Corporations Outline Scott Fall of 1994 (it starts on p2- sorry) 2.Partnership(cont.) b.Limited Partnership-Uniform Limited Partnership Act & 1985 Revised -unlike general partnerships it is created by statute STATUTES: 101-definitions (p.110), 201-certificate must be filed in Secr. of States office, and set forth...but does not need to include the names of the limited partners nor the capitalization (p.112), 302-voting-can vote on matters but be careful not to pass the safe harbor, 303-Limited partner will be liable if also a general partner or participates in control of business...(b)does not participate solely by doing one or more of the following...(p.116-7) Requirements: 2 or more persons, 1 or more general partners, 1 or more limited partners, must be specifically formed :Filed cert. of limit partnership and a written agreement-if you fail you get a hybrid.-general partners-same powers as those of general partner-Limited partners -1)limited liability as per investments, 2) pass through of profits and losses (stockholders do not get this- b/c can only realize profits through dividends or sale of stock) 3) Limited management- Characteristics: limited liability, free transf., can arrange continued existence, can take a loss - 303 of ULPA -limited partner cannot exceed these rights (cannot make these decisions)or limited partner becomes a general partner.-must comply with formalities. - publicly traded limited partnerships are treated usually as corp. for tax purposes. 4)Continuation: if prior agreement, it can have a perpetual life 5)After Dissolution- all partners are treated as creditors 6)Transferability: limited partner can transfer a substituted limited partner if cert. says so and will not resolve the partnership, and same with adding new general partners *ideal situation: flow through tax benefits, limited mgmt control, no general partner with full personal liability (because a corporation acts as general partner)- Subchapter S Corp. is taxed like a partnership, but tax law constraints- limited to a single class of stock, certain number of individuals, complicated negotiations-States have newly passed L.L.C. laws (limited liability company) -limited partnerships in corp. form-eliminate general corp. partner, owners are called members, if it goes public it will be treated like a corp..----- 1) no full liability 2)shareholder salary 3)get mgmt. benefits 4)IRS treats them as partnerships as long as no more than two of the below exist: 1)perpetual life 2)free transferability 3)centralized mgmt. 4) limited liability--------corp. has all four, general partnership has none, and a limited partnership has 2 & 4. C.Corporations-Legal entity -via enabling statute-has legal and some constitutional rights Characteristics:
*Management-centralized, but all parties vote, shareholders have no legal interest in assets, board manages business but fundamental changes require shareholder approval, sh have no authority to bind, profits not shared except via dividends *Liability---- fiduciary duty between board and sh, parent/subs but not between shs to each other, limited liability to shs amt. of investment *Capital-easy to raise taxes---double taxation (tax corp. profits, can't retain earnings to avoid taxes beyond reas. needs of a business), tax shs on dividends; interest paid on debt is deductible; corp. can set off losses against profits within *Transferability----freely transferable, interest is descendible, liquid investment, can do a right of first refusal therefore giving present shareholders a right of first refusal *Duration---perpetual life unless cert. says otherwise *State and Fed. Statutes apply *pros limited liability, continuity, size, lack of accountability of owners, easy to form, excellent vehicle for attracting investment, good form for organizing, producing, distributing.. *External constraints- FCC/UCC regulations, environmental regulations Who has Authority? Executives, Bd. of Directors, and Shareholders Capital Structure: *Statutes: Delaware--152-(p.157)issuance of stocks, lawful consideration;fully paid-can be cash or services -the bd. must reas. determine the value of the K- stockholders; ---153(a) --(p.158)Price of Stock is up to board but par value acts as legal limit on how much stock can be sold for. It refers only to initial sale. RMBCA---6.21-(p.253)issuance of shares-consideration-tangible or intangible- includes services performed or a k to do so- comment on p.255 states that K for future services is a departure from usual corp. law --also eliminates par value. (note: they are called shareholders) NYBCL--- 504--(p.504)- she said it is the same? is it?--shareholders 506--(p.507)par value; 501(a)-(p.503)one or more class may have par value and at least one shall have voting rights. Types of Capital: *Equity--- value of assets-liability. Stock is equity in a corp. Stocks vote, are transferable (can be modified), dividends (profits that come out of the co. --cash in hand) Types of Stock: Preferred- first to be paid if co. is liquidated, certain types of preferred some with a stated dividend or participating. Non-voting with a stated dividendPros:corp. not obliged to pay, it continues to accrue, growth potential Cons: for investor not as good as debt b/c no bankruptcy here to act as enforcer, also no maturity. Also some are cumulative and others are not. Participatory Preferredno stated amount to be received but it does allow for share in growth
of co. Stated and preferred can be combined. Common- last to be paid out, always votes Note:NY requires at least one class be voting *Debt--- usually has a fixed rate of interest (a coupon) but floating rate also exists, transferable (can be made freely transferable), negotiable, date of maturity (demand debt -pay whenever called in), Different types ex. senior debt gets priority over junior debt, senior secured debt has particular assets tied to it ex. mortgage on a bldg.Pros: priority over stock, can sell it and still maintain voting unless agreement, get an interest rate, stated rate of return (in contrast to dividends), maturity datenegotiable. The corp. then has a liability, and the debt owner has an asset. Cons: default can put corp. into bankruptcy and no growth potential. Also IRS may state that the debt is really equity and you'll have to pay taxes on it. Convertible Debt: can convert debt into equity ( stated on the instrument)-investors love this b/c allows you to participate in growth potential, when corp. begins to do well equity price rises over that of debt.
