Corporations Flashcards
Three business forms
– Agency
– Partnership
– Corporation
Agency generally
Simplest form of joint economic organization
– Principal (P) extends range of activity by engaging Agent (A) to
act on her behalf
– Need for extra-contractual (fiduciary) duties to protect P
Agent must act in principal’s best interest, and ALL profits made by the agency are due to the principal (Tarnowski)
Agency formation and termination
Consensual relationship between P granting authority and A accepting responsibility (Rest. (3d) Agency § 1)
Does not require formal agreement—can be entered into inadvertently by “course of dealing”
Either party can terminate at any time
But if the agreement sets a term, then breaching party subject to
damages
Agency Authority (Contract liability)
Actual authority
Apparent authority
Inherent authority
Need to show one of these things to get liability on P for CONTRACTS
No apparent or inherent authority? Go to estoppel and try and make an argument.
Agency authority estoppel or ratification (Contract liability)
Liability even when A’s actions are not authorized by P or within inherent agency power of A
– 3rd party have changed their position to their detriment in reliance on representations made
Alternatively, accepting benefits under unauthorized contract
Respondeat superior
P typically liable if A is employee, not general contractor
– I.e., master/servant relationship can trigger vicarious liability for torts
Ability of P to control A’s actions as proxy to differentiate between employee and general contractor
– Can argue financial responsibility as proxy for control
Agent Liability in Torts
Apparent authority
– P liable for intentional tort when acts on P’s behalf with apparent authority to do so
– E.g., Corporation (P) can be liable if CEO (A) makes fraudulent misstatement
Inherent authority: analogize to respondeat superior?
Actual authority
– Does not apply in the sense that P would not authorize A to commit tort
– However, can analyze actual authority given to A to assess respondeat superior liability (e.g., employee or contractor)
Agent’s Duties
Overarching concept: any legal power A has over the property and affairs of P has the sole goal of advancing the aim of the relationship which provided this power
Agents as fiduciaries
not bright-line rule
Duty of care: to act as a reasonable person would (water down by BJR)
Duty of loyalty: to advance the purposes of the beneficiary, not one’s personal benefit (strong duty)
also
Duty of good faith and duty of candor: more problematic
no real Duty of Obedience left
Actual authority (Agency)
that which reasonable person in A’s position would infer from P’s conduct
– Can be express (directions) or implied (pattern of behavior)
Apparent authority (Agency)
that which reasonable 3rd party would infer from P’s conduct
–(Signed document with P’s letterhead)
Inherent authority (Agency)
that which reasonable 3rd party would infer from A’s conduct
– Not conferred by Ps; rather, imposed on Ps by law
– Not included in Rest. (3d) Agency
General Partnership
personal liability for partners,
cannot modify fiduciary duties,
no claims on partnership assets
Joint Ownership
Joint ownership allows partners to pool capital
• “Exchange co-ownership for capital”
Limited partnership
limited partners share in profits, but enjoy limited liability
– General partner has unlimited liability (can be circumvented)
– Limited partners share in profits, but are not active
– Limited partners enjoy limited liability
– Contractual flexibility to eliminate fiduciary duties
– Registration at state level
Formation and Fiduciary Duties (general partnership)
General partnership can be inferred without formal agreement
(E.g., receipt of profits as prima facie evidence of partnership)
Once partnership is inferred, fiduciary duties emerge
“the punctilio of an honor the most sensitive, is then the standard of behavior.”
Dieckman v. Regency GP LP (DE 2017) (fiduciary duties)
– GP tries to merge 2 LPs that it controls => conflicted transaction
– Partnership agreement provides for approval by either independent committee or unaffiliated unitholders
» But Court says neither safe harbor available because committee conflicted and GP made
false statements to unitholders
“Covenant of good faith and fair dealing cannot be eliminated by contract.”
Limited liability Company (LLC):
“pass-though” taxation + limited liability
Limited liability partnership (LLP)
• Limit liability with respect to negligence, malpractice, wrongful act or misconduct of another partner or
agent of partnership not under partner’s direct control + contractual debts
• Some states require minimum capitalization or insurance
White v Thomas (agency)
Blank check case
No actual, apparent, or inherent authority to overpay and sell piece of side deal
need a bit more than the most basic apparent and inherent authority
“A purported agent’s claims about his or her authority may be evidence of the existence and scope of apparent authority, but this must be corroborated by outside evidence.”
