Chapter Five
Common Stock
Limited Liability Issues
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•
•
•
•
•
•
•
•
•
•
•
Partnership – joint & several liability
The risk for wealthy investors
Discouragement of passive investments
Inability to accumulate large amounts of capital
The Scottish bank exception
Externalizing Losses – the Contract Case
– Protection by contract:
– Personal shareholder guarantees in close corporations
– Negative covenants from debtor corporations
– Security interests in debtor’s assets
– Higher interest rates to compensate for risk
The Tort Case
(1) Firms may take excessive risks
(2) Corporations may underinsure
(3) Product costs may not reflect social costs of production (accidents)
Large size of many corporations formerly solved the problem
Mass torts mean some tort creditors don’t recover
5-2
The History of Limited Liability
5-3
• Joint & several liability existed in Rome, but so did some limited
liability.
• 12th & 13th century – Italian shipping ventures gave limited
Liability to passive investors.
• The spread of the Limited Partnership form on the Continent.
• Corporations, except royally chartered ones, remained like
partnerships.
• 1855 – England granted limited liability to companies.
• 1816-1850 – states adopted limited liability with adoption of
general incorporation acts.
Issuing New Shares
5-4
• A decision of the Board of Directors
• Can be limited by:
– Par value protected against economic dilution
but with low or no par value it does not any
more.
– Charter (authorized number of shares)
– Charter (pre-emption rights)
– Shareholder Agreement (restrictions)
– Provisions of Corporate Law and Directors
Duties
DGCL 152
5-5
The consideration. . . for subscriptions to, or the
purchase of, the capital stock to be issued by a
corporation shall be paid in such form and in
such manner as the board of directors shall
determine. . . . In the absence of actual fraud in
the transaction, the judgment of the directors as
to the value of such consideration shall be
conclusive. The capital stock so issued shall be
deemed to be fully paid and nonassessable
stock upon receipt by the corporation of such
consideration. . . .
Voting But Not Economic Dilution
• Value of A’s outstanding common
stock:
100 shares @ $10 = $1,000
• New issue of common stock:
100 shares @ $10 + $1,000
• New value of A’s stock:
200 shares @ $10
= $2,000
5-6
Extreme Economic Dilution
5-7
• Value of A’s common stock:
100 shares @ $10 = $1,000
• New issue of common stock:
100 shares @ $0
+
• New value of A’s stock:
200 shares @ $5
= $1,000
0
Penalty Dilution - Option (i)
5-8
• Assume, for example, a $1,000,000 investment that has gone
bad, so that creditors will get one-half of the firm’s assets if no
new funds are put in. But if an additional $1,000,000 is
invested, the investment will be worth $1,750,000. If 100
original units were sold at $10,000 each, consider the options:
• (i) Another 100 units are sold at $10,000 each. At the end,
200 units will share a net worth of $1,750,000, or $8,750 per
unit. A rational investor who owns one unit, looking out
exclusively for his own interest, will decline to invest a fresh
$10,000, hoping that others will do so. His loss on one unit:
$1,250; Loss on two: $2,500
Penalty Dilution - Option (ii)
5-9
• Assume, for example, a $1,000,000 investment that has gone
bad, so that creditors will one-half of the firm’s assets if no new
funds are put in. But if an additional $1,000,000 is invested, the
investment will be worth $1,750,000. If 100 original units were
sold at $10,000 each, consider the options:
• (ii) 133.33 new units are offered at $7,500 each. At the end of
the day, 233.33 units will share a value of $1,750,000, or
$7,500 per unit (we have ignored rounding, where there is a 7¢
difference. The investor is now indifferent: he can invest
another $10,000, and own 2.333 units worth a total of $17,500.
He has lost $2,500. If he fails to invest, his original unit is worth
$7,500, and his loss is $2,500.