*Assets--- include any money put into co. and the book value of co. Priority of Repayment:Debt, liquidation preference of preferred, common stock. Setting up structure:Summaryif different amts.of funds and all want equal voting power, there will be an impasse with only common stock, therefore: 1st)set up all with equal shares of common stock at some price so now all have equal voting power - price of stock depends if par value (see above under Statutes)-it serves only initial accounting purpose so that a stated amount must stay in corp. for creditors. Money paid over it is "money paid in excess of par"-therefore, there are three accounts:retained earnings, profits, and par value-so don't start out with a high par value b/c then you can't get it out later-set very low. 2nd) balance out the rest with either debt or other equity (preferred stocks) - see pros and cons above Example: CS-votes, $10 per share if person with least $ has $100 then all get 10 shares. PS-non-voting (can be voting but we want to equalize votes), Participatory preferred(-gets growth -2x dividend on common, but no guarantees), $1000/share (liquidation pref. of 1000 per share) then divide each contribution by 1000 to find out how many shares each gets. 3rd) if trying to create incentive for someone to work hard...who has little money to contribute-can issue a different class of participating preferred stock, option to purchase stock in the future, an employment contract with a salary, stock options and perhaps a bonus, covenant not to compete Where to incorporate? * Pros of Delaware:law is clear, easy, predictable, market knows Delaware, law favors mgrs *Cons of Del.: have to pay franchise tax to incorporate and stay there, as well as at principal
place of business, it has created a race to the bottom to attract corp.(p.100-2) * close corp. usually incorp. locally Formation: Statutes: Delaware: (sections 101-09) 101(a)-(p.135) incorporate by filing with Secr. of State 102--(p.136) Certificate of incorporation;Contents-name shall include.., (2) address-in registered in State office (3)purpose-any lawful activity...is sufficient (4)class of stocks, number of shares of stock, preferences and rights.....(6)powers of incorporators (6(b(2)))-if a majority representing 3/4 in value of the creditors or a class of creditors or stockholders agree they can bind all others ..6(b(5)))if not perpetual existence, must say so here 6(b(7)))must state if limiting liability for breach of fiduciary duty 103---(p.139) Execution, Acknowledgment, Filing, Recording...Incorporator signs cert. unless initial board listed 106---(p.141) Commencement of corp. Existence-upon filing with secretary- technical stuff 107--(p.141) Powers of Incorporators-shall manage until the directors are elected and do whatever is nec. and proper to perfect the organization of the corp. 108---(p.142) Organization Meeting of Incorporators- sets requirements for electing directors to hold office until first annual mtg. or until successors are elected-also sets notice requirements to other incorpr. 109--(p.142) By-Laws- incorporators may repeal, amend or adopt or by initial directors if named in cert. Once it has received payment for any of its stock, the power will be in the voting stockholders or if no-stock corp., in members entitled to vote- can confer such powers to directors but this does not divest stockholders of their power. RMBCA: 1.2----(p.233) Filing Requirements--nit picky stuff -technical 2.02---(p.239) Articles of Incorporation- must set forth...and may set forth..4.01 sets forth names 2.03----(p.241) Incorporation-filing w/Secr. of state is beginning of corp. existence and proof that incorp. satisfied all requirements-can specify a delayed effective date. 2.05---(p.244) if initial directors named, they will hold an organiz. mtg to appoint officers, adopt by-laws, and other business, (2) if not named, the incorporators will hold such a mtg to elect directors ... 2.06---(p.245)By-Laws can be adopted by incorporators or bd. of directors 3.01---(p.245) Purposes- unless limited purpose is stated all corp. have purpose of engaging in any lawful business. 3.02---(p.245) General Powers-all have perpetual duration unless otherwise stated, can be sued or sue in corp. name...pay pensions, make donations to public welfare, transact any lawful business that will aid gov'tal policy 3.04---(p.247)ultra vires6.01--(p.249) Authorized Shares- (a) articles of incorp. must prescribe shares and number of shares of each class...(b)must authorize one or more classes of shares that together have unlimited voting rights NYBCL: (402 and 630) 402---(p.502)Certificate of Incorporation;Contents-....(2) general purpose clause provided it states any lawful business activity (7)secr. of state is the agent within state...
501--(p.503) Authorized Shares (a)at least one class of shares shall be entitled to full voting rights 601---(p.514)By-Laws630---(p.526) liability of Shareholders for Wages due to Laborers-(a) the ten largest shareholders...shall jtly and severally be liable ...per pro rate share List of Power Hierarchy: -statute, charter, by-laws, resolution of bd. of directors -limit the charter to the statutory requirements or the essentials, by laws may be more detailed b/c not publicly available, also resolutions are not publicly available Ex. of Charter -see p.659 Del Name: check above statutory requirements. must be distinguishable from other corp. on file at secr. of state and trademarks(Del.) and cannot suggest that it does something it does not (RMBCA). Therefore, immediately reserve the name. Number of shares: set forth in statutes, Hint: when initial charter set a low # of initial shares b/c filing fees vary w/# of shares, and it is easy to amend and then retain a high number- it requires a shareholders vote Organizers Meeting: set bd. of directors and then they hire people, accepts offers for shares and authorizes opening of a bank acct--- Example of by-laws is on p.660-69 sample. In NY incorp. have the power of both shareholders and until stock issued and directors until elected(Section 404(a), 615(c)) but in Del. the incorp. have the powers of shareholders and directors unless initial directors named in cert. of incorp.
