Law School Outline - Corporations - NYU School of Law- Scott 13

CORPORATIONS Professor Scott Fall 1994 GENERAL NONSENSE I.Corporation - A legal construct; an organization recognized by state law which is entitles to certain benefits A.The corporation has a completely separate existence, creating limited liability for shareholders in the corporation B.Corpoations have a potentially unlimited existence C.Rationale for having corporation is based on efficiency grounds 1.Organized production of goods 2.Organized mechanism for investment/capital formation II.Three models of corporate form A.Contract model -- a series of relationships B.Fiduciary model -- obligations held in trust for others C.Governmental model -- corporation acts as a governmental unit with a series of checks and balances (corporate shareholders vs. directors) III.Public corporation -- a corporation whose shares are traded on a public exchange or NASDAQ IV.Private corporation -- any corporation not public V.Institutional investors -- entities who invest on behalf of others (insurance companies, mutual funds, etc.) VI.Sole proprietorship -- a business owned by one individual VII.Business association -- a network of ownership, agency, and employment Introduction to agency I.Agency law is the legal basis of organization II.Agent -- a person who by mutual assent acts on behalf of another (a principal) and subject to the other's control III.Agency is a default relation at law A.No contract is required B.No intent to create agency relationship is required IV.Principal's intentions determine what other decisions an agent can take--use objective standard; what reasonable person would understand as scope of authority V.Elements required to establish agency: A.Manifestation by the principal that the agent shall act for him B.Agent's acceptance of the undertaking C.Understanding of the parties that the principal is to be in control of the undertaking VI.A principal is liable to a thrid party as a result of an act of the principal's agent if the agent had actual, apparent, or inherent authority, or if the prinicpal subsequently ratified the agent's act. A.Actual authority: authority where principal's words or conduct would lead a reasonable -1- person in the agent's position to believe that the principal had authorized him to so act. 1.Express actual authority: Where principal mintuely specifies what the agent is to do 2.Implied actual authority: Where agent's powers inferred from words used, customs, and from the relations of the parties a.Incidental authority: Authority to do acts reasonably necessary to accomplish an authorized transaction or that usually acoompany it. B.Apparent authority: authority where the words or conduct of the principal would cause a reasonable third party to believe that the principal had authorized the agent to so act. 1.Can be created by appointing person to particular position which carries with it generally recognized duties; to those who know of appointment there is apparent authority to do tasks ordinarily entrusted to one occupying such a position, regardless of unknown limitations imposed upon agent. The scope of such authority is defined by the ordinary habits of persons in the locality, trade, or profession. C.Inherent authority 1.Power of an agent to subject his principal to liability in tort based on activity by the agent within the scope of his employment 2.Authority to take an action that a reasonable person in the principal's position should have foreseen the agent would be likely to take, even though the action would be in violation of the agent's instructions (13). D.Ratification -- even if an agent has neither actual, apparent, nor inherent authority, the principal will be bound to the third party if the agent purported to act on the principal's behalf and the principal, with knowledge of the material facts, either: 1.Affirmed the agent's conduct by manifesting an intention to treat the agent's conduct as authorized (Express ratification) 2.Engaged in conduct that was justifiable only if he had such an intention (Implied ratification); example: principal retains something to which he would not otherwise be entitled E.Actual or apparent authority by acquiescence: if the agent performs a series of acts of a similar nature, the failure of the principal to object to them is an indictation that he consents to the performance of similar acts in the future under similar conditions VII.A principal normally has the power to terminate an agent's authority, even if doing so violates a contract between the parties (Rationale: contracts relating to personal services will not be specifically enforced). VIII.A third party is liable to a principal if the principal would be liable to the third party under the same contract. The major exception is that the third party is not liable to an undisclosed principal if the agent or the principal knew that the third party would not have dealt with the principal IX.An agent is usually liable to the third party unless the principal is bound by the agent's act and was disclosed to the third party (i.e. the agent told the third party he was acting on behalf -2- of a principal and disclosed the identity of that principal). X.If an agent has acted within his actual authority, principal must indemnify agent for payments necessary in executing the principal's affairs. XI.If an agent binds a principal by virtue of apparent authority (and no actual authority), agent is liable to the principal for any resulting damages. XII.Gay Jenson Farms Co. v. Cargill (2) A.Cargill is a buyer who finances a seller Waren's operations (think Cambell's soup and tomato farmers) over a thirteen year period. P is farmers whose contracts went unpaid B.Court finds that by Cargill's control and influence over Warren, Warren had become Cargill's agent, and Cargill was liable for the transactions entered into by Warren. C.Factors indicating Cargill's control: 1.Telephone recomendations -- indicative of a creditor/debtor relationship 2.Cargill's right of first refusal -- demonstrates superior bagaining position 3.Warren couldn't enter mortgages, purchase stock, or pay dividends without Cargill's approval -- negative covenant re-enforces Carill's control 4.Cargill's right of entry for audits 5.Cargill's criticism and correspondence over Warren's finances 6.Cargill's internal memo desiring "strong paternal guidance" 7.Provision of drafts and forms to Warren upon which Cargill's name was imprinted a.If Cargill's name was on Warren's form to Warren's customers, this would clearly create apparent authority 8.Financing of Warren's purchases and operating expenses 9.Cargill's power to end Warrens's finances and operations D.Effect of the decision: 1.Disincentive for buyers to finance sellers out of fear of libility predicated on an agency relationship 2.If you're in this type of relationship you can: a.cut your losses quick -- effectively forcing seller company into bankruptcy b.take total control E.This case might be sui generis -- farmers in the 1981 recession F.Conclusions: 1.Don't have to know or consent to be an agent 2.Third Party is critical to existence of relationship; determines existence and scope of relationship 3.Principal indemnifies agent as long as the agent acting in good faith (here Warren was liable, but was bankrupt agent) 4.So a third party can always sue the agent, the corporation, or both; in this way, a corpoaration is said to indemnify its agents XIII.Restatement (second) of Agency A.§387: Unless otherwise agreed, an agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connect with his agency. B.§388: Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to -3- the principal 1.An agent can retain gratuities received on account of principal's business if because of custom or otherwise, an agreement to this effect is found. 2.An agent who acquires confidential information in the course of his employment or in violating of his dutires has a duty not to use it to the disadvantage of the principal. He also has a duty to account for any profits made by the use of such information, although this does not harm the principal. C.§389: Unless otherwise agreed, an agent is subject to a duty not to deal with his principal as an adverse party in a transaction connected with his agency without the principal's knowledge D.§390: An agent who, to the knowledge of the principal, acts on his own account in a transaction in which he is employed has a duty to deal fairly with the principal and to disclose to him all facts which the agent knows or should know would reasonably affect the principal's judgment, unless the principal has manifested that he knows such facts or that he does not care to know them. 1.If the principal has limited business experience, an agent cannot properly fail to give such information merely because the principal says he does not care for it; the agent's duty of fair dealing is satisfied only if he reasonably believes that the principal understands the implications of the transaction 2.The agent must not take advantage of his position to persuade the principal into making a hard or improvident bargain. If the agent is one upon whom the principal naturally would rely for advice, the fact that the agent discloses that he is acting as an adverse party does not relieve him from the duty of giving the principal impartial advice based upon a carefully formed judgment as to the principal's interests. XIV.Tarnowski v. Resop (16) A.Defendant was collecting secret commissions while acting on behalf of the plaintiff. B.All profits made by an agent in the course of an agency belong to the principle, whether they are the fruits of performance or the violation of an agent's duty, and regardless of whether the principal has suffered any damage or has even profited from the trasaction. C.Principal's ability to recover profits made by agent in course of agency is not affected whether upon discovering fraud the principal had rescinded the contract and recovered his costs. D.Rationale--We allow recovery to compensate actual injury, but to achieve agent's loyalty. E.Rst. Agency § 407(1)--if an agent has received a benefit as a result of violating his duty of loyalty, the principal is entitled to recover from him what he has so received, its value, or its proceeds, and also the amount of damage thereby caused, except if the violation consists of the wrongful disposal of the principal's property, the principal cannot recover its value and also what the agent received in exchange therefore. F.Where the wrongful act of D has caused P to suffer costs, such costs (including attorneys' fees) should be treated as the legal consequences of the original wrongful act and may -4- be recovered from D in damages. XV.Costs of Agency: A.The monitoring expenditures by principal B.Bonding expenditures by the agent--costs of making principal trust you (extra phone calls & non-compete agreements) C.Residual loss--no matter how careful parties are, some decisions the agent makes will not be exactly the ones you would have made; principal bears this loss INTRODUCTION TO PARTNERSHIPS AND LIMITED PARTNERSHIPS I.Revised Uniform Partnership Act A.§202 [at 63] -- Formation of partnership 1.[(a)] An association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership 2.[(c)(1)] Joint or common tenancy, community property, etc. does not by itself establish a partnership 3.[(c)(2)] The sharing of gross returns does not by itself establish a partnership 4.[(c)(3)] A person who receives a share of the profits of a business is presumed to be a partner in the business, unless the profits were received in payment for . . . B.§201 [at 63] -- A partnership is an entity distinct from its partners C.§401 [at 70] -- Partner's rights and duties 1.[(f)] Each partner has equal rights in the management and conduct of the partnership business a.Right to equal management must mean right to information concerning the partnership business, and right to be consulted in partnership decisions. So a majority of parners who made decisions without consulting a minority partner would violate the "equal management" provision absent an agreement to the contrary (37) 2.[(g)] A partner may use or possess partnership property only on behalf of the partnership 3.[(h)] A partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership a.However, courts often find an implied agreement to pay compensation for services (38) 4.