Corporations

Corporations Study Guide--- Fall 2013

MBCA3Chapter 1: Business and Risk6Introduction6Categories of Risk6Risk Preference7Allocating Risk7Chapter 2: Introduction to Corporation Law8Introduction8Why Do Corporations Exist?8Some Basic Terms and Concepts9Fiduciary Duties10Equitable Limitations on Corporate Actions12Regulating the Modern Corporation: The Search for Accountability14Chapter 3: The Corporation and the Constitution14The Rights of Corporations under the Constitution In General14The Rights of Corporations under the First Amendment14Ways of challenging corporate action:17How does one corporation acquire another?19Chapter 4: Corporation Law in a Federal System20The Introduction to Federalism and Corporate Law20The Internal Affairs Doctrine21The Internal Affairs Doctrine as a Constitutional Principle21Choice of State of Incorporation23Chapter 5: The Corporation and Society 24Framing the Issues24The Role of the Lawyer25Corporate Charitable Contributions25Chapter 6: The Choice of Organizational Form26Introduction & Chart26Default Rules28The Limited Liability Company31Planning Considerations31Chapter 7: Forming the Corporation33The Process of Incorporation33Lawyers Processional Responsibilities: Who is the Client?34Problems during Incorporation35Chapter 8: An Introduction to Financial Accounting and Valuation36Financial Accounting Demystified36The Balance Sheet37Analyzing the Balance Sheet:39The Income Statement40Statement of Cash Flows:41Valuing the Enterprise41Chapter 9: Financial Structure of the Corporation42Corporate Securities43Equity Securities 43Common Stock44Preferred Stock45Debt Securities 46Options47Corporate Capital Structure Decisions, decisions47Tax Considerations48Leverage and the Allocation of Risk48Regulation of Legal Capital49Corporate Dividend Policy: Legal and Economics Issues51Distributions of Stock52Chapter 11: Piercing the Corporate Veil52Introduction to Veil Piercing53Tort Creditors55Contract Creditors56Parent-Subsidiary Corporations58Veil-Piercing in Limited Liability Companies59Alternatives to Limited Liability59Chapter 12: Actions Binding on the Corporation60Agency60Formalities of Board Action63Board Action at a Meeting64Notice and Quorum 64Committees of the Board64Chapter 13: Planning in the Close Corporation65Introduction66Realignment of Shareholder Control66Cumulative Voting67Class Voting68Shareholder Voting Arrangements68Restrictions on Board Discretion69Contractual Transfer Provisions71Purposes and Legality of Transfer Provisions72Types of Transfer Provisions72Valuation of Restricted Shares73Ch. 14 Oppression in the Close Corporation75Dissension and Oppression in the Close Corporation75Judicial Protection of Minority Owners75The Fiduciary Approach75Contractual and Tort Approaches76Statutory Remedies for Oppression76Dissolution as a Remedy77Oppression of Shareholder-Employees78Non-Dissolution Remedies in Oppression Cases78Valuation of Minority Shares78Chapter 15: Shareholder Voting78Federal Regulation 80Solicitation81Chapter 16: Disclosure Duties to Shareholders82Elements of a Federal Action for Proxy Fraud:83Chapter 17: Shareholder Rights of Inspection85Shareholder Information & Derivative Suits87Chapter 18: Mechanics of Corporate Combinations:88Terminology:88Theory/Policy:89General rules90Statutory merger90Triangular Merger91Asset Acquisition92Chapter 19: Corporate Governance & Models92Chapter 21: Role of the Shareholder in Governance95Dynamics of shareholder voting and the Collective Action problem96Shareholder Proposals97Fiduciary Duties (USE EMANUELS as skeleton)100Overview101Duty of care102The Duty of Care Standard102BJR stuff103Shlensky v. Wrigley103Duty of Oversight104Francis104Reliance (MBCA 8.30(d) - (f))104Van Gorkom105Graham107Caremark107Citigroup107SUM OF IT ALL:108Duty of Loyalty108Director Conflict of Interest Transactions109Fundamental point: 109Former 8.31 and DGCL 144110Subchapter f - applies to Directors conflicting interest transactions (DCITs)110Case law111In re InfoUSA: Vinod Gupta case112Oracle113Director Liability in Cash-Out Transaction114

MBCA

2.01 Incorporators One or more persons may act as the incorporator or incorporators of a corporation by delivering articles of incorporation to the secretary of state for filing

2.02 Articles of Incorporation Dictates what must be set forth corporate name, number of shares the corp is authorized to issue, street address of initial office; name & address of each incorporator States what may be set forth, such as defining, limiting, and regulating the powers of the corporation, its board of directors, and shareholders. Also a provision eliminating or limiting the liability of a director to the corporation or its shareholder for money damages for any action taken, or any failure to take any action, as a director, except liability for (A) the amount of a financial benefit received by a director to which the director is not entitled; (b) an intentional infliction of harm on the corp or the shareholders; (C) a violation of section 8.33; or (D) an intentional violation of criminal law

2.03 Incorporation Unless a delayed effective date is specified, the corporation existence begins when the articles of incorporation are filed The Secretary of States filing of the articles of incorporation is conclusive proof that the incorporators satisfied all conditions precedent.

2.04 Liability for Pre-incorporation Transactions All persons purporting to act as or on behalf of a corporation, knowing there was no corporation under this Act, are jointly and severally liable for all liabilities while so acting Comments: Recent case law indicates, however, that even where a version of this section is present in the State statute, courts have continued to rely on common law concepts of de facto corporations, de jure corporations, and corporations by estoppel that provide uncertain protection against liability for pre-incorporation transactions See reading notes for more, but basically: What seems to be most important is knowing that no corporation exists but acting anyway

2.05 Organization of Corporation (a) After incorporation: (1) If initial directors are named in the articles of incorporation, they shall hold an organizational meeting, at the call of a majority of the directors, to complete the organization of the corporation by appointing officers, adopting bylaws, and carrying on any other business brought before the meeting (2) If original directors arent named in the article, the incorporator(s) shall hold an organizational meeting at the call of a majority of the incorporators: (i) to elect directors and complete the organization or corp.; or (ii) to elect a BoD who shall complete the org or corp

2.06 Bylaws The bylaws of a corporation may contain any provision that is not inconsistent with law or the articles of incorporation Section 2.06(d) allows directors to ensure that such bylaws adequately provide for a reasonable, practicable, and orderly process, but is not intended to allow the board of directors to frustrate the purpose of a shareholder-adopted proxy access or expense reimbursement provision

4.01 Corporation Name (pg 11 of PDF, ~ 35 reading notes) (a) A corporate name: (1) Must contain the word corporation, incorporated, company, or limited, or an abbreviated form of one of them. (2) May not contain language stating or implying that the corp is organized for a purpose other than that permitted by section 3.01 and its articles of incorporation (b) Except as authorized by subsections (c) and (d), a corporate name must be distinguishable upon the records of the sec of state from [other corps]:

5.01 Registered Office and Registered Agent Each corp must continuously maintain in this state: (1) a registered office that may be the same as any of its places of business; and (2) a registered agent who may be: (i) pg 13 of PDF

5.02 Change of Registered Office or Registered Agent A corp may change its registered office or agent by delivering to the sec of state a filing statement that sets forth item listed (1 6)

5.03 Resignation of Registered Agent

5.04 Service on Corporation (a) A corporations registered agent is the corps agent for service of process, notice, or demand required or permitted by law to be served on the corporation (b) If a corp has no registered agent or the agent cannot with reasonable diligence be served, the corp may be served by registered or certified mail addressed to the sec of the corporation at its principal office Subsections 1 3 define the date upon which service is effectuated (c) this section does not prescribe the only means, or necessarily the required means of serving a corporation

6.01 Authorized Shares (a) The articles of incorporation must set forth any classes of shares and series of shares within a class, and the number of shares of each class and series, that the corporation is authorized to issue. The articles of incorporation must prescribe a distinguishing designation for different classes or series and must describe, prior to the issuance of shares of a class or series, the terms, including the preferences, rights and limitations, of that class or series. (b) The articles of incorporation must authorize: (1) one or more classes or series of shares that together have unlimited voting rights; and (2) one or more classes or series of shares that together are entitled to receive the net assets of the corporation upon dissolution (c) the articles of incorporation may authorize one or more classes or series of shares that: etc etc.. (pg 15 of pdf)

