Corporations, Partnoy, Fall 2013
1. INTRODUCTION, August 27, 2013
a. Roles and Risks
i. Owner – the guy with all the money, bears most of the risks, gets all the profits.
ii. Employee – reputation is the key asset.
b. Key questions p. 3, blue insert.
i. Who should bear the key risks?
ii. how should they divide profits and losses?
iii. how should they allocate authority and responsibilities? – usually done upfront, with a view of potential litigation.
iv. how long should their business and their responsibilities last? – employees are generally at will, but sometime contracts are concluded, and such contracts specify the duration.
v. how should they be able to change their relationship?
c. These are all the measures designed to constrain agency costs. The costs of shirking by employees. Separation of ownership and control is the key reason for agency costs. Another thing is avoiding moral hazard.
d. Risks: controllable (quality, safety, hard work) and uncontrollable (interest rates, demand, input prices, acts of God).
i. Expected return – top of p. 11:
1. Weighted average: probability x magnitude
2. Risk tolerance
ii. Risk management methods:
1. Insurance* option: you pay consideration to cover potential loss.
2. Diversification: different risks, correlation
3. Internal allocation
4. Externalization: limited liability, externalities.
e. There are many theories what is a corporation: a person, a set of contracts or relations, a network or people etc.
i. Corporate law imposes a set of rules on owners and employees to help minimize agency costs.
f. Meinhard v. Salmon (1928) Cardozo
i. 50-50 investment, one provided the capital, another managed the venture. When the lease was about to expire, the manager negotiated for another deal and took it for himself.
ii. Holding: they were joint adventurers owing to each other, while the enterprise continues, the duty of finest loyalty.
iii. Dissent, Andrews: they are business people, and they have not negotiated for the unlimited term of the partnership. There was a writing embodying the agreement.
iv. It is all about allocation of risks and roles between investors and managers.
g. Issues for the business firm
i. basic structure
iv. fiduciary duties
v. liquidity rights (how it can be terminated)
vi. change of the relationship, how do we vote. Basic rights of the shareholders:
h. Default Rules vs. Mandatory Rules
i. cannot negotiate over mandatory rules (shall), but the default rules are just gap-fillers, the parties can contract around (may).
ii. Important factors: information asymmetry and transaction costs
iii. Impose duties when there are opportunities for strategic behavior.
iv. Generally, what would the parties have agreed to. Neutral rules.
2. Corporations Basics – class 2
a. Key characteristics of corporate entities and differences with natural persons.
i. separate entity
ii. perpetual existence
iii. limited liability
iv. centralized management
v. transferable ownership interests
b. Sources of corporate law
i. Constitutive documents (private law)
1. Articles of Incorporation 102(b)(7) Del Code affects it. Exculpation of directors for a breach of fiduciary duties. Duty of loyalty cannot be waived, but duty of care can be exculpated.
a. filed with the Secretary of State, very basic
a. more detailed
ii. Statutory requirements
1. Model Business Corporation Act
2. Delaware General Corporation Law
3. California Corporations Code
4. ALI Principles
5. Judge-made law
a. E.g.: Internal Affairs Doctrine: the law of the state of incorporation applies if a corporation is sued in another state for internal affairs (relationships among the owners, directors, managers). Another law may apply to external affairs (employment practices, securities regulations etc.)
c. Managing the corporation:
i. Shareholders vote for BoD. Shareholders rights:
1. sue, sell (the Wall Street Rule), vote, and (yell)
2. exit vs. voice.
a. the boards sometimes meet with large institutional investors.
ii. BoD appoints officers and makes major decisions
iii. Officers manage the day-to-day operation
d. Types of corporations
i. public vs. close
ii. for-profit vs. non-profit
e. Separation of ownership and control is the main legal principle
f. Classes of actors
ii. Directors (elected by shareholders, not employees, they are independent, supposed to oversee the important questions). Independent (no interest, no affiliation) called outside directors.
iii. officers (appointed by BoD, employees, including CEO/CFO etc).
iv. stakeholders – not affiliated with the corporation
1. the community
3. creditors etc.
v. In general, corporate law is focused on the shareholders. But the actual statutes state that fiduciary duty is owed to a corporation, not Sh. How much directors should care about other constituents?
g. Types of Securities
i. Stock: authorized (total permitted by bylaws or AoI), issued (currently traded), outstanding (not owned by the co), treasury (owned by the co).
