I.
CHAPTER 1 – INTRODUCTION
A.
Enterprise Organization i.
Laws of Agency / Partnership / Corporations

Agency
Simplest form of business organization and may be terminated at anytime by either principal or agent.

General Partnership
Simplest form of jointly owned business firm; firm being defined as a form of business relation that has a temporal dimension, a social identity, and a separate pool of dedicated business assets.

Corporation
Most stable, complex, and socially important
Efficiency is the dominant, if not the SOLE , criterion for academic evaluation of corporate law documents; yet, courts frequently invoke concept of fairness and
B.
Corporate Law rarely address efficiency.
i.
Addresses the creation of economic wealth through the facilitation of voluntary , ongoing
collective action

Deals w/the creation & governance of the private legal entities that are the principal economic actions in the modern world

Succeeds to the extent that it enables individuals to increase their utility
We implicitly agree that economic efficiency is the principal standard by which this law should be evaluated ii.
Pareto Efficiency

A given distribution of resources is efficient when, and only when , resources are distributed in such a way that no reallocation of resources can make at least one person better off w/o making at least one person worse off.
Voluntary Exchange + Net Utility Gain = Pareto Efficient iii.
Kaldor-Hicks Efficiency

An act is efficient (leads to overall improvement in social welfare) if at least one party would gain from it after all those who suffered a loss were fully compensated
As long as there is a net-benefit it is ok iv.
Legal Actor v. Social Scientist

Must know both the interior rooted in history and the exterior rooted in practical need to produce a good society v.
Fairness & Efficiency

Courts apply, rather than create, law . But, policy making choices are inescapable
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Deciding what counts as a cost & as a benefit can prove difficult, so often, courts look to fairness, reasonable/justifiable reliance, good faith , etc. looking not to technical meanings, but to everyday notions of conduct.
vi.
Modern Firm Theories

Incentives effects of owners & managers of firms
Much of what happens in markets is accomplished not by individuals in buy & sell transactions, but by firms entering into complex Ks

Coase Theory
The nature of the firm costs associated with transactions b/t market participants were substantial so he suggested that firms exists b/c it is sometimes more efficient to organize complex tasks within a hierarchical organization with its established authority & compensation structures than on a market

Transaction Cost Theory
Reduction of transaction costs & share of resulting efficiency gains by owners of various resources committing to some contractual governance arrangement (firm) in order to reduce their transaction costs & share the resulting efficiency gains
Example – Information Costs = When buying a used car, the information costs could be finding out the condition of the car – buyer bears the information cost, then he bears the information risk

Agency Cost Theory
Agents in an economic sense usually act w/respect to property that principals own, and the reliance on these agents gives rise to a specific form of transactional costs.
-
View agents as “maximizers” of their own interests and not the principals
Firm could be understood as a complex combination of Ks between owners of various factors of production of the firm.

Here, management is sees as offering to investors a share of the utility that can arise from centralizing information & expertise in a single enterprise
Agency cost is any cost associated w/the exercise of discretion over the
principal’s property by the agent. Three Types:

Monitoring, Bonding, and Residual Costs
Agency Problems:

Conflict b/t managers & investors/owners

Ability of majority owners to control return in a way that discriminates against minority owners
 Problem b/t the firm & all other parties w/whom it transacts

Example = Creditors
2

II.
CHAPTER 2 – THE LAW OF AGENCY
A.
Introduction i.
Simplest form of joint-economic undertaking occurs when one person extends the range of her own activity be engaging another to act for him and be subject to his control.

Agency Law is indispensible b/c it can create legal relationships b/t strangers
(Principals & 3rd Parties) with whom their agents interact

Principal
A person or entity who authorizes another (the agent) to act on its behalf & subject to its authority to the extent that the principal may be held liable for that actions of the agent

Agent
An individual who has the authority to act on behalf of another
B.
Formation i.
Agency is the fiduciary relationship that arises when one person (principal), manifests assent to another person (agent), that the agent shall act on the principal’s behalf and subject to the principal’s control and the agent manifests assent or otherwise consents to act. ii.
Types:

Special Agents
The agency is limited to a single act

General Agents
The agency contemplates a series of acts. iii.
Disclosure:

Principals may be disclosed when 3rd parties transacting with the agent understand that the agent is acting on behalf of a particular principal

Principals may be undisclosed when 3rd parties are unaware of a principal & believe that the agent herself is a principal

Principals may be partially-disclosed when they understand they are dealing with an agent, but do not know the identification of the principal. iv.
Employee or Independent Contractor

Agent is an employee when principal exercises a great amount of control over agent

Agent is an independent contractor when agent is a professional who provides an independent judgment
C.
Termination i.
Agency can be terminated at anytime by either party
 But if the K b/t them fixes a set time, the principal’s decision to revoke, or agents decision to renounce can give rise to a claim of damages under a breach of K ii.
Case

Jenson Farms v. Cargill
Rule:

An agency is created through a course of conduct where the facts, taken as a whole, show that one party has manifested consent that another party be its agent; the second party acts on behalf of the first party; and the first party exercises control over the second party.
D.
Liability in K i.
Both parties must manifest intent to enter into an agency relationship
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
The agent must reasonably understand from the action or speech of the principal that she has been authorized to act on the principal’s behalf ii.
Authority

Actual Authority
Express
Implied/Incidental
 Looks at “reasonable belief” of agent

Apparent Authority
-
Focuses on the “reasonable belief” of a
3rd party based on P’s manifestations.

Agency by Estoppel or Ratification
When agent does some act that is not authorized, but the principal goes ahead & accepts or ratifies it, its another type of valid action.

White v. Thomas
Rule:

In the absence of a principal and any indicia that an agent has authority to engage in a specific action on the principal’s behalf, the agent does not have apparent authority to engage in such action merely because the agent asserts she has such authority

Inherent Authority
Power not conferred on agents by principals, but represents consequences imposed on principals by the law.

Easiest to understand in an undisclosed principal transaction
Gives the agent the power to bind a principal, whether disclosed/undisclosed to an unauthorized K as long as the agent would ordinarily have the power to enter such a K and the 3rd party does not know the matters stand differently
-
P is liable for A’s action when it is an employee/employer relationship and the A was acting in the scope of their duty.

This would not be the case if the A was acting as an independent contractor

Encourages employer to take due care & oversee his employees
 Idea is if you have the right to control then you are in the best position to prevent tortuous conduct (accidents)

Gallant Ins. Co. v. Isaac
Rule:

An agent has inherent authority to bind its principal where the agent acts within the usual and ordinary scope of its authority, a 3rd party can reasonably believe that the agent has authority to conduct the act in question, and the 3rd party is not on notice that the agent is not so authorized.
E.
Liability in Tort i.
In most circumstances, principals are liable for torts committed by a class of agents known as employees , as distinguished from independent contractors.

On the employer/employee relationship triggers vicarious liability

Test:
-
Was the purpose of the agent’s act to serve the principal?

Employer/employee relationship depends on control
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F.
Agency Costs i.
The Sum of the monitoring & bonding costs , plus any residual loss , incurred to prevent shirking by agents.

Bonding
P needing more than a promise from the A that they will do a reliable job and not overstep their bounds – Go to insurance company & get a bond

Residual Losses
Monitoring & Bonding will not catch everything ii.
Cases

Humble Oil v. Martin
Rule:
 A party may be liable for a contractor’s torts if he exercises substantial control over the contractor’s operations.

Hoover v. Sun Oil
Rule: A franchise is considered an independent contractor of the franchisor if the franchise retains control of inventory & operations
AUTHORITY
Is P Liable to 3rd Party
DISCLOSED
Yes
UNDISCLOSED
Yes
PARTIALLY
Yes
Is A Liable to 3rd Party No Yes (Credit of A) Yes
Is 3rd Party Liable to P Yes Yes Yes
G.
Fiduciary Obligation of Agents i.
At Common Law, an agent is a fiduciary of the principal.

