Ba-corporation Law.docx

Spring 2019

Business Association: Corporation Law

Prof. Lee

Is X an Agent? An agent is any person who is authorized to act on behalf of another, known as the principal. An agency relationship is a consensual relationship between a principal and an agent. An agency relationship is created when 1) the principal “manifests assent” to have the agent act on the principal’s behalf and under the principal’s control, and 2) the agent “manifests assent or otherwise consents” so to act. Did X have actual authority, either express or implied, to bind Principal to X’s K with 3rd party? Actual authority is created by a manifestation from the principal to the agent that the principal consents to the agent taking actions on principal’s behalf. In determining the actual authority of an agent, one would evaluate the communications from principal to agent. An agent’s actual authority can include both express and implied kinds. Express actual authority of an agent to act on a principal’s behalf may be conveyed orally or in writing. Implied actual authority is the power to do those things necessary to fulfill the agency. Did X have apparent authority to bind Principal to X’s K with 3rd party? Apparent authority arises when a third party reasonably believes that an agent has authority to act in a specific way on behalf of the principal, and that belief can be traced to the principal’s manifestations to the third party. An agent cannot create apparent authority for herself. Does X have a fiduciary duty to the Principal? An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the agency relationship. An employee may breach the duty of loyalty owed to an employer in three situations: (1) when an employee competes with an employer, (2) when the employee misappropriates an employer’s profits, property, or business opportunities, and (3) when the employee breaches an employer’s confidences. Does Y have a fiduciary duty to the Agent? (1) Good faith and fair dealing; performance of contractual obligations; indemnification under certain circumstances. (i.e. expense account) Inward v. Outward looking Inward: Fiduciary duties as to the agency-principal relationship – liabilities thereof Outward: Authority of the agent act on principal’s behalf with 3rd party – liabilities thereof Partnership A general partnership is an association of two more persons as co-owners of a business for profit. Partnership Creation There is no requirement that the parties subjectively intend to form a partnership, only that they intend to run a business as co-owners or form an agreement to share profits. Joining a Partnership

Spring 2019

Business Association: Corporation Law

Prof. Lee

No one can become a partner without the unanimous consent of all other partners. Partner Each partner is an agent for the partnership. An agent has the power to bind a principal to a contract if the agent had actual authority, expressed or implied, or apparent authority to enter into the contract. Liability A partnership is liable for loss or injury caused to a person by a partner acting in the ordinary course of business or with authority of the partnership. Once a partnership is created, partners are personally liable for all debts and obligations of the partnership and are also entitled to equal sharing of the profits. When there is no explicit agreement as to losses, losses are divided equally between the partners, without regard to the amount each partner contributed to the venture as long as each of the partners contributed capital to the enterprise. When a partner only contributed labor and the other only capital, the partner contributing only labor takes a loss in the form of lost labor. In a partnership, all partners must consent to actions falling outside of the partnership’s ordinary course of business, proven by circumstances/agreement, while matters within the normal course of business may be decided by a majority of partners. Actual Authority: 

A majority of partners is necessary to approve an act that is in the ordinary course of the firm’s business, while a unanimous vote is necessary for actions that are not in the ordinary course of business.

Apparent Authority: 

It appeared to the third party that the partner had the authority to act on behalf of the partnership in engaging in the ordinary course of the partnership’s business, and the third party had no actual or constructive notice that the party lack actual authority.

Fiduciary Duties (RUPA) A partner owes a duty of loyalty to the partnership that includes not placing the partnership at a competitive disadvantage. A partner may breach the duty of loyalty by sharing confidential information. A partner owes a duty of care to the partnership, for the breach of which is shown by gross negligence, recklessness, intentional misconduct or knowing violation of the law. (UPA): A partner owes a duty of loyalty to the partnership that provides only that partners must not steal from the partnership Dissolution

Spring 2019

Business Association: Corporation Law

Prof. Lee

A partnership may be dissolved by any partner if the partnerships is formed for an indefinite term or for no particular undertaking. If the partners formed the partnership for a particular purpose or for a particular time period, then one partner does not have the right to terminate the partnership until the term has run or the goal has been achieved. Partnership Accounting A capital account tracks each partner’s ownership against the partnership, which is calculate by looking at: (1) (2) (3) (4)

Contributions made by each partner; Each partner’s share of profits/losses from partnership operations Any withdrawal of funds from the partnership Each partner’s gains or looses upon sale of the partnership or its assets.

Partners are entitled to a repayment of any capital contributions/advances made to the partnership. The partnership must reimburse a partner for payments made and indemnify a partner for liabilities incurred in the ordinary course of business. Paying Liabilities Assets of the partnership are used to pay liabilities in the following order: (1) (2) (3) (4)

Amount owed to creditors, who are not partners; Amount owed to partners other than for capital and profits Amounts owing to partners for repayment of capital; and Amounts owing to partners for any remaining profits.