D.When deciding whether or not to incorporate consider: 1) Public Investment?- general partnerships do not have shareholders, but there are publicly traded limited partnerships -also debt instruments can be traded, but you cannot sell your management rights or liability in a general partnership Corp: usually preferred by public investors b/c limited partnerships lack depth (capability of absorbing trades more or less instantaneously) and attributes not widely known and residual threat of liability. 2) how mush capital will be needed and over what length of time? -Partnership: can borrow money 3) tax questions -consider what will happen over time -will there be losses? Corp- double taxation, because dividends also get taxed, also if you sell stock there is a capital gains tax Partnership- partner's share of income gets taxed whether or not left in the business -good because allows losses to offset other taxes 4) how will it be managed? Corp.: managed by a board of directors; shareholders(owners) have no right to participate in mgmt., no power to act on its behalf, and no power to bind to a K---Centralized Management-but a shareholder can also be a manager without risking liability Limited Partnership: centralized in general partners- if participate in mgmt. may become
liable General Partner: many have mgmt. centralized in designated partner. 5) when do you want the corp. to dissolve? Continuity of existence? Sole Prop.: no legal existence apart from owner General Partner: dissolves on death...and can be wrongfully dissolved by a partner (but can continue if agreement says so) Limited Partnership: death of limited or general partner will not dissolve unless agreement otherwise. Corp.: perpetual unless cert. of incorp. states otherwise 6) Limited Liability? Sole Prop. and General Partner: personally liable for all conduct arising out of business, may be able to limit liability through contract and tort through insurance Corp:shareholder has limited liability to the extent of his investment , managers are normally not personally liable even if owners also 7) do owners need cash soon?-free transferability Corp: if loss it does not get passed through, can give a salary to an owner who will need $ which is deductible to corp and taxable to her, free transferability will allow an owner to reap benefits when it goes public-but can also limit extent of transferability. Partnership (both): transferee requires unanimous vote unless agreement says otherwise Sole Prop.: usually freely transferable 8) Cost and Simplicity? Corp.: costly (atty's fees, filling fees, certain formalities) Sole proprietorship and general partnership: simple and cheaper
E. Valuation and Efficient Market Hypothesis: *Appraisal Remedy: Piemonte v. New Boston Garden Corp. (1979)(p.1094)Facts: P minority stockholders in Boston Garden seeking a judicial determination of the fair value of their shares as of the day preceding the date of the vote approving the merger. Held:judge's procedures were within range of discretion but treatment of evidence was or may have been in error and therefore, remand for valuing Boston Gardens, Bruins Franchise, and concession op. Ct. Reas.: Ps took nec steps-objected in writing to merger, none of their shares voted in favor, each P seasonably demanded in writing their fair value and no agreement reached within 30 days. Based upon Similar statute to Del 262 "appraisal rights" Value weight result market value 26.50 x 10% = 2.65 earnings value 52.60 x 40% = 21.04 net asset value 103.16 x 50% = 51.58 ---------------------------------------------------------------------------------------Total Value Per Share: $75.27 Discussion: appraisal rates are offered to those who do not wish to go along with a merger and since statutes do not require a unanimous vote to merge (only maj.) then a minority can get blocked. The Fair Market Value (Del 262 p.197 and RMBCA 13.01p.362) is not defined and
therefore look to all relevant factors-market value, assets and earnings. But in Piemonte there was a very thin trading market which means the market price is no longer the best predictor of future financial returns b/c not efficient market hypotheses (not readily available and transaction costs and lack of info)-the greater the liquidity (the # of shares traded) the more efficient the market. Securities markets are not rational but if many people making these decisions than the subjectivity gets washed out. Criticism:if large publicly traded corp. then only market price should matter. *Earnings:if well est. market w/free trade then market price would include earnings, but here market is defective and control can manipulate the earnings, also stock market valuates earnings in ways that are only imp. to it-control block determines earnings, it can invest in long term big invest. so earnings go down- therefore the Judge in Piemonte average over the past five years and excluded extraordinary gains or losses- looked at earnings over a reas. period of time. The multiplier of "10" was arbitrary- appraisal becomes a battle of the experts. *Dividends: already reflected in market price so not looked at 2x *Asset Value: ct. trying to give Ps some future value even though statute will not allow them enjoy new value of co.-difficult to value Bruins because it is a people "asset" - ct. used book value(but not relevant to cost or value today) POLICY: 1)willing seller/buyer- you are entitled to what you could have sold stock for, assumes corp are fungible, if market value dominates it will discourage appraisals therefore, Ps almost always get a premium over market value. 2) property notion of shares (personal property)-dissenting shareholders are being cashed out and therefore they must be compensated, tends to emphasize earnings and assets, but is this realistic to use when H is a min. and vote cannot affect anything anyway 3) particular facts- what these shareholders lost and what maj. gained. Its historical basis- it is a trade off for eliminating shareholder's veto of a merger. Reasons to go private: info. can be more private, cheaper b/c reporting acts included potential litigation risk, fiduciary duty to shareholders, reorganizing creates benefits and facilitates process *Takeover premium-people will pay a premium over a straight market price to gain control b/c if the assets> market price then you can break it up or it you could manage it differently. When one co. becomes subject to a takeover the other co. in same industry's stock prices rise b/c maybe someone will be interested in them. Presence of control block depresses stock prices but does not nec. affect dividend. *Ps in Piemonte are being compensated for being forced to sell, emotional loss, but they knew when they invested that part of the risk is that control blocks will form *In stocks there is P/E ratio which gives the last reported earnings -a number to compare to other stocks. In re Valuation of Common Stock of McCloon Oil Co., 1989 (p.11 of handout 2) Facts:two dissenting shareholders of a Maine companies sued for appraisal rights. what is the fair market value and proper interest rate. Held: for dissenters -entitled to the proportionate share of each Maine Co. at its full fair value...and compounded interest rate.
Discussion: any rule that gave shareholder less than their proper share would encourage squeeze outs - this would be a transfer to wealth from min. to maj. However, the min. is getting more than the market price, therefore, more than they could get on their own. In large publicly traded corp. the shareholders are generally interested in market price. The presence of a control block skews it b/c potential for behavior disadv. to minority and unanticipated. Trying to create incentive for control block to act in corp. best interest, but the reality is that it is part of the risk. *Manager's job is to maximize net present value (therefore no need to know shareholders values) Present Value =discount factor x C (C is the expected pay off at time period 1 -1 year from now ) (r is rate of return) Discount Factor = 1/1+r
F. Ultra Vires (p.108-15) Definition- beyond the corporations power- unenforceable against the corporation because beyond the corp.'s power therefore, lacks mutuality. Original purpose-protect the public or state from unsanctioned corporate activity. It was meant to protect shareholders. Today: Policy shifts- statutes explicitly empower a corp. to make guarantees, purchases... even without stating so in cert. of incorp. (Del 123) With no limits beyond legality of action in purposes clauses there is no reason to have ultra vires except: What is left? Corporate waste doctrine-unreasonable use of corp assets for a non-corporate goal, no defensive use of ultra vires, no offensive use by third party. Permitted Now: A) shareholders can bring action to enjoin ,but ct. may not set aside unless 1)still executory (not performed), 2)all parties are before the court 3) ct finds it equitable 4) ct. provides compensation to third parties B) by corp against officers and directors for damages suffered- personal liability C) claim by atty general to dissolve or enjoin- generally used for ex. when ins. co w/out proper regulations complied with. Statutes: Del 124 ----(p.145) Ultra vires- no longer may be used except if by 1) stockholder to enjoin corp from acting 2) corp against incumbent or former director for unauthorized acts 3) Atty General to dissolve or enjoin corp. RMBCA 3.4---(p.247) same as above
G. Objectives of the Corporation *objective of a corp.- long term or short term profit enhancement (ALI)- although criticism today is that we are obsessed with short term due to 1)compensation structure and 2) stock market-keep prices up- causes R&D to go down - this does not occur in Japan and Germany.-*Root of problem-separation of shareholders and directors (owners and mgmt.) but the threat of takeovers are the only disciplinary force on corp.