Penalty Dilution - Option (iii)
5-10
• Assume, for example, a $1,000,000 investment that has gone
bad, so that creditors will one-half of the firm’s assets if no new
funds are put in. But if an additional $1,000,000 is invested, the
investment will be worth $1,750,000. If 100 original units were
sold at $10,000 each, consider the options:
• (iii) 200 new units are offered at $5,000 each. At the end of the
day, 300 units will share a value of $1,750,000, or $5,833 per
unit. The investor who buys two new units has invested
$20,000 for a total of three units worth $17,500. He has lost
$2,500. If he fails to invest, his original unit is worth $5,833,
and his loss is $4,167.
Dilution Equation
5-11
• L = ma - (mx + p) (a)
•
x+d
• where: L = existing shareholders’ loss through dilution;
•
m = market price of a share before issuance;
•
a = a shareholder’s share ownership at the time new
shares are issued;
•
x = shares outstanding before dilutive issuance;
•
d = number of shares issued in dilutive distribution;
•
p = proceeds from sale of new shares.
Pre-emption
5-12
• The right to buy shares in a new issue pro rata to existing
holdings.
• Created by Courts in the US
• Created by Charter in the UK
Stokes Case
5-13
• Shareholders authorized issue of new
shares (doubling shares), par value $100,
and then sale to Blair at $450 per share.
• Stokes voted for first resolution but not
second.
• He claimed a pre-emptive right to buy a
pro rata portion for par value.
• Court held he had the eright.
Stokes Case
5-14
1. What business reasons motivated the
increase in authorized stock and the
sale to Blair & Co.?
•
Stokes Case
5-15
1. What business reasons motivated the
increase in authorized stock and the
sale to Blair & Co.?
•
Enlarge the size of the business;
•
Bring Marshall Field and other
merchants into management;
•
Obtain their banking business.
Stokes Case
5-16
2. Do you have any reason to believe that
$450 per share was an unfairly low
price for the sale of new shares in
Continental Trust Company?
Stokes Case
5-17
2. Do you have any reason to believe that
$450 per share was an unfairly low
price for the sale of new shares in
Continental Trust Company?
• Not a self-dealing transaction, at least
as reported.
• The shareholders approved the sale,
presumably by a majority vote.
• The Dissent notes stock had never
sold for a price this high before.
Stokes Case
5-18
3. Would it have been fair to other
shareholders to allow Stokes to
purchase newly issued shares at their
par value of $100?
Stokes Case
5-19
3. Would it have been fair to other
shareholders to allow Stokes to purchase
newly issued shares at their par value of
$100?
• The Dissent points out it would have denied
the Company $350 per share.
• Second, it defeats purpose of bringing
Marshall Field and others into management
and getting their banking business.
• Note that it would deny Blair effective
control, with a 50% block.
Stokes Case
5-20
4. Assuming the shares of Continental had a
fair market value of $450, and could have
been sold for that price to Blair, how much
of a loss would the other Continental
shareholders have suffered if Stokes were
allowed to purchase 221 new shares at their
par value of $100? (See the dilution
formula that precedes this opinion. Note
that you can’t simply use Stokes’ bargain
purchase ($450 - $100) for his 221 shares,
because the dilution reduces the value of all
shares below $450.)
Dilution Equation
5-21
• L = ma - (mx + p) (a)
•
x+d
• where: L = existing shareholders’ loss through dilution;
•
m = market price of a share before issuance;
•
a = a shareholder’s share ownership at the time new
shares are issued;
•
x = shares outstanding before dilutive issuance;
•
d = number of shares issued in dilutive distribution;
•
p = proceeds from sale of new shares.
Stokes Case
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•
•
•
5-22
Note that there were 5,000 original shares,
and the company proposed to issue another
5,000, so 10,000 shares would be
outstanding.
Assume that the purchase price of $450
represented the market value of each share.
And assume that 5,000 - 221 shares were
sold to Blair & Co., (before Stoke’s
exercise), so that 9,779 shares were
outstanding.
At this point Stokes is allowed to buy 221
shares @ $100.