[(i)] A person may become a partner only with the consent of all of the partners 5.[(j)] A difference arising as to a matter in the ordinary course of business of a partnership may be decided by a majority of the partners. An act outside the ordinary course of business of a partnership and an amendment to the partnership agreement may be undertaken only with the consent of all of the partners 6.[(a)] {Description of constructive pass-through account for taxation purposes} 7.[(b)] Each partner shall share equally in partnership profits, and shall share in partnership losses in proportion to the partner's share of the profits 8.[(c)] A partnership shall reimburse a partner for payments made and liabilities incurred by the partner in the ordinary course of the business of the partnership or for the preservation of its business or preperty -5- 9.[(d)] A partnership shall reimburse a partner for an advance to the partnership beyond the amount of capital the partner agreed to contribute 10.[(e)] A payment or advance made by a partner which gives rights to a partnership obligation under §401(c) or (d) constitutes a loan to the partnership which shall accrue interest from the date of the payment or advance D.§301 [at 65] -- Partner agent of partnership 1.[(1)] Partnership is bound by acts of partner apparently within ordinary course of partnership's business unless partner lacked express authority and opposing party knew about this. 2.[(2)] Partnership is not bound by acts of partner not apparently within ordinary course of business unless partner had express authority. E.§302 [at 65] -- Transfer of partnership property (sucks ass) F.§303 [at 66] -- Statement of partnership authority 1.[(a)(1)] Must include partnership name, office address, names and addresses of partners or of the agent 2.[(a)(2)] May state authority or limitations on authority of partners 3.[(d)(1)] Will establish express authority unless superceded by subsequent filling or unless 3d party knew to the contrary 4.[(d)(2)] Real property bullshit. 5.[(e)] 3d party is deemed to know of filled authority with resepct to real property 6.[(f)] 3d party is not deemed to know of filled authority for anything else 7.[(g)] Statement is good for five years G.§304 [at 68] -- Statement of denial: Partner may file a statement denying a fact, including a person's authority or status as a partner H.§305 [at 68]: Partnership is liable for loss, injury, or penalty as a result of wrongful acts of partner acting with authority or in ordinary course I.§306 [at 68]: All partners are liable jointly and severly for all partnership obligations J.§307 [at 68] -- Actions by and against partnership and partners 1.[(a)] A partnership may sue and be sued in its name 2.[(c)] A judgment against a partnership is not a judgment against a partner. A judgment against a partnership may not be satisfied from a partner's assets unless there is also a judgment against the partner K.§308 [at 68]: A purported partner is liable to a person whom the representation is made if that person, relying on the representation (unless a public representation), enters into a transaction with the actual or purported partnership L.§103 [at 61] -- Effect of parnership agreement; nonwaivable provisions 1.[(a)] Relations among partners and between partners and partnership are governed by partnership agreement. If silent or non existent, RUPA governs. 2.[(b)] Parnship agreement may not eliminate . . . M.§104 [at 62]: Principles of law and equity supplement RUPA unless displaced N.§403 [at 71]: Partnership shall provide partners and their agents access to its books and records (copy & inspect during business hours) O.§404 [at 72] -- General standards of partner's conduct -6- 1.[(b)] Duty of loyalty to partnership 2.[(c)] Duty of care (no gross negligence, reckless conduct, etc.) 3.[(d)] Obligation of good faith and fair dealing 4.[(e)] Partner may act out of self interest P.§405 [at 72] -- Actions by partnership and partners 1.[(a)] Partnership may sue partner for breach of parnership agreement or for violation of duty to partnership 2.[(b)] Partner may sue (includes accounting actions) partnership to enforce partnship agreement or her rights II.Martin v. Peyton (25) A.A brokerage firm -- K, N & K -- were starved for cash. The firm got a loan from Payton to keep them from going under. The firm would pay out roughly 40% of its profits (subject to minimum and maximum caps) as interest on the loan. Lenders were termed "trustees." They were given: 1.A portion of the firm's securities as collateral on the loan 2.Right to be advised as to the conduct of the business and consulted as to important matters 3.Right of inspection of firm books 4.Right to veto highly speculative business 5.Option to become a member of the firm B.P claims that lenders were sufficiently connected to the business to make them partners. C.A partnership is an association of two or more persons to carry on as co-owners a business for profit. 1.Partnership is a form of agency 2.Partners are fully and personally liable for obligations arising out of the partnership D.Partnership is formed by agreement, express or implied: 1.Written documents, oral testimony, or circumstantial evidence 2.Receipt of a share of the business profits is enough 3.Statements that no partnership was intended are not conclusive. E.Court finds no partnership to exist, because the acts here did not constitute "an association in the business," but only safeguards to interests of lenders. III.Zajac v. Harris A.Basis of the suit is an accounting -- a suit based in equity for a sharing of assets, profits, etc. B.Z claimed that H was merely an employee, given commission based on half the profits arising out of his work, and was not a partner. But H was also given half the profits of Z's work. Those profits cannot be characterized as wages, so court finds partnership to exist. C.Next time, GET A LAWYER to avoid unwanted formation of a partnership. D.Factors in determining partnership: 1.Intent of the parties (not intention to form partnership, but intention to do things in the nature of a partnership) 2.Right to share in the profits 3.Obligation to share in losses 4.Ownership of business assets--but don't need to bring assets to become a partner -7- 5.Management/Control of the enterprise 6.Language of the agreements IV.Summers v. Dooley (33) A.Partner in two person parnership hires an additional employee and sues other parner for pro rata share of salary expense. B.Business differences must be decided by a marjoity of the partners provided that no other agreement between the partners speaks to the issues C.If the partners are equally divided, those who forbid a change must have their way. D.Court finds for D because he continually voiced object to the hiring, and did not sit idly by and aquiesce in the actions of his partner. V.Each partner is individually liable to a parnership creditor for partnership obligations. As between the partners, however, each partner is liable only for his share of a partnership obligation. VI.Owens v. Palos Verdes Monaco (39) A.Issue--was one partner's signature alone (parner F) sufficient to bind the partnership (this is an authority question). B.RUPA §301 -- actions taken by one parner in the ordinary course of the partnership's business bind the remaining partners. No express authority is needed. C.Express authority is required where the partner's acts fall outside of the usual course of the parnership's business D.Scope of partnership's business depends on conduct of partnership and partners and what they cause third persons to believe about authority of partners. If third party observes business which appears consistent with existence of agency, and the third party was justified in believing, then within scope of partnership. E.Here the third party always took reasonable care as to whether or not F had authority. F.Acts not in scope of usual course of business: (44) 1.Disposing of business' goodwill 2.Doing any act which would make it impossible to carry on the ordinary business of a partnership. G.Some states have provisions under their statute of frauds that where a contract that must be in writing is made by an agent, both the contract and the agent's authority must be in writing to be enforceable against the principal. H.Course of business of other firms in the same locality and line of business may be evidence of partner's authority because narrower rule imposes undue burden on third party to learn habits of a particular firm (Crane). I.Expansion of list of acts which partners have no apparent authority to reflect modern business practices: (47) 1.Filing for bankruptcy 2.Pledging assets for money borrowed 3.Pledging substantially all of the assets of the partnership. 4.Sale of all or most of partnership's assets 5.Merger or joint venture w/another entity 6.Relinquishment of partnership opportunity -8- 7.Change of name 8.Sale of partnership goodwill 9.Any action apparently not for carrying on the business of the partnership. VII.Partners have a fidicuciary duty towards one another A.This duty is higher than the normal duty of loyalty B.Minimizes agency costs -- imposes legally enforceable standards of behavior, thus principal need not monitor as much (less monitoring costs) VIII.Meinhard v. Salmon (56) A.Meinhard and Salmon were "co-adventurers" for a hotel. Meinhard fronted half of the capital and received a share of the profits, while Salmon had all management resposibilities. B.Lease on hotel was to expire in April of 1922. Salmon accepted a proposal to fund a project which would demolish the hotel after April and would raise a new building. Salmon accepted this proposal w/o informing Meinhard C.Although Meinhard was just an investor and could not have done this on his own is irrelevant: 1.The proposal can be seen as an extension of the lease. Meinhard would have reasonably believed Salmon would seek to extend the hotel's lease. Salmon failed to disclose opportunity of the new project to Meinhard, thus not giving him a chance to compete or bid for the other proposal (must act open and fairly with other party to whom fiduciary tie is owed) 2.It was reasonable for Meinhard to rely on Salmon to find out this type of information because Salmon's control and exclusive powers of direction charged him with a duty of disclosure, since only through disclosure could opportunity be equalized. 3.Salmon learned of the proposal in his capacity as a manager of the hotel. D.This is easy case b/c with these three things together, the law imposes a duty ot do something and here he did nothing. E.Fiduciary model of relationship is exceptional. Most often, the contract (arms-length bargaining) model is used. Fiduciary duty requires selfless dealing. It was used here because of Salmon's management control. IX.General Parnership (legal fallback position) A.Management rests equally in all partners B.No free transfer of interests (under RUPA, unanimous vote required) C.Full personal liability D.Death, bankruptcy, or resignation of one partner disolves the partnership 1.Partnership can be reconstituted 2.Dissolution process is called "winding up" X.Uniform limited partnership act (ULPA) A.§101 [at 110] -- Definitions 1.[(7)] Limited partnership means a partnership having at least one general and one limited partner B.§201 [at 112] -- Certificate of limited partnership 1.[(a)] Must have: partnership name, office address, name and address of agent for svc of -9- process, name and address of each general partner, latest date on which partnership dissolves 2.[(b)] Limited partnership is formed upon filing with Sec. of State, but can be delayed as stated in certificate C.§302 [at 116] -- Parnership agreement may grant limited partner the right to vote on any matter, subject to §303 D.§303 [at 116] -- Liability of limited partner to third parties 1.[(a)] A limited partner is not liable for the obligations of a limited partnership unless he is also a general partner, or in addition to the exercise of his rights and powers of a limited power, he participates in the control of the business. However, if the limited partner participates in the control of the business, he is liable only to persons who transact business with the limited partnership reasonable believing, based upon the limited partner's conduct, that the limited partner is a general partner. 2.