*today many institutions own large blocks of stocks and therefore, cannot dispose of them quickly b/c it would cause the stock price to drop. It is also difficult to sell in pieces b/c they own it for many others ex. public employees retirement funds, pension funds, ...and they are legally responsible to beneficiaries. Many are limited by statute as to what type of investment they can make- ex.grade A.. Therefore, these stockholders cannot effectively influence mgmt. by merely selling stock. -Fiduciary duty of these institutions is to raise rate of return for shareholders. Shareholders are low risk investors for the most part. *the management's interests should be linked to the shareholder's interests- wants compensation to be based on merit. *See ALI Principles-the law represents our best guess at societal consensus on behavior-does not allow corp. to break the law -2.01(b) are the exceptions to enhancing profit 1)must act within boundaries of law- includes ethics. Allows corp to do what not legally obligated to do as ling as within "reasonable limits" Cases: Smith v. Barlow, 1953, p.115 Facts: Corp manu. and sold valves for fire hydrants.., bd. of directors adopted a resolution to give to Princeton University-aid to philanthropic and benevolent institutions to obtain goodwill in the community. Held: voluntarily made within reasonable belief that it would aid the public welfare and advance interests of P as a private corp, therefore, the defendants cannot now close their eyes to present day realities. Ct Reas.:such donations have been sustained under common law, sociological/economic arguments for corp. donations, transfer of wealth of corp. hands, it is within corp. power to contribute "within reasonable limits" Dodge v. Ford Motor Co, 1919, p.1372 Facts:Ford who owned 58% had paid 1.2 mil and for 4 yrs. had paid 41mil in dividends, but he decides to only pay 1.2 mil and put rest into community. Ps are Dodge Bros b/c the purpose of the policy is to be less profitable.Held: a corp is organized for profit, therefore, it is unlawful to have purpose of benefitting others. Statutes: Del. 122(9)---P.144- make donations.... RMBCA:3.02(13)---p246-make donations for the public welfare... although not all limit explicitly to reasonableness, but commentators agree that it is implied.
. H.PROMOTERS(p.130-140) *the promoter transforms an idea into a business capable of generating a profit, brings together people and superintends various steps *three stages of corp. promotion: 1)discovery-generation of an idea 2) investigation -analysis of what resources... 3) assembly-getting property, $ and personnel together
*absent extraordinary circumstance the promoter will be liable. Exceptions to holding promoter liable: 1)equitable estoppel- ex. P in Quaker was estopped from looking to promoter 2)Unjust Enrichment- MacArthur corp did get benefit of services and knew sufficient amount How a Corp becomes Liable: Ratification- corp cannot ratify acts of promoters b/c it is an agency principle and there can be none if no principle.-many court still say it was ratified anyway. Promoter stays liable. Adoption- as part of K is a continuing offer, the corp joins the K and becomes a party. Promoter remains liable Assignment- (Assumption)- promoter can assign K to corp and corp becomes liable but promoter remains liable too. Assignment and assumption of obligation are separable. Novation- promoter wants this. Substitution of corp for promoter; it is new K b/c a new party. All parties must agree. Corp held liable even when it did not assume K obligations: 1) corp got benefits and rights under K 2) alter ego theory-corp and promoter are alter egos of each other 3) quantum meruit -unjust enrichment liable for benefits received 4) estoppel (reliance based)-ct is estopped from denying obligation POLICY: Ks must be construed reasonably and people do not intend to enter an agreement with a non-existent party, certainty of dealings, incentive structure-promoter usu. has best info. and is best bearer of risk. No rule that once a corp formed liable for all acts of promoters b/c so many people involved that do not have knowledge of promoters Ks and obligations. Better to put burden on Promoter b/c greater access to info.
Cases; RKO-Stanley Warner Theatres, Inc. v. Graziano, 1975 (p.131) Facts:RKO sued for judicial enforcement of agreement of sale of theatre to Jenofsky and Graziano. Graziano & Jenofsky had been promoters and failed to complete a settlement. held: intent of the parties was to have the Ds personally liable until such time as the intended corp. was formed and ratified the agreement. Ct. Reas.: Even though para. 19 stated it was between corp and Ps, the obligation continues until Ps release or there is a novation. Agency creates an inference of liability. Construed para. against drawer and looks to intent of the parties. Quaker Hill, Inc v. Parr, 1961, p.136 -Anomalous Case-Facts:P, quaker, sued D, promoter for payment even though P had insisted that the contract be formed even though the corp had not yet been formed. Then when corp formed it had a different name. Held for Ds b/c Ps agreed to look to corp. and not to promoters. D.A. McArthur v. Times Printing Co., 1892, p.137 Facts: D discharged P violating K. D claims contract was week to week and P was fired for good cause. P wants damages for breach of K. D claims no formal bd. action and s of frauds
defense. Held: for P b/c D adopted the contract and therefore not void under statute of frauds b/c it does not commence until D adopts it. Clifton v. Tomb, 1947 p.139 Corp is not liable until it is formed and through ratification, adoption, and novation accepted liability. Then it is estopped from denying liability.