Stokes’ Gain on Shares @ $100 Purchase
Price
5-23
• Stokes’ gain: $350 gain per share x 221
= $77,350
• All shareholders’ losses on Stoke’s purchase:
•
L = ($450)(9779) - (($450) (9779) + (($100)(221)) (9779)
•
9779 + 221
•
L = $4,400,550 - ($4,400,550 + $22,100) (9779)
•
10,000
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L = $4,400,550 - ($4,422,650) (9779)
•
10,000
•
L = $4,400,550 - ($442.265) (9779)
•
L = $4,400,550 - $4,324,909 = $75,640
• Stokes’ outcome: gain on purchase
$77,350
• Less 221/9779 share of dilution ($75,640)
1,709
• Stokes’ net gain:
$75,641
Stokes Case
5-24
5. Why would the other shareholders vote
to dilute their own share of ownership by
selling new shares to Blair at $450?
Stokes Case
5-25
5. Why would the other shareholders vote
to dilute their own share of ownership by
selling new shares to Blair at $450?
• They would not, as a general rule.
• But this looks like voting dilution, not
economic dilution.
• That’s the best assurance this is a fair
price - a sale to a third party.
Stokes Case
5-26
6 What effect would honoring Stokes’
preemptive rights be likely to have on
Blair’s interest in acquiring one-half of
the total shares of Continental?
Stokes Case
5-27
6 What effect would honoring Stokes’
preemptive rights be likely to have on
Blair’s interest in acquiring one-half of
the total shares of Continental?
• Destroy it. Stokes’ free riding attempt
could destroy the deal for everyone.
• Presumably Blair wants control.
Stokes Case
5-28
7. Does the majority opinion suggest any limits
on the preemptive rights doctrine that might
provide a way for Blair and the other
shareholders to avoid Stokes’ claims? If so,
how would you suggest restructuring the
transaction if you represented Blair or the
majority of the shareholders?
Stokes Case
5-29
7. If the sale is other than for cash. The court
stated at page 293:
– “As the right to increase the stock belonged
to them, the stock when increased belonged
to them also, as it was issued for money
and not for property or for some purpose
other than the sale thereof for money.”
• Have Blair buy property the Company
wanted and then sell it to Copmany for
stock.
Stokes Case
5-30
7. Or if the sale is at a public auction, as the
court stated at page 293:
– “The new stock belonged to the
stockholders as an inherent right by virtue of
their being stockholders, to be shared in
proportion upon paying its par value or the
value per share fixed by vote of a majority of
the stockholders, or ascertained by a sale at
public auction.”
• Have the vote authorizing the sale of
shares fix the price at $450.
Quick Check Question 5.1
5-31
How do RMBCA and DGCL deal with this
issue of pre-emption?
Quick Check Question 5.1
5-32
In the early 20th century some statutes
required preemptive rights unless the
corporation opted out of them in its articles.
RMBCA § 6.30: Shareholders’ Preemptive Rights
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•
•
5-33
– (a) The shareholders of a corporation do not have a preemptive right
to acquire the corporation's unissued shares except to the extent the
articles of incorporation so provide.
– (b) A statement included in the articles of incorporation that “the
corporation elects to have preemptive rights” (or words of similar import)
means that the following principles apply except to the extent the articles
of incorporation expressly provide otherwise.
–
(1) The shareholders of the corporation have a preemptive right,
granted on uniform terms and conditions prescribed by the board of
directors to provide a fair and reasonable opportunity to exercise the
right, to acquire proportional amounts of the corporation's unissued
shares upon the decision of the board of directors to issue them.
–
*
*
*
–
(3) There is no preemptive right with respect to:
(i)
Shares issued as compensation to directors, officers,
agents, or employees of the corporation, its subsidiaries, or affiliates;
(ii)
Shares issued to satisfy conversion or option rights
created to provide compensation to directors, officers, agents, or employees
of the corporation, its subsidiaries, or affiliates;
(iii)
Shares authorized in articles of incorporation that are
issued within six months from the effective date of incorporation;
(iv)
Shares sold otherwise than for money.
RMBA § 6.30 – Slide 2
•
•
•
5-34
(4) Holders of shares of any class without general voting rights but with
preferential rights to distributions or assets have no preemptive
rights with respect to shares of any class.
*
*
*
(b ) A statement included in the articles of incorporation that “the
corporation elects to have preemptive rights” (or words of similar
import) means that the following principles apply except to the
extent the articles of incorporation expressly provide otherwise.