[(b)] A limited partner does not participate in the control of the business simply by doing . . . XI.Limited Parntership A.At least one general partner and one limited partner B.Must be expressly created; formal document -- certificate of limited partnership C.Limited partners have the advantage of limited liability and pass through of losses in exchange for limited management rights 1.If a limited partner has enough managment power, the entity will revert to a general partnership XII.Limited Liability Companies A.This new form was designed to combine the benefits of partnership (pass through of losses for tax shelters) with the benefits of being incorporated (limited liability) 1.Taxes a.Partnership is not taxed as an entity; individual partners are b.Corporations pay taxes directly c.So shareholders of corporations get socked with double taxation (once as profits to corporation, and again on the dividend) 2.Pass through of losses in partnerships creates tax shelter possibilities. One's tax desires influence the form of business one uses. 3.Corporations have limited liability B.Limited liability companies have a corporation as a general partner C.So LLC is an incorporated limited partnership 1.allows for general partners to manage with limited liability while treated like partnership for tax purposes. 2.Mainly used for small enterprises and startups as a means of acquiring venture capital. Corporate statutes are moving toward greater flexibility. 3.But if LLC goes public then taxed as corp, but will have freely transferrable interests. D.IRS will treat an entity as a corporation for tax purposes if it has at least 2 of the following attributes: 1.Perpetual life 2.Free transferability - 10 - 3.Centralized Management 4.Limited liability E.-- General partnerships have none, corporations have all, and limited partnerships have 3 & 4. XIII.RULPA v. Uniform Partnership Act: (89) A.Settling of accounts after dissolution 1.UPA--claims by creditors who are also partners rank below those of other partners. (§ 40(c)) 2.RULPA-- §804 during dissolution assets first distributed to creditors including partners. B.Dissolution 1.UPA--Death, bankruptcy, or resignation of one partner disolves the partnership 2.RULPA--Death, bankrupcy, or resignation does not cause dissolution if the certificate of limited partnership permits the business to be carried on by the remaining general partners and they do so. C.Transferrability 1.UPA--general partner can assign interest, but rights of assignee are severly limited. 2.RULPA-- limited partner can transfer interest and assignee can substitute as limited partner if cerificate of limited partnership so provides (§19). THE DECISION TO INCORPORATE I.Imporant attributes to consider in determining the form of the entity: A.Limited liability 1.Sole proprietors and general partners are personally lible for obligations that arise out of the conduct of their business 2.Shareholders of a corporation and limited partners are not personally liable for the corporation's debts B.Free transferability of interests 1.Shares of corporate stock and ownership of a sole proprietorship are freely transferable 2.Partnership interest cannot be transferred without unanimous consent of the remaining partners, unless the partnership agreement otherwise provides C.Sources of capital 1.Public ownership is best facilitated by either corporations or limited partnerships D.Continuity of existence 1.Sole proprietorship has no legal existence apart from its owner 2.General partnership is dissolved by death or bankruptcy of parner, etc. 3.Existence of a corporation is perpetual unless a shorter term is stated in the certificate of incorporation 4.Limited partnerships: a.Death or bankrupcy of a limited partner will not cause dissolution b.Death or bankrupcy of a general partner will not cause dissolution if the agreement permits the business to be carried on by the remaining general partners E.Management structure 1.A shareholder in a corporation can act as an officer or director (and can therefore participate in the control of the corporation) without becoming individually liable for the corporation's obligations - 11 - 2.General partner has control, but is always liable for partnership obligations 3.Limited liability partner has little control, otherwise, she losses limited liability status F.Cost and simplicity 1.Organizing a corporation or a limited parnership is complex; it requires attorney services, filing fees, and generally sucks ass. 2.Sole proprietorship or general partnership can be organized and maintained with little or no formalities or filing fees. G.Tax considerations 1.Sole proprietorship and all parnerships have flow through of profits and losses 2.Corporations have double taxation on dividends ORGANIZING THE CORPORATION I.Where do I incorporate? A.Franchise fees 1.Wherever a corporation does business, it must pay a franchise fee as a "foreign" corporation 2.Small companies will incorporate in its "home" state in order to minimize fees. B.Choice of law 1.A corporation's internal affairs are governed by the law of its state of incorporation 2.Deleware is a popular state to incorporate because: a.Managers decide where the corporation will incorporate and Delware's law is titled to favor managers b.It has an ununsually well-developed case law in the corporate area that assures reliability. II.Deleware provisions A.§101 [at 135] -- Incorporators; How Corporation Formed; Purposes 1.[(a)] Corporation is formed by filing certificate of incorporation with Secretary of State 2.[(b)] Corporation may be incorporated any lawful business or purposes B.§102 [at 136] -- Certificate of Incorporation; contents 1.[(a)] Certificate must have 1) name of corp [see restrictions] 2) name & address of in- state agent 3) purpose [can be general] 4) total # of shares and par value (and # of classes if applicable) 5) name & address of incorporators 6) [optional] name & address of inital directors until sucessors are elected 2.[(b)] Certificate may have . . . 5) dissolving date 6) denial of limited liability to shareholders C.§103 [at 139]: All instruments before board is named shall be signed by incorporator; thereafter chariman of the board, VP, etc., and attested by the secretary 1.[(d)] Existence of corporation can be delayed up to 90 days D.§106 [at 141]: Corporation exists when certificate is filed with Sec of State, subject to §103(d) E.§107 [at 141]: Until directors are elected, the incorporator shall manage the affairs of the corporation and may do whatever is necessary and proper to perfect the organization of the corporation F.§108 [at 142]: After the filing of the certificate, an organization meeting of the incorporators (or initially named directors) shall be held to adopt by-laws, elect directors to serve until first annual meeting, and doing any other acts to perfect the - 12 - organization of the corporation G.§109 [at 142]: The original by-laws of a corporation may be adopted, amended, or repealed by the incorporators or board before a corporation has received any payment for any of its stock. Thereafter, the power to adopt, amend, or repeal by-laws shall be in the shareholders, unless otherwise states in the certificate. By-laws may contain any provision not inconsistent with law or the certificate of incorporation. H.§152 [at 158]: Board decides the value of consideration for stock. Consideration must be in the form of cash, services rendered, personal property, real property, leases of real property, or a combo I.§153 [at 158]: Par value is the minimum stock must origianlly sell for. It is determined by the board, or shareholders if the cert of incorporation so provides. III.Rmbca provisions A.§2.02 [at 239]: Articles of incorporation must set forth 1) name [See restrictions at §4.01] 2) # of authorized shares 3) address of office & agent 4) name and address of each incorporator. It may include initial directors . . . B.§2.03(a) [at 241]: Corporate existence begins upon filing unless delayed C.§2.05 [at 244]: Meeting of the incorporators (or initially named directors) shall be held to adopt by-laws, elect directors to serve until first annual meeting, and doing any other acts to perfect the organization of the corporation D.§2.06 [at 245]: Incorporators or board of directors shall adopt initial bylaws. By-laws may contain any provision not inconsistent with law or the articles of incorporation. E.§1.20 [at 233] -- Filing requirements 1.[(f)] Document must be signed by 1) chairman, pres, or another officer 2) an incorporator; or 3) a court-appointed fiduciary 2.[(g)] The person signing shall state beneath his signature his name and the capacity in which he signs. May contain attestation by secretary, etc. F.§6.21 -- Issuance of shares 1.[(b)] Board may authorize shares for consideration. Consideration can be tangible or intangible property or benefit to the corporation: cash, promissory notes, services performed, K for services to be performed, or other securities of the corporation. 2.[(c)] Board determins value of consideration 3.[(a)] Art may confer these powers to shaerholders IV.Captial Structure A.Short term debt B.Long term debt C.Equity 1.Common stock (voting instrument) 2.Preferred stock V.Qualities of stock A.Voting privileges B.Transferability C.Capital appreciation - 13 - 1.Participation in growth 2.Cash in hand (Dividends) D.Residual claim (1st - preferred stock, 2nd - common stock) E.Par value 1.Means nothing 2.Originally was an attempt to protect creditors; par value is the minimum value that must be left in the corporation 3.Del §153(a) -- Stocks cannot be issued below par value 4.Principle function of par value is an accounting value (amount to put in the stated capital account) 5.Where board issues "no par value" stock, board still must determine allocation into stated capital acount; if no allocation is made, ALL value goes into the stated capital account F.Common stock 1.Voting 2.Sharing in growth G.Preferred stock 1.Protection against insolvency (preferred claims settled before common claims) 2.Dividends a.Limited dividends b.Stated dividends (but no enforcement mechanism) (1)Cumulative (accrued liability for unpaid preferred dividends must be satisfied prior to declaring dividends on common stock) (2)Non-cumulative (3)Stated dividend stock usually does not have voting rights VI.Qualities of debt A.Stated rate of interest (fixed or floating) B.Maturity date (although some are "demand" notes) C.Principle amount D.Debt payments are deductible to the corporation (but IRS may reclass heavily debted company as equity-held) E.No growth potential VII.Hierarchy of corporate documents A.Statute B.Certificate of incorporation 1.What are the provisions so central to the business that they should not be changed? 2.Hard to amend 3.Usually very vague -- contains minimum required by statutes and things that are necessary to function and make deals 4.Publicly available C.Bylaws -- Day-to-day procedures; not publicly available VIII.Certificate of incorporation (also known as "charter" or "articles of incorporation") A.Corporate existence is usually established upon the filing of the certificate of incorporation - 14 - (Del §106) 1.But establishment can be delayed (Rmbca §2.03) B.Naming the corporation -- Del §102(a)(1); Rmbca §4.01 1.Contact the secretary of state of the state in question and reserve the name (usually effective for 30-60 days) C.Number of shares and par value -- Del §102(a)(4) 1.Low # of shares and amend later as necessary a.Filing fee varies with # of shares authorized b.But shareholders must approve the authorization of additional shares 2.High # of shares a.Allows the corporation to use the shares as "currency" D.All statutes prove for the allowance of a super-majority voting provision within the charter E.Purpose clause 1.Deleware only requires a general purpose clause -- Del §102(a)(3) 2.Rmbca does not even require it -- §2.02(b)(2)(i); §3.01(a) IX.Organizational meeting of the corporation A.Once the corporation is underway, its board of directors is elected by shareholders. But there can be no shareholders until stock is issued, and the function of issuing stock is normally committed to the board. So: 1.The incorporators have the powers of shareholders and directors unless initial directors are nomed in the certificate of incorporation 2.If initial directors are named in the certificate of incorporation, then functions of the incorporators pass to the directors when the certificate is filed and recorded. X.Ethics -- single attorney representation in corporate formation A.Are YOU satified that there are no conflicts? B.Is each party individually satisfied with single-attorney representation after being given full disclosure of the potential conflicts at hand? C.One attorney can save costs and reduce adversarial nature of negotiation. But this might sacrifice individual interests of the incorporating parties. INTRODUCTION TO VALUATION AND THE EFFICIENT MARKET HYPOTHESIS I.Efficient Market Hypothesis: A.Security prices constitute the "best estimate" of the returns of each security B.Prices are efficient in two senses: 1.Current price of security best predicts its future price 2.The market immediately assimilates new information into the price C.So there should be no way to achieve superior rate except by chance because everyone has equal information. But information is not perfectly available: 1.Informations costs 2."Insider" access D.Market efficiency exists only because competition is keen and portfolio managers are doing their job - 15 - II.Methods of valuing a corporation: A.Market price: price per share x number of shares outstanding B.Capitalization of prior earnings (backward looking valuation) 1.Estimate expected income by averaging past earnings 2.Determine a P/E ratio (risk adjusted rate of return) by looking to P/E ratios of similar industries. 