Discussion: How do you bind a third party, but keep promoter off the hook? -explicit language is not enough (Graziano) b/c then it becomes an illusory K, -if used signature as "Pres. of Corp" and used corp. name, but misrepresentation if other party does not know corp not formed or binds promoter b/c it looks like a K, or option K, -while it costs $ it is less than if bound to whole K Case against Promoter: -construe K against drafter, no express waiver of liability, employment Ks are favorable viewed to employee Case for Promoter: -corp took on obligation of K, intent of parties for employee to look to corp, employee had full knowledge that the corp. not yet formed, employee assented to corp taking over payments by accepting checks, Statutes: RMBCA 2.04 -(p.242)all promoters acting as or on behalf of corp., knowing not incorp, are jointly and severally liable for all liabilities. 6.21(b)- allows promoter to get paid for services rendered prior to formation of K
I. Disregard the Corporate Fiction (p.151-191) *Almost never pierced if passive shareholders who change hands quickly Piercing the Corporate Veil- based on concept of limited liability *pros of limited liability: 1) allows stocks to be traded as fungible b/c otherwise everyone would have their own value as to risk. Criticism: Limited liability externalizes the costs 2)encourages risky investment 3)lowers cost of monitoring corp and shareholders b/c lowers risk each takes on 4) investor can minimize risk by diversifying portfolio 5) stabilizes price -price standardization Theories for piercing the corp veil 1) Inadequate Capitalization- Minton v. Caveney- ex. almost no capital, assess at start up and then again if substantial change in the business 2) Intermingling theory- corp treated as sh's personal property;See Walkovzsky. Excessive control-failure to observe formalities ex. draining the profits not treating as sep. entity, same bd. of directors, capital dealings only with parent instead of bank- are formalities observed?sep. books, sep. officers, formal transactions,
3) Instrumentality theory- from Zaist v. Olsen : Rule: three elements of proof: 1)control-complete domination-at no time had a separate mind, will or existence of its own ex. used same office, running the others business 2)control used by D to commit fraud or wrongdoing, violate legal duty ex. look to see if sucked out and then loaned back3)and proximately cause the injury or unjust loss complained of ex. includes placing parents above creditors. Complementing this is the identity rule; unity of interest and ownership that the independence of the corporations had in effect ceased or had never begun ..adhering to separate identity would only defeat justice.Alter ego theory:Minton v. Cavaney. 4) fraud- usu. actions to benefit shareholders over creditors (K or tort) 5) mandated or permitted by legisl statute-circla and superfund statutes environmental 6) mismanagement in excess of simple negligence *Equitable Subordination: Costello v. Fazio, deep rock doctrine- can subordinate parent's claim as creditor to that of other creditors and preferred stockholders b/c of mismgmt. and inadequate capitalization. Same doctrinal basis as that underlying ending the limited liability. ie a misuse of the corp. form. IRS looks closely at privately held corp and recharacterizes debt into equity. Policy: we want the rule to provide incentives to internalize risk. We also want the rule to protect parent/subsidiary relationship b/c it encourages R and D. Also note the difference between Olsen and Walkovzsky -involuntary tort v voluntary contract creditors. But surprisingly, courts are usually more willing to pierce for contract. Ask if the limited liability was used to encourage outside investment. In Olsen it was not. We do not want to hurt wholly owned corp. more than others (intermingling). How to protect the limited liability: -invest with people richer than you, carry adequate insurance, adequate capitalization, get an actuary-don't share offices, phone #s, stationary, -outside board members on parent/subsid.-does better under intermingling and instrumentality theories, bring in outside shareholders-but limits freedom of action, reduce amount of dividends and leave more money in subsidiary, insure that they are separate entities, replace debt with an outside creditor or at least make sure that the interest rate is market rate Statutes: NYBCL: 630----(p.526)top 10 shareholders liable ... CASES: Walkovzsky v. Carlton,1966, p.156 Facts: P tort victim severely injured by cab and sues D to pierce corp. veil back to shareholder who owns to corp. each with 2 cabs and min. $10,000 ins. Held:not fraudulent for P to take out only min. ins., nor to have so many such corp. in order to limit liability. Rejects Ps claims that a single entity(intermingling) and that structure itself is a fraud .But gave leave to amend to prove that D actually did business in individual capacity w/out regard to formality. Ct.Reas.: Mangan case did not apply b/c it was piercing it horiz. not to shareholders; P did not go after other cabs b/c also inadequate capitalization;Cannot state any principled reason why following the statutory min. is not enough.An actuary would be no better b/c still the "best" amt.Dissent:public policy b/c D was not a small shareholder, was vested in public interest,
insufficient capital to meet needs likely to arise, but allows limited lability in corp. if funds have dwindled b/c of economic hard times- even if mgmt. is to blame for dwindling funds. Discussion: no better argument to hold liable if sole shareholder b/c then just puts added pressure on sole business. Student suggested we bankrupt the co. Zaist v. Olsen, 1967, p.166 Facts: Olsen held controlling stock in Olsen, inc and East haven. East Haven contracted with other corp to erect shopping centers and paid contractors with funds from other Olson Corp out of bank loans secured by mortgages on tracts. Held: for P that East Haven was an instrument of Olsen and Olsen, inc. It was the manner in which he utilized them. Discussion: even if Olsen had hired a CEO to control he'd still be liable but what is complete dominion? It would protect him to bring in other officers and shareholders or bd. of directors. East Haven gained nothing and Olsen was making the money. Ct alluded to syphoning out of funds. Minton v. Cavaney, 1961, p.170 Facts: D is Seminole who conducted a public swimming pool in which P's daughter drowned. P sueing to pierce corp. veil to D, Cavaney, who was director, secretary, treasurer and atty. Seminole had used Cavaney's office to keep records and receive mail. Held: that P alter ego doctrine can apply to both tort and contract claims, and that P could be held personally liable but remand so that D can be a party and defend self. Dissent:disagrees and says D failed to be alter ego, instead he was just practicing law. 2 part test:1)inadequate capitalization and 2) active participation of D MORAL: do not as lawyer put your name on board of new corp. Discussion: how much capital would have been enough since this corp. was only in existence for 4 months, but capitalization must be adequate form the start.