Gallant v Isaac
Court sua sponte brought up inherent authority (car insurance case)
Humble Oil v Martin (1949) (agency)
Car rolls down hill, gas station liable
Humble claims not liable as they have no authority, independent contractor
Court disagrees,
–> Humble had control over the day-to-day operations (therefore liable)
Hoover v Sun Oil (agency)
Not on the hook this time (distinguish from Humble)
Sun was not in control of day to day operations, it lies with Barone
Not liable
Self Dealing
A trustee who was acting in good faith breaches his fiduciary duty if he engages in self-dealing, even if the trust suffers no injury as a result. (in re Gleeson) (Duty of loyalty)
Two Agent fiduciary duties well-articulated:
Duty of care: to act as a reasonable person would
(Significantly watered down by business judgment rule)
Duty of loyalty: to advance the purposes of the beneficiary, not one’s personal benefit.
Common features among LPs, LLPs, LLCs
• Contractual flexibility
– Preference for detailed ex ante contracting vs. ex-post adjudication
– Statutory permission to contract around fiduciary duties
– Limited liability as default term
» But can opt out of default (e.g., “personal guarantee”)
• Pass-through taxation—assuming ownership interests not public
– Dramatic rise in LLCs since 1997 IRS “check-the-box” rules (i.e., could simply choose to be taxed as partnership)
– As an alternative to LLC, can form corporation and elect pass-through taxation under Subchapter S of Internal
Revenue Code.
» Advantages: easier to convert to C-Corporation; more familiar to public; more legal precedent; possible tax benefits
» Disadvantages: limited to 100 shareholders; shareholders limited to US persons; only 1 class of stock; less flexibility
(e.g., more procedural formality, must distribute income proportionately to investment)
Where are these entities used? (LP, LLP, LLC)
• LP: hedge funds, private equity, venture capital
– Arguably easier to list on exchange than LLC
– LPs recognized by foreign investors
• LLP: law firms, accounting firms, medical practices
– Some states (e.g., NY) allow Professional LLCs (PLLC) and Professional Corporations (PC) which are gaining
popularity
• LLC: other industries (“jack-of-all-trades”)
– DE trying to parallel the lead it has in the market for corporate charters (TBD)
– Might explain its willingness to grant significant contractual flexibility (above)?
Characteristics of corporations
- Artificial legal personality with indefinite life
- Limited liability for investors
- Free transferability of shares
- Centralized management
“Close” corporation
Typically incorporated not to raise capital, but for tax and liability purposes
– Shareholders tend also to be directors & officers (e.g., family members)
– Might restrict transferability of shares
“Controlled” corporation
Shareholder (or group of shareholders) controls the corporate machinery (e.g., appointing majority of board, access to
confidential information, relative shareholdings)
– Controller need not necessarily be majority shareholder (TBD)
Corporation modern formation
File charter (“articles of incorporation,” “certificate of incorporation”) with state
Secretary of State—minimal requirements, typically:
– Name and purpose of corporation
– Incorporators and board
– Address; if necessary, Registered Agent
– Capital structure (number of shares x par value/share)
• By-laws not filed
– Operating rules—e.g., board committees and quorum, responsibilities of officers
Basic concepts of corporations
Law of state where incorporated governs “internal affairs” of corporation
Shareholder vote required to amend charter; relative power of board vs. shareholders to propose or modify by-laws remains contentious (e.g., DGCL § 109 vs. § 141)
Shareholder agreements allowed (e.g., ability to buy or sell shares, voting)
– Typically arise in close or controlled corporations
“Veil” of limited liability
shareholders (investors) cannot lose more than they invest
Plus side:
– Creditors cannot seek personal assets
– Decreases need to monitor management and other shareholders
– Allows investor to diversify among investments (e.g., high vs. low risk)
Lack of creditor protection
• Creditors must contract ex ante to protect themselves
• Involuntary creditors (tort victims)?
Transferable Shares concept
Managers can continue to run corporation even as share ownership changes
• Otherwise, credit rating of firm would change every time shares transferred
– Listing on capital markets becomes possible
• Access to capital
• But threat of possible takeovers
– Default provision: can restrict by contract
• E.g., shareholder agreement to limit ability to buy or sell shares in close corporation
Board of directors basics
to mediate between shareholders and management
• Board represents corporation => all shareholders
Board of directors typical responsibilities
– Appoint, compensate, remove officers
– Declare and pay dividends
– Monitor and approve management decisions
– Make major business decisions
– Initiate and approve extraordinary corporate transactions (TBD)
Board of directors importance of formal process
– Board can act only at duly constituted meeting
Board members cannot act alone. Board members are still agents however. But only can make decisions if they follow proper process at a duly constituted meeting.
» Some states allow action without formal meeting if unanimous
consent
– Delegation to committees and sub-committees
– Use of outside experts
Cycle of board and management
Shareholders (P) elect–> Board (A) appoint –> Management (A)
Management (A?) nominate –> Board (A?) dictate –> Shareholders (P?)