1. Common Stock
a. riskiest, highest expected return
2. Preferred Stock
a. Not voting
b. Similar to debt
c. Has a preference in terms of rights to dividends and liquidated proceeds of the company.
ii. Debt: bonds, debentures, notes
1. least riskiest, lowest return
h. Duties of directors
i. Duty of care – a director is called ipon to use care, to exercise judgment, the degree of care, the kind of judgment, that one would give in similar situations to the conduct of his own affairs.
ii. duty of loyalty 0 personal transactions of directors with the corporations … may tend to produce a conflict between self-interest and fiduciary obligation, are when challenged examined with the most scrupulous care.
1. Business Judgment Rule is a judicial presumption that the director decisions
a. are informed
b. serve a rational business purpose
c. are disinterested
d. are made independently
i. Types of suits
i. derivative suits: equity suits by shareholders on behalf of corporation for violation of corporate duties by BoD members. Corporations keep all the recovery in the suit. Corporation is the nominal defendant. Plaintiffs are shareholders.
ii. class action suits: the recovery goes to a class. Sh sue the corporation and the insiders on behalf of a class for violations of direct duties.
j. Cases in Ch. 2. Changing the annual meeting.
i. Schnell: it is not a duty of managers to move the meeting date to prevent shareholders from expressing their opinion even if it is perfectly legal. Inequitable action does not become permissible simply because it is legally possible.
ii. Stahl: Stahl, who issued a tender offer and was threatening with a proxy contest, did not have the right to force the corporation to hold an annual meeting when the date was not yet officially set.
1. record date: the date as of which the voting rosters are determined
2. staggered board
3. defensive tactics
iii. One of the lessons to take away of Stahl criticism is that it is narrowly tailored to the facts of the case. If Allen had a new opportunity to decide, they might have decided it differently.
k. Who owes fiduciary duties to whom?
i. We generally talk about directors and officers owing fi
out less in order to create more workplaces and invest in facilities. Minority shareholders sued him because he was not acting in Shs’ best interests.
b. Holding: on the dividend part, the business exists on behalf of the shareholders. Vertical integration: the judge decided not to interfere with the business plans, it is just sound planning for the future.
c. The basic idea is whether or not Ford can take into account interests of other people (not shareholders). In terms of dividends – no, in terms of vertical integration – yes.
d. HYPO: in discharging the duties as directors the board may consider all other groups and their interests. That’s permissive, and Penn Bus Corp Law §1715 is a good example.
e. Takeover example: duty to charge the highest price for the stock (Revlon) when a company is up for sale.
f. Legal arbitrage example: Exogen uses Durasol which is a carcinogen. OSHA is considering banning it. What should the board do? All the options are legally permissible, and not necessarily ethical. Just take the best ethical option. Legal arbitrage – legally riskless transactions. Engage in a transaction to obtain an advantage by seeking some different regulatory treatment (Apple tax example).
4. Benefits corporation – see how it works, including certification.
5. In general, boards are focused on shareholders and they keep them in mind. But there is permissive aspect for board government too. Smth else here.
6. Corporate Charity Example: MBCA 3.02 General Powers (13) make donations for the public welfare or for charitable purposes.
a. Why would the companies give to charities instead of distributing to shareholders?
i. IRS §170 offers a deduction for charitable gifts. That means that the society will have to pay up to compensate for the money not collected – the downside for charitable deductions. Limitation: 10% of the taxable income.
b. Theodora Holding Corp. v. Henderson (Del 1969)
i. Theodora makes a lot of donations through the Board of Alexadner Dawson, Inc. Mr Henderson, her husband, wants to give money through the company. Wife is furious. The issue is whether the Board can make such a gift.
1. There are two statutes at play: corporate and tax.
a. Corporate: corp has the power to make the donations.
b. IRS: the gift is within the tax deduction limitation, and this is a boys camp, a charitable organization. So, also can do this.
ii. If the gifts are too large, they may be subject to controversy. But the Business Judgment Rule will apply in most cases.
CHAPTER 5 Corporations as political actors.
1. Constitutional Limits on state regulation
a. Citizens United
i. “Hilary” movie before the campaign. Citizens is a nonprofit, speech is a or-pay movie. Although Citizens is a nonprofit, they took corporate money for the production, and caused the controversy.
ii. Some people thought that the court would do a narrow construction (non-electioneering, movie, non-profit). But the other option was to overrule Austin.
iii. Holding: corporations are persons, their speech is protected by the first amendment. But requiring a disclosure is OK