-risk allocation at the time of set up. Costello v. Fazio, 1958, p.178 Facts: p is a trustee who sues three Ds. Ds were partners in corp who made initial capital contributions. When they decided to incorp., they all withdrew all but $2000 and then recharacterized the rest as debt (demand notes payable whenever- today IRS would have forced him to pay interest). Then two years later they filed for bankruptcy. CPA said that the corp was inadequately capitalized. Held: they undercapitalized (Scott disagrees b/c they had 46,000 and all other $), acted in violation of their fiduciary duties for own personal benefit. Test: is whether the transaction can be justified within the bounds or reason and fairness and that fraud is not an essential ingredient. The fraud was in action to the detriment of the present or future creditors. Equitable subordination - not piercing the corporate veil. News:RJR is intending to reduce ownership of food to 81% and thereby est. market price for food to prove it is undervalued. Then it will spin off the 81% it owns to its shareholders and RJR will own tobacco. It will only do this if it will not cause investment grades to drop. It is doing this to prove to a court down the line that it was adequately capitalized at the time of the spin off in case Ps sueing tobacco and claim inadequate capitalization. This saves the food. If franchisors are liable for their subsidiaries it will cause a restructuring
J. Allocation of Power Between Management and Shareholders Statutes: Delaware: 141-(p.147) Bd. of Directors -(a) managed by or under a bd. of directors (c)-committees (d) directors may be divided into one or more classes..and a share of stockholders can have the right to elect one or more... (h)can fix compensation of directors ..(k) can be removed with or without cause by a majority of shareholders unless cert.. says otherwise, or if cum. voting then only if vote otherwise enough to remove. RMBCA 8.01(b)---(p.302)-All corp powers shall be exercised by or under authority....board of directors 8.08---(p.305)-Removal of Directors by shareholders- (a)with or without cause unless cert....and then limits that (b) if elected by a certain class can only be removed by that class (c) if cumulative voting ...or if not...(d) can be removed at a special meeting called for that purpose. 8.09---(p.305) -Removal of director by Judicial Proceeding (see next section for how Board votes -8.20(b), 8.24, 8.21) NYBCL 701--(p.527)-same but must be 18 years old. 706--(p.528)(a) default is removal of director with cause only, but (b) allows cert. of incorp. or by laws to allow without cause & (c)sets normal requirements Discussion: *It has changed and now the board rarely performs mgmt. or policy making functions. In closely held it is the owners-mgrs who manage. Today the executives have the main mgmt. function. *Control of Corp: 1)board of directors2)group of shareholders- owners w/limited mgmt. control- only residual component- elect and remove directors- sale of subst. assets, mergers, dissolution, consolidation, charter amendments, authorization of new classes of stock 3)executives *Inverted pyramid: Executive Officers Board of share Directors holders
This is b/c time constraints, information constraints, and composition constraints make it difficult for the bd. to manage efficiently. *ALI (p.211) sets forth bd's duties to elect executives, oversee conduct, review and approve plans, make recommendations to shareholders, manage business... *In NY, the director should have access to all information, and his intent is irrelevant, but otherwise the cases are split. *B.o.D.- hires/fires officers, decides policies, issues securities, incurs substantial debt on behalf of corp., but limited by statutes, charter, and sometimes by-laws and shareholder's votes. *Different frameworks for Corp.
1) contractual- then the only obligation of directors to shareholders is good faith and can bargain out of (disclosure and insider trading) 2) governmental relationship- then stockholders have certain inalienable rights that cannot be legislated away through charter... 3) fiduciary relationship- principle retains rights that cannot be contracted out of - certain protections- an extreme form of agency relationship (Del 141 -governs board of directors) Cases: Charleston Boot & Shoe v. Dunsmore, 1880 (p.197) Facts:Derivative Litigation. P=manufacturing corp and corp shareholders elected a committee w/ Osgood to do close up affairs. The Ds refused to work with Osgood and then Ds contracted new debts.Held:b/c the statute holds that this part of the business shall be run by bd. of directors, their own limitation is the by laws and cert. and ordinary care and diligence, but they were not bound to work with Osgood because not elected by them. As long as no gross negligence or breach of fiduciary duty, board may make bad judgments. Discussion: if under K model, unless K says otherwise, all must consent to amending the K unless says otherwise in K. Therefore, the shareholders have no claim. Auer v. Dressel, 1954, p.199 Facts: Ps are a majority of stockholders of class A stock. Ps wanted to call a special meeting as the by laws provided that they could. Corp. officer had no discretion. The Ps wanted to vote on resolution, proposal to amend by laws and charter, proposal that stockholders hear certain charges preferred,D claimed he did not know if actual shareholders, but ct. rejects this. Also, D claims not a proper purpose since they could not actually hire Auer. ...Ct decided Ps real purpose was express approval of Mr. Auer. Held: For Ps, that they have a right to call the meeting. At least they have the right to meet and effect votes. Since these stockholders have the right to elect 9 directors and remove them for cause, it is reasonable that they amend by laws so that they can elect their replacements. Discussion: the K theory does not work with removal of directors b/c its remedy is specific performance. Note: Del 141(k) now allows for removal without cause. Campbell v. Loew's Inc, 1957, p.202 Facts: P claims that shareholders have no power to remove directors even for cause Held: stockholders have such powers, but that the Ps have a right to be heard Gerard v. Empire Square Realty Co., 1921, p.224 Facts: P sued related corp for breach of employment K. Corp. shares were owned by 5 directors. Evidence that each separately agreed to hire P, but no meeting was held. Held: Corp was liable to P b/c otherwise traps the unwary. Discussion: Should always include in an employment K that the signature represents consent as member of the board. Under Del, RMBCA, NYBCL all require written consent. The conception of a meeting is important b/c can reveal new info. No proxies are allowed for the board of directors. Hypothetical: if 5 directors and 3 agree to hire x but the other 2 will not meet, should the statute be disregarded and uphold K? Policy- if protecting stockholder's expectations that the directors
will only act in their best interest than probably do not overrule statute. but if protecting legit expectations of employee...?However, 3 is a quorum and therefore, K is upheld under statute b/c no notice req for regular meetings unless charter sats otherwise.Cont. in next section.