The legal power over property (including information) held by the fiduciary is held for the sole purpose of advancing the aim of a relationship pursuant to which she came to control that property. ii.
Duties of Fiduciary: (OLD)

Duty of O bedience

Duty of L oyalty

Duty of C are iii.
The Agent’s Duty of Loyalty to the Principal
 §8.01
-
An agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected with the agency relationship.
 §8.02
An agent has a duty not to acquire a material benefit from a 3rd party in connection w/transactions conducted or other actions taken on behalf of the principal or otherwise through the agent’s use of the agent’s position.
 §8.03
An agent has a duty not to deal w/the principal as or on behalf of an adverse party in a transaction connected w/the agency relationship
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 §8.06
(1) Conduct by an agent that would otherwise constitute a breach of duty stated in
8.01-8.03 does not constitute a breach of duty if the principal consents to the conduct, provided that:
-
(a) in obtaining the principal’s consent, the agent

Acts in good faith

Discloses all material facts that the agent knows, has reason to know, or should know would reasonably affect the principal’s judgment unless the principal has manifested that such facts are already known or does not wish to know, and

Otherwise deals fairly with the principal; and
-
(b) the principal’s consent concern wither a specific act or transaction, or acts or transactions of a specified type that could reasonably be expected to occur in the ordinary course of the agency relationship
(2) An agent who acts for more than one principal in a transaction between or among them has a duty:
(a) to deal in good faith with each principal;
(b) to disclose to each principal

The fact that the agent acts for the other principal(s), and
 All other facts that the agent knows, ahs reason to know, or should know would reasonably affect the principal’s judgment unless the principal has manifested that such facts are already known by the principal or that the principal does not wish to know then, and
(3) Otherwise to deal fairly with each principal iv.
Case

Tarnowski v. Resop
-
Rule: An agent is liable to a principal for the agent’s profits made during the course of the agency and the damages caused by the agent’s breach of his duty of loyalty. v.
The Trustee’s Duty to Trust Beneficiaries

Trust resembles the agency relationship insofar as the trustee has obvious powers to affect the interests of the beneficiary. Here, a trustee is allowed to hold legal title to trust property, which the trustee is under a fiduciary duty to manage for the benefit of another person

In re Gleeson
Rule: A trustee of real property who is almost a tenant of the trust property must account to the trust for profits made as tenant.
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III.
CHAPTER 3 – THE LAW OF PARTNERSHIP
A.
Introduction i.
In the transition from Agency to Partnership, it is important to note that it is the rules that give distinct legal treatment to partnership property.

Property held by the partnership is entitled “Tenancy in Partnership”
So that the partnership qua firm, rather than individual partners exercise true ownership rights over partnerships property ii.
Chapter 2 touched on 2 fundamental agency problems, Partnerships will bring about a third:

Conflict b/t agents and principals,

Conflict b/t principal and 3rd parties, and

Conflict of controlling co-owners v. minority co-owners
B.
The Basics of Partnership i.
Formation

No formalities required

Requires two or more persons (can be 2 corporations) ii.
Management

Unless the partners explicitly decide otherwise, each partner in a partnership has an equal interest & plays an equal role in managing the partnership.
Any partner can bind the partnership (apparent authority)

For ordinary transactions, a majority of the partners is required.

For extraordinary transactions, unanimity is required

Partners have fiduciary duties to other partners and the partnership iii.
Profits & Losses

Shared by the partners, unless agreement says otherwise iv.
Liability to 3rd Parties

Each partner has unlimited liability for partnership debts.

Act must be within the scope of the business
For tort, liability is joint & several
For K, liability is joint (pro rata share) v.
Transferability

Not generally transferable, unless the K says its permissible.

A partner may assign his interest (profits) in the partnership
The assignee does not become partner and cannot participate in the management of the partnership’s affairs or exercise other rights of partners vi.
Continuity of Existence

A partnership is terminable at will unless a fixed date of dissolution is expressed/implied

If a Partner dies, becomes incapacitated, or withdraws, the partnership automatically is dissolved vii.
Tax

Partnerships have pass-through taxation
-
The entity doesn’t pay taxes
 Business losses can offset a partner’s individual income

Corporations have double taxation
The Corporation pays and the Shareholders pay taxes
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C.
The Agency Conflict Among Co-Owners i.
Partners are agents of the partnership and partners have apparent authority to bind the partnership ii.
Cases

