corp is a private institution created by private contracts. Shhs have voting rights which give them more power.
(c) Critique: too limited and ignores the external aspects
(d) Tends to exclude employees from having role in the corporation
2. Social Institution: corporation has a public purpose. Corp comes into being and continues as a legal entity only b/c of state statutes. State govt gives corp its limited liability and unlimited life. Corp has duty to all those affected by the corp.
(a) Internal Social Institution: matter of individuals getting together and working toward a common goal. “team production” model
(b) External Social Institution: Corporation has its own “corporate” speech
C. “Organic Documents”
1. Articles of Incorporation
(a) Required in every state, must be filed w/ Secretary of State
(b) the “constitution of the corporation”
(c) Mandatory provisions
(1) Corporate Name
(2) # of shares authorized
(3) Address and contact info for Agent for service of process
(4) Address and info of incorporator
(a) not filed with the state
(b) rules governing the internal affairs of the corporation
D. Sources of Corporate Law
1. No Federal Corporate law
2. Model Business Corporation Act (MBCA): created by the Committee on Corporate Laws of the ABA. Followed by about 40 states
3. Delaware General Corporation Law (DGCL): amended annually to account for new developments, practices, and judicial decisions in corp law. State of incorporation for > 50% NYSE corps.
4. “Default Rules” –
(a) corporate statutes are generally default rules, but there can be mandatory provisions.
(b) “enabling laws – b/c they enable participants to structure the business how they see fit
E. Why Delaware Corp Law?
1. Del corp law is amended annually to account for new developments, practices, and judicial decisions in corp law.
(a) Delaware courts have an expertise and highly developed corp law jurisprudence that other state courts often follow even though their statutes are different.
2. 4 Reasons
(a) law designed to give management flexibility in structuring and running the business
(b) Del courts are highly experienced and sophisticated in corporate law matters
(c) large body of case law interprets the Del statutes → provides certainty to corporate planners
(d) Delaware legislature is a leader in corporate law reform and amends the Del statute often
F. Corporate Actors
1. Stockholders (Shhs): the “owners” of the corporation. Stock carries residual financial rights and basic voting rights. Ownership does not = control of the corporation (technically)
(a) note: stockholders have the right to vote on only those matters that are specified in the statute.
(1) Right to vote on certain “fundamental transactions” (e.g. merger, sale of all assets, etc)
(2) Shh approval needed to amend articles of incorporation, remove directors, and dissolve the corporation.
(3) Shh have right to amend bylaws, vote on matters on which corporate management seeks their approval
2. Board of Directors (BOD): elected by the stockholders and responsible for managing/supervising the corporation’s business.
(a) inside directors: directors who are corporate employees or officers
(b) outside directors: directors who generally have no affiliation w/ corp except board membership
(c) fiduciary duty: duty to act in the best interests of the corporation when acting in their capacity as directors. When acting as directors, they are not considered corporate EEs either.
(d) Constituency v. Non-Constituency: defense mechanism for local companies that are subject to hostile take over. The directors can consider the interest beyond the stake of the stockholders – look to employees general economy, community interest.
(e) Level of scrutiny: DE – 1) day-to-day decisions 2) defensive decisions 3) change of control decisions
3. Officers: elected by the board. Includes a president, vice-president (can be multiple VPs), secretary, and treasurer.
(a) Responsible for running the corp’s day-to-day business
(b) Bylaws generally describe officers’ duties
4. note: the shh → BOD → officers model is typical of public corps but not the same w/ close corps
(a) In close corp, the Shhs are often directors and officers and are active in operating the business.
(b) Some statutes are at odds with the closely held corp and create some issues.
5. Stakeholders: other actors with a stake in corp. Creditors, employees, customers and community.
(a) Creditors usually have contractual relationship w/ corporation b/c there is no fiduciary duty to creditors. Bankruptcy laws favor creditors and give them first dibs
G. Corporate Securities
1. Two Types of Securities
(a) Debt Securities
(1) Risk: least risky, lowest expected return
(2) Payments: Right to receive fixed payments over time (interest + principal)
(3) Priority: Debt securities have priority over equity securities
(b) Equity Securities
(1) Common Stock
a. Risk: assumes the greatest risk of the corp’s success/failure and has greatest expected return
b. Low Priority: common stock shh have residual claim to corporation’s income and assets after corp satisfies all claims. If corp insolvent, usually receives nothing
c. Payment: payment through dividends + increase in stock value
§ dividends: cash payments which BOD may choose to make
d. Vote: usually entitled to vote
(2) Preferred Stock
a. Risk: less than common stock, more than debt
b. Payment: lower expected return than common stock, higher ER than debt
§ receives fixed dividend. Declaration of preferred stock dividend at BOD’s election.
c. “Preferred”: right to receive dividend before any dividends paid to common stock holder and right to receive distributions in liquidation be common stockholders
H. Shareholder Options
1. Exit: a person who is dissatisfied w/ an organization can sever his connection w/ the organization
(a) “Wall Street Rule”: sell your shares. If enough shh sell the shares, could drop the share price
(b) Good: exit can effect change and promote shh interests b/c the threat of selling shares might scare the BOD. Threat of change in ownership leads to new a threat of change in management.