(5) Holders of shares of any class with general voting rights but
without preferential rights to distributions or assets have no
preemptive rights with respect to shares of any class with
preferential rights to distributions or assets unless the shares with
preferential rights are convertible into or carry a right to subscribe
for or acquire shares without preferential rights.
(6) Shares subject to preemptive rights that are not acquired by
shareholders may be issued to any person for a period of one year
after being offered to shareholders at a consideration set by the
board of directors that is not lower than the consideration set for the
exercise of preemptive rights. An offer at a lower consideration or
after the expiration of one year is subject to the shareholders’ p
reemptive rights.
(d) For purposes of this section, the term "shares" includes a security
convertible into or carrying a right to subscribe for or acquire shares.
Del. GCL §102(b)(3)
• (3)
5-35
Such provisions as may be desired granting to the
holders of the stock of the corporation, or the holders of any
class or series of a class thereof, the preemptive right to
subscribe to any or all additional issues of stock of the
corporation of any or all classes or series thereof, or to any
securities of the corporation convertible into such stock. No
stockholder shall have any preemptive right to subscribe to
an additional issue of stock or to any security convertible into
such stock unless, and except to the extent that, such right
is expressly granted to such stockholder in the certificate
of incorporation. All such rights in existence on July 3, 1967,
shall remain in existence unaffected by this paragraph unless
and until changed or terminated by appropriate action which
expressly provides for the change or termination;
Katzowitz v. Sidler – Investments & Payouts
•
•
•
•
•
•
Three shareholders own corporation equally.
Each are owed $2,500.
Two want to take shares instead of cash.
Two vote to issue new shares for $100 each.
Book value is $1800
Third declines and argues is diluted.
5-36
Katzowitz v. Sidler – Investments & Payouts
Invested:
At Start
Dec. 1961
Payouts:
Sidler
Lasker
$500
2,500
3,000
$500
2,500
3,000
$18,885.52
$18,885.52
5-37
Katzowitz
$500
0
500
$3,147.59
Katzowitz v. Sidler – Investments & Payouts
5-38
• Pre-emptive Rights Might not Protect a
Shareholder.
• Normally shareholders can protect themselves
either by exercising their preemptive rights or
selling them to others who will exercise.
• But when shares are sold below fair value,
existing shareholders who either don’t want to
or lack the funds to invest can have their
investment diluted.
• The effects of stock rights are illusory in close
corporations, because there’s no market for the
Katzowitz v. Sidler – Investments & Payouts
5-39
• The corollary of the equal right to buy is a right
not to buy, without being diluted, if no valid
business justification exists for the dilution.
• Here the disparity between price and value was
calculated to force Katzowitz into investing
more money.
• The price was a tactic, designed to place
Katzowitz in a compromising position.
Katzowitz v. Sidler – Investments & Payouts
5-40
1. If you think of this as penalty dilution,
could the defendants argue that the
offer wasn’t unfair to Katzowitz?
Katzowitz v. Sidler – Investments & Payouts
5-41
1.If you think of this as penalty dilution, could the
defendants argue that the offer wasn’t unfair to
Katzowitz?
• Recall that penalty dilution is justified by forcing
an investor to bear his share of a burden.
• The business justification here was to loan the
money to another corporation all of them
controlled.
• It’s hard to tell if this was an urgent decision,
needed to salvage value for all of them, in
which it was fair to ask Katzowitz to participate.
Katzowitz v. Sidler – Investments & Payouts
5-42
2. What does it mean that the book
value of Sulburn’s shares was $1,800
at the time the stock was offered to
the three shareholders?
• Recall the meaning of book value, as
historical cost of assets less precalculated depreciation.
Katzowitz v. Sidler – Investments & Payouts
5-43
2. What does it mean that the book
value of Sulburn’s shares was $1,800
at the time the stock was offered to
the three shareholders?
• Recall the meaning of book value, as
historical cost of assets less precalculated depreciation. So this
historical cost less depreciation
divided by 15 shares equaled $1800
per share. Thus $27,000 BV
Katzowitz v. Sidler – Investments & Payouts
5-44
3. Is book value the ultimate test of the
price at which shares should be
offered in a corporation? Why or why
not?