Meinhard v. Salmon
Rule: Joint adventurers owe to one another, while their enterprise continues, the duty of finest loyalty, a standard of behavior most sensitive

Vohland v. Sweet
Rule: For purposes of creating a partnership, one partner’s contribution may consist of labor & expertise. iii.
Third-Party Claims Against Departing Partners

When a partner leaves the partnership, they are still liable for existing obligations before they left, but not for anything that might happen after they left.
The only problem is they can no longer exercise any control of the functioning of the partnership. iv.
Third-Party Claims Against Partnership Property
 In partnerships, their form of joint ownership is known as “tenants in partnership property”
This affords to individual partners virtually no power to dispose of property, thus transforming this property into de facto business property.
 So a partner cannot possess or assign, heirs cannot inherit, and a partner’s creditors cannot attach or execute upon it v.
Claims of Partnership Creditors to Partner’s Individual Property

Today, when a partnership files for bankruptcy, which usually includes the individual partners filing for bankruptcy, the Bankruptcy Act of 1978 allows the creditors to go after the estate of the partnership first, and then to the assets of the general partners

National Biscuit Co. v. Stroud
Rule: The acts of the partner, if performed on behalf of the partnership & within the scope of its business, are binding upon all co-partners vi.
Limited Liability Modifications of the Partnership Form

General Partnerships have the bare minimum of features necessary to establish an investor-owned legal entity:
A dedicated pool of business assets
A class of beneficial owners (the partners), and
A clearly delineated class of agents authorized to act for the entity (partners)

The separation between the partnership as a legal entity and the investors who finance it can be further increased by adding limited liability as a forth element to the form.

Limited Liability means that business creditors cannot proceed against the personal assets of some or all of a firm’s equity investors
 To the extent that investors enjoy limited liability, business creditors can rely on the assets of the partnership, but these are also the ONLY assets on which they can rely.
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vii.
The Limited Partnership

Limited partners share in the profits w/o incurring personal liability for business debts.
So all limited partners must have at least one general partner, with unlimited liability in addition to one or more limited partners

They may not participate in control/management beyond voting in major decisions, but enjoy liability limited to this contribution. viii.
Limited Liability Partnership
Similar to corporation from liability perspective
Partner in an LLP is not personally liable for partnership obligations arising from negligence, wrongful acts, or similar misconduct unless it was committed by the individual partner or a person operating under that partner’s direct supervision & control

Pass-Through taxation ix.
Limited Liability Company
Like a corporation: limitation of the liability of investors to the amount invested in the firm & avoidance of the double tax on corporate income

Pass-Through taxation

Requires more drafting
IV.
CHAPTER 4 – THE CORPORATE FORM
A.
Introduction i.
Problems with Partnership that make Corporations Attractive:

Personal liability of those who contributed capital

Instability of the firm
 Illiquidity of an individual’s investment

Cumbersome joint management ii.
Basic Characteristics of a Corporation:

Legal Personality w/indefinite life

Limited liability for investors

Free transferability of share interests

Appointed by equity investors iii.
Two Main Distinctions between Corporations:

Type:
Public Corporation
Closely Held (Close) Corporation

Shareholders:
Single shareholder corporations or a small group of affiliated persons

Controlled Corporations
Corporations that lack controlling shareholders or control group
B.
Creation of a Fictional Legal Entity i.
Corporations are considered as a separate person in the eyes of the law

About 60% of Public Corporations are incorporated in Delaware
Race-to-the-Bottom: (DE Law)

Corp. Law that provides poor protections for SHs
9


They can enjoy the private benefits of the law because the law poorly protects
SH rights

Why else would all the corporations go there?
Race-to-the-Top:
 Is the opposite the DE and provides the best protection for the SHs.

Can make the argument that this theory is better b/c shareholders weigh in on the decision of where to incorporate and they are listened to b/c they are the ones that provide the money. ii.
History of Corporation Form

Before the 19th Century, creating a corp. was seen as a significant public act to be undertaken only to achieve a special public advantage.
In the U.S., creations of Corp has from our earliest days been seen as requiring governmental action.