Protection of Creditors generally
– Some risks creditors might face • Falsification of income and/or assets • Hiding or shifting assets subsequent to borrowing • Taking on more senior debt • Adopting riskier business model
– Most important line of defense is commercial law
• Importance of ex ante contractual protections cannot be overemphasized
– Creditor protections not focus of corporate law
• Typically “last resort” when other avenues have failed
Mandatory disclosure (creditor protection)
Corporate law makes little use of this
• State corporate law does not require private corporations to prepare or file financial statements
– Only small number of states require annual financial statements to shareholders
minimum capital
Minimum capital and/or capital maintenance requirements do not exist
Director liability
Relatively clear at two extremes
– Under normal circumstances, duty owed to shareholders
– In bankruptcy, federal bankruptcy code applies
• But what about director liability at or near insolvency?
– Firm unable to meet its financial obligations (economic concept)
– Some caselaw to suggest that directors owe a duty to creditors as well—i.e., maximize
value of entire corporation (equity + debt)
» But prioritizing obligations can be very difficult
– seems to suggest only derivative claims and no standing if “zone of insolvency” but not (yet) insolvent
Creditor liability: fraudulent conveyance law
2 ways in which creditors can attack transfer
2 ways in which creditors can attack transfer
– Actual fraud: “present or future creditors” can void transfers made with
- “actual intent to
- hinder, delay, defraud any creditor of the debtor”
– Constructive fraud: “creditors” can void transfers made “without receiving a
reasonably equivalent value” if the debtor is left with “remaining assets.
unreasonably small in relation to its business” or the debtor “intended, believed or reasonably should have believed he would incur debts beyond his ability to pay as they became due” or the debtor is insolvent after the transfer
Two possibilities for arguing fiduciary duties:
- Argue fiduciary duties aren’t waived
- Even if waived, argue covenant of good faith and fair dealing
(Likely fails, but all you have.)
Automatic Self-Cleansing Filter Syndicate Co. Ltd. v Cuninghame (boards)
A corporation’s board of directors is not bound to carry out the resolution of a simple majority of the shareholders in violation of the articles of association.
55% not enough due to the articles
Fogel v. U.S. Energy Systems, Inc. (boards)
Informal meeting, no notice to the CEO
Despite 3/3 board vote to fire
Need formal process
Obsessed with process
Good decision with no process will lose
Bad decision with good process will win
Process and board members
Boards can act as duly constituted board members at meetings.
Board members cannot act alone.
Board members are still agents however.
But only can make decisions if they follow proper process at a duly constituted meeting. (Fogel)
Bylaws will determine what the process is for the corp.
(ie. meeting place, number of members required, voting majority required, etc.)
Insolvent companies
Not bankrupt but unhealthy companies. Can’t meet obligations as they come due.
Some caselaw that suggests creditors have standing to sue the board of directors.
Must be insolvent, not “zone of insolvency”
Credit Lyonnais Bank Nederland, N.V. v. Pathe Communs. Corp.
Take a $12MM settlement? Or try for the $15.5MM?
If under $12MM, lawsuit for not taking settlement from shareholders probably
However creditors get paid first
RULE: At least where a corporation is operating in the vicinity of insolvency, a board of directors is not merely the agent of the residue risk bearers, but owes its duty to the corporate enterprise.
How Assets Are Distributed in a Liquidation/Bankruptcy
Secured bondholders and other secured creditors
Unsecured creditors (include bank lenders, employees, the government if any taxes are due, suppliers, and investors who have unsecured bonds.)
Shareholders
Credit Lyonnais Bank Nederland, N.V. v. Pathe Communs. Corp.
If a corporation is close to insolvency, its directors owe duties to creditors as well as stockholders.
Can’t just think of stockholders especially if better for company to not. Taking a risk may not be right
Leverage Buyout
Company has around equal equity/debt, but is in pain.
Leverage buyout company takes the company private and makes it mostly debt (go to banks, borrow, buyout shareholders)
Why?
- Out of the limelight, no need to disclose
- Take advantage of the tax subsidy, lower tax bill
Then, take company public again. Sell the equity at a much more expensive price than bought.
CREDITORS UNHAPPY as they are less likely to get paid, risk was increased, some say its fraud as it dramatically increases risk
Courts by and large don’t go for that. Should’ve made it contingent in the loan.