Chapter 1: Business and RiskIntroduction Shirking: Occurs when somebody works less hard than they would if they owned the business for which they are working themselves. Can be offset by monitoring, but this requires monitoring costs Monitoring costs + shirking = agency costs

Categories of Risk Controllable risks those that the parties have some ability to influence Non-controllable risks. Cannot be completely eliminated Important difference between risk, which can be quantified, and uncertainty, which cannot An expected return is defined as the weighted average return based on the probabilities of events. Depends on being able to quantify the risks associated with a particular decision To calculate: multiply the probability of each event happening by the return associated with that event and add up the results

Risk Preference Some people are risk seekers, other risk averse, other risk neutral

Allocating Risk Non-controllable risks can be managed by: Insurance The financial markets people can, for instance, bet against themselves through futures contracts (e.g. invest money on the chance of their being a drought if a drought occurring would be detrimental to you; then either way youre covered) Diversification Allocate the risk to the person best able to bear it Controllable Risks Shirking can be mitigated by monitoring and disciplining devices that align the agents incentives with the interests of the principal However, if they have greater incentives that the business will do well, theyll often want more control Sometimes, those best able to control risks are the best to bear them (e.g. the person who waters the plants best bears the risk of them not getting watered) Allocating Risk to the Owner Theyre typically less risk averse than, say, their employees Can monitor through direct supervision or setting benchmarks or doing post-work evaluation, or contract for sanctions for failure to perform certain duties But these can all be expensive and dont always account for unforeseeable/unpredictable things Allocating Risks to the Employees One example: Ernests annual salary is $x. But if the annual income of our venture is less than $y, then his salary shall be reduced by z% However, might run into problems of employee thinking in short term interest, owner thinking more long term Middle ground solution: Can divide profits between owner/employee in mutually agreeable proportion, but then employee might want more control and it could be hard to do with no pre-established relationship

Chapter 2: Introduction to Corporation LawIntroduction Corporations have the following characteristics, subject to modification: Separate entity: every corporation is a legal entity, separate from its investors or mangers Perpetual existence: can be of unlimited life, as opposed to those that work for or invest in them. Limited liability: a shareholders liability is limited to the amount of money she paid for her shares. The corporation, not the shareholders, owns the assets of the business and is liable for its debts Centralized management: directors have a duty to act in the best interest of the corporation rather than in their own best interest Transferability of ownership interests: shareholders are free to transfer their shares without obtaining the consent of other shareholders

Why Do Corporations Exist? A firm is a legal entity used to assemble, organize, and manage resources to carry on some economic activity Individuals can expand the scope of their economic activities by entering into contracts with other individuals Theories: Firms come into existence because their hierarchical relationships can minimize the transaction and agency costs inherent in the principal-agent relationship. A firm acts as the centralized contractual agent in a team productive process is in a position to monitor the productivity of each member of the team and allocate rewards to each in accordance with their contribution * All of the theories agree that one of the principal reasons that firms exist is that they reduce the information, transaction, and agency costs that would exist in a theoretical free market in which individuals cooperate only by contracting among themselves* Why the Corporate Firm? The corporate form is particularly useful in addressing the problem of raising capital Other major advantage: Limited liability Other advantages: well-understood structure; relatively clear legal rules; well-understood and convenient means of dividing up and allocating risks and rewards Fiduciary obligation: a vague constraint applied to employment relationships between those who undertake to accomplish some object for another person and that individual.

Some Basic Terms and Concepts Public vs close or private In close corporations, there is typically no market for the corporations securities and there is a substantial overlap of ownership and management In public corporations, the governance structure separates ownership from control and shareholders generally do not play an active role in the management of the business Corporate Statutes: (there is no one; we focus on the Model Business Corporation Act (MBCA) and Delaware General Corporation Law (DGCL) Although state corporate statutes have some mandatory provisions, to a substantial extent they consist of a set of default rules that set forth the relationship among corporate actors unless they agree otherwise Organic Documents Articles of incorporation represents the constitution of the corporation Bylaws usually set for the details of the corporations internal governance arrangements Corporate Actors: Stockholders or shareholders Stockholders elect a board of directors, which is responsible for managing or supervising the corporations business. Are required to act in the best interest of the corporation For public corps, the board consists of inside and outside directors Officers are elected by the BoD --- include president, VP, secretary, treasurer --- duties are typically described in the bylaws; they take care of day-to-day operations GENERAL STRUCTURE: stockholders elect BoD elects officers Other corporate actors stakeholders are those who dont fit the legal categories above. Include creditors, employees, customers, the public Theyre not protected by the fiduciary duty, but are often protected under common law, statutes regulating the environment or workplace, etc. Corporate Securities Corporations raise money by issuing securities to their investors. There are two kinds of securities: debt and equity. Equity securities consist of common stock and preferred stock. Debt securities generally are the least risky and have the lowest expected return. The holder typically expects to receive only fixed payments of interest over time and the return of the principal on the maturity date of the debt. Debt securities can be secured or unsecured and are called bonds, debentures, or notes Common stock assumes the greatest risk of the success or failure of the corporation and has the greatest expected return. Common stockholders can receive payment through dividends cash payments that the corporation may make at the discretion of the board of directors. Preferred stock sits between common stock and debt (i.e. between them risk-wise and return-wise) Judge-Made Corporate Law State corporation statutes are not all-encompassing and court decisions fill many interpretive and theoretical gaps. In fact, a central aspect of corporate law, fiduciary duties, is largely judge-made Corporate Choice of Law The law of the state of incorporation, with rare exceptions, governs the internal affairs of the corporation --- this affords a high degree of certainty to corporate managers when planning transactions or other courses of action

Fiduciary Duties Also known as duty of care and duty of loyalty Concept: The fiduciary must subordinate his individual and private interests to his duty to the corporation whenever the two conflict Requires a director to act in the corporations best interests and to exercise reasonable care in overseeing the corporations affairs and in making business decisions In order to encourage directors to take risks on behalf of the corporation without fear of personal liability for any losses which may ensue, courts have developed a rule of abstention, known as the business judgment rule (BJR) under which courts will defer to the judgment of the board of directors absent highly unusual circumstances, such as conflict of interest or gross inattention The BJR creates a presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the bests interests of the company To rebut, P must show that a decision: (1) was not informed; (2) was not made in good faith; (3) did not have a rational purpose; (4) was made by a director(s) with a personal interest in the decision; or (5) was made by a director(s) who otherwise were not independent. The derivative suit was designed to enable shareholders to hold corporate managers liable for a breach of fiduciary duty. It is an action in equity brought by a shareholder on behalf of the corporation. Any recovery belongs to the corporation for whose benefit the suit has been brought. Bayer v. Beran (1944) Facts: Defendants are the directors of Celanese Corporation of America. For advertising, Dr. Camille Dreyfus, who owned a majority share in the corporation, suggested a $1 million radio campaign built around a radio musical program. One of the stars of the program is also his wife. The Board approved the campaign, and it has subsequently been renewed. Synopsis of Rule of Law.A director has a fiduciary duty to support the corporations interest over his or her own conflicting interests, and any competing interests renders the business judgment rule inapplicable (judged under a greater level of scrutiny, looking at it for duty of loyalty) 1st the claim involving the corporations decision to advertise by way of an opera program This raises a duty of care question Their conduct passes muster, even if a different advertisement plan might have reached a wider audience, because of the BJR: the court wont put its own opinions of what would have been best above that of the corporation 2nd claim director chose his wife to be the singer in the ad person close to the decision stood to make money from this, so we cant presume the decision was made in the best interest of the corporation Raises a duty of loyalty claim Burden of proof was on the directors: required to prove total fairness of transaction to the corporation Conclusion: no violation of the duty of loyalty shows that cases for breach of fiduciary duty arent easy to win. * Fiduciary rules are less strict in corporate law than elsewhere Break fiduciary duty into 2 different duties: Duty of care Has to do with competence: has director acted with the requisite care? Business judgment rule: courts bend over backwards not to simply second guess the decisions of executives. The BJR says that if the director properly informed him/herself, the court wont substitute its own judgment even if the decision turns out to be wrong.--- strong presumption that director acted properly so long as they can show they were informed. Threefold reasoning: Judicial competence: courts arent as competent as the business in the matter before them Courts come at the problem ex post the conduct already took place and whatever went wrong went wrong and its difficult not to think about this when judging initial conduct Relationship between business and risk we dont want businessmen afraid of what is going to happen to them personally because they take a risk that could be profitable but might end up being wrong Duty of loyalty An agent cannot serve 2 masters If there is a duty of loyalty problem, the business judgment rule does not apply. The duty of loyalty trumps the presumption we made because their own best interests are involved Initial burden is on the director to show the total fairness of the transaction to the corporation