Katzowitz v. Sidler – Investments & Payouts
5-45
3. Is book value the ultimate test of the price
at which shares should be offered in a
corporation? Why or why not?
• Given the fact that book value tends to
diverge from market value over time for
almost any asset, it’s hard to tell whether
it’s fair value.
• If all assets were purchased relatively
recently, then it can be a pretty good
proxy for market value.
Katzowitz v. Sidler – Investments & Payouts
5-46
4. If you represented Katzowitz at the
time new shares were offered at $100
each, how would you advise him
assuming he did not have a pressing
need for the $2,500 he had just
received from Sulburn? Why?
Katzowitz v. Sidler – Investments & Payouts
5-47
4. If you represented Katzowitz at the time
new shares were offered at $100 each,
how would you advise him assuming he
did not have a pressing need for the
$2,500 he had just received from Sulburn?
Why?
• He has two choices:
(1) Go ahead and buy the new shares and
protect himself from dilution; or
(2) Sue the other directors for breach of
duty in making a coercive offering at such
a low price.
Katzowitz v. Sidler – Investments & Payouts
5-48
5. The court states that preemptive
rights were created by the courts to
protect two distinct rights of
shareholders - their equity in the
corporation and their proportionate
voting control. Which is more
important here?
Katzowitz v. Sidler – Investments & Payouts
5-49
5. The court states that preemptive rights
were created by the courts to protect two
distinct rights of shareholders - their equity
in the corporation and their proportionate
voting control. Which is more important
here?
• Since Katzowitz will always get outvoted
unless he has a shareholders’ agreement
that gives a 1/3 shareholder a veto power,
it must be his economic interests.
Katzowitz v. Sidler – Investments & Payouts
5-50
6. If shares had been offered to each
shareholder at $1,800 per share,
would Katzowitz have any complaint?
Katzowitz v. Sidler – Investments & Payouts
5-51
6. If shares had been offered to each
shareholder at $1,800 per share,
would Katzowitz have any complaint?
• As long as there is a plausible
business purpose for the stock issue,
when it’s offered pro rata to all
shareholders at a presumably fair
price, the business judgment rule
should protect the decision.
Katzowitz v. Sidler – Investments & Payouts
5-52
7. If the existing shares of Sulburn were
worth $1,800, what is the amount of
damages Katzowitz has suffered
because of his failure to purchase?
(Hint: see the formula preceding the
Stokes case.)
Dilution in Katzowitz v. Sidler
5-53
• At time of issue: $1,800 book value x 15 shares = $27,000
• Book value after issuing 50 new shares @ $100 each:
• Original Equity:
$27,000
• Proceeds of issue
5,000
•
$32,000 / 65 shares = $492.30 book
value/share
• Katzowitz’s loss:
•
Original value: $1,800 x 5
•
Present value: $492.30 x 5
•
Loss:
=
$9,000
-2,461.50
$6,538.50
Katzowitz v. Sidler – Investments & Payouts
8. Is this an offer that normally a
shareholder like Katzowitz can’t
refuse? If so, can you think of any
justification for allowing directors to
make such an offer?
5-54
Katzowitz v. Sidler – Investments & Payouts
5-55
8. Is this an offer that normally a
shareholder like Katzowitz can’t refuse?
If so, can you think of any justification for
allowing directors to make such an offer?
• It is a coercive offer that he can’t refuse.
• Because of this, it should take an
emergency to permit it, such as salvaging
existing investments. (penalty dilution)
Katzowitz v. Sidler – Investments & Payouts
5-56
9. If the right to purchase shares for
$100 that are worth $1,800 is offered,
and Katzowitz chooses not to
exercise these rights, is there any
other way he can obtain value from
the right? If so, why didn’t he do so?
Katzowitz v. Sidler – Investments & Payouts
5-57
9. He could sell the right to someone else,
who presumably would be willing to pay
nearly the entire difference between the
exercise price, $100, and the post-sale
value of $492.30, or $2,461.50.
• The obvious problem is that there is no
market for these rights.