Necessary & Proper Clause in Constitution
 Today’s statutes on Corporations are largely free of substantive regulation.
The fact that Cor. Law is State , and not Federal, gave those who sought a more liberal corporate law an important means to their objective at the end of the 19th century.
C.
The Process of Incorporating Today i.
Incorporator (271B.2-010)

A flesh & blood individual signs the requisite documents & pays the necessary fees.
Often clerks or secretaries who act in a purely ministerial capacity
They draft or have prepared the Certificate of Incorporation ( Charter ), which state the purpose and the powers of the Corporation.

After execution, the document is filed with the designated public office within the state of if there is not one, the name of the agent in the state upon whom process may be served.
A fee is due when filed
First act of business in a new corporation is the election of directors, adopting bylaws, and appointing officers.

Has the power to appoint directors ii.
The Articles of Incorporation or Charter (2-020)

Charter contains the most customized features of the Corporation

May contain any provision that is not contrary to law

Must provide for voting stock, a board of directors, & shareholder voting for certain transactions

Must name the original incorporators, Corporation name, and its business (Broadly)

Defines how many share & classes the corporation will be authorized to issue and what the characteristics of those will be

When the Secretary of State receives your charter and files it, you are incorporated.
Do not become a corporation just by sending in your charter (2-030)

The Sec. of State will send a receipt giving notice charter has been filed
Then, a meeting of the board of directors will be appoint offices, structure, and adopt bylaws.
Then, get the money from the shareholders that promised the money

At this point, the directors are probably the same as SHs iii.
Bylaws (2-060)
10


Least fundamental of the corporation’s constitutional documents
They must conform to both the Corporate Statute & the Charter

Generally, they fix the operating rules for the governance of the Corporation
Can mandate size of the board if the Charter doesn’t

Happens Regularly
 If you don’t have detailed bylaws, then the default corporate law will prevail

It is more difficult to amend AOI than Bylaws.
To amend AOI you need a SH vote
To amend Bylaws you only need the Board.

If you want to change your default capital structure, you must do so in the AOI.
If not changed, then the default is common stock
Another possibility is preferred stock
Stock can also be subdivided into classes or series iv.
Shareholder Agreements

Typically address such questions as restrictions on the disposition of share, buy/sell agreements, voting agreements, and agreements w/respect to the employment of officers or the payment of dividends v.
Limited Liability

Technically, neither the corporation or the SHs have limited liability
Corporations have unlimited liability and the SHs have no liability for the debts or obligations of the Corp.

The Rationale of Limited Liability:
Decreases need to monitor managers
Reduces the costs of monitoring other SHs
Gives managers incentives to act efficiently by promoting free transfer of shares
Possibility for mkt. prices to impound additional info about value of firms
Allows more efficient diversification
Facilitates optimal investment decisions vi.
Transferable Shares

Provides that equity investors in the entity legally own something distinct from any part of the corporation’s property – they own a share interest
This share or stock , is their personal legal property, and generally absent special restrictions imposed by Charter or K, such a share may be transferred together with all the rights it confers

Transferability allows the firm to conduct business uninterrupted as the identities of its owners change.
Investors can freely trade stock as well vii.
Centralized Management

Corporate law attempts to mitigate the agency problem mainly by requiring, as a default rule, that management be appointed by a board of directors that is elected by the holders of common stock in the company.

Unique to Corporate Firm in Two Ways:
Makes the centralization of management power in the board a strong default option for firms organized as corporations; and
By contrast, it vests more power in the board than even large partnerships commonly do.
 Distinction between a Corporation’s Board and its Management:
11

Initiation & Execution are the province of management
Monitoring & Approval are the province of the Board

Board elected by SHs
12

V.
CHAPTER 5 – DEBT, EQUITY, AND ECONOMIC VALUE
A.
Capital Structure i.
A corporation raises capital to fund its operations by selling legal claims to its assets and prospective cash flows.

Two Types of Long-Term Claims that a Corp. may sell:
Borrow Money through issuance of debt instruments
Sell ownership claims in the entity by issuing equity securities ii.
Legal Character of Debt

Debt securities are Ks.
Typically, there is a loan agreement filed with these terms & often heavily negotiated.