Equitable Limitations on Corporate Actions Schnell v. Chris-Craft Industries, Inc. (1971) Issue: Can the directors, in complying with state law, move a meeting solely to obstruct shareholders efforts to gain control of the corporation? Holding: no, it would be inequitable to go along with this scheme even though the directors did strictly comply with state law. Catch line: Inequitable action does not become permissible simply because it is legally possible

Bove v. Community Hotel Corp. of Newport, R.I. (1969) FACTS: Attempt by common shareholders to eliminate preferred shareholders. Why? they wanted to sell more common stock/expand the corporation but to do that they had to pay off their liability to preferred shareholders Rule to get rid of preferred stock: needed unanimous consent of preferred shareholders What did management do to get around the problem? Created another corporation and had the new board of directors get together with initial B of D and merge. The new company has only common stock; the original has common and preferred stockholders. But in order to merge, all you need is a 2/3 vote of each class of stock, and the directors could get that. So used a merger device to get rid of need to get unanimous consent of preferred shareholders. (got around the problem) Court allows them to get around the rule in this way Why? Because nothing in the statute forbids a merger between parent and subsidiary corp. also, the preferred shareholders have a way of keeping the value of their preferred stock they can go to some sort of court thing. Doctrine of independent legal significance

So whats the difference (Schnell v. Bove)? How do we go about advising a client? ** Independent legal significance In Bove, there may have been another reason why they wanted to do a merger Schnell shows that at some point, courts will step in as a matter of equity no matter what the rules say Theres an outer limit on corporate conduct. But where to draw the line?

Regulating the Modern Corporation: The Search for Accountability Stockholders can exit if theyre unhappy What is the purpose of the corporation: Is it just property of the stockholder-owners and the function of the directors is to faithfully advance the financial interests of owners? Or Is it private property of stockholders AND also a social institution?

Chapter 3: The Corporation and the ConstitutionThe Rights of Corporations under the Constitution In General Corporations are given life by a states corporate statute The law treats corporations as having the attributes of a legal person for many purposes --- can own property, enter into contracts, and sue/be sued in its own name. Can be held liable for its debts while the people who created it are not Currently, all states reserve the power to amend the corporate charters they issue (this emanates from states having added reserved powers clauses to their constitutions, general corporation laws, or both) Santa Clara County v. Southern Pacific Railroad Co. (1886): Court examined the extent to which a corporation is entitled to the rights and privileges that the Constitution provides to natural persons. Held that a corporation is entitled to equal protection of the law under the Fourteenth Amendment. Minneapolis & St. Louis Railway Co. v. Beckwith (1888) extended the holding of Santa Clara and ruled that a corporation also is entitled to due process of law. Hale v. Henkel (1906) established that a corporation is protected against unreasonable searches and seizures by the Fourth Amendment BUT, the Fifth Amendments protection against self-incrimination is not available to a corporation.

The Rights of Corporations under the First Amendment In 1907, Congress enacted the Tillman Act, which prohibits corporations from contributing $ to federal political campaigns because: Fear that corporate managers were exercising control over $ in ways that unduly influenced political decisions; OR Seen as giving away other peoples money (shareholders) without any restraints. First National Bank of Boston v. Bellotti (1978): Court held unconstitutional a Massachusetts statute that prohibited certain expenditures by banks and business corporations for the purpose of influencing the vote on referendum proposals other than those that materially affected the property, business or assets of the corp. Synopsis of Rule of Law.The government may not restrict the topics of speech for corporations. A corporation should not be treated differently than private persons. The corporation may freely discuss government affairs Dissent: what some have considered to be the principal function of the First Amendment, the use of communication as a means of self-expression, self-realization, and self-fulfillment, is not at all furthered by corporate speech --- they do not represent a manifestation of individual freedom or choice Shareholders may share a common interest in making money, but their ideological hegemony breaks down aside from this Under the majoritys holding, shareholders must choose between supporting the propagation of views with which they disagree or passing up investment opportunities. Austin v. Michigan Chamber of Commerce (1990): Clearly inconsistent with Bellotti. Court upheld the Constitutionality of a Michigan statute that prohibited corporations from using corporate funds for contributions or independent expenditures in support of or in opposition to any candidate in elections for state office. Basically said that any such funding had to come from a PAC. Michigans regulation aims at a different type of corruption in the political arena: the corrosive and distorting effects of immense aggregations of wealth that are accumulated with the help of the corporate form and that have little or not correlation to the publics support for the corporations political ideas. The unique state-conferred corporate structure that facilitates the amassing of large treasuries warrants the limit on independent expenditures On dangers of corporations (Marshall): corporations as dangerous corrosive and distorting effects of immense aggregations of wealth that are accumulated with the help of the corporate form and that have little or no correlation to the publics support for the corporations political ideas (pg 58) Dissent: (Scalia) Government cannot be trusted to assure, through censorship, the fairness of political debate Citizens United v. Federal Election Commission (2010): Court expressly overruled Austin by striking down a federal prohibition of the use of corporate funds for electioneering communication Holding: We return to the principle established in Bellotti: the Government may not suppress political speech on the basis of the speakers corporate identity. No sufficient governmental interest justifies limits on the political speech of nonprofit or for-profit corporations. The concept that govt may restrict the speech of some elements of our society in order to enhance the relative voice of others is wholly foreign to the First Amendment Moreover, most US corporations dont have massive wealth Dissent: Corporate speech is derivative speech speech by proxy. Denying it does not prevent anyone from speaking his or her own voice. From class, holding: There can be no limit on corporate political speech

Class discussion dangers of corporations: Is the danger of restraining speech more dangerous than the danger of restraining corporations? --- what is more dangerous, corporations or the government? Power of money Some candidates might have great ideas and want to run for office but dont have the corporate backing to compete with other candidates who do Whose money is being spent when a corporation spends on advertising? What can people do if they disagree with the way a corp spends its money? Exit: sell shares But if we want capital markets to run effectively, we only want people exiting because of inefficiencies, not moral rationales Derivative suit: claiming that people running the org arent doing their job properly Proxy vote: get people behind him to get new director

Four models that come out of our discussion: (different ways of viewing corporations) Corporation is an entity (entity theory) Treat corporation as a single person Economic entity Is an entity that is only there for profit maximization (legal person with one value) Does this take morality out of the picture? Concession theory The corporation is what the state says it is Contractarian theory The corporation can be viewed as nothing more than an association of people (nexus of contracts) This is the view of the majority in Citizens United*Be aware when youre going back and forth between views; make sure youre being consistent with the theories when using them to argue for one or another side

Ways of challenging corporate action:

PROXY FIGHTSDirectors elected by the shareholders. Federal law deals with proxies a document that gives people the right to vote for them. People sometimes use proxies to enable shareholders to vote for directors. All shareholders get proxy forms (that are sent out by the board of directors), they send them in, and then people read them and the individual with the most proxies wins. One way to take control of a corporation is to wage a proxy fight Proxy fight: somebody comes in as an outsider and comes up with a slate of directors. They then send information to all of the shareholders asking them to vote for their directors rather than the directors suggested by the board of directors. Board of directors doesnt have to pay for the other side to wage a proxy fight. Proxy fights are very expensive. It is possible but not mandatory that if you win a proxy fight you get paid back for your expenses. Proxy fights are not easy to win.

