Business Organizations LONG Outline – (Fall 2009)
An Introduction to Corporate Law:
· Important Characteristics of Corporations: (these are default rules)
o (1) Separate Legal Entity
§ Corporations have a separate legal identity from corporation’s SH’s, employees, directors
§ This is relates to limited liability; it also reason why a lawyer can be attorney for corporation and not the attorney for individual directors and employees.
· Implications:
o Corporations can own property
o Enter into contracts
o Sue and be sued for torts or breach of contract
o Borrow money
o Can be charged and convicted of crimes
§ Arguments For:
· May be difficult to prove mens rea of particular officers/employees despite clear crimes
· No stranger than finding corporation liable for torts requiring a particular mental state
§ Arguments Against:
· Corporations don’t commit crimes; people in the corporation commit crimes
· Many innocent employees suffer if criminal charges force corporation out of business
o Constitutional Protections:
§ Entitled to:
· due process of law under the 14th amendment
· equal protection of the law under the 14th amendment
§ Protected against unreasonable searches and seizures by the 4th amendment
§ No 5th amendment right against self-incrimination (with caveat)
o (2) Transferability of Ownership Interests
§ Ownership interests are called “stock” and they are measured in “shares”
· If company has 100 shares of stock each share is 1% ownership in the company
· Owners can transfer their ownership interests to others by transferring their shares
· Harder to transfer stock in private corporations; easier in public corporations.
o (3) Perpetual Existence
§ Corporation continues even if all original shareholders and managers are gone.
§ This is different from general partnership if one of the partners leaves the partnership ends.
o (4) Centralized Management
§ Shareholders elect board of directors who manage/oversee corporation.
· This is really only management that SHs have
o (5) Limited Liability
§ Liability for the corp. debts and obligations is limited to the assets of the corp.
· Shareholders can’t lose money aside from the investment they put in.
· It makes a lot of people more willing to agree to centralized management.
§ Exception exists when corporate veil is pierced
o (6) Double Taxation
§ The corporation is taxed twice for its earnings:
· (1) The corporation is taxed on any profits it makes.
· (2) Shareholders are taxed on any profits they get from the corporation
o (i.e. dividends, capital gains)
§ Dividends: payment by corporation of profits to share holders
§ Capital Gains: when sell stock you have to pay taxes on that.
§ Double Taxation Example:
· Company’s Revenue à $ 1,000,000 – $700,000 = $300,000
· Corporate Tax (33%) ($100k) = $200,000
· Corporation distributes all income $200,000 to shareholders
· Dividend Tax (15%) ($30k) = $170,000
· Legal Environment Surrounding Corporations:
o State Corporate Law:
§ Corporation must be incorporated under the law of a particular state
· Incorporation statute describes:
o How to incorporate
o Basic structure of the corporation
o Many rules for the corporation
· Each statute is unique
o About 70% follow the MCBA
§ The MCBA is drafted by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association.
o DE General Corporate Law (DGCL) is influential, but binding only in DE.
§ Why most Corp’s choose DE Law
· In early 1900’s, DE passed a very unrestrictive general corp. law, allowing businesses to incorporate w/o much restriction on size, scope , or duration
· Gives corps a lot of flexibility
· DE relies on corporate franchise tax for their revenue
o Creates incentive to keep corps happy
· Law is stable and can’t be randomly changed: DE constitution requires 2/3 vote of both houses of legislature to amend corporate law
· Rapid processing of corporate filings
· Courts have become experts on corporate law
o There is a comprehensive body of case law
o Law is predictable, which facilities business judgments.
§ State law is Judge Made
· B/c state corp. law is statutory, judge’s decisions often clarify and fill in gaps in statutes.
· No “Restatement of Corporate Law” exists, American Law Institute’s (ALI) “Principles of Corporate Governance: Analysis and Recommendations” has limited influence.
§ Internal Affairs Doctrine
§ State Regulation of Business:
· Regulatory statutes: Antitrust, Civil Rights, Environment, Labor, Product Safety
· Other law: Contract law, tort law, etc.
o Federal Law:
§ Less important than state law
§ There is significant federal regulation of business
· Antitrust, Civil Rights, Environment, Labor, Product Safety, etc.
§ Publicly-traded corporations subject to registration and disclosure requirements
· Protects people who might invest!
· Disclosure requirements
§ Insider trading laws
§ Sarbanes-Oxley Act (2002) (big change in this going from very little law)
· Reaction to corporate scandals (Enron)
· Specifies functions and membership of board audit committees of public corps
· Requires senior corporate executives to personally certify the corporation’s financial statements
· Prohibits certain transactions between public corporations and their managers
· Authorizes SEC to require lawyers representing public corps to be whistle-blowers if they see corruption or fraud.
o Lawyers have to move up the latter (GC, then to the board, its internal) –lawyers can break confidences if necessary to prevent harm.