3.Multiply the two together C.Discounting Future Cash Flows (forward looking valuation) 1.Present value of estimated future receipts (adjusted for risk) 2.Estimated salvage value D.Net asset value: the whole = the sum of its parts III.Principles of Corporate Finance A.A dollar today is worth more than a dollar tomorrow because of interest B.NPV = FV / (1+r)n - Investment C.A safe dollar is worth more than a risky one D.Return = profit - investment / investment E.Strategy: 1.Accept investments that have positive net present values 2.Accept investments that offer rates of return in excess of their opportunity costs of capital. IV.Piemonte v. New Boston Garden Corp (1094) A.Case involved a merger; constitutent shareholders of the subject corporations must vote in favor of the merger. 1.Generally 51% of shareholders must approve the merger for it to go forward 2.At common law a unanimous vote was required. The appraisal remedy was a compromise; dissenting shareholders had the right to be cashed out at "fair value" (see Del §262; Rmbca §13.01) B.So here the issue is how to determine the fair value of the corporation C.Valuation is not finite due to uncertainty; valuation of a company as a liquidated concern is different from valuation as a going concern. D.Here the Court uses the Delaware Block method to value the corporation 1.Determine value based on: a.Market price; b.Earnings; and c.Net asset value. 2.Determine the value of the corporation by assigning a proportional weight to each of the value determinations above. E.So when is market value suspect? 1.Thinly traded securities a.Less people so less information is assimilated into price b.Less information is circulated because there is less public interest as a whole in the company 2.Control blocks a.Potential for "oppressive" behavior (i.e. declaring 0 dividends) b.Informational advantage over the market - 16 - c.Elimination of a "control premium" in market price d.Timing -- merge when market is "in a slump" e.But initial buying price of the security was probably lower due to all this; so why should we allow a shareholder to get an extra benefit F.Earnings valuation 1.In an efficient market, market price already accounts for earnings value a.But markets may value earnings industry-wide, as opposed to by company 2.Control block can manipulate and reduce earings (large salaries, capital expenditures, dividends.) 3.Past earnings may not be a good indicator of future earnings 4.Choice of P/E ratio or multiplier seems random -- inevitable battle of the experts G.Net asset valuation 1.Book value -- sucks, but at least its there 2.Appraisal value 3.Replacement cost H.Assigning a weight to the components: Before weighting values one must decide what interest you are really valuing 1.Willing buyer/willing seller; investing value a.Is there a minimum level of market activity? b.Which sales price (i.e. when?) 2.Property-based valuation a.A valuation of the proportionate ownership rights, including the right to control timing of investment b.This favors earnings value, with a minor emphasis on net asset value 3."Particular facts" valuation a.What did this particular shareholder lose? I.Bottom line is that "fair value" may not always be "market value." 1.Market value may undervalue because of loss of timing and informational advantage of control block. 2.But property and particular facts valuations may overcompensate; if we compensate for other than market value, we may be compensating for psychological injuries. 3. So fair value may be conceptualized as a fiduciary penaly. J.Why go private if you have a control block? 1.Reporting expense 2.Fact of reporting requires release of information 3.Litigation risks 4.Tax/Estate planning V.In re valuation of common stock of McLoon Oil Co. (Handout) A.Going private transaction between family brats B.P claimed that court erred in its valuation by failing to apply minority and nonmarketability discounts in determining the fair value of the dissenting shareholders' stock. C.Fair value is defined as the shareholder's proportionate interest in a going concern D.Court rejects minority discount argument. New test is: - 17 - 1.What is the best price a single buyer could reasonably be expected to pay for the firm as an entirety? 2.What is the dissenter's pro rata share of that amount. E.Dissenters should also be entitled to compound interest on the amount (254). ULTRA VIRES I.Generally (Del §124 [at 145]; Rmbca §3.04 [at 247]) A.Ultra vires literally means "beyond its powers" (not the same as illegality) B.Act is void if it is beyond the scope of activities corporation is authorized to engage in (i.e. the purpose clause in its charter). C.Original rationale: Doctrine protects the shareholder from unanticipated and unsanctioned activities of the corp. (control mechanism over corp.) D.Modern policy has shifted: now statutes favor protection of third parties as more important than protection of shareholders 1.We want people to be able to rely on deals they have made with corporations 2.Most corporations now use a "general purpose" clause in their charter E.Corporate waste doctrine still remains--unreasonable expense of corporate funds for non-corporate goal is void F.Corporation may no longer use the claim as a defense and a third party may no longer use it as a sword to get out of agreements. But several actions still remain: 1.Shareholders can bring action to enjoin performance of ultra vires contract: a.Performance must not yet be completed b.All parties must be present before the court *** c.Court must find it equitable to set aside contract d.Compensation is granted to other party of agreement *** 2.By corp. against officers or ex-officers and directors a.Based on fiduciary notion b.Can be personally liable for damages brought to corp. for ultra vires acts 3.By attorney general a.Can bring ultra vires action to dissolve corp. or enjoin it b.Remnant of public control of corp.--certain activities corp. can't do such as become an insurance co. or agent II.Goodman v. Ladd Estate (112) A.A court may set aside and enjoin the performance of the ultra vires if it deems such a course equitable. B.The statute says the agreement is enforceable even though ultra vires, and to accept P's argument that it is ultra vires and therefore inequitable would be to effectually emasculate the statute. C.If a shareholder himself has participated in the ultra vires act he cannot thereafter attack it as ultra vires. This is emphatically so of a shareholder who exercises the entire voting power of the corporation. III.Inter-Continental Corp. v. Moody (114) A.A defense of ultra vires by the corporation is barred under the statute even if the third party - 18 - actually knew that the corporation lacked authority to enter into the transaction. B.A shareholder can intervene to enjoin an ultra vires act even if he has been solicited to do so by the corporation, provided the shareholder is not the corporation's agent. C.Then if stockholder is entitled to some relief, the other party will not receive the full amount of the note, but only to the extent that the stockholder is held not to be entitled to relief. *** IV.Kings Highway Corp. v. FIM Mariner Repair (115) A.Ultra vires may not be invoked as a sword in support of a cause of action any more than it can be utilized as a defense. OBJECTIVES OF THE CORPORATION I.Why people are suspicious of corporations A.Perpetuity -- go on forever B.Size -- huge accession of capital C.Lack of accountibility of owners; they don't suffer the consequences of their decisions II.General corporate objective is to maximize corporate profit and shareholder gain -- but over what time frame? A.Markets are obsessed with short-term results B.Management tries to maximize its own compensation (think ISOs), so it also attempts to maximize profits in the short term C.It is easier for markets to value short-term rather than long-term plans D.This goes against research and development, and long run efficient allocation of resources III.The "wall street" rule is no longer good because of institutional investors A.Size of portfolios are expanding B.Less companies are publicly trading C.Size of holdings with the corporations are large D.Legal requirements on institutional investors to substantially diversify and to invest in "investment grade" securities IV.Relational investing -- if you can't beat 'em, join 'em: A.But sitting on the board creates liability based on fiduciary responsiblity, so take conservative stance to reduce risk 1.Example: during the 1980's some pension funds resisted takeovers because of the interests of employees who might be laid off. SEC said feduciary duty is to maximize returns B.Insitution may however have social interests to further C.Interest in executive compensation V.A.P. Smith Mfg. Co. v. Barlow (115) A.Facts--stockholders questioned corporation's donations to Princeton. B.Common law--those who managed a corp. could not disburse any corporate funds for philanthropic or other worthy public cause unless the expenditure would benefit the corporation. C.This was because corps. made up such a small part of country's wealth that the rule did not significantly interfere with the public interest. Today the wealth has been - 19 - transferred from individual entrpeneurs to dominating corps., and courts have begun liberally interpreting the common law rule broadly to enable corporate donations with indirect benefits to the corp. D.Holding--corporate power to make reasonable charitable contributions exists under modern conditions, even apart from express statutory provision. The legislative enactments simply constitute helpful and confirmatory declarations of such power, accompanied by limiting safeguards. VI.Dodge v. Ford Motor Co. (1372) A.Ford stopped paying out "special dividends" so that it could "employ still more men; to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their homes." B.The Dodge brothers brought an action to compel Ford to pay a dividend of 75% of its cash surplus and to enjoin the expansion of Ford's Motor facilities. C.The Court required that Ford declare 50% of its cash surplus as dividends. "A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end and does not extend to a change in the end itself, to the reduction of profits or to the nondistribution of profits among stockholders in order to devote them to other purposes. D.The Court did allow the expansion of the company to continue because "the ultimate results of the larger business cannot be certainly estimated." VII.Del §122(9) and Rmbca §3.02(13) allow for charitable donations. Allthough these provisions do not explicitly incorporate a limit or reasonableness, the commentators generally agree that such a limit is to be implied. VIII.ALI Principles §2.01 -- The objective and conduct of the corporation A.A corporation should have as its objective the conduct of business activities with a view to enhancing corporate profit and shareholder gain. B.Even if corporate profit and shareholder gain are not thereby enhanced, the corporation, in the conduct of its business: 1.Is obliged, to the same extent as a natural person, to act within the