DERIVATIVE SUITS Commonly, a shareholder will file a claim against a director saying that s/he has violated their duty to the corp and therefore owes the corporation $ A derivative suit can be filed by one or more shareholders. It raises a claim in the name of the corporation. Youre basically suing the corporation to force the corporation to collect a debt. If there is a recovery in a derivative case, it almost always goes to the corporation The pressure is not really from the shareholders, its from the Bar and attorneys can gain a lot of money from them, so its lucrative enough to bring these suits Its a form of private enforcement. How they work and problems/solutions: Theres a problem with derivative suits: the board of directors manages the corp; if there is a claim, who decides to sue on the claim?; what if the claim is against all of the directors then theres a conflict of interests. Other problem: strike suits suits that are brought not with the intention of collecting money for the corporation, or not with the intent of getting corp to do something. The only purpose is to get attorneys fees. Basically a way of settling that gets money out of the corporation Same if directors want, for their own motives, to get rid of a case Law gets rid of these problems by putting numerous procedural hurdles in the way of derivative suits E.g.: must own stock in the company, often for a certain amount of time, sometimes need to own a particular amount of stock There are also rules governing settlements: cant settle without approval of the court Most important: Demand Board of directors manages the corp. Demand means that the P in the derivative suit goes to the corporation and says will you, the corp, go forward with this claim? Delaware and MBCA have different procedures but come out the same in the end In Delaware, prior to filing suit, you must make demand on the board of directors unless its a demand excused situation If BoD decides it will take control of the case, then the Ps role is gone. Corporation, not P, files the suit. Corporation can also take control of the suit and dismiss it corp can do this as long as directors arent themselves conflicted A demand is excused if you can show that half the BoD is disqualified either because theyre interested or not independent If the shareholder doesnt plead demand excused (with particularity) or demand the BoD, then the claim is dropped for failure to follow procedure. Under MBCA, you must make demand in every case. And then the corp will move to dismiss and youll end up litigating the same things you would have litigated in Delaware (conflict, etc) Directors are typically divided into inside directors (are related to company employee, CEO, etc) and outside directors (only relation to company is being on the board) Outside directors are seen as being more independent Stock ownership itself is not enough to make you an inside director Special Litigation Committee is comprised of outside directors who make a determination of whether a suit should be continued if there is a conflict of interest among other directors can also come up in a demand excused situation if case is filed, BoD can set up a SLC made up of outside directors if everybody on the BoD is conflicted, BoD can put 2 new outside directors on BoD and turn them into SLC and then they handle the question of whether the derivative suit should be allowed to go on but these are interested people appointing supposedly independent directors To deal with this: In demand situations, Ps must come forward with reasonable proof that directors are conflicted or not independent. But if its a SLC, the burden is on the company to prove that the SLC is independent or disinterested

THIRD TYPE OF CHALLENGE Suppose theres a claim by a shareholder that the corporation has harmed the shareholder or a class of shareholders. --- claim belongs to the mistreated individuals, not the corporation. --- can try and make it a class action; representing all of the shareholders This is not a derivative suit, however its not a claim of the corporation and recovery doesnt go to the corporation.

How does one corporation acquire another? Friendly merger: Board of A goes to board of corp B and says they want to merge. Corp B says fine. May or may not require shareholder (or even board) approval If the merger is approved by shareholders, then B is merged into A and B goes out of existence. Payment is made directly to the former stockholders of B could be given cash or shares in A. A steps into Bs legal shoes its not as if theres a transfer of property for instance, A doesnt have to rerecord land deeds in As name, just has to step in for B. BUT, mergers arent usually done this way Usually, A creates a subsidiary A becomes the sole shareholder of the sub and appoints the board of directors. Then B get merged into SubA --- triangular merger There are times when A wants to merge with B and B doesnt want to. One way to handle this is for A to buy a majority share of stock in B and start a proxy fight and change the board Another way: a tender offer --- A makes an offer directly to Bs shareholders asking them to sell A their stock in B. Tender offers are always above the market price. Are also done in a specific way that protects the tender offerer in case the offer isnt accepted. Once A has control of B, A wants to merge B into A Are expensive and usually involve taking on a lot of debt (to buy tons of stock) might take the form of Bs assets. Williams Act A federal statute that regulates tender offers After this Act, there was still dissatisfaction because a lot of companies feel in danger when other companies make tender offers --- the possibility of a tender offer is claimed to be detrimental to many companies So states started to pass statutes to make tender offers more difficult to pass off There were 3 cycles the first was declared unconstitutional The second was upheld (CTS) ** These made it much more difficult to complete tender offers

Chapter 4: Corporation Law in a Federal SystemThe Introduction to Federalism and Corporate LawWith few exceptions, corporations are creatures of state law. The federal government still regulates corporations in many ways, however. For example: under antitrust laws, banking regulation, civil rights laws, environmental law, labor law, and product safety laws. Particularly, public companies are regulated by federal law. CTS and Amanda introduce the topic of the relationship between state corporate law and federal law, as well as choice of law issues.

The Internal Affairs Doctrine A business can choose to incorporate under the laws of whatever state best suits its needs. It can also relatively easily reincorporate elsewhere. The law of the state of incorporation governs the internal affairs of the corp. This means that the relationship between shareholders and managers (directors and officers) will be governed by the corporate statutes and case law of the state where the corporation is incorporated. The law of the state of incorporation also determines the procedures by which the board of directors will act, the right and extent to which officers and directors may be indemnified by the corp, and the corps right to issue stock and merge with other companies. The external affairs of a corporation are generally governed by the law of the place where the activities occur and by federal and state regulatory statutes (e.g. state labor laws, tax laws) Some activities are governed by both internal and external rules. E.g. mergers

The Internal Affairs Doctrine as a Constitutional Principle Courts have said that the internal affairs doctrine presents questions of US constitutional law: Violates the federal dormant commerce clause if a state statute treats domestic and foreign corps differently or if it generates multiple and conflicting standards that would burden interstate commerce. Another argument: may violate federal due process clause. States cant apply their laws to corps incorporated in other states if they lack sufficient contacts with the corporation and its conduct. Antitakeover Statutes: CTS and its Progeny During the takeover wave of the 1970s and 1980s, a number of states adopted laws designed to protect corporations conducting local business from uninvited takeover bids that were opposed by the target companys management. (~ 76) CTS Corp. v. Dynamics Corp. of America (1987) Synopsis of Rule of Law.States, as the creators of corporate entities, have the ability to define the protections afforded to shareholders providing that it is possible to comply with the state law and federal law. Issues: (1) whether the Williams Act preempts the Indiana Act. (2) whether the Indiana Act violates the Commerce Clause due to unequal treatment between in-state and out-of-state entities. Holding: The Indiana Act is not preempted by the federal law because entities can comply with both federal and state law without frustrating the federal law. The state law furthers the federal laws goal of protecting shareholders from tender offer abuses but does not tip the balance between management and acquirers. The Indian Act does not violate the Commerce Clause because corporations by definition are entities created by state law, and therefore it is only logical that states would define the rights and characteristics of corporations. Because nothing in the Indiana Act imposes a greater burden on out-of-state offerors than it does on similarly situated Indiana offerors, we reject the contention that the Act discriminates against interstate commerce. No discrimination The state is only regulating the voting rights of the corporations it has created, so each corporation is only subject to the law of one state. There is no risk of inconsistent regulation by different states. No risk of conflicting standards Why was there no conflict with (/preemption by) the Williams Act? For instance, Williams Act says you have 20 days to do something but the CTS state law says you have 50 days to do it. Corporations are creatures of state law. And SCOTUS is very sensitive about anything it considers as a federalization of this state prerogative. They want to protect states ability to govern these corporations Importance of CTS: SCOTUS/the law defers greatly to states ability to regulate/create corps. Where federal government does intrude, its typically in a non-substantive way Aftermath of CTS: led to a third generation of statutes that seek to protect an acquirer from entering into a range of transactions with the acquired corp for the period of time specified in the statute Amanda Acquisition Corp. v. Universal Foods Corp. (1989) A third generation takeover statute was at issue. Issue was whether the statute was consistent with the Williams Act and Commerce Clauses? Important considerations: No interstate transaction is regulated or forbidden and the Act doesnt leave open the possibility of inconsistent regulation, therefore its constitutional. It might be protectionist, but the protected people are the exiting body of managers, suppliers, etc, which bears no necessary relation to state boundaries. Internal Affairs Doctrine: when a matter deals with the internal affairs of a corporation e.g. relationship between corp and shareholders or directors; about what powers the corp has or what stock may be issued; things coming out of the corporate statute, bylaws, articles of incorp - then the law that applies is the law of the state of incorporation When were talking about external affairs i.e. corps relationship to outside world, like labor and tax laws - then the regular conflict rules apply and the law that usually applies is the law of the place where the action occurs. The internal affairs doctrine provides certainty. Look for: hypo with many corporations. Itll deal with various relationships between and among corps. LOOK AT what is the state of incorporation of each corporation. If its an internal affair, whose internal affair is it? Careful because with respect to mergers, there might be voting rules that differ between then and the rules applied to each are eachs state of incorp.