Contains a maturity date

Debenture:
An unsecured, Long-Term (20-30 yrs) loan

Bond
Also long-term, but very secured

Short-Term Debt can be secured or unsecured iii.
Legal Character of Equity

Common Stock
Owners of stock can vote to elect directors and that stock carries one vote per share.

So equity has not the right to payment, but the right to vote on certain things
-
Common stock holders also have residual claim on the corporation’s assets & income
After the company has paid its expenses and creditors, whatever is left over can
“belong” to the stockholder in the payment of dividends .

Preferred Stock
Any equity security on which the corporate charter confers a special right, privilege, or limitation
Just as malleable as bonds, but also receives a dividend before common stock holders.
 Less risky than common stock
 Doesn’t vote iv.
Risk Premium

Assessment of risk in gaining or losing comes in the form of interest rates.
The market decides the risk premium, not the person looking for investments or capital. v.
The Relevance of Prices in the Securities Market ( In re Emerging Communications)

Appropriate to apply a small stock premium in determining the cost of capital where doing so is shown to be appropriate in a particular case

Not appropriate to apply a super-small size premium in determining the cost of capital where although the company is very small it is also insulated from risk through several advantages

Not appropriate to apply a weather-related premium in determining the cost of capital where such a premium is unsupported by valuation literature or empirical evidence

The market price of a publicly-traded stock does not corroborate fair value where there are factors that indicate the market price is below fair value
13

14

VI.
CHAPTER 6 – THE PROTECTION OF CREDITORS
A.
Introduction i.
The problem of creditors in corporations is no different from any other since debtors can do all types of things including diluting assets, misrepresenting their income, etc.

Corporate creditors face the same qualitative risks as other creditors and naturally benefit from the protections offered by the general law of debtor-creditor relations.

But Corporate Law also provides additional protections in all jurisdictions
Afforded extra protections b/c limited liability great exacerbates the traditional problems of debtor-creditor relationship

LL opens opportunity for both express & tactical misrepresentation in transactions with voluntary creditors.
 “Bait & Switch” misrepresents assets and simply walk away if business fails.

LL makes it possible to shift assets out of the corporation after a creditor has extended credit to the corp.

This is why creditors must be vigilant & negotiate for K protections, even though this may be too costly for smaller creditors

Focus on the default provisions of law that will protect all creditors; 3 Ways:
It can impose a more/less extensive mandatory disclosure duty to corp. debtors
It can promulgate rules regulating the amount & disposition of corp. capital
It can impose duties to safeguard creditors on corp. participants, such as directors, creditors, and shareholders.
B.
Mandatory Disclosure i.
Federal securities law imposes extensive mandatory disclosure obligations on public corporations & creditors can benefit from this. ii.
But State Corporate law generally makes little use of mandatory disclosure to protect creditors of closely held corporations.
C.
Capital Regulation i.
Involves requiring investors to contribute a minimum amount of capital to the Corp. and restricting the removal of capital from the firm ii.
However, neither capital regulation or mandatory disclosure provides real protection to creditors under US Corporate Law – but do regulate Corporate Capital. iii.
Financial Statements

The Corporate versions of the two principal accounting statements in the context of a general partnership are:

The Balance Sheet
Represents the financial picture of a business organization as it stands on one particular day, in contrast to the –
Assets – Includes all of the businesses tangible property, intellectual property, goodwill, and even outstanding legal claims
Liabilities – debts of the business
Stockholders Equity – Book value (not found on the B.S) of the owners economic interest:

Stated or Legal Capital: Represents all/portion of the value that SHs transferred to the Corp at the time of the original sale of the company’s stock to its original SHs

Capital Surplus: If the stock is sold for more than its par value (an arbitrary $ amount stated in the charter and on the stock certificate that bears no
15

relationship to the stocks economic/market value) the excess is accounted for in a capital surplus or paid-in-surplus account.

Accumulated Retained Earnings/Earned Surplus: These are merely the amounts that a profitable corporation earns but has not distributed to the SHs
One limitation is that they typically reflect historical costs instead of current

The Income Statement
Presents the results of the operation of the business over a specified period
One limitation is that it does not reflect the amount of cash available to owners

Notes:
Assets = Liabilities + Owners Equity
D.
Distribution Constraints i.
The BS can affect capital regulation and help protect creditors by representing a particular fund as permanent capital that could not be paid to SHs and upon which creditors could rely in extending credit.