boundaries set by law; 2.May take into account ethical considerations that are reasonably regarded as appropriate to the responsible conduct of business; and 3.May devote a reasonable amount of resources to public welfare, humanitarian, educational, and philanthropic purposes. C.Comment g: Compliance with legal rules. It is sometimes maintained that whether a corporation should adhere to a given legal rule may properly depend on a kind of cost-benefit analysis, in which probable corporate gains are weighed against either probable social costs, measured by the dollar liability imposed for engaging in such conduct, or probable corporate losses, measured by potential dollar liability discounted for likelihood of detection. Section 2.01(b)(1) does not adopt this position. With few exceptions, dollar liability is not a "price" that can properly be paid for the privilege of engaging in legally wrongful conduct. Cost-benefit - 20 - analysis may have a place in the state's determination whether a given type of conduct should be deemed legally wrongful. Once that determination has been made, however, the resulting legal rule normally represents a community decision that the conduct is wrongful as such, so that cost-benefit anaysis whether to obey the rule is out of place. ROLE OF PROMOTERS I.Generally A.A promoter is a person who transforms an idea into a business capable of generating a profit, who brings and holds together the persons needed, and who superintends the various steps required to bring the new business into existence. B.Del §152(1): Promoter's services are lawful consideration for shares. C.Rmbca §2.04 [at 242]: All persons purporting to act on behalf of a corportion knowing there was no incorporation under this act are jointly and severally liable for all liabitilites created while so doing II.RKO-Stanley Warner theatres, Inc. v. Graziano (131) A.A promoter will be held personally liable on contracts made by him for the benefit of a corporporation he intends to organize. B.This personal liability will continue even after the projected corporation is formed and has received benefits unless there is a novation or other agreement to release liability C.Here agreement was silent as to whether promoter was to be released from personal liability after corp. formation; so court used principle of interpretation that where there are two reasonable interpretations, courts construe most strongly against the drafter. D.Other rationales: 1.Preferred construction of K is a rational construction: people won't contract with a "nothing" 2.Promoter is better to assume the risk of loss E.A contract made by a promoter, even though made for and in the name of a proposed corporation, in the absence of a subsequent adoption (either expressly or impliedly) by the corporation, will not be binding upon the corporation. III.Quaker Hill, Inc. v. Parr (136) A.If the contract is made on behalf of the corporation, and the other party agrees to look to the corporation and not to the promoters for payment, the promoters are not personally liable B.Here the new corporation was never formed C.Quaker Hill's knowledge that there was no corporation, coupled with their insistence that the contract be made in the name of the proposed corporation, led the court to conclude that they assumed the risk of that the new corporation would eventually be formed. IV.R2d of Agency § 326: When a promoter makes an agreement with another on behalf of a corporation to be formed, the following alternatives may represent the intent of the parties: A.They may understand that the other party is making a revocable offer to the non-existent corporation which will result in a contract if the corp. is formed and accepts the - 21 - offer prior to the withdrawal (this is the normal understanding) B.They may understand that the other party is making an irrevocable offer for a limited time. Consideration to support the promise to keep the offer open can be found in an express or limited promise by the promoter to organize the corporation and use his best efforts to cause it to accept the offer. C.They may agree to a present contract by which the promoter is bound, but with an agreement that his liability terminates if the corp. is formed and manifests its willingness to become a party. There can be no ratification by the newly formed corp. since it was not in existence when the agreement was made. D.They may agree to a present contract on which even though the corp. becomes a party, the promoter remains liable either primarily or as surety for performance of the corporation's obligation. V.D.A. McArthur v. Times Printing Co. (137) A.P claims that corporation would bound by a contract which hired him as an employee for one year. Corporation argues that there was no formal action to adopt the K (it was actually signed by a promoter) and that it violated the Statute of Frauds. B.Where a contract is made in behalf of, or for the benefit of, a projected corporation, the corporation, after its organization, cannot become a party to the contract by ratification of it. 1.Rationale is that the corporation's action could not relate back to the date of the agreement because it was yet not in existence at that time C.But the corporation may, after its organization, make such engagements its own contracts. 1.It may do this precisely as it might make similar original contracts; formal action of its board of directors being necessary only where it would be necessary in the case of a similar original contract. D.Here the court inferrs adoption of the contract based on: 1.Knowledge of the contract by all stockholders, directors, and officers of the corporation. 2.Failure of anyone to object to or repudiate the contract 3.Actual retaining of plaintiff in the employment of the company E.As for the SOF, court construes the contract as starting on the date of adoption (or in this case, the date the corporation was formed) F.Employment contracts are favored in the law VI.Theories for holding the corporation liable on a contract signed by a promoter A.Ratification 1.Based on agency theory 2.Principal can always ratify agent's acts even if they were not originally authorized 3.Ratification relates authority back to the time of signing 4.So many courts avoid ratification for promoter activities on grounds that relating back would bind the corporation before it even existed B.Adoption 1.Conceptualization of K as a continuing offer to join on the K whenever the coroporation adopts it 2.Adoption does not end promoter's liability - 22 - 3.Adoption can be accomplished by: a.Formal action b.Failure to act with inferred knowledge C.Assignment and assumption 1.Still will not release promoter 2.Requires the consent of the third party D.Novation (substitution of corporation for promoter in all respects) 1.Works like a new contract 2.Releases promoter 3.Requires consent of the third party E.Third party beneficiary F.Alter-ego theory G.Quantum meruit (unjust restitution) -- corporation should pay reasonable amount for benefits enjoyed/retained H.Estoppel/reliance VII.Lawyering A.Use explicit language concerning the fact that the corporation is not yet formed & express negation of liability for promoter 1.But without mutuality of obligation, there is no contract B.Use the corporate form of signature (i.e., Mandler Corp, by R.M., President) C.Make it an option contract DISREGARD OF THE CORPORATE FICTION I.Incorporation statutes establish limited liability for shareholders as a "default" (Del §102(b)(6); Rmbca §6.22(b)) II.Justifications for limited liability: A.Without limited liability, equity investors would demand a risk penalty 1.Compare with debt holders, whose obligations are fixed by contract B.Limits investment decision to merits of the company, not relative wealth of shareholders 1.Equalization of share prices 2.Facilitates capital markets a.Lowers transactions costs of raising capital b.Creates standardized prices C.Allows corporations to externalize costs (permits more risky activity) D.Lowers "monitoring" costs by shareholders of the corporation and of other shareholders E.Facilitates diversification of assets III.Justifications for piercing the corporate veil: A.Undercapitalization B.Intermingling 1.Where corporation is treated as individual's property 2.This is an equity concept; The intermingler fradulently represents to others that the corporation is separate from himself or from a different corporation C.Fraud -- "Milking" the corporation; notions of equity - 23 - D.Legislative piercing (i.e. Federal environmental statutes, NYBCL §630 -- shareholder liability for wages to employees, etc.) IV.Walkovsky v. Carlton A.P hit by cab in NYC. Cab is owned by corporation whose total assets consisted of two cabs subject to mortgage and insured with stautory minimum of $10,000. D is principal shareholder 10 such corporations with identical assets. B.P sues under theories of undercapitalization and a control-type theory (see below). Majority rules for D. C.Mangan precedent: in Mangan the corporate veil was pierced horizontally to combined separate corporations into one entity. But this is not what P was seeking here: 1.P was seeking to pierce vertically 2.P was seeking to pierce to a shareholder and not to another corporation a.Question here is whether "the stockholder is carrying on the business in his personal capacity for purely personal rather than corporate ends." [Intermingling] b.Court reject liability based on claims that the shareholder "organized, managed, dominated, and controlled a fragmented corporate entity." D.Court rejects undercapitalization theory on the grounds of the minimum insurance statute. 1.BUT see 174 -- courts should proceed on the assumption that the underlying legislative policy contemplated more than nominal capitalization, but declined to specify precise amounts because the figures would vary in relation to the nature and size of the business E.Existence of competing values (dissent)--there are policies so strong they overcome corporate form; here policy of providing recovery for negligent acts of others overcomes corporate form. F.Keating's (dissent) test--a particpating shareholder of a corporation vested with a public interest, organized with capital insufficient to meet liabilities which are certain to arise in the ordinary course of the corp's business, may be held personally responsible for such liabilities. Where corporate income is not sufficient to cover the cost of insurance premiums above the statutory minimum or where initially adequate finances dwindle under the pressure of competition, bad times or extraordinary and unexpected liability, obviously the shareholder will not be held liable. G.But the language of this test is unclear. What is meant by participating shareholder or vested with public interest? H.Dissent also implies these are bad acts: 1.Incorporating intentionally for limited liability--but this is primary purpose for doing business as corp. so can't be true 2.Boils down to insurance coverage--only taking out the stautory minimum I.To pierce veil in this case, court would have to explain why the corporation was not entitled to rely on the statute which was a legislative decision for public safety. J.Key is that there is limit to how far we want corp. to go? (here there is element of bad faith which makes it harder not to pierce--he did this intentionally) K.Policy of limited liability is weaker with sole shareholder, but the veil is almost never pierced - 24 - to shareholder in public corporations 1.Piercing the corporate veil is a fraud-based concept. shareholders have neither the access, not the control to be acting fradulently. L.Problem with Keating's exception is that it seems to based on wealth--where income is insufficient to go beyond minimum, no liability M.Piercing is a separate issue than a decision of liability: 1.First decide if corporation is liable 2.Then decide whether can pierce N.Shareholders can protect themselves from veil piercing by: 1.Seeking other rich shareholders 2.Consulting an actuary V.Zaist v. Olson (166) A.Olson owned several corporations, two of which were East Haven and Olson Inc. P's are contract creditors of East Haven. East Haven was builder and Olson Inc. owned the land. East Haven defaulted, so P sued Olson Inc. and Martin Olson (personally) for balance of money. B.Court found for P on instrumentality theory: 1.Corporation is a mere instrumentality or agent of another corporation or individual owning all or most of its stock. 