Choice of State of Incorporation State corporation laws are essentially enabling statutes that establish a relatively flexible organizational framework that allows considerable room for self-ordering and involves minimal regulatory intervention. Louis K. Liggett Co. v. Lee (1933) States didnt use to give the benefit of incorporation so freely; the removal by the leading industrial states of the limitations upon the size and powers of business corporations seems to have been due to the conviction that it was futile to insist upon them because local restriction would be circumvented by foreign incorporation. So there was a race of laxity Cary v. Winter debate Carys theory: management chooses the state, not the shareholders, in order to get corps to incorporate in their state. So state legislatures will keep making their rules more attractive to management (more power to management, less to shareholders) and there will be a race to the bottom. Cary says we need the state to make positive law so that this doesnt happen Problems with this view: if there ever was a race to the bottom, its over. No state can unseat Delaware Winters approach: we have to look at what effect this race to the bottom will have on the corporations ability to survive/make money. Rules will affect their share price and ability to raise capital. If its more difficult to raise capital, their costs will go up and they wont survive. So states are looking to create the most efficient rules to govern corporate conduct. Winters says the most efficient organizations come organically; we dont need positive law to regulate the market. Problems with this view: might lead to wealth disparities. While government can regulate to correct this, that regulation might distort the market. Additionally, theres the problem of Citizens United: what if corps are exercising power over the govt? Another view (discussed in class): these are all problems of federalism (the race to the bottom). So what we could do is just come up with Federal Rules; however, this would run into the problem of the laws preference for corporate law being the States domain The Preeminence of Delaware Many corporations reincorporate in Delaware because they feel confident that Delaware will respond promptly to the concerns of corporate managers in the future, because it has done so in the past. Three factors bolster this belief: D relies heavily on corporate franchise taxes and would have much to lose by failing to provide firms with advantages offered elsewhere The D state constitution requires a two-thirds vote of both houses of the legislature to change its corporate code. This makes it particularly difficult for the legislature to deprive corporations of benefits they currently enjoy Delaware has tremendous assets in terms of legal capital, including case law, judicial expertise, and an admin body that is geared to process corporate filings expeditiously Delaware and Federal Law (pg 92) Delawares primary competition comes not from the other states but from the federal government. It is the fear of federal incursion that keeps Delaware from going too far in one direction or the other Think about: what is the purpose of a corporate statue? Is it, as Judge Winter believes, to supply standard terms which reduce transaction costs? Another possible purpose is to consider the interests of shareholders, managers and other constituencies and have the statute strike a balance among them Delawares doesnt strike a balance, however. Its pro-management.

Chapter 5: The Corporation and Society Framing the Issues Dodge v. Ford Motor Co. (1919) Synopsis of Rule of Law.The purpose of a corporation is to make a profit for the shareholders, but a court will not interfere with decisions that come under the business judgment of directors. As long as the goal of the corp is profit maximization, the directors have virtually unfettered discretion to choose the strategies to be employed to that end Insert stuff on Milton Friedman and other views of corporate social responsibility (CSR) ---- inter-relationship between long-term social gains and short/long-term business profitability A significant development in corporate social responsibility is the creation of a new type of business entity, the benefit corporation. Under this model, in addition to having a fiduciary duty to shareholders, directors also have a legal duty to other stakeholder interests, including employees, suppliers, customers, society, and the environment. Must release annual benefit reports to shareholders and post them online

The Role of the Lawyer Some theorize that the best role for lawyers is ability and willingness to give independent legal advice to business clients The moral interdependence theory is premised on the assumption that actions of lawyers and clients are not always easily distinguished. Often, lawyers and clients accomplish objectives together, not separately.

Corporate Charitable Contributions There are two principal concerns in these expenditures: how to protect the interests of shareholders who may not agree with the choices that corporate management has made and how to create a system of managerial accountability with respect to such expenditures. Theodora Holding Corp. v. Henderson (1969) Rule: the test to be applied in passing on the validity of a gift such as the one here in issue is that of reasonbleness, a test in which the provisions of the Internal Revenue Code pertaining to charitable gifts by corporations furnish a helpful guide. Due to theBusiness Judgment Rule, the Court was not going to second guess a business decision unless it wasunreasonable, and this big corporate donation seemed reasonable (was within the 5% of corporate revenue limit, set by the Internal Revenue Code). Additionally, the court wanted to promote the public policy of corporate donations Kahn v. Sullivan (1991) Had to do with Occidentals donation, prompted by Hammer. Facts: The Trial Court found that the huge donation was not a good business decision. However, whether or not it was a good decision was not their problem. TheBusiness Judgment Ruleonly requires that a business decision to not be reckless or unconscionable. Appellate holding: because of theBusiness Judgment Rule, the only time a court should overturn a business decision was when it amounted tocorporate waste. Corporate wastecan be defined as "an exchange of corporate assets for consideration so small as to lie beyond the range at which a reasonable person might be willing to trade. Conclusion: the Trial Courts finding that the donation didnt amount to corporate waste was not an abuse of discretion Perspectives on Corporate Charity Is there a difference between traditional advertising and advertising a companys socially responsible behavior? both are attempts to increase sales & profits

Chapter 6: The Choice of Organizational FormIntroduction & Chart

Limited liabilityContinuity of lifeTransferability of interestManagement structureAbility to raise capitalTax treatment

CorpYesPerpetualFree transferabilityCentralized, butSell more stockAs a separate individual; own losses

PartnershipNoDeath, withdrawal, or bankruptcyNot transferableNot centralizedLimitedNot a taxable entity

General Partner---------Limited PartnerNo-YesDeath, withdrawal, or bankruptcy but only of general partnerNot transferable

transferableManagement

Not managementNo

Sell limited partnershipLike partnership

LLCYesPerpetualEithereitherVery flexibleOption

Forms: Partnership, the corporation, and the limited liability company (LLC) Corporation: Is a legal entity distinct from its owners; formed by filing papers; formed under and governed by the corporate law of the state in which it is incorporated Management is centralized in a board of directors elected by shareholders The liability of the shareholders is limited to whatever amounts theyve agreed to contribute to the corp and doesnt extend to any debts of or liabilities that the corporation incurs In general, owners of shares in a corp can transfer them by sale, gift, or devise as easily as they transfer ownership of any other intangible property Basic document: articles of incorporation; secondary document: bylaws Owners called shareholders or stockholders General Partnership: Is an entity in which all partners have unlimited liability, an equal voice in management and the authority to act as agents for the partnership and incur obligations that will bind all partners Generally not possible to transfer all of the rights included in a partnership interest Default form when two people do business/contract together Limited Partnership Combines elements of the corp and general partnership Formed by filing papers with state; there are limited partnership statutes Must have at least one general partner in addition to limited partners. The general partners have comparable liability to those in a general partnership but a limited partners liability is limited to the capital she has contributed. A limited partner has no voice in the active management of the partnership but can vote on major decisions The Limited Liability Corporation (LLC) is a hybrid form of business organization that has proliferated since the 1990s. It is a legal entity distinct from its owners, who are called members and receive the benefits of limited liability Set up pursuant to state statute and established by filing articles of organization; lesser rules are found in the operating agreement, and these generally specify management arrangements An LLC can elect to be taxed as either a partnership or a corporation, making it attractive in a variety of business settings. State LLC statutes vary much more than do state corporate and partnership statutes Are either member managed or manager managed (by outside manager who comes in to run the LLC)