• The other problem is that most rational
investors would not want a minority
investment in a close corporation without
some guarantees of control.
Rights Plans – Slide 1
5-58
• Dividend Declaration Date – When Rights Plan Dividend is
Declared
– Right to purchase preferred stock at unrealistic price
– Rights stapled to stock certificates – not separately transferable
– Rights are void in the hands of an “Acquiring Person”
• Rights Distribution Date - When Separate Rights Certificates
Issue
– Announcement of a Tender offer
– “Acquisition Date” – when a Bidder Becomes an “Acquiring Person”
• Acquisition Date – When Rights “flip in” to become exercisable in
Common Stock
– Rights are no longer redeemable by Target’s Board
– Rights exercisable at 50% discount from fair market value of
Common
Rights Plans – Slide 2
• Target shares outstanding:
5-59
1,000,000
• Pre-bid market price per share:
$10.00
• Bidder’s per share cost for the first 15%:
$15.00
• Expected takeover bid price per share:
$15.00
• Exercise price for preferred stock rights:
$40.00
• Assumed market value per share of target shares for
calculating common stock acquisition price:
$15.00
• Flip-in trigger:
• Flip-in discount:
• Shares issuable per right if market price is $15 ($80/15):
15%
50%
5.3333333
How Rights Plans Dilute
5-60
•
Bidder’s initial acquisition of 150,000 shares @ $15.00
$2,250,000
•
•
•
•
•
•
•
•
•
•
Rights flip in for 5.3333333333 shares for 850,000 rights
Shares Outstanding:
New shares
4,533,333.333
Original shares
1,000,000
Total shares
5,533,333.333
Proceeds of exercise: (850,000 x $40):
$34,000,000
Market’s estimate of value of target:
$49,000,000
Value per fully diluted share ($49,000,000/5,533,333): $8.855421
Value of bidder’s 150,000 shares: $1,328,313
Bidder’s dilution losses:
$921,688
•
•
•
Bidder’s cost for remaining shares (5,383,333 x $8.855422) =
47,671,688
Total Cost to Bidder:
$49,921,688
Less: Dividend of cash proceeds from exercise
(34,000,000)
•
Net Cost to Bidder:
$15,921,688
Del. G.C.L. Sec. 157
5-61
• Subject to any provisions in the certificate of incorporation,
every corporation may create and issue, whether or not in
connection with the issue and sale of any shares of stock or
other securities of the corporation, rights or options entitling the
holders thereof to purchase from the corporation any shares of
its capital stock of any class or classes, such rights or options
to be evidenced by or in such instrument or instruments as shall
be approved by the board of directors.
Dilution Equation
5-62
• L = ma - (mx + p) (a)
•
x+d
• where: L = existing shareholders’ loss through dilution;
•
m = market price of a share before issuance;
•
a = a shareholder’s share ownership at the time new
shares are issued;
•
x = shares outstanding before dilutive issuance;
•
d = number of shares issued in dilutive distribution;
•
p = proceeds from sale of new shares.
Bidders’ Dominant Strategies
5-63
Table 4
Bidder's Dilution When Shares Are Issued at Higher
Levels of Bidder Ownership
Bidder's %
Ownership
15
20
30
40
50
85
90
95
97
98
Bidder's Dilution
Losses
$921,688
1,215,100
1,774,513
2,285,537
2,727,055
2,833,057
2,347,583
1,493,285
1,003,331
708,349
Percent of Investment
Lost
41%
40.5%
39.4%
38%
36.4%
22.2%
17.4%
10.5%
6.9%
4.8%
RMBCA § 6.20
5-64
• (a) A subscription for shares entered into before incorporation
is irrevocable for six months unless the subscription agreement
provides a shorter or longer period or all the subscribers agree
to revocation.
• (b) The board of directors may determine the payment terms
of subscriptions for shares that were entered into before
incorporation…* * *
• (d) If a subscriber defaults in payment of money or property
under a subscription agreement entered into before
incorporation, the corporation may collect the amount owed as
any other debt. * * *
• (e) A written subscription agreement entered into after
incorporation is a contract between the subscriber and the
corporation subject to section 6.21.