(c) Bad: Can harm other shh b/c it might drop the market price and the shh might take a loss.
(1) might not work in bull market b/c other investors will buy up the shares. Prices have to be sufficiently low to trigger corporate takeover.
a. tender offers are costly
2. Voice: a person can remain within the organization and attempt to remedy the situation
(a) Limitation: a shh’s reliance on voice is limited by shh’s estimate for the prospect of success
(b) Shh voting: shh can tell corp what they want
(1) Individual Investor: old form of ownership was large number of shhs w/ small ownership
a. Rational Apathy: voice was too costly, most shhs thought voting wasn’t worth it
§ the ones who did vote didn’t get too involved
b. Collective Action Problem: aka free-rider problem
(2) Institutional Investor: growing trend is increased activism b/c greater concentration of large # of shares in fewer hands.
a. pensions or investment funds.
b. b/c of greater stake, are more likely to use voice
(3) Changes in activism: more activist today b/c changes in technology and institutional shhs
(c) Litigation: also an example of voice. Sue corporation, directors, controlling shhs.
(1) corporation: it is an entity that can be sued (has 1st Am rights)
(2) directors: sue directors through derivative action
(3) controlling shhs: sometimes can sue if they exercise too much control
3. Loyalty: a factor that determines whether people will choose exit or voice
(a) ask: does the law create appropriate balance b/n exit and voice? to what extent does the law permit exit and voice? How will availability of exit or voice influence rights and remedies of the person? how does the nature of the corp affect the need to create different exit and voice mechanisms and the rules that facilitate each?
I. Internal Affa
direct control, the other partners want to determine if the new partner is capable.
(b) Most statutes restrict the right to transfer control, but they do allow severance of the economic interest.
(c) Corp: default rule is free transferability of shares
(d) GP: default rule is that all partners must consent to the transfer of a control interest and the admission of a new partner. A partner can transfer the economic interest while retaining governance interest.
(e) LP: LP can transfer partnership interests, but assignee only has governance rights of a limited partner w/ the consent of the remaining partners
(a) Corp: perpetual
(b) GP: dissolution by GP – withdrawal or death
(c) LP: dissolution by GP by death or withdrawal
(d) LLC: perpetual under some statutes, but logic doesn’t really work if a member-managed
(e) Logic: perpetual life of the entity continues beyond the life of the owners. It also permits exit. Since free transferability, makes sense to have perpetual life. In Pship, limited transferability, so makes sense to have limited life.
· Where there is an official filing of an organizing document w/ the state, there is limited liability
· Where there is limited liability, there is usually centralized management
· Where there is centralized management, there is free transferability of ownership interests
· Where there is free transferability of ownership interests, there is generally perpetual life
· Where there is no government filing, there is generally personal liability
· Where there is personal liability, there is generally direct (decentralized) control
· Where there is direct control, there is generally a requirement of the consent of other owners before one can transfer governance rights (as distinct from economic rights)
· Where there is a consent requirement for transfer, there generally are dissolution rights (org terminates upon exit)
6. Limited Partnerships
(a) Combines elements of a corporation and the GP
(b) Requires at least one general partner who is subject to unlimited liability just like in a Corp
(c) Limited Partners have liability limited to the amount contributed to the partnership.
(1) Limited Partners have no voice in the active management of the partnership.
7. Limited Liability Companies
(a) Hybrid business organization
(b) Legal entity distinct from “members”
(c) “members” like Corp shhs receive limited liability protection
(d) Management: can have either decentralized or centralized management
(1) determine this through the “operating agreement”
(e) Taxation: LLC can elect taxation as partnership or as corporation
(f) Laws: state LLC statutes vary much more than state Corp and Pshp statutes
(g) Files “Articles of Organization
(1) Must include naem of the LLC and the address of its registered agent
(h) “Operating Agreement”
(1) sets forth the member’s rights and duties
(2) some statutes require operating agreement in writing
8. Two New Forms
(a) Limited Liability Partnerships
(1) like an GP, but gives limited liability to the GP
(2) has all the characteristics of a GP except that general partners have limited liability.
(3) Requires Govt Filing
(b) Limited Liability Limited Partnerships
(1) like a LP but the general partners have limited liability
(2) Insurance: some states require these forms to get insurance b/c of the risk run by LL
(3) Liquid Asset Rules: some state require enough assets to cover potential liability
(4) Centralized management, no right to dissolve, trickier than LP
(5) Full-shield: everyone has limited liability
(6) Partial-Shield: liable for acts of GPs, liability for what you do.
E. Inadvertent Partnership
1. A Partnership can be formed when two or more people enter into a contract. However, b/c a Pship is legally an association of two or more person to conduct a business for profit, a partnership can be created by operation of law.
(a) “non consensual partnership”