· Two Big Issues of Corporations
o (1) What is the purpose of a corporation?
§ Corporation is the “property” of the SH’s, b/c owned by SH’s.
· Corporation should always do what’s in the best interest of SH’s
o It should maximize values of shares.
§ Corporation is a separate “entity” which is responsible to other “constituents” (employees, community) than just the SHs
· Should not only look out for SHs best interest b/c there are other factors to be considered
o (2) How should disputes between SH’s and managers be resolved?
§ SH exit
· SH’s can sale their shares
o Not that strong of argument for privately traded companies; shares hard to sell
§ SH Voice
· Elect new management
· Propose/enact new policies
· Influence management by speaking out
§ Lawsuits against management.
· Key Corporate Documents
o Articles of incorporation (or “certificate of incorporation” or “charter”)
§ This is the constitution of the corporation
· contains many key provisions, including many that regulate internal affairs
§ This can’t conflict w/ state corporation statute
· If DE law says you have to have board meetings every quarter, you can’t say our board will have board meetings every year!
§ This must be filed w/ the state
o Bylaws (under the articles of incorporation)
§ Contains more detailed provisions, including some regarding internal affairs
§ Can’t conflict with articles of incorporation or the state corporation statute
· Key Corporate Actors
o STOCKHOLDERS (or “shareholders”)
§ Own residual financial rights to the corporation’s income and assets
§ Elect the Board of Directors
§ Must approve amendments to articles of incorporation
§ Can amend the bylaws
§ Must approve certain fundamental transactions (mergers, sale of all assets)
§ SHs can bring different kinds of lawsuits w/in their capacity as shareholders:
· Direct Actions:
o SHs suing in their own capacity to enforce their rights as SHs
§ Ex: suit to compel management to allow SH’s to inspect corporate books or records
· Class Actions:
o SH sues in both their own capacity and on behalf of other similarly situated shareholders.
§ Ex: suit to compel corp. to pay dividends that have been declared.
· Derivative suits:
o Suit is brought by SH on behalf of corporation to enforce duties owed to the corp. the corporation is a nominal D.
o Corporation gets any damage award
o Usually directors and management are indemnified and so the only party who really benefits is the law
ather than classical program.
o Court holds that there is no breach of the duty of care
§ Many co’s still advertise during war
§ Seeking business for future does not breach duty of care
§ BJ rule allows director to choose type of show:
· “The director of a business corporation is given a wide latitude of action. The law does not seek to deprive him of initiative and daring and vision. Business has its adventures, its bold adventures; and those who in good faith, and in the interests of the corporation they serve, embark upon them, are not to be penalized if failure, rather than success, results from their efforts. . . . Because they are given this wide latitude, the law will not hold directors liable for honest errors, for mistakes of judgment. The law will not interfere with the internal affairs of a corporation so long as it is managed by its directors pursuant to a free, honest exercise of judgment uninfluenced by personal, or by any considerations other than welfare of the corporation.”
o Duty of Loyalty
§ President’s wife was hired to sing in musical program
§ Courts look really carefully at conflict of interest situations
o Court holds that there was no breach of the duty of loyalty:
§ This is potential conflict b/c wife may have influence d the decision about the radio show.
§ This results in much higher scrutiny
· Burden is on director to prove good faith of transaction and show its inherent fairness
o Here, singer was competent and was not paid more than other performers
o The amount of deference in this rule is great
§ “business decisions should be made in the boardroom not the courtroom”
o SH Duties
§ SHs generally do not owe a fiduciary duty to the corporation.
§ Rationale:
· SH’s might not invest if they know someone will question every decision.
· They naturally have self-interest and can vote however they want too.
§ Only liable if:
· Exception if SH’s exercise control through their share ownership, courts will often hold that they owe duties to the other SH’s.
· This occurs most frequently in the close corp. context, where a shareholder has substantial ownership stake and acts in a way that disadvantages other shareholders.
· Equitable Limitations on Corporate Actions
o Judges provide equitable limitations this ensures fairness
o Doctrine of Independent Legal Significance:
§ Validity of corp. actions taken pursuant to one section of law isn’t dependent on the action being valid under another section
· Bove v. Community Hotel Corp. (RI, 1969)
o Preferred shareholders are upset:
§ They had the right to receive 24 years of unpaid dividends before the corporation could pay any dividends to common stock owners.
§ Management wanted to eliminate the preferred stockholder’s claim so that the corporation could sell new common stock and raise needed capital.
· But not all owners of preferred stock would agree to the elimination of dividend claims, and a unanimous vote was required.
§ So instead the corp. used another law that governs this merger:
· 2/3 of preferred shareholders vote for this merger to occur.
o Preferred shareholder’s argued:
§ To permit the less restrictive provisions of the merger statute to accomplish indirectly what otherwise would be incapable of being accomplished by the more stringent amendment is a perversion of that law.