Known as the Legal Capital/Stated Capital Account ii.
But in most cases, this is a week protection b/c the Board is entitled to restructure the capital account by shifting any portion of the stated capital to the surplus account if authorized to do so by the SHs
E.
Minimum Capital & Capital Maintenance Requirements i.
One obvious problem to distribution constraints is that they can be avoided by placing trivial sums in the “trust fund” of legal capital reserved for creditors ii.
One way to combat this, although it seems not to be that effective & declining, is to require that a minimum amount be given by the SHs and most of the time this is very minimum or non-existent.
F.
Standard-Based Duties i.
Corporate law typically subjects certain participants in the corporate enterprise to limited duties to protect the interest of creditors under specific circumstances.

Directors, fellow creditors, and SHs
G.
Director Liability i.
Under certain circumstances, directors owe an obligation to creditors not to render the firm unable to meet its obligations to creditors by making distributions to SHs or to others w/o receiving fair value in return
H.
Creditor Protection: Fraudulent Transfers i.
Fraudulent conveyance law imposes an effective obligation on parties contracting with an insolvent or soon to be insolvent debtor to give fair value for the case/benefits they receive/risk being forced to return those benefits to the debtors estate. ii.
Designed to void transfers by a debtor that are made under circumstances that are unfair to creditors.

Statute provides a means to void any transfer made for the purpose of delaying, hindering, or defrauding creditors.

Can attack on 2 grounds:
Present/Future creditors may void transfers made w/the actual intent to hinder, delay, etc.
Creditors may void transfers made w/o receiving a reasonably equivalent value if the debtor is left w/remaining assets unreasonably small in relation to its business or the debtor intended & believed or reasonably should have believed he would incur debts beyond his ability to pay as they became due or they are insolvent after transfer.
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I.
Shareholder Liability i.
Shareholders may either find themselves liable to corporate creditors or have any loans they have made to the company subordinated to other creditors under at least two legal doctrines:

Equitable Subordination

Corporate Veil Piercing ii.
Equitable Subordination

Courts of equity invoke the equitable sub. Doctrine when they feel compelled, by consideration of equity, to re-characterize debt owed by the company to its controlling SHs as equity.

This is a means of protecting unaffiliated creditors by giving them rights to corp.
Assets superior to those of other creditors who happen to also be significant SHs in the firm

Requirements:
The creditor be an equity holder & typically an officer of the company
The insider creditor must have behaved unfairly/wrongly toward the Corp. & its outside creditors

Costello v. Fazio
Rule: Where, in connection w/the incorporation of a partnership, and for their own personal & private benefit, partners leaved the corp. undercapitalized by their actions to the detriment of the corp. & its creditors, their claims should be subordinated to the claims of the general unsecured creditors iii.
Piercing the Corporate Veil

Most frequently invoked & radical approach to creditor protection where the court sets aside the entity or status of the Corp. (piercing the veil) to hold its SHs liable directly on the K or tort obligations
Will not permit the attributes of the Corp. form to be used to perpetuate a fraud

Two Tests:
Lowendahl Test : Where veil piercing requires the P shows the existence of a SH who completely dominates Corp. policy & uses her control to commit a fraud/ wrong that proximately causes the P’s injury
Other Form: Disregard the corp. from whenever recognition of it would extend the principle of the incorporation beyond its legitimate purposes & would produce injustices/inequitable consequences.
-
“Two-Part” Test:

Unity of interest
 Something unfair

Sea-Land Services v. Pepper Source
Rule: The corporate veil will be pierced where there is a unity of interest & ownership between the corporation & an individual & where adherence to the fiction of a separate corporate existence would sanction a fraud or promote injustice

Some element of unfairness, something akin to fraud/deception or the evidence of a compelling public interest must be present in order to disregard the corporate fiction