K. Action by the Directors Statutes: Del 141---p.147(b)--one or more members unless cert. of incorp. says otherwise, it must be a fixed number in by-laws, but may be amended. Quorum=majority of total directors, but may be changed in by laws unless cert. says otherwise, but it cannot be less than 1/3. A majority of the quorum shall be an act of the board..(f)action may be taken by board members outside meeting if all or the committee consent in writing...(i) conference phone is ok.. 229---(p.185) Waiver of noticeRMBCA 8.2--(p.307) Meetings, 8.21---(p.307) Action Without Meeting, 8.22---(p.308)Notice of Meeting-special meetings require 2 days notice, but need not specify purpose, 8.23---(p.308) Waiver of Notice, 8.24---(p.309) Quorum and Voting- it is a maj of fixed number of directors or a set number, but can set in article of incorp or by laws if less but cannot be less than 1/3. Book Discussion: Validity of Action is covered by: meeting, notice, quorum and voting. Today in general, most courts do hold informal but explicit approval by all of the directors to be effective as in Gerard.(p.225) Will probably also be treated the same if a majority of the bd. knows and silently acquiesces (p.227) Policy: designed to protect parties who deal in good faith with a close corp. However, if a majority approve explicitly or through acquiescence, but the rest do not know, then some courts might not hold the corp. liable. Discussion: Notice: notice is not required for regular meetings, but it is for special meetings. Is vote effective: 1)is a quorum present? (check by laws and articles to see what a quorum is) 2)was there notice? 3) did a majority of those present vote in favor? If all yes, then the vote is valid. Policy: 1)whose interests are represented and endangered 2)delaying with a corp is common today and courts are less reluctant to say you should have asked for authority 3)did P know entity was a corp? Should P have known?who in corp knew or should have known? or acquiesced? 4)practicality-how feasible was it for corp to act? 5) look at equity- did corp receive benefits? Exceptions: conference call meetings, unanimous written consent, equitable remedies
L. Action by Officers Delaware 142---(p.150) Officers- (a)such titles and duties as set forth in by laws and/or resolution...(b)such
terms as set forth in by laws...and hold office until successor... RMBCA 8.4---(p.316)Required Officers-(a)officers set forth in by laws or appointed by Bd. of directors in accordance with by laws (b) officer may appoint one or more assistants if authorized by laws or bd. (c) requires a secr. but does not call the persona "secr", and (d)this person may hold more than one office 8.41---(p.317)Duties of officers-as set forth in by laws or consistent with them as prescribed by bd. or under direction of an officer authorized by the board Class Discussion: *President has authority to bind in the usual and regular course of business *Apparent Authority: 1) nature of K/type of K - long term or short term 2) usual mgmt. course of business 3) officer involved- position of officer in co 4) size of corp- operational vs. policy distinctions -the larger the K in terms of the size involves policy and therefore requires bd. action. 5) # of stockholders 6) circumstances under which K entered into- does officer usus. enter into these? does corp know? should it/ who is beneficiary of K? 7) reasonableness of K 8) amounts involved *Express statement of Authority : located in statute, cert. of incorp, by-laws, maybe a resolution of bd. of directors(an express grant per particular transaction)- but always just ask the secr. *Implied authority- necessary to carry out express authority *Directors cannot usually bind corp individually by virtue of position- unless explicitly authorized to do so *If advising someone who is entering a K with a corp: best source of authority is real authority-under state laws by-laws are not publicly available, but if traded publicly, then fed. law requires old report but you cannot be sure with this if it is old, also resolutions are not publicly available, therefore, get it from secr a "cert. copy of source of authority". * If authority exists it does not matter if third party knows *if no real authority, turn to apparent authority. Based on reasonable belief of third party. *Issuing stock-without actual authority, only bd. of directors can issue stock b/c in statute you must know. Shareholders must vote to issue a new class of stock, but not to issue stock. *some offices do carry a certain amount of apparent authority -Secretary -lots!frequently a lawyer, takes minutes, cert. copies of by-laws, secr's cert, will bind the corp- usually need at least two officers -one to execute and the other to certify- in Del this is required. Hypothetical: 1)mgr. of delivery- does not require bd. action nor probably CEO 2) general mgr. in charge of principle store base salary 50,000 for 2 years- president might be able to do it- if no actual authority look to see if he'd done it before, and how salary compares to other ... 3) V.P. for Finance- 5 years- high salary, pension benefits and stock options clearly must go to the board b/c of stock options
Cases: Lee v. Jenkins Brothers, 1959, p.228 Facts: P,Lee, sued D to recover Pension payments allegedly due under oral agreement by Yardley on behalf of corp., and for his own account made in 1920. No proof of actual authority. Pension supposed to be payed at the age of 60 whether or not Lee still working there and also personally liable for it. It is a matter of whether Yardley had power to bind the corp. and if this is the ordinary course of business. Held: not a matter of law that Yardley had no authority. Pension plan is ord. nowadays. Ct. Reas.: pres. usually has authority to hire and discharge employees and fix compensation but life time employment Ks are extraordinary Discussion: Judicial recognition of changing business practices. *Pensions were thought to be lifetime Ks which were extraordinary b/c 1)unduly restricts future boards and shareholders 2)subjects corp. to an inordinate amount of liability 3) runs for an indefinite period of time (commercial law loves certainty). *but court found pensions were different b/c a common way to secure employees , therefore, they are now ordinary.