Default Rules Formation Corporation: file articles of incorporation with state Must include: corporate name, number of shares of stock that the corporation is authorized to issue, and the name and address of each incorporator May include: provisions regulating the management and affairs or limiting the powers of the corp and its shareholders, officers, or directors General Partnership: Most are formed consensually when 2+ people enter into a contract, governing for instance - such matters as managerial rights, distribution of rights, interests in profits and losses, and rights upon dissolution of the enterprise. Limited Partnership: file w/ state certificate of partnership setting forth rights and duties of partners and IDing general partners. If new general partners are added, amended filings are required LLC: requires filing articles of organization with the appropriate state agency; articles must include the name of the LLC and address of its registered agent Members also enter into an operating agreement that sets forth the members rights and duties Limited Liability Corporations: this is one of their key features. Means that a creditor of the corporation ahs the right to satisfy the debt out of any assets owned by the corp but once those assets are exhausted, the creditor of the org doesnt have a right to go after the personal assets of the shareholders of the organization However, three major exceptions: Shareholders will be personally liable (1) where the corporation is not properly formed; (2) for unpaid capital contributions that they have agreed to make (e.g. if youre subscribed for but havent yet bought stock); (3) where the veil of limited liability is pierced for equitable reasons. Shareholders are not liable for debts as shareholders, however, there may be other reasons why a shareholder is liable for instance, as a guarantor General Partnership: partners as individuals can be held jointly and severally liable for partnership obligations in tort, and jointly in contract. Partners have the ability to bind the partnership as long as they acted in the ordinary course of the partnerships business If there is joint and several, somebody can sue just one partner and get all the money; if its joint, then a person has to sue all partners Limited Partnership: general partners have the same unlimited liability as partners in a general partnership. Limited partners exposure is limited to the amount of their investment so long as they dont participate in management. If you structure it so that the general partner is a corporation, then nobody is liable as an individual LLC: statutes limit the liability of the entitys members and managers for its obligations but let the members participate in management and still receive limited liability makes it more potentially attractive than a limited partnership Management and Control Corporation: management is centralized in its BofD elected by the shareholders. The board is charged with managing or overseeing the corporations business and affairs. The business judgment rule effectively protects the directors from monetary liability for their good faith decisions With smaller and close corps, youre basically allowed to get rid of the centralized structure but still be a corp General Partnership: Not centralized. Management authority is vested in all partners. Each has an equal voice regardless of capital contribution. Decisions generally made by a majority. But some things, like modification of a partners decision-making authority, require unanimous consent. Limited Partnership: general partners have responsibility for most management decisions. Limited partners cannot participate in management without losing the protection of limited liability. However, they do maintain the right to vote on major decisions LLC: is either member-managed or manager-managed. In member-managed, all members have the authority to make management decisions. In a manager-managed LLC, members are not agents for the entity and make only major decisions (decentralized). Continuity of Existence Importance generally: allows for long-term planning Corporation: Exist in perpetuity unless the articles of incorporation say otherwise General Partnership: can be at will or for indefinite period. Absent contrary provisions in the partnership agreement, an at-will partnership is dissolved at the death, bankruptcy or withdrawal of any partner Limited Partnership: the business generally continues upon the death, bankruptcy or voluntary withdrawal of a limited partner but the partnership agreement must specify the latest date upon which the partnership must be dissolved. Absent a provision to the contrary in the partnership agreement, a limited partnership is dissolved only when a general partner withdraws, dies, or goes bankrupt. LLC: Statutes provide that LLCs exist in perpetuity unless the operating agreement or articles of organization provide otherwise Transferability of Interests What were transferring: Value (income and residual value like assets if the business is dissolved); and control (esp. important in partnerships) Corporation: Default rule is free transferability of everything. Everything (right to dividend, residual value, and vote) adheres to the stock General Partnership: general rule is that all partners must consent to the transfer of a partnership interest and admission of a new partner. However, there are exceptions sometimes that give the right to income but not control or residual value to a trasnferee Limited Partnership: Limited partnerships are transferable; general aren not LLC: depends some statutes (esp. recent) allow for free transferability of member rights; used to be that they could only transfer financial interest and not management interest w/o unanimous consent of other members Transfer is controlled by the articles of the LLC Which is better? One thing you get from transferability is the ability to exit In terms of absolute free transferability corporations are best. However, there is a glitch if there is no market for the stock, then you may legally have full transferability but you wont be able to find anybody to buy your interest. Same with LLCs LLCs change so much that there often isnt a market for shares of LLCs Fiduciary Duties The basic fiduciary duties of corporate directors, officers, and controlling shareholders are the duty of care and the duty of loyalty. Duty of care requires the directors to act in the corporations best interests and to exercise reasonable care in making decisions and overseeing the corporations affairs. Duty of loyalty requires directors to place the best interests of the corporation above their own personal interests. These duties dont necessarily apply to partnerships or LLCs, which are contractual in nature, so the parties can agree to limit of expand fiduciary duties as they wish. If partnership or operating agreements fail to address fiduciary duties, the judge may draw on fiduciary duties as theyve been applied in the corporate context even through the corporation is not contractual to the same extent as partnerships and LLCs. Ability to Raise Capital (equity, not debt) Corporations Sells more stock; can sell to public, but there has to be a market Partnerships Limited to raise more equity capital, you have to bring another partner in Limited Partnership Can sell more limited partnerships LLC Very flexible

The Limited Liability Company Has, in recent years, become the preferred form of doing business for many entrepreneurs and their lawyers. Elf Atochem North America, Inc. v. Jaffari (Del. 1999) Synopsis of Rule of Law.The Delaware LLC statutes give great deference to the freedom of LLC members to contract, providing the terms do not overstep any of the mandatory statutory provisions. Stuff about LLCS: The Delaware LLC Act was adopted in 1992. The LLC is an attractive form of business entity because it combines corporate-type limited liability with partnership-type flexibility and tax advantages The policy of freedom to contract underlies the Act theres broad discretion in formulating provisions

Planning Considerations Balancing Ownership Interests Corporate law favors the interests of majority shareholders. In a close corporation, a minority shareholder unhappy with the direction of the business may want to sell her shares. But the majority shareholder is likely to be the only one willing to buy and probably at a price less than the minority holder would consider fair. The ability to obtain relief is far less certain than the ability to withdraw unilaterally form an at-will partnership and obtain cash payment for the withdrawing partners interest. In general partnership, the default rule allowing at-will dissolution is critical. Allows parties to get around the unanimous consent rule (can just dissolve and reform without the person who you dont like (157) Minority partners can also use at-will dissolution to deal opportunistically with the majority. For instance, if they have needed skills, they can threaten to withdraw if they dont get what they want ** To deal with these sorts of problems, investors planning a partnership should consider drafting provisions that reduce the risk of opportunism. Tax Considerations (bottom 158) Differences between corporations and partnerships in taxation: A corporation is treated as a taxpaying entity separate from its shareholders A partnership is treated as an aggregate of individuals rather than as a separate entity. All income that the partnership makes is imputed to the partners and the partners pay it as if it were their personal income There might be situations where partnership is making tons of money but partners cant pay the tax on it Corporate partners cannot claim a deduction if the corporation operates at a loss (its deducted against the corporations income, not the owners); partners in partnerships can There are 2 ways a corporation can distribute money: Can give money made on shares (increases) as dividends to shareholders --- then the stock is worth the base value plus the dividend If you dont pay dividends, then the stock is worth more and if shareholders want their dividends, they just have to sell their share Limited Partnership: divide income like a partnership LLCs are allowed to select how theyll be taxed. By default theyll be taxed as a partnership There are ways by which some corporations can avoid tax at the corporate level (pay the shareholders salaries, etc all of which are generally tax-deductible business expenses) Another option is to qualify as an S corporation these must be domestic corporations with no more than 100 shareholders. The shareholders must not be nonresidents, and the corporation can only have one class of stock Need to understand the significance of tax rates There was a big disparity between corporate tax and individual tax. This impacted whether corps would pay dividends or not if corporate tax rates were way lower than personal, it made sense to not pay dividends then the corporate income would be taxed less than if the people had to pay the corporate tax and then the individual (higher) tax on the dividends

Chapter 7: Forming the Corporation

First thing: Discuss conflict of interest problem inherent in being an attorney for three individuals all forming one company Second: Need information about the business they want to found and their own personal info Because of liabilities how much liability might they face, do they have kids that they are saving money for? Use this info to determine what kind of corporation we want to be Third: Where to incorporate Rule of thumb: incorporate locally unless theres a reason not to Why: local counsel knows local rules; local courts are more hospitable Why incorporate in a different state? Laws might be more favorable Large corporations typically go to Delaware Now what do we do to incorporate? 2.01-.02; 3.01-.02; 4.01; 6.01

So all you need to start are: name, name and address of agent; name and address of each incorporator; class(es) of stock and the legal rights associated with them; and then you take the form and give it over to the secretary of state.