2.There must be such domination of finances, policies, and practices that the controlled corporation has, so to speak, no separate mind, will or existence of its own and is but a business conduit for its principal. C.But this is always the case with sole shareholders, so there must be more, or it would eliminate limited liability for solely owned corporations D.Elements of instrumentality theory: 1.Control must be complete (domination) -- so corp has no separate existence of its own 2.Such control must be used to commit fraud or wrong 3.Fraud must have been proximate cause of injury E.Identity rule: If P can show that there was such a unity of interest and ownership that the independence of the corporations had in effect ceased or had never begun, an adherence to the fiction of separate identity would serve only to defeat justice and equity by permitting the economic entity to esape liability arising out of an operation conducted by one corporation for the benefit of the whole enterprise. F.On its face, the structure in this case does not suggest fraud--good tax and business reasons for separating builder and landowners, so complete dominion is something more than owning all the stock. G.Reasons for piercing the veil: 1.Olson had complete domination of East Haven and Olson Inc. 2.All corporations shared the same office 3.Benefit of P's work was ultimately retained by Olson and Olson Inc. 4.Little or no formal action by the boards of the corporations 5.East Haven gained nothing from whatever part is play in the transaction. H.Court says East Haven gained nothing, but it was not losing money -- only breaking even. - 25 - There is signifcant difference from breaking even and running corp. which continually incurs losses because losses indicate a bigger scheme (i.e., a tax shelter) is going on. I.One claim by company is that they did not know they were dealing with a corp. because they dealt with Olson himself. However, this is weak because dealt with East Haven and received corporate checks for 5 years. J.Difference between Zaist and Walkovsky is in the plaintiffs. Walkovsky was an involuntary creditor, while here it is voluntary contract creditor--here P should bear risk because can protect himself, but the cases come out the opposite way. In fact, in general, contract creditors more often are able to pierce. K.Now the question most often arises in parent-subsidiary situation--should it be easier or harder to pierce in this case? L.Reasons for having a subsidiary: 1.Separate functions for adminstrative ease 2.Control many businesses with minimal capital investment 3.Comply with various legal requirements 4.Minimize or insulate certain assets from liability (massive tort suits) 5.Allow more risk taking in R&D. 6.For tax purposes (most important) M.But limited liability exists to protect passive equity investors--don't want to encourage those who control to be free from liability, only passive investors who have no control. We have to decide if these rules go beyond risks we want to encourage; is it fair to externalize risks and place them on helpless individuals as in Union Carbide case? N.Safest way to insulate subsidiary is to put in more capital than you deem adequate and then have no say in how business is run. 1.No identity between your board and officers and their board and officers. 2.Give some stock to others 3.Figure out how much capital you need and double it 4.But the more you do this the less business sense it makes. You can substantially minimize the risk of veil piercing, but never eliminate it. O.The key is: at what point does your control become so great that we will make you liable in damages for this action? P.What about franchise liability? 1.This is contractual relationship. 2.But does it also constitute agency? If so, court would redefine business relationship. VI.Minton v. Cavaney (170) A.P's daughter in pool and brought action against corp. which it couldn't satisfy, so now suing estate of director of corp. B.This case was decided on undercapitalization theory. Here the corporation was undercapitalized from the get go. Adequate capitalization is capital which covers reasonably forseeable obligations as they arise in the course of business C.D actively participated in conduct of the business. He was: 1.Secretary and treasurer of the corporation - 26 - 2.Director 3.Entitled to receive one third of the shares to be issued D.Dissent--he was just acting as attorney and allowing use of his office, and this should not constitute active particiaption, but it did E.Lawyering: Don't go on board of directors when client invites you! VII.Some contract creditors should be treated as involuntary (i.e. tort creditors) because practically they are not in a position to select whom to contract with or to discover their financial condition. A.Creditors lacking bargaining power B.Employees C.Consumers D.Homeowners dealing with contractors E.Utilities (required to provide services to all) VIII.Undercapitalization generally needs to be combined with other factors constituting misuse of the corporate form before a court will pierce the corporate veil. IX.Time at which capitalization should be measured A.At the beginning period of corporate existence: 1.A corporation formed with adequate capital will not subsequently be rendered undercapitalized, so as to impose shareholder liability or require subordination of shareholder loans, merely because the business sufferes losses 2.But were a corporation that was initally underfinanced subsequently becomes adequately capitalized either trough additional shareholder contributions, or as a result of business sucess, limited liability should attach. B.When a corporation subsequently expands the size or nature of its business, with an attendant increase in business hazards. X.Truckweld Equipment Co v. Olson (177) A.Although there may be situations in which a corporation is so thinly capitalized that it manifests a fraudulent intent, we do not find such to be true in the case at bar. B.Olson acquired Aztec when it was financially troubled; he was not the original incorporator and he sought only to improve Aztec's profit picture. XI.Equitable Subordination: A.It is solely a bankruptcy or receivership doctrine, limited to denying or subordinating a claim of a shareholder or control person to the claims of other creditors. B.Similar to denial of limited liability because it requires a misuse of the corporate form. 1.Fraud or other wrongdoing 2.Mismanagement in excess of simple negligence 3.Undercapitalization 4.Commingling of funds and properties 5.Failure to develop the subsidiary into an independently profitable business, and/or an overdependence of the business of the bankrupt upon that of the claimant 6.Excessive control, indicated by a failure to observe the formalities of separate corporations C.When no misuse of the corporate form has been found, a shareholder is entitled to assert his claim against the corporation the same as any other creditor. - 27 - D.Any claim by a shareholder arising out of loans or advances will be subjected to rigid scrutiny, and as in cases of personal shareholder liability, inadequate capitalization is considered one of the most important factors of misuse which may result in subordination. E.It is much less drastic than personal shareholder liability. Here only takes an investment already made and denies it status of an outside creditor's claim, and does not affect one's personal assets. XII.Costello v. Fazio (178) A.This was general partnership which decided to incorporate to reduce liability. B.F originally had capital of $43,000, A had capital of $6,500, and L had capital of $2,000. This capital was recharacterized so that each had $2,000 of capital, with the remainder appearing as non-maturing, non-interest demand notes. C.This was done to equalize management as in previous partnership. Way to equalize management in corp. is to give all parties equal shares. Two yeras later filed for bankruptcy. D.Court subordinated F's debt to that of the other creditors. E.Court claims that inadequate capitalization led to business failure, but this is bullshit. No money was ever removed from the corporation; the only change was on paper. F.Court also claims that F was acting primarily for his personal benefit. But equalizing capital of the corporation is the proper way of equalizing control (but different classes of stock could have been used instead). G.Here court didn't pierce veil--F was ultimately successful in limiting his liability; he didn't lose his personal assets. XIII.Parent-subsidiaries and bankruptcy: A.Absent a factor of misuse of corporate form, the claims of parent and affiliated corps. must be allowed to compete with claims of outside creditors for the assets in bankruptcy. The relationship between claimant and bankrupt is not enough, by itself, to overturn the normal consequences of separate corporate status. B.Criticisms: 1.Since owners of the enterprise are concerned with maximizing return on their investment commensurate with the desired risk, any loan to the subsidiary must be designed to maximize overall profits and thus is inherently more like risk capital than ordinary debt, and should not be given equal status with ordinary debt. 2.Since the enterprise owner is concerned with maximizing return on his entire investment, decisions regarding the operation of the subsidiary will be made with that goal in mind, not with a view to ensuring that the subsidiary will function as a viable corporate entity. Thus since the parent has not used its control in the best interest of the subsidiary it should not be given equal status. ALLOCATION OF CORPORATE POWERS I.Generally A.Management structure of corporations is an inverted pyramid - 28 - 1.Shareholders -- limited power to interfere in corporation's conduct 2.Board of directors -- makes policy and selects officers 3.Executive officers -- run the day to day management B.There are several matters on which shareholders must vote: 1.Election of the board of directors (and sometimes removal) 2.Organic changes (mergers, consolidations, dissolutions, sale of assets) 3.Charter amendments (ceiling on number of shares, and authorization of classes of shares) 4.By-law amendments (sometimes) C.The board of directors decide: 1.Matters of "policy" 2.Hiring, supervising, and firing of executive officers 3.Securities and debt matters a.Issuing b.Declaring dividends D.Limitations on the board: 1.Corporate by-laws 2.Shaerholder votes E.Models of corporate governess 1.Contractual model--you can bargain out of certain provisions a.BUT if relationship between directors and stockholders is wholly contractual, then you should be able to bargain for right to use inside info. So this model has limited value 2.Quasi-governmental--certain provisions cannot be legislated away. 3.Fiduciary model--principal retains certain enforceable rights at all times. The beneficiary is assumed to be at a disadvantage, so the dependent party is given certain protections which cannot be bargained away. II.Statutes A.Del §141(a)--The business and affairs of every corporation shall be managed by or under the direction of the board of directors (these can be amended in certificate of incorporation) B.Rmbca §8.01(b)--[Same schpeel] III.Charstown Boot & Shoe (197) A.Shareholder derivitive suit against directors for harm to corporation -- Shaerholders voted to choose a committee to act with the directors to terminate the corporation. The directors of the Corporation refused to cooperate with the committee head appointed by the shareholders. The Court denied relief. B.Corporate by-laws and votes may define the business, its nature and extent, prescribe rules and regulations for the government of its officers and members, and determine whether its business shall be wound up or continued. C.But the business thus defined and limited is to be managed by its directors, and by such officers and agents under their direction. The shareholders may not compel the directors to act with one who is not a director. D.Contract model: bylaws and charter constitute contract. Where a hundred people sign a - 29 - contract, the hundred's consent is needed to amend E.Directors are answerable for ordinary negligence in the management of the business, but are not liable merely for poor business judgment. F.Lawyering: Shareholders could have accomplished their objective by voting for a new board of directors IV.Auer v. Dressel (199) A.Article I of corporation's by-laws requires President to call special meeting whenever requested to do so by a majority of stockholders. B.55% of shareholders signed petition requesting such a meeting, but President refuses to call one on two grounds: 1.President claimed insufficient information to know whether stockholdings on petition were accurate. Court easily rejects this. President could have easily found this out if he wanted to 2.Shareholders did not allege a proper purpose for such a meeting C.Plaintiffs assert four purposes: 1.Vote upon resolution to endorse Auer, who had just been removed as president, and to demand his reinstatement 2.Resolution to amend charter and by-laws to provide that certain vacancies on the board be filled by a specified class of shareholders 3.Vote on charges against four directors, vote upon their removal, and vote for the election of their successors 4.Vote to amend by-laws to increase quorum D.Court rules that stockholders have no right to reinstate Auer as President -- they do not have power to hire or fire executives -- but they may express themselves on the matter and put the directors on notice as to what they want. Court allows everything else. E.Charter specifically authorizes the board to remove directors on charges. Yet the Court finds that shareholders empowered to elect directors have the inherent power to remove them for cause. 