M. Action and Access by Shareholders under State Law Delaware 141(d)-(p.148) allows for staggering of board 211---(p.173)Meetings of Stockholders- (b)annual meeting at time...designated in by laws (c) failure to hold the meeting... (d) special meeting of stockholders may be called by the board or other persons as may be authorized by cert. of incorp. or by laws (e) written ballot unless... 212---(p.174)Voting Rights of Stockholders; Proxies;Limitations (a)one vote per share of stock unless cert. says otherwise (b) proxy is ok but only good for three years unless proxy says more (c) types of proxy that works 214---(p.176)Cumulative Voting-cert. may provide for this- it is total number of stocks x number of officers, and can cast votes any way 216--- (p176)Quorum and Required Vote for Stock Corporations- by laws and cert. of incorp. may specify quorum but may not be less than 1/3 of those eligible to vote. All actions require a maj of quorum except election of directors which is through plurality. May be present in person or by proxy. 219----(p179) List of all Stockholders Entitled to Vote;Penalty for Refusal to Produce-at least ten days prior to every meeting of stockholders- and it will be open to any stockholder if germane to the meeting during ord. business hours at least 10 days prior.. 220----(p.179)Inspection of Books and Records-(a)stockholder of record ...(b)stockholder or atty or agent may upon written demand under oath for a proper purpose which is reasonably related to such person's interest as a stockholder, see a list of stockholders, other books and records, and make copies or extracts therefrom. (c)if corp does not respond within 5 days... see shifting burden of proof once shareholder has complied. NYBCL 609----(p.515)Proxies-(a)may authorize another to act for him by proxy (b) must be signed and is no good after eleven months unless otherwise provided by proxy. RMBCA 7.01---(p.270) Annual Meeting-(a) annually as fixed in by laws (b) if not fixed, then at principal
office (c) failure to do so does not affect validity of corp. action 7.02---(p.270) Special Meeting-(a) may be called by bd. or other authorized person , and by 10% of those shareholders entitled to vote 7.05---(p.272) Notice of Meetings-corp shall notify shareholders of each annual and special at least 10 days but no more than 60days, but only to those shareholders entitled to vote, (b) annual meeting not include a description of the purpose (c) notice of a special meeting must include purpose. 7.22---(p.277)Proxies-shareholder may cast vote through proxy-good for 11 months unless states otherwise 7.25---(p.279) Quorum and Voting Requirements7.27---(p.283) Separate Quorum or voting requirements7.28---(p.284) Voting for Directors; Cumulative Voting-(a)directors are elected by a plurality (b) no right to cumulate unless articles of incorp. say so 8.06--(p.304)Staggered Terms for Directors-if nine or more members may be divided up into groups of 2 or 3. 7.20---(p.274)Shareholders list for meeting-must be available for inspection beginning two days after notice of meeting. 16.01---(p.386) Corporate Records-corp. must maintain... 16.02--(p.387) (a) shareholder may easily get any of 16.01(e)... (b)but must do more to get these documents...(c) requirements to get "b" documents Discussion: *Special Meetings- In Del if the by laws do not allow special meetings, then only board can call a one. But RMBCA also allows 10% of shareholders to call a special meeting.(but NY and Del.do not allow this) -If special meeting, only business explicitly mentioned *Voting- right to vote only for those whose names appear on stock books as owners of stock as of time of record- corp. not bound to recognize new owners if stock has not changed hands, but most stocks are not held by individual but rather by entity so that it can be fungible and quickly traded- ex. "Cede Co" *usually settlement time for business transactions are T+5 but we are moving to T+3 *Proxy- authority for someone to vote for you-last dated and signed proxy is your vote. *Stockholders may vote in own self interest *Bd. Members may not vote in own self interest and therefore cannot give proxy *Cumulative Voting- protection of minority stockholders by facilitating election of directors by less than plurality- (see Del 214) *If representing a shareholder what do you ask for? -prohibit classifying the board b/c it undercuts cumulative voting and cannot require maj. vote for individual directorship b/c of statute- could issue more share(does not require shareholder approval) and that dilutes the minority vote- could create a different class of shares so each class elects different directors- or design it so that proxys through shareholders agreements as a matter of K vote a certain way * can undercut cumulative voting by- repealing, director elected by min. is not part of the board,
reduce the number of the directors *if shareholder is unhappy, can: 1) sell (may not be possible in private corp.) 2) contact corp and see if you can change things-communications office 3) vote for new directors if any are up for new election 4) buy and take over- drastic 5) shareholder derivative suit(class action) 6) contact other shareholders and try to build support but federal restrictions* shareholder access to books and records under State Law: (Del 219, 220 and RMBCA 720, 16.01, 16.02) *Proper Purpose-can always get a list when a meeting is called b/c that is a proper purpose -shareholder derivative suit is always a proper purpose. -in Del developed by case law- a proper purpose can outweigh mixed motive but subject to limitations - summary proceeding may be called -NY limits the number of times per year that a shareholder can inspect -balance right of shareholder with disruption to the business *shareholders do not have authority to make operational decisions but they can affect policy ex. in Matter of Auer *RMBCA balances differently than Del and makes some easier to get and others harder. *if corp. needs time to get in shape, it has only 5 days or it can say no proper purpose but must be made in good faith, can only push administrative arguments so far Hypothetical- insurance co. $5 mil mortgage- requires at least bd. action b/c substantial debt. Rule: if it represents a sale of all or substantially all of assets then it would require shareholders vote ( but board can mortgage to the hilt) Rule: shareholders vote is needed to issue new class of stock but not to issue stock Annual Meeting of Shareholders: required to elect bd. of directorsCases: Bohannan v. Corporation Commission, 1957, p.243 Facts:principle shareholder- claim that the two provisions undercut the other 1)classification of board members 2) cumulative voting. Ps claimed that the staggered board each with a term exceeding 1 year(Del 141, RMCA 8.06), but if a fewer number of seats the more shares it will take to elect one. If staggered and classified the majority will always win. Ps claim they are given a right to proportional voting by cumulative voting. Held: cumulative voting creates a chance not a right. State ex rel Pillsbury v. Honeywell, 1971, p.249 Facts: D, honeywell, was doing defense contracting and making fragmentation bombs. P wanted shareholder list to get support to stop D from making bombs. Held: court denied P access b/c improper purpose- not germane to interest as a shareholder