The Process of Incorporation See MBCA 2.01-.07; filing requirements and procedures are simple & quick After the corp has come into legal existence, an organizational meeting must be held. At its first meeting, the board accomplishes a number of standard tasks, including the election of additional directors, if any; the adoption of bylaws; the appointment of officers; the adoption of a corporate seal; the designation of a bank as depository for corporate funds; and often the sale of stock to the initial shareholders Choice of State of Incorporation Corps. generally incorporate in the state theyre operating in, if only operating in one state (reduce filing, reporting, tax burdens) Other considerations: corporate and franchise tax rates; ease of operating the corp; regulation of sale of stock and payment of dividends

Lawyers Processional Responsibilities: Who is the Client? This question is important bc lawyers have specific duties to clients that they dont have to non-clients E.g. to deal honestly, to comply with obligations concerning the clients confidences and property, to avoid conflicting interests The lawyer as planner might find it difficult to stay neutral since every solution involves tradeoffs among parties with differing goals The Model Rule 1.7 of the ABA Model Rules of Professional Conduct permits multiple representation, albeit with the informed consent of the parties after full disclosure of the consequences. A particularly important factor in determining the appropriateness of common representation is the effect on client-lawyer confidentiality and the attorney-client privilege. The prevailing rule is that the attorney-client privilege doesnt attach; so, if litigation eventuates between the clients, the privilege will not protect any such communications and the clients should be so advised. Model Rule 1.13: (g) A lawyer representing an organization may also represent any of its directors, officers, employees, members, shareholders or other constituents, subject to Rule 1.7. If the orgs consent to the dual representation is required by Rule 1.7, the consent shall be given by an appropriate official of the org other than the individual who is to be represented, or by the shareholders. Entity Theory of Representation Many jxs have adopted the entity theory of the corporation as embodied in Model Rule 1.13. The core of the theory is that the lawyer represents the corporation, rather than its officers, directors, employees or shareholders Appears to adopt the paradigm of the publicly-held corp: the corp is an individual, standing apart from its constituents. Jesse by Reinecke v. Danforth (1992) Rule: Entity Ruleholds that where a lawyer represents a corporation, the client is the corporation, not the corporation's constituents. RULE (2): Where (1) a person retains a lawyer for the purpose of organizing an entity; (2) the lawyers involvement with that person is directly related to that incorporation; and (3) such entity is eventually incorporated, the entity rule applies retroactively such that the lawyers pre-incorporation involvement with the person is deemed to be representation of the entity, not the person See pg ~ 47 reading notes for determinative facts A lawyer can represent a yet-to-be-formed corp the entity theory applies retroactively An alternative view is the aggregate theory - the lawyer is found to represent the incorporators/constituents collectively as joint clients Once the corporation is formed, the clients must determine whether the lawyer will continue to represent all of the constituents and the entity, or just the entity ** Lawyers must make clear WHO they do/do not represent With respect to confidentiality obligations, lawyers should specify how information conveyed to them will be treated for confidentiality purposes Aggregate Theory of Representation The lawyer represents all of the owners individually in addition to the entity A lawyer has no duty to keep information confidential among the shareholders if the information relates to the representation, nor does the attorney-client privilege obtain if there is litigation between the shareholders Many courts have applied the reasonable expectations test, rather than trying to apply entity or aggregate theory Under this test, as set forth in Westinghouse Elec. Corp. v. Kerr-McGee, if an attorney leads an individual or entity to believe that they are a client and the belief is reasonable under the circumstances, an attorney-client relationship will be created, whether or not the client enters into a formal retainer agreement. Lawyer for the situation functions vary with specific circumstances --- but basically, lawyers in these circumstances have a holistic view of everybodys wants, desires, conflicts, and potential areas for synergies. It can be difficult for a lawyer to clearly identify his role as such, however

Problems during Incorporation Ultra Vires Is a common law doctrine meaning beyond the power a corporation could not engage in activities outside the scope of its defined purposes. Used to be much more important; now really only comes into play in a few situations like whether charitable contributions constitute a waste of corporate assets Defective Incorporation In response to these questions, courts developed the concept that the business association could be a de facto corporation, even if it was not a corporation de jure theres also a corporation by estoppel concept MBCA 2.04 imposes liability on people who act as or on behalf of a corporation knowing that no corporation actually exists. De facto incorporation Three conditions must be met: There must be a corporation statute There must have been a colorable attempt to comply Have to show that the corporate privilege was exercised (have to show that the people were acting on behalf of the corporation) *This doctrine has come under attack in some jxs because its so easy to form a corporation or to follow up and find out if the corporation has been formed Pre-incorporation transactions: Occur when people want to act on behalf of corporation but know that the corporation hasnt been created What not to do: never sign the name of a corporation knowing that the corporation doesnt yet exist. If an agent acts on behalf of a non-existent principle, the agent is the principle (and is held liable as it) What could maybe do: could file a boilerplate form of corporate articles create corp as a shell and then amend once you work out the finances, etc. Or get an option contract (only works where the value of what you want stays the same at least in short run (like land)) Another thing to do: insert a clause into the contract signing as a corporation yet to be formed this gets rid of the misrepresentation grounds for holding you liable. But it doesnt take care of the agency problem Its not the lawyers position to choose among these options, but instead to inform the client of what the options and associated risks are

Chapter 8: An Introduction to Financial Accounting and ValuationFinancial Accounting Demystified Generally accepted accounting principles (GAAP) * there is no such thing as objective truth in accounting * What gives a company value: Cash; inventory; property; workers; human capital the relationships built up between people; patents (that we develop) & trademarks/name; leases

The Balance Sheet A snapshot of the financial status of the business at a particular moment; done yearly Contains sections for assets, liabilities, and equity. Assets include property, both tangible and intangible, owned by the firm Liabilities accounts for the amounts that the firm owes to others Equity or net worth represents the accounting value of the interest of the firms owners Total assets are always equal to total liabilities plus equity ASSETS = LIABILITIES + EQUITYAssets: Going concern principle: some assets are of great value to the corp, but only when the company is in operations. So when youre doing a balance sheet, you have to assume that the company is a going concern i.e. not going out of business Principle of conservatism: when choosing between two solutions, the one that will be least likely to overstate assets and income should be picked you have to take the lower cost or market value of goods into account (e.g. if the market drops out on something you bought, like steel). This is also called mark to market Are listed in order of liquidity, beginning with cash and end with more fixed assets Current assets: include cash and other assets that in the reasonably near future will be converted into cash. Also include marketable securities, which are mark to market because theyre marked on the balance sheet to their current market price. Accounts receivable: are amounts not yet collected from customers to whom goods have been shipped or services delivered GAAP require that accounts receivable be adjusted by deducting an allowance (or reserve) for bad debts; firms usually estimate the bad debt allowance on the basis of past experience or experience of similar businesses. Reserve for doubtful accounts Notes or Loans Receivable: usually represent a very large portion of the assets of firms engaged in financing businesses Inventory: Represents goods held for use in production or for sale (parts, finished products, works in progress) The amount of items sold from inventory is the Cost of Goods Sold (COGS) and often represents a firms largest cost of doing business Firms that cant keep track of the cost of each item in inventory compute COGS by adding their purchases during a reporting period to the value of their inventory at the start of the period (called opening inventory) and then subtract the value at their closing inventor. The firm can use one of three methods to value its closing inventory: The average cost method, which visualizes inventory as sold at random from a bin; the first in, first out (FIFO) method, which visualizes inventory as flowing through a pipeline; and the last in, first out (LIFO) method, which visualizes inventory as being added to and sold from the top of a stack In any period in which prices change significantly, the inventory method a firm uses can have a material impact on the value of its inventory account, on COGS, and hence on the firms reported profits which can be exploited for tax purposes; see example in CLASS NOTES!!! Prepaid expenses: Payments made in advance of services received Deferred Charges: Represent a type of asset similar to prepaid expenses, in that they reflect payments made in the current period for goods or services that will generate income in subsequent period, such as advertising for a new product Fixed Assets: Sometimes referred to as long-term assets or as property, plant, and equipment, are the assets a firm uses to conduct its operations When a firm acquires a fixed asset, it records the asset on its balance sheet at cost. GAAP then uses depreciation value to reflect more accurately the value of fixed assets on the balance sheets What you do is take a certain amount of the cost and assign a portion of those expenses to each year Intangible Assets Exs: patents and trademarks GAAP requires firms to carry intangible assets they have purchased at cost less an allowance for amortization (the equivalent of depreciation, applied to intangibles) However, GAAP does not allow a firm to record as an asset the value of an intangible asset a firm has developed itself, rather than purchased.Lots of things dont show up on the balance sheet that are part of what the company is worth (e.g. workers, patents that we develop, our name and trademarks) So there is a concern that our company is worth more than its book value because these things arent included

Liabilities: Are usually divided into current and long-term liabilities Current liabilities are the debts a firm owes that must be paid within one year of the balance sheet date. Long-term liabilities are debts due more than one year from the balance sheet date. Many liabilities dont show up on the balance sheet. However, GAAP requires companies to put money aside if things like lawsuits occur