1.Court's reasoning: If this avenue were not available, shareholders would be without remedy in a case where a majority of the directors were accused of wrongdoing and would be unwilling to remove themselves from office. F.What model of rights is the court using? 1.Under the contractual model, court would be interpreting the language of the charter. But typical remedies are damages or specific perf. Court decision allows for future removal w/o going to court, so this isn't the model. 2.Agent/Principal model--Under pure agency law, agents are removable by principals at any time. Directors can be conceptualized as agents and shareholders as principals. But if this is true shareholders could also remove without cause, so this isn't the model either. V.Campbell v. Loew's Inc. (202) A.Stockholders have the power to remove a director for cause. B.A director sought to be removed for cause must be afforded an opportunity to present his case - 30 - to the stockholders before they vote. VI.Removal of directors A.Under the common law: 1.Shareholders can remove a director for cause 2.Shareholders cannot remove a director without cause, absent specific authority in the charter or by-laws 3.The board cannot remove a director with or without cause a.It is doubtful whether the charter can change this rule 4.Cases are split on whether a court can remove directors for cause B.Del §141(k): Generally, any and all directors may be removed with or without cause by a majority of shareholders entitled to vote at an election of directors. C.Rmbca §8.08 1.Shareholders may remove one or more directors with or without cause unless the charter provides that directors may be removed only for cause 2.If a director is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove him. 3.If cumulative voting is authorized, a director may not be removed if the number of votes sufficient to elect him under cumulative voting is voted against his removal. If cumulative voting is not authorized, a director may be removed only if the number of votes cast to remove him exceeds the number of votes cast not to remove him. 4.A director may be removed by the shareholders only at a meeting called for the purpose of removing him and the meeting notice must state that the purpose, or one of the purposes, of the meeting is removal of the director. VII.Rationale for not allowing shareholders to manage the corporation A.Statute (ipse dixit!) B.Shareholder action would be "cumbersome" C.Informational advantage of the board D.Efficiency of process ACTION BY DIRECTORS I.Deleware provisions A.§141(b) [at 147]: 1.Quorum = 51% of total directors unless greater # in cert or bylaws a.By-laws may lower this to 1/3 of total directors 2.Vote required = 51% of attending directors unless cert or by-laws require a greater vote B.§141(f): Unanimous written consent can be used to act without a meeting C.§141(i): Board can meet by telephone D.§299: Notice can be waived in writing before or after a meeting & attendance at a meeting constitutes a waiver unless the director attends merely to protest against holding the meeting II.Rmbca provisions A.§8.20(b): Meeting can be conducted through any means of communication capable of - 31 - simultaneous hearing B.§8.21: Unanimous written consent can be used to act without a meeting C.§8.22: No notice is required for regular meetings; notice is required special meetings but need not include purpose unless required by art or bylaws D.§8.23: Notice can be waived in writing before or after a meeting & attendance at a meeting constitutes a waiver unless the director attends merely to protest against holding the meeting E.§8.24 [at 309]: 1.Quorum = 51% of total directors unless greater # in cert or bylaws a.Art or by-laws may lower this to 1/3 of total directors 2.Vote required = 51% of attending directors unless art or by-laws require a greater vote III.Formalities required for action by the board: Basic model A.Meetings 1.Directors can act only at a duly convened meeting at which a quorum is present 2.Directors have no power to act on the corporation's behalf except at such a meeting B.Notice 1.Formal notice is not required for a regular board meeting (since it is regular, directors already know date, time, and place) 2.Special meeting requires notice. Notice need not include the purpose of the meeting unless the charter or by-laws require C.Quorum: Majority of the authorized # of directors -- not a majority of directors then in office, which may be less than the authorized number because of board vacancies D.Voting: Assuming a quorum is present, the affirmative vote of a majority of those present (not a majority of theose voting) is required. IV.Explicitly approved variations A.Meetings 1.Telephone 2.Unanimous written consent, without a meeting of any kind. a.Act of meeting is important in board decision-making because it fosters debate and scrutiny b.A director opposed to an action that is proposed to be taken by unanimous consent may compel the holding of a meeting simply by withholding consent. B.Notice 1.Notice can be waived in writing before or after a meeting 2.Attendance at a meeting constitutes a waiver unless the director attends merely to protest against holding the meeting C.Quorum 1.Charter or by-laws may require a greater number for a quorum than a majority of the full board 2.Charter or by-laws may set a lower number, but not less than one-third of the full board D.Voting 1.Charter or by-laws can require a greater-than-majority vote for board action V.Consequences of noncompliance A.In a publicly held corporation, failure to comply will all formality will usually render board action ineffective. - 32 - 1.Deliberative model is a surrogate for the legitimate expectations of shareholders. B.In closely held corporations, where formalities are seldom followed and the shareholders tend to make their own rules, the results of a failure to observe proper formalities are much less clear-cut. C.Unanimous informal approval 1.Gerard v. Empire Square Realty Co. (224) a.P alleged breach of employment contract. b.Corporations' shares were held by five persons, all of whom were directors. They hated each other and refused to hold formal meetings. c.Each director had separately agreed to hire plaintiff. d.Court binds corp. because it would be unfair to P otherwise (i.e. P's reliance). 2.Shareholder acquiescence model -- corporation should be bound where all the shareholders have acquiesced, in their directorial or shareholder capacities, either to the transaction or to a practice of informal action 3.Today many cases involving unanimous informal approval fall under the statutory rule that such approval is effective if it is in writing. But results are split: a.Some cases argue by negative implication that courts should not give effect to informal unanimous approval not in writting b.Other cases argue that intent of such statutes is to protect persons dealing with a corporation, and have held the corporation bound by unanimous oral consent D.Unanimous acquiescence is generally treated the same as unanimous informal approval (227) E.Marjority acquiescence -- where majority of directors either approve of a transaction (explicitly or by acquiescence), but the remaining directors lack knowledge of the transaction, cases are split (228). VI.Attacking board action problems A.Who is represented? Whoses interests are at stake? B.Sophistication of parties/knowledge that opposing party is in the corporate form 1.As corporations become more common, less reliance is allowed C.Notice to relying party D.Notice to corporation (i.e. members of the board) E.Practicality -- bias against making corporations unworkable F.Equities -- did the corporation receive benefits? ACTION BY OFFICERS I.Del §142(a): One officer is required to record proceedings of meetings II.Rmbca §8.40(c): One officer is required to prepare minutes of the directors' and shareholders' meetings and for authenticating records of the corporation III.Lee v. Jenkins Brothers (228) A.President has the authority to bind the corporation in transactions that are ordinary (in the usual course of its business), but cannot bind it to extraordinary contracts. B.Pensions are lifetime time contracts and thus are extraordinary, so they are beyond authority of President. Rationales: 1.They unduly restrict future boards and shareholders - 33 - 2.Subject corporation to inordinate amount of liability 3.Run for indefinite period of time C.The board has power to enter into lifetime contracts, even though the officers do not, and even though this would restrict future boards. D.Here, Court realizes that pensions are now different because they have become ordinary even though they are lifetime contracts; they are now a normal part of business compensation E.Factors for determining an officer's apparent authority: 1.Nature of the contract (its type) 2.Position of officer involved 3.The corporation's usual manner of conducting business 4.Size of corporation and # of shareholders 5.Circumstances giving rise to the contract 6.Reasonableness of the contract 7.The amounts involved 8.The nature of the contracting third party F.A president as part of the regular course of business has authority to hire and discharge employees and fix their compensation G.Sources of actual authority: 1.Statute (publicly available) 2.Certificate of incorporation (publicly available) 3.By-laws (Publicly available if public company) 4.Resolution of the board: express statements of authority delegated by the board. They can be broad or narrow (towards one specific transaction). Not publicly available. H.In certain instances a given contract may be so important to the welfare of the corporation that outsiders would naturally suppose that only the board of directors (or even the shareholders) could properly handle it. It is in this light that the ordinary course of business rule should be given its content. I.Beyond such extraordinary acts, whether or not apparent authority exists is simply a matter of fact. J.Bottom line: 1.Jenkins directs lower courts that "times have changed" 2.Notions of authority must be judged by modern day business practice, not common law formalities. IV.Factors indicative of extraordinary action A.Economic magniture of the action in relation to corporate assets and earnings B.Extent orf risk involved C.Timespan of the action's effect D.Cost of reversing the action V.Lawyering: A.Require actual authority by corporate officer 1.Check publicly available documents - 34 - 2.Get documents of corporate authority certified by company secretary B.If authority is present, contracting party is not requried to have knowledge of it C.Apparent authority (through the eyes of the third party) 1.Reaonable belief by contracting party concerning officers authority with respect to the corporation (i.e. not reasonable to believe officer can make K with stock options). D.Range of authority is defined by "position" of an officer. Certain power cannot be delegated (i.e., powers given to the board by statute) VI.Secretary has apparent authority to certify the records of the corporation, including resolutions of the board. Secretary declarations are binding on the corporation even if false. VII.Corporations generally need two officers. An officer could hold more than one corporate position. ACTION AND ACCESS BY SHAREHOLDERS UNDER STATE LAW I.Del provisions A.