If partnership assets are insufficient to cover these liabilities, partners must contribute to the payment of those liabilities. Corporate Formation Closely Held: (MBCA) A corporation created when the articles of incorporation (charter) are filed with the Secretary of State and includes the mandatory provisions: (1) Business name with “Inc.” (2) Address of registered office and agent (3) # of shares issued, types, preferences, limitations or restrictions on particular classes of stock, and par value of each if different classes. (4) Name/Address of incorporators After incorporated, a meeting must be held to adopt bylaws, appoint officers, and carrying on another other business. Public Held: (DGCL)

Spring 2019

Business Association: Corporation Law

Prof. Lee

A corporation is created when a certificate of incorporation (charter) is filed with the Secretary of State and includes the mandatory provisions: (1) Business name with “association” “corp” (2) Address of registered office and agent. (3) # of stocks issued, types, preferences, limitations or restrictions on particular class of stock and par value if different classes. (4) Name/Address of the Incorporators (5) Business Purpose “Corporation may be formed for any lawful reason” (6) Name/Addresses of persons who are to serve as directors until first annual meaning. After incorporated, a meeting must be held to adopt bylaws, elect directors, and carrying on another other business. How to amend the Articles? – public document Amendment is proposed by board, approved by shareholders, and filed with state. Bylaws – private document Bylaws are internal rules regulation enacted by the corporation to governs its acts and relations to its shareholders, directors, and officers. How to amend the Bylaws? The power to amend bylaws is at the sole discretion of the shareholders. Management of a Corporation – Power Struggle – Directors – DGCL The directors manage or supervise the operations of the corporation; this includes: hiring, firing, advising and making decisions in the ordinary course of business (quorum that constitutes majority required) Under DGCL, having a board is required, under a staggered board director may only be removed for cause, unless otherwise stipulated in charter. Under MBCA, board can be removed via shareholder agreement, with or without cause unless otherwise stipulated in charter, or by a judicial proceeding for fraudulent conduct or gross abuse of authority. Inside Directors Employed as corporate officers as well as board members. Outside Directors They just serve as board members. Officers If appointed, the top executive officers exercise control over the corporation’s day to day matters.

Spring 2019

Business Association: Corporation Law

Prof. Lee

Shareholders The shareholders own the corporation and have the power to:  Elect/remove directors via the annual director elections  Vote on: o Amending the Charter/Bylaws o Approving a merger o Ratifying conflict of interest transactions o Sale of assets not in the ordinary course of business. How do Shareholder’s Vote? - A quorum constituting majority required unless otherwise provided  In Person or by proxy – giving authorization to 3rd party to vote shares (retain legal title)  Via a voting pool agreement (to protect the minority shareholder interest) o Shareholders vote together as a single block  Via voting trust – gives authorization, and legal title, to 3rd party to vote shares (retain financial rights) o Trustee is subject to a duty of good faith What Impacts Voting Power? Classified Shares – Shareholder Hierarchy – Preferred/Common/Class C Policy Allocate control among various classes of shareholders by: (1) Providing a class: a. Veto power b. No voting power (only financial rights) c. Voting power only on certain transactions; OR Preemptive Rights – Must opt in – (common in MBCA) Preemptive rights provide shareholders with the right of first refusal in deciding whether they will subscribe to their proportionate percentage of stock during a subsequent issuance of stock. Generally, the corporation must opt in for minority shareholders to have preemptive rights. Cumulative Voting – Must opt in Charter Method of counting shareholder votes where each shareholder in director elections are entitled to vote the product of their share’s times the number of director’s to be elected; and casting their votes in favor of single director (as opposed to straight voting where the votes are allocated among candidates). Policy Increase minority shareholder influence on the board. Supermajority (Quorum) Requirements - % required to pass/elect – Policy

Spring 2019

Business Association: Corporation Law

Prof. Lee

Ensure giving minority shareholders voice in corporate affairs. Under DGCL Must be provided for in charter/bylaws. If in charter – can be amended/repealed only by supermajority. If in bylaws – can be amended/repealed by simple majority; unless otherwise specified. Under MBCA Must be provided for in charter – can be amended/repealed only by supermajority. Deadlock – Business Comes to a Standstill Occurs when shareholder or director vote is evenly divided. Leads to dissolution; unless:  Use provisional directors; buyout; arbitration; mediation; judicial intervention Capital Structure Equity Claims They are the corporation’s capital stock, and the individual units of capital stock are called shares. Debt Claims Corporations borrow money and incur indebtedness by issuing bonds (loan), and these debt claims have tax advantages over equity claims. Redemption allows corporation to buy back the debt securities created by the bonds. Paying the Shareholder – Residual Assets – Dividends – 2-fold tax Dividends are a payment from a corporation to its shareholders calculated on a per share basis. Share Repurchasing – Transfer Restrictions Occurs when a corporation repurchases its own stock, pays money to shareholders, and retires shares. How is the distribution Calculated? – Limitations on Distributions DGCL (1) There is a solvency restriction on distributions, which means that the corporation cannot distribute money if it would result in insolvency, inability to pay debts as they are due. (Solvency Test) (2) Distributions can be made out of the surplus, which is calculated by determining all capital in excess of the aggregate par value, generally set at a penny to maximize surplus, of the issued shares plus any amounts the board has elected to add to its capital amount. (Impairment of Capital Test) MBCA