Equitable Subordination
- Controlling shareholder recharacterizes its position in the capital structure to gain priority (e.g., equity to debt, junior debt to senior debt)
- Court uses its equitable powers to subordinate the debt–ie., “push” it back down in capital structure–where it would be unfair for controlling shareholder to have same priority as other creditors ostensibly now in the same position as controlling shareholder
Courts typically look for under-capitalization, withdrawal of equity at time of business failing.(e.g., Costello v Fazio)
Typically invoked in bankruptcy (e.g., § 510(c))
Piercing the Veil Test
Two-part test (e.g., Sea-Land Services v Pepper Source)
1. Unity of interests and ownership (ie., failure to maintain corporate formalities, commingling funds, undercapitalization; “control” of subsidiary) (crucial prong) (strong alignment of interest between the shareholders and the business itself)
The following factors are relevant:
(i) if the corporation fails to observe corporate formalities;
(ii) if the business fails to keep its assets separate from those of shareholders and each other; and
(iii) if the business is undercapitalized.
plaintiff must show that a shareholder used the corporation as his agent to conduct business in an individual capacity. (Carlton)
- Injustice or fraud (sometimes embeds assumption of risk, but not explicit)
Usually both needed, but in some cases only 2 if extreme circumstances
Test applies both to voluntary creditors and involuntary creditors (tort victims) (e.g., Walkovsky v Carlton)
Costello v Fazio
Can’t jump up for debt payment, plumbers case
Risk of starting a business ($6k in equity also super undercapitalized)
Shareholder Voting Overview
Most important applications
– Electing directors
– Fundamental changes (Dissolutions, changes to charter, typically: mergers, sale of assets)
– Shareholder resolutions (SEC Rule 14a-8 process in public companies)
Venue (shareholders voting)
Venues
– Annual meeting: Court will force annual meeting after 13 months (DGCL § 211)
– Special meeting
» Typical way to initiate action between annual meetings
» DE allows board or person with authority in charter to call special meeting (DGCL § 211(d))
• Other jurisdictions also allow large shareholders (e.g., > 10%) to call meeting (e.g., RMBCA § 7.02)
Consent solicitations (shareholder voting)
» Written consent instead of meeting
» Originally developed for close corporations, but also used by hostile bidders
» DE allows any action that can be taken at meeting of shareholders to be taken by written concurrence
• Other jurisdictions require unanimous consent (e.g., RMBCA § 7.04(a)
Electing directors
Every corporation must have board (even if it is 1 person) (§ DGCL 141(a)) + at least 1 class of voting stock with 1 share/1 vote default (DGCL § 212(a)) – Directors must be elected annually (DGCL § 211)
– Variations:
Staggered (classified) boards (~40% large public companies)
Cumulative voting
Staggered (classified) boards (~40% large public companies) (voting)
Only a fraction (e.g., one-third) of board up for election each year => takes at least 2 election cycles to gain control of board
• Simple and powerful takeover defense
• Empirical research suggests companies with staggered boards have lower shareholder returns
Cumulative voting (~10% large public companies)
- Each shareholder gets to vote # shares owned x # directors to be elected
- Facilitates representation of minority shareholders because allows shareholders to cast their votes for one or more candidates
Removing directors
At common law, directors could only be removed “for cause” (e.g., Campbell v. Loew’s
(DE Ch. 1957))
Right to be heard by shareholders first
– Today, distinction between “for cause” and “without cause” most relevant in
employment law context (e.g., severance benefits)
– Shareholders, courts can remove directors
» Some statutes permit shareholders to give the board power to remove individual directors
Proxy Voting
Allows shareholders to vote without attending annual meetings
Shareholders receive proxy statement and proxy ballot (“proxy card”)
Shareholders return proxy card by mail, indicating how their shares should be voted
Proxy holder must vote as directed
Proxy battles can be extremely expensive, deters insurgents
Froesell rule can discourage hostile takeovers
“Froessel Rule” (proxy voting)
(Fairchild):
win or lose, incumbent board can be reimbursed from corporate treasury,
however insurgents only reimbursed if win (Rosenfeld v Fairchild Engine)
Class Voting (e.g., Class A Shares, Class B Shares)
Each class must approve (e.g., majority of outstanding shares) (some shares have higher voting power) Designed to make sure decisions are fair to sub-groups, but gives each class a veto (“hold-up” problem (5 classes say yes but 1 says no, torpedoes deal))
Shareholder Information Rights
Easy to get stockholder list (DGCL 220) Books and records? More difficult. --Also opens up suspicions --Company will fight back --E.g., Ps carry burden of showing “proper purpose”
(all over the map on using this for litigation info)
Shareholders must be informed to vote, but state law leaves this to the market
No mandatory disclosure (above)
Shareholders have right to inspect books and records “for proper purpose”
Courts broadly grant access; typically don’t look if additional “improper purpose”
Taxonomy of State Fiduciary Duties
Robust Case Law goes to both Duty of Care and Duty of Loyalty (stronger)
Sparse Case Law goes to both Duty of Good Faith and Duty of Candor
–Good faith standard is very light, really only applies to intentionally or consciously neglecting duties or hurting the company
(4 list) Duty of:
- Care
- Loyalty
- Good Faith
- Candor