Equity: Or net worth represents the owners interest in the firm. It is NOT actual $; its an accounting representation of the book value of a company A corporations equity has two components: The first, often recorded as paid-in capital, reflects the total amount the corp has received from those who have purchased its stock The second, called retained earnings or earned surplus, reflects the cumulative results of the corporations operations over the period since it was formed This amount is also reduced by the distribution of any dividends to shareholders or any amount the corp has paid to repurchase stock

Analyzing the Balance Sheet: One focus is liquidity: does a firm have sufficient cash or assets it is likely to convert into cash to meet its financial obligations as they come due? Three commonly used indicators of a firms liquidity are its: Working capital, defined as the difference between current assets and current liabilities Current ratio, computed by dividing current assets by current liabilities; and Liquidity ratio, computed by dividing quick assets like cash, marketable securities, and accounts receivable by current liabilities. A gradual increase in a firms current ratio, based on a comparison of successive balance sheets, is a sign of financial strength Creditors often compute a firms debt-equity ratio, dividing long-term debt by book value of equity. A high ratio may indicate that the firm is relying primarily on borrowed capital. This can be dangerous for debt holders if the firms business falters

The Income Statement The income statement is the bridge between successive balance sheets it records whether the firm realized a profit or loss during the period between successive balance sheets In general: Look at total operating expense to see whether theres profit --- but we still dont know if the company is actually viable there might be interest on loans that is greater than the amount of profit after operating expense ** There are two reasons why a business can fail: underlying business isnt sound (its losing money); OR it might be financed in such a way that it cant make money GAAP require that most firms use the accrual method of accounting to prepare their financial statements rather than the cash method. Under the Realization Principle of accrual accounting, a firm must recognize revenue in the period in which it ships goods or renders services, even if it does not receive payment for the goods or services in that period Under the Matching Principle, a firm must allocate the expenses it incurs to generate revenues to the period in which it recognizes the revenues Earnings: The statement of income starts with net sales represents the total value of a firms revenue during the relevant year Once we know the revenue, we can deduct expenses First Cost of Goods Sold (COGS). These generally represent the cost of items sold from inventory The difference between Net Sales and Cost of Goods Sold is the companys Gross Profit Operating expenses are the costs associated with the operation of a business but not directly related to the costs of goods or services. These are sometimes referred to as indirect expenses or overhead Exs: Depreciation expense decrease in value of fixed assets Selling and administrative expense Research and development To obtain operating income, we subtract all of the operating expenses from gross profit. Operating income is sometimes referred to as EBIT, Earnings Before Interest and Taxes Net Income: Interest expense represents the amount of interest the firm paid on its debt during the year Income before taxes is obtained by subtracting interest expense from operating income --- this is sometimes called taxable income Net income is very important and considered heavily by investors. It is the link to both the balance sheet and cash flow statements. Whatever is left from net income, after a firm pays dividends, goes to the retained earnings section of the firms balance sheet Finally, one indicator of a firms value is its return on equity, which one can compute by dividing equity at the end of the previous year into the net income reported for the current year. That percentage can be compared to the returns available on alternative investments. Net income is the starting point for the statement of cash flows

Statement of Cash Flows: The Statement of cash flows reports on the movement of cash into and out of the firm. It is divided into three parts, based on whether the cash flow is from operating activities, investing activities, or financing activities Structurally, the statement of cash flows starts with net income and then corrects for each of the non-cash changes reflected in the balance sheet and income statement This doesnt let you see whether youre making money on particular items, however, there are less judgment calls necessary in making a statement of cash flows than in doing an accrual statement Over a long period, cash flow is really preferred

GOOD LAST PARAGRAPH questions to ask --- PG 217.

Valuing the Enterprise In valuing a business, it is extremely important to keep in mind the time value of money The process of figuring out how much future cash flows are worth today is called discounting The value of future cash flows in todays terms is called present value One good way to value a firms stream of income is to look at earnings of a comparable firm Another way to do this is with operating cash flows rather than reported profits Another approach: the discounted cash flow or DCF: Estimate the stream of cash flow or earnings the business is expected to generate in the future and then discount that stream of payments to a present value Other things: a purchaser should inquire what is behind the COGS, investigate overhead charges, understand the selling and marketing expenses, determine whether receivables can really be collected, and ascertain whether inventory is obsolete; should also inquire as to contingent liabilities Consider economic goodwill: the value of the brand, advertising and marketing, oligopoly or monopoly power, or unique market opportunities

Main places where you get a lot of info: Look at changes in statements over time you can see things in trends Various financial ratios that are listed in the book - Use relationship between two accounts to get information about a company For instance, current assets divided by current liabilities. If there is a decline, thats bad. Tells you whether or not a company has enough assets to cover liabilities.

Chapter 9: Financial Structure of the Corporation

MBCA 6.01 Authorized Shares The articles of incorporation must set forth any classes of shares and series of shares within a class, and the number of shares of each class and series that the corp is authorized to issue Except to the extent varied as permitted by this section, alls hares of a class or series must have terms, including preferences, rights, and limitations that are identical with those of other shares of the same class or series (b) The articles of incorporation must authorize (c) The articles of incorporation may authorize

MBCA 6.21 (a) (e): Issuance of Shares (a) the powers granted in this section to the BoD may be reserved to the shareholders by the articles of incorporation (c): Before the corp issues shares, the BoD must determine that the consideration received or to be received for shares to be issued is adequate (e) The corporation may place in escrow shares issued for a contract for future services or benefits or a promissory note, or make other arrangements to restrict the transfer or the shares, and may credit distributions in respect of the shares against their purchase price, until the services are performed, the note is paid, or the benefits received

Corporate Securities Corporate securities can be divided into equity and debt In general, equity represents permanent commitments of capital to a corporation, while debt securities represent capital invested for a limited period of time (e.g. the maturity of a loan) Returns on equity securities generally depends on the corporations earning a profit The rights of equity securities are subordinated to the claims of creditors, including those who hold the corps debt securities However, holders of equity securities typically elect the BoD and thus exert more control over the conduct of the business and the risk it incurs Debt securities generally have priority in terms of payment if the firm becomes insolvent or liquidates voluntarily Because theyre less risky, debt securities are typically only entitled to a fixed return Holders of debt securities can back them by placing liens on some or all of the corporations assets or by negotiating contractual covenants restricting the corps operations; aside from this, debt holders ordinarily play no role in the firms management

Equity Securities The terms common stock and preferred stock are used to describe the two basic kinds of equity securities Corporate statutes require that at least one class of equity security must have voting rights and the right to receive the net assets of the corporation in the event that the corp is dissolved or liquidated. When a corp is formed, the articles of incorporation will create authorized shares Until theyre sold to shareholders, they are authorized but unissued When sold, theyre authorized and issued or authorized and outstanding If theyre repurchased by the corp, theyre authorized and issued, but not outstanding Statutes require that the articles of incorp. Include the number of shares that a corp is authorized to issue and describe certain characteristics of those shares. To issue more stock, the articles must be amended. The BoD must recommend the amendment, and holders of at least a majority of outstanding stock must approve The percentage of the corporations outstanding stock that a persons shares represent determines her position relative to other stockholders Common law doctrine of preemptive rights: held that a shareholder had an inherent right to maintain her interest in a corporation by purchasing a proportionate share of any new stock issued for cash. This was meant to get around the problem of diluting shareholders stocks Now, many states have an opt-in approach to pre-emptive rights. This gets complex when you have different classes of stock with different proportional rights (e.g. common stock with 1 vote, 1 dividend; preferred stock with no vote, 1 dividend)

Common Stock Is the most basic of all corporate securities all corps must have it, and many have only it. Can have many different classes of it within one corporation, each with different rights. Rights (e.g. to income, vote, right on dissolution) are set out in articles of incorp. Exception: sometimes you want the BoD to be able to amend the rights without amending the articles of incorp. To do this, you allow for blank check stock BoD has the ability to define the rights of that particular set of securities going forward Board has discretion as to issuance of dividend. Large companies typically issue it quarterly: steady divided = steady income. But this isnt required. Voting rights: Common stock normally carries 1 vote. Sometimes, corps create two classes of common stock e.g. class 1 has one vote and has 100% of the dividend; class 2 will have 10 votes per share and 90% of the dividend. People can choose but only those that want to run the thing will go with class 2. Holders of common stock usually have the exclusive power to elect a corps B oD (so they have the most control)