Kinney Shoe v. Polan
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Rule: In a breach of K, the corp. veil will be pierced where a unity of interest & ownership blends the 2 personalities of the corp. & the individual SH, & where treating the acts as those of the corp. alone would produce an inequitable result

Carter-Jones v. LTV Steel
Rule: Mere control of a corporation, no matter how complete, is not sufficient, as a matter of law, to trigger veil-piercing

Note:
PCV will never, and has never happened in a publically owned company
Might see piercing to the public company via a subsidiary to the parent corp. but never to the SHs
VII.
CHAPTER 7 – NORMAL GOVERNANCE: The Voting System
A.
The Role & Limits of Shareholder Voting i.
Much of the utility of the corporate form derives from the broad discretion that it delegates to a centralized management structure – but this discretion is not absolute

It can be restricted by Statute, Charter, and even Bylaws
 Very few public companies restrict the Board’s managerial power in charters

Instead, equity investors rely largely on default terms built into corporate law to control law to control the agency costs of management. ii.
Default Powers of Shareholders (Dean Clark)

The Right to Vote
Electing directors and on certain fundamental corporate transactions/changes

The Right to Sell
-
Power to sell their stock if they are disappointed with their company’s performance

The Right to Sue
The Directors for breach of a fiduciary duty in certain circumstances

Although analyzed separately, in practice they work together iii.
The most important factor affecting SH voting is the collective action problem faced by
SHs in large public companies:

2 Extreme Cases:
Corp. wholly owned by a single SH. Here there are not costs of collective SH action and the voting system is merely a formality b/c the SH appoints directors at her pleasure. So the Corp.’s manager enjoying discretion would depends on how closely the SH monitored them.
Shares of Corp. held by 100,000 SHs. Here the informed shareholder action vote would require that some investment in information be made by a very large number of SHs. Here, one SH’s vote isn’t likely to affect the outcome of a vote, and so here as well, voting may be seen as merely a formality. iv.
The 1934 Securities Exchange Act made an attempt to create a more active shareholder democracy by empowering them with forced disclosure of information
 During the 1980s a new SH’s rights movement was underway which led to today, where we no longer live in a world of extreme cases in which collective action costs are either nonexistent or preclusive
Instead, growing institutional portfolios, cheaper costs of communication b/t institution, and the evolution of new agents of shareholder organizations have created ownership & coordination structures that fall between these two extremes.
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B.
Electing Directors (7-280) i.
Foundational & mandatory voting right ii.
Requirement that every corporation must have at least one class of voting stock is easily gotten around by creating nonvoting common stock AND a SINGLE class of voting stock containing a single share iii.
All common stock carries voting rights b/c the right to appoint a Board is more valuable to common stock investors than to any other class of investors.

Their security has no maturity date and no legal right to periodic payments
So they have a greater need for the default protection of voting rights than other investors iv.
Another mandatory feature of the voting system is the annual election of directors

Each year the holders of voting stock elect either the whole board when there is a single class of directors or some fraction of the board if the charter provides for a staggered/classified board made up of classes of directors each serving a set term v.
Corporate law facilitates the election of directors by creating a flexible framework for holding the annual meeting of SHs

Generally, the state statute will fix a minimum & maximum notice period.

(7-050) vi.
Cumulative Voting

Example: A Corp. has 300 shares outstanding: A holds 199 & B holds 101. The Corp. has a 3 person Board. Assume that shareholders A & B support different candidates for the board, in straight voting, A would win every seat 199 to 101.

But, in cumulative voting , B could case 303 votes (=101 shares x 3) all for a single candidate instead of spreading them out with 101 going to one, 101 to another, and
101 to the last. Thus, B would be guaranteed to get one seat on the board, because A’s
597 votes cannot be divided three ways so that all three of A’s candidates receive more than 303.

Have to know the difference between straight voting & cumulative voting
Find Formula
C.
Removing Directors (8-080) i.
At common law, SHs could remove a director only “for cause”

Here, SHs can initiate the act ii.
State law in all jurisdictions bar directors from removing fellow directors, for cause or otherwise, in the absence of express SH authorization.

In all events, if the Board uncovers cause for removal, it can petition a court of competent jurisdiction to remove the director from office

SH removal is more difficult when a board is classified
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