§141(d): Allows for classification of directors B.§211 -- Meetings of stockholders 1.[(b)] Annual meeting of stockholders shall be held to elect directors on a date designated in by-laws. Any proper business may be introduced. 2.[(d)] Special meetings may be called as authorized by cert or by-laws C.§212 -- Voting rights of stockholders; proxies 1.[(a)] One share = one vote, unless otherwise provided in cert 2.[(c)] Allows proxy voting 3.[(e)] A proxy may be made irrevocable D.§213 -- Fixing the record date E.§214 -- Cumulative voting may be authorized in the cert F.§216 -- Quorum and required vote 1.Quorum = 51% of shareholders entitled to vote unless greater # in cert or bylaws a.Art or by-laws may lower this to 1/3 of those entitled 2.Vote required of proposals = 51% of attending shares unless art or by-laws require a different amount 3.Vote required for dir elections = plurality G.§222(a): No notice is required for regular meetings; notice is required special meetings but need not include purpose unless required by art or bylaws H.§228: If # of written consents from voting stockholders = # votes needed to affirm a proposal at a meeting, such action can be taken without a meeting I.§229: Notice can be waived in writing before or after a meeting & attendance at a meeting constitutes a waiver unless the director attends merely to protest against holding the meeting II.Rmbca A.§7.01: Annual meeting will be called at a time in accordance with bylaws B.§7.02: Special meetings 1.[(a)(1)] Can be called as authorized by art or bylaws - 35 - 2.[(a)(2)] Can be called if 10% of votes entitled to be cast on issue proposed sign demand for meeting and describe the purpose for it 3.[(d)] Only business within purpose in notice can be conducted there C.§7.04: Unanimous written consent to act without shareholders' meeting D.§7.05: Notice for regular meeting must have date time and place. Notice for special meeting must have purpose E.§7.06: Notice can be waived in writing before or after a meeting & attendance at a meeting constitutes a waiver unless the shareholder attends merely to protest against holding the meeting F.§7.07: Record date (see also 7.02(b) & 7.05(d)) G.§7.21: One share = one vote, unless art provides otherwise H.§7.22: Proxy voting I.§7.25: Quorum and required vote 1.Quorum = 51% of shareholders entitled to vote unless art says otherwise 2.Vote required of proposals -> votes cast for > votes cast against, unless art requires a greater number J.§7.27: 1.[(a)] Art may raise requirement for quorum or required vote 2.[(b)] If art requirements for quorum or required vote are amended, required quorum and vote for passage of such amendment is the greater of the old art or the proposed art 3.Art may reduce quorum even below 1/3! (see note 5 at 281) K.§7.28 -- Voting for directors; cumulative voting 1.[(a)] Directors are elected by plurality unless art otherwise provides 2.[(b)] No cumulative voting unless art otherwise provides L.§8.06: If # of directors > 8, staggered terms are allowed III.Generally A.Annual meetings and notice 1.Corporations must hold an annual meeting of shareholders 2.Notice of place, time, and date is required 3.Notice is given to owners of record on a designated record date prior to the meeting 4.Only owners of record as of the record date are entitled to vote 5.Most shares are held in "street name" or nominee accounts -- the physical shares are held by stockbrokers or by a depository (i.e. Cede & Co.) 6.Beneficial Ownership -- right to sell & direct the shares or to receive dividends B.Special meetings and notice 1.Special meetings may be called: a.By the board b.By a certain # of shareholders depending on the by-laws c.When 10% of voting shareholders request one (Rmbca §7.01) 2.Special meetings require notice of place, time, date, and purpose 3.If a proposal is not included in the notice, it is not properly brought during a special meeting C.Quorum (Del §216, Rmbca §7.25, .27-.28) - 36 - 1.Generally, a majority of the shares entitled to vote is necessary for a quorum unless the charter sets a higher or lower figure. 2.The number generally cannot be lowered to less than 1/3 of outstanding shares D.Voting 1.Ordinary matters a.Generally the vote required = majority of shares represented at the meeting b.Charter may be amended to require greater than majority voting 2.Structural changes a.Usually requires approval by a majority or 2/3 of the outstanding voting shares, rather than a majority of those present or voting at the meeting 3.Election of directors a.Usually requires a plurality vote -- those candidates who receive the highest # of votes are elected, up to the maximum number to be chosen at the election, even if they receive less than a majority of the votes present at the meeting b.Some states require cumulative voting in the election of directors 4.Sherholders can vote in their own self interest, board members cannot. E.Proxy voting (Del §212; Rmbca §7.22) 1.A proxy is a limited power of attorney 2.It is a signed and dated authorization for a proxyholder to vote your shares 3.The last, dated, signed proxy is your vote. Proxies are generally revocable, at least with respect to publicly held companies 4.Board of directors may never vote by proxy IV.The mechanics of voting A.Shareholder voting is all about control B.Each shareholder has votes = # shares x # of directors C.Directors are elected by plurality D.Normal voting requires slots tied to directors 1.Example: 10 shares--3 directors Director #1 gets 10, Director #2 gets 10, and Director #3 gets 10 You have a vote for each share for each position; you can vote less than you have, but cannot normally cummulate more than 10 votes for one position. E.Cumulative voting allows you to cumulate votes in whatever combination you chose, while normal voting requires slots tied to directors F.Rationale underlying cumulative voting 1.Protection of minority voters 2.Allows minority to get a voice on the board of directors G.Cumulative voting is not the norm -- it must be specific in the corporation's own laws (charter only!) H.Classification of board members (Del §141(d); Rmbca §8.06) 1.If board > 9 directors, it can have classifications 2.# of classes determines # of directors up for election each year 3.But with less directors, more shares are needed to elect a given director - 37 - 4.Rationale for size requirement is to prevent board of 3 with three classes because then would be one director elected each year and minority could never win. V.Bohannan v. Corporation Commission (243) A.Arizona constitution requires cummulative voting for corporations B.Issue is whether classification of the Board violates the principles underlying cumulative voting. Court says it does not. C.Cumulative voting is not an entitlement to elect minority board members. It only creates the possibility of doing so. So the constitution gives you the right to the possiblity; not to the outcome. D.Other devices to ensure your client has a mangement say if there is cummulative voting: 1.Classify board 2.Can issue more shares--doesn't require shareholder vote; this minimizes effects of cummulative voting because there are more people. 3.Different directors elected by different groups of shares; allowing minority to vote only for certain directors. 4.Make a deal (shareholders agreement)--agree to vote in certain way as a matter of contract (you vote for me & I'll vote for you). 5.Can set up trust and instruct trust to vote in certain way. 6.Can try to repeal it from charter. 7.Can reduce size of board of directors.--may not be able to remove incumbents, but can reduce size (and if majority holder can probably get them to step down) 8.Executive committee--delegate all powers you can under statutes and then don't let member elected by minority on to executive committee. E.What options does a shareholder have under state laws if unhappy: 1.Sell your shares (may be hard or impossible to do in private corps.) 2.Write letters to officers and directors complaining. 3.Run for directorship 4.Take over the corporation 5.Litigation--bring class action or shareholder derivative action. 6.Contact other shareholders -- requires a shareholder list from the corporation VI.Shareholder's right to inspect books and records of the corporation A.State ex rel. Pillsbury v. Honeywell, Inc. (249) 1.P bought shares in Honeywell for the purpose of changing its policy of manufactiruing war munitions 2.P now wants to inspect shareholder list and all corporate records dealing with weapons and munitions 3.Delaware statute requires that the shareholder have a proper purpose germane to his interest as a stockholder in order to inspect corporate records (Del §220(b)) 4.Inspection will not be permitted for curiosity, speculation, vexation, adverseness to management, or a desire to gain control of the corporation for economic benefit. 5.Mere desire to communicate with other shareholders is not a proper purpose; whether or not the purpose is proper depends on the underlying purpose of the - 38 - communication. 6.The power to inspect is the power to stiffle, and thus destory. 7.A proper purpose is related to an economic or investment interest 8.So court would allow inspect if investor were motivated by the short or long term economic effects to Honeywell of engaging in this kind of business. B.Credit Bureau Reports, Inc. v. Credit Bureau of St. Paul, Inc. (254) 1.The desire to solicit proxies for a slate of directors in opposition to management is a purpose reasonably related to the stockholder's interest as a stockholder 2.Any further or secondary purpose in seeking the list is irrelevant 3.Insofar as Pillsbury is inconsistent with this, it is inconsistent with Del §220 as properly applied. C.Del §219(a): Stockholder list shall be open to examination by any stockholder, for any purpose germane to an upcoming meeting, during ordinary business hours, during at least 10 days prior to the upcoming meeting. D.Del §220: 1.[(b)] Any stockholder upon written demand under oath with 5 days notice stating the purpose thereof shall have the right during the usual hours for business to inspect for any proper purpose the stockholder list, its other books and records, and to make copies or extracts therefrom. A proper purpose is one reasonably related to such person's interest as a stockholder. 2.[(c)] If corp. refuses to allow inspect, stockholder can go to Court of chancery for an order. a.For shareholder list, corporation has burden of proving improper purpose b.For other records, shareholder has burden of proving proper purpose c.Court may prescribe limitation or conditions with reference to the inspection. E.Rmbca 1.§7.20: Shareholder can inspect the shareholder list without limitation, but can copy the list only after complying with §16.02(c) 2.§16.01 Sets out books and records that corps are required to keep in accessible form; §16.01(e) governance records must be kept at principal office 3.§16.02 gives access rights a.[(a)] always access to 16.01(e) -- formal actions with written notice within 5 days b.[(b)] other records (accounting records) are not automatically accessible c.[(c)] For records described in (b) must state in good faith a proper purpose, with particularity and describe records with particularity, which must be directly related to your stated purpose 4.So Rmbca splits difference between total access and no access a.Easy access to governance reocrds b.Harder access to financial records F.If you want to wage a proxy fight you need access to the shareholder list: 1.Del §220 -- same requirements; for shareholder lists, need proper purpose, but then burden shifts to corporation to show improper purpose -- shareholders generally have right to it 2.Rmbca §7.20 -- you can inspect but cannot copy unless you meet the standards of 16.02 - 39 - 3.Acquiring the list for sale is not a proper purpose a.But what if mixed motive -- like communicating with other shareholders b.Must ALL motives be proper? c.Under Del law, a proper purpose can outweigh an improper one, but the books and records are protected by quick court actions - 40 -