•
RMBCA § 6.21 (b) – (d)
5-65
• (b) The board of directors may authorize shares to be issued for
consideration consisting of any tangible or intangible property or benefit to
the corporation, including cash, promissory notes, services performed,
contracts for services to be performed, or other securities of the corporation.
• (c) Before the corporation issues shares, the board of directors must
determine that the consideration received or to be received for shares to be
issued is adequate. That determination by the board of directors is
conclusive insofar as the adequacy of consideration for the issuance of
shares relates to whether the shares are validly issued, fully paid, and
nonassessable, and the authorization by the board of directors of the
issuance of shares constitutes such determination.
• (d) When the corporation receives the consideration for which the board of
directors authorized the issuance of shares, the shares issued therefor are
fully paid and nonassessable.
•
Official Comment
• “Practitioners and legal scholars have long recognized that the statutory
structure embodying “par value” and “legal capital” concepts is not only
complex and confusing but also fails to serve the original puprose of
protecting creditors and senior security holders from payments to junior
security holders. Indeed, to the extent security holders are led to believe
that it provides this protection, these provisions may be affirmatively
Delaware’s Legal Capital Rules
5-66
§ 152.Issuance of Stock, Lawful Consideration; Fully Paid Stock
•
The consideration, as determined pursuant to subsections (a) and (b)
of section 153 of this title, for ...the purchase of the capital stock to be issued
by a corporation shall be paid in such form and ... manner as the board of
directors shall determine. In the absence of actual fraud in the transaction,
the judgment of the directors as to the value of such consideration shall be
conclusive. The capital stock so issued shall be deemed to be fully paid and
nonassessable stock, if: (1) the entire amount of such consideration has
been received by the corporation in the form of cash, services rendered,
personal property, real property, leases of real property, or a combination
thereof; or (2) not less than the amount of the consideration determined to
be capital pursuant to section 154 of this title has been received by the
corporation in such form and the corporation has received a binding
obligation of the subscriber or purchaser to pay the balance . . .
• § 153.
Consideration for Stock
•
(a) Shares of stock with par value may be issued for such
consideration, having a value not less than the par value thereof, as is
determined from time to time by the board of directors, or by the
stockholders if the certificate of incorporation so provides.
•
(b) Shares of stock without par value may be issued for such
consideration as is determined from time to time by the board of directors, or
by the stockholders if the certificate of incorporation so provides.
The Old Dominion Cases
5-67
• Facts: The promoter contributed over-valued assets for shares,
while public investors paid a much higher price.
• Old Dominion Copper Mining & Smelting Co. v. Lewisohn, 210
U.S. 206 (1908) (Holmes, J.):
• The promoter hadn’t breached any duty, because at the time of
incorporation he controlled the directors, & they all knew what the
mine was worth.
• Thus he hadn’t breached any duty of candor to the corp. at the time
of the contribution.
• Old Dominion Copper Mining & Smelting Co. v. Bigelow, 203
Mass. 159, 89 N.E. 193 (1909), aff’d, 225 U.S. 111 (1911) (Rugg,
C.J.):
• The promoters’ duties extend to the corporation at it will ultimately be
formed, after the public investors have paid for their shares.
• Thus, until they approved his shares after full disclosure, he had not
fulfilled his duty of candor & loyalty.
RMBCA § 6.22
5-68
(a)
A purchaser from a corporation of its own shares is
not liable to the corporation or its creditors with respect to the
shares except to pay the consideration for which the shares
were authorized to be issued (section 6.21) or specified in the
subscription agreement (section 6.20).
•
(b)
Unless otherwise provided in the articles of
incorporation, a shareholder of a corporation is not personally
liable for the acts or debt of the corporation except that he may
become personally liable by reason of his own acts or conduct.
The Advent of No-Par Shares: MBCA (1950)
§§ 14, 17 & 18
5-69
• MBCA § 14 (1950):
• “Each corporation shall have power to create and issue the number of
shares stated in its articles of incorporation. Such shares may be divided
into one or more classes, any or all of which may consist of shares with
par value or shares without par value....”