Spring 2019

Business Association: Corporation Law

Prof. Lee

(1) A corporation can make distribution only out of there surplus, and the surplus can be calculated in any reasonable manner, as long as they acted in good faith. (Technical Insolvency Test)

Policy Behind Limitations To protect debtholders, including creditors, when a business fails – to ensure they get paid. Capital Impairment Where distributions are made in excess of the surplus. Limited Liability Generally, individuals who are part of or invest (shareholders) in corporations have limited liability. Policy Under the DGCL Removes the risk of unlimited liability, allows for the free transfer of shares in the public markets (diversification), reduces the monitoring cost of managers/shareholders. Under the MBCA Advantages are present because investors do not invest to diversity because they are employed by the corporation, and the shareholders/managers are often the same people Effects (1) Increases cost of corporate debts, while decreasing the cost of corporate equity – because it increases the business risk for voluntary/involuntary creditors. (lenders/tort victims) (2) Incentive to engage in riskier behavior, moral hazard, since they don’t have to bear the total cost. Exception to Limited Liability – Piercing the Corporate Veil – Courts can impose more liability to shareholders beyond the amount of their investments. (MBCA) Analytical Framework: (1) Whether liability may attach to the shareholder directly by reason of the shareholder’s own actions? (2) If no personal liability, a. Were corporate formalities observed? i. i.e. lack of separate corporate/personal: records, property, or bank accounts b. If not, most courts require a showing of injustice or unfairness showing that the wrongdoing is connected to the harm. i. i.e. third party confused about whether dealing with corporation/person ii. i.e. shareholder has treated funds as own. – comingling of funds Transferring Shares

Spring 2019

Business Association: Corporation Law

Prof. Lee

Under the DGCL Generally, shares of stocks are freely transferable. Under MBCA Generally, transferring stocks is ill-advised, as shareholders want to: - encourages transfer restrictions (1) Retain power to select future associates – to main collegial work environment – (2) Prevent competitors from buying shares. (3) Prevent one shareholder from gaining absolute control. Transfer Restrictions Are within the charter, bylaw, a separate agreement among shareholders, or between shareholders and the corporation that restrict a shareholder’s freedom to sell his or her shares. Transfer Restrictions are valid only if: (1) The restriction complies with formal requirements related to the adoption of the restriction and must be clearly noted on the share certificates. (2) The restriction must be for a proper purpose – reasonableness standard – Types of Transfer Restrictions  Buy/Sell Agreement: only shareholders/corporation can buy the share. – reasonable  An option: corporation/shareholders given option of first refusal to purchase shares either at specified price or price offered by third party purchaser. – reasonable  Prior approval or consent requirement: approval by shareholders/corporation - reasonable  Prohibition: prohibited from transferring to certain persons - unreasonable Liabilities/Claims against Directors – agents – Directors are fiduciaries to the shareholders and corporation. Under the shareholder primacy norm doctrine, the shareholders are the primary beneficiaries of the duty of care. Breach of the Duty of Care – Most Jurisdictions have Exculpation Clauses for this Duty The duty of care is primarily a procedural duty, that is a duty to make lawful decisions in a well informed and careful manner. Under the business judgment rule, a court will not second guess the decisions made by corporate directors, unless there actions were grossly negligent, in that they did not inform themselves of all material information reasonably available to them. Generally, courts will not second guess the actions by directors because it encourages directors to serve by limiting their exposure to liability. Policy Judges have no expertise and it encourages directors to avoid making decisions. Breach of the Duty of Loyalty – Pick your flavor to Satisfy – How to Prove:

Spring 2019

Business Association: Corporation Law

Prof. Lee

The duty of loyalty requires that directors serve the interests of the corporation over their self-interests. The duty of loyalty is breached if a director has a conflict of interest and has engaged in self-dealing. Additionally, part of the duty of loyalty includes the duty to provide oversight, that is to have a have a proper reporting and compliance system in place to ensure that directors are informed about was happening within the corporation. The duty of loyalty is breached when there is an intentional dereliction of one’s duty or a conscious disregard for their responsibilities.  The duty of loyalty is breached if a director had a conflict of interest and engaged in self-dealing.  Duty of Oversight: (EE engaged in illegal activities several times and they paid settlements)  Duty of Good Faith: (not to compete; usurp corporate opportunities without giving them opportunity)  Duty not to act in a Self-Interested Manner (case- company selling property to director’s kin) Corporate Waste To prove a claim of corporate waste, the exchange must be so one sided that no person of sound business judgment would have made the decision.