• MBCA § 17 (1950):
• “… shares having a par value may be issued for such consideration
expressed in dollars, not less than the par value thereof, as shall be fixed
from time to time by the board of directors.”
• MBCA § 18 (1950):
• “In the case of the issuance of shares without par value, the entire
consideration received therefor shall constitute stated capital unless the
corporation shall determine as provided in this section that only a part
thereof shall be stated capital. Within a period of sixty days after the
issuance of any shares without par value, the board of directors may
allocate to capital surplus not more than 25 percent of the consideration
received for the issuance of such shares.”
Del. G.C.L. § 154
5-70
• § 154. Determination of amount of capital; capital, surplus and net
assets defined
•
Any corporation may, by resolution of its board of directors,
determine that only a part of the consideration which shall be received
by the corporation for any of the shares of its capital stock which it shall
issue from time to time shall be capital; but, in case any of the shares
issued shall be shares having a par value, the amount of the part of such
consideration so determined to be capital shall be in excess of the
aggregate par value of the shares issued for such consideration having a
par value, unless all the shares issued shall be shares having a par
value, in which case the amount of the part of such consideration so
determined to be capital need be only equal to the aggregate par value
of such shares. * * * The amount of the consideration so
determined to be capital in respect of any shares without par value shall
be the stated capital of such shares. * * * The excess, if any, at
any given time, of the net assets of the corporation over the amount so
determined to be capital shall be surplus. Net assets means the amount
by which total assets exceed total liabilities. Capital and surplus are not
liabilities for this purpose.
RMBCA § 6.01(b)
5-71
• “The articles of incorporation must authorize (1) one or more
classes of shares that together have unlimited voting rights, and
(2) one or more classes of shares (which may be the same
class or classes as those with voting rights) that together are
entitled to receive the net assets of the corporation upon
dissolution.”
US Securities Laws
•
•
•
•
•
Securities Act of 1933
Securities Exchange Act of 1934
Investment Company Act of 1940
Investment Advisors Act
Trust Indenture Act of 1939
5-72
US Securities Laws
5-73
• Securities Act, Section 5: Cannot offer to sell a
security without filing a registration statement.
Cannot sell a security without registration
statement becoming effective and delivering a
statutory prospectus
• Exemptions:
– Certain Securities (commercial paper)
– Exempted Transactions
US Securities Laws
5-74
• Exempted Transactions
– No issuer, underwriter or dealer
• Market Trading (underwriter broadly
defined)
– No public offering
• Regulation D Offerings (AIs)
• Rule 144A Offering (QIBs)
– Intra-state
– 3(a)10 Approved by Court (Bankruptcy)
US Securities Laws
5-75
• Basic Rule: Cannot publicly sell stock
which was not originally registered unless
exemption applies
–Rule 144
US Securities Laws
• IPO Timetable
– Working Group Formed
– Draft Registration Statement
– File Registration Statement
– Receive First Comments
– Respond to Comments
– Circulate “red”
– Roadshow Ends
– Price Offering
– Close Offering
5-76
Day 1
Day 30
Day 31
Day 61
Day 91
Day 95
Day 105
Day 106
Day 109
US Securities Laws
• Shortcuts
– Shelf Registration
– Rule 144A offering (A/B Exchange)
5-77
US Securities Laws
•
•
•
•
•
•
Rule 144A A/B Exchange timetable
Working Group Formed
Draft Offering Memorandum
Distribute Preliminary OM
Price Offering
Close Offering
5-78
Day 1
Day 31
Day 32
Day 42
Day 45
US Securities Laws
•
•
•
•
•
•
Draft Registration Statement
File Registration Statement
Receive Comments
Resolve Comments
Begin Offer to Exchange
Close Exchange Offer
5-79
Day 55
Day 55
Day 85
Day 115
Day 115
Day 145
US Securities Laws
5-80
Exchange Act
• Requires Periodic Disclosure (annual, quarterly
and events) if
– Listed on an exchange
– More than 500 shareholders
– Had a registration statement effective
• Regulates markets and punishes fraud
• Insider trading
• Regulates Proxy Contests
• Regulates Tender Offers (Williams Act)