Business associations
Chapter 1:
Acting through others
Prof. Amitai Aviram
Aviram@illinois.edu
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
F15
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
–
–
Overview of the course
Administrative details about the course
b. Firms
c. Actors
2
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Introduction to BA
3
What is business law?
• What is business?
– Strategy: identifying a match between • a combination of resources that produce a product/service
• your firm’s competitive strengths in combining these resources
• a market that values the product at or above production price, and in which the
firm’s competitive strengths allow it to capture the most of the surplus value
– Operations: combining the resources to produce & supply the product
(& maximizing surplus value by reducing costs / increasing the product’s value)
– Governance: the rules, process & enforcement mechanisms that coordinate
between people that have the required resources (“stakeholders”)
• Business law facilitates governance (i.e., coordinates stakeholders in
business transactions)
– Corporate law (organizational law) is the portion of business law that facilitates
acting through others (legal issues arising from one person acting on another’s behalf)
– This course teaches the foundations of corporate law
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Introduction to BA
4
What is corporate law?
• The main goal of corporate law is to facilitate acting through others:
allowing one person (B, the beneficiary) to have another person (A,
the actor) act on their behalf
– This often involves A dealing with a third party (T) on B’s behalf
– E.g., Bank of America (B) asks Andy (A) (employee or a real-estate agent), to
find & buy an office building in Chicago
• Acting through others creates two major problems:
1. The shielding problem: Preventing B from exploiting T by dealing through A
(balanced against B’s interest to limit liability from A’s reckless behavior)
•
•
•
2.
E.g. (contracts), A agrees to buy T’s building for twice the market price. Must B pay?
E.g. (torts), when A negotiates to buy T’s building, she loses her patience with T and punches
him. Is B liable to T for damages?
Law & practices dealing with the shielding problem are called corporate
compliance (or external governance); will be covered in Chapter 2
The agency problem: Preventing A from shirking or stealing
•
•
E.g., Tony (T) offers A $1M if he causes B to buy T’s building. Can A accept this payment?
Law & practices dealing with the agency problem are called corporate
governance (or internal governance); will be covered in Chapter 3
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Introduction to BA
5
What is corporate law?
• The agency problem: solutions
– Bonding solutions (align A’s welfare with B’s welfare)
• Morality/identity
• Joint ownership
• Performance-based compensation
– Voice solutions (let B unilaterally express dissent in a manner that may affect A’s behavior)
• Appointment
• Authority / Approval
• Protest
– Litigation solutions (Have a third party (a judge) enforce appropriate behavior by A)
• Fiduciary duties
– Exit solutions (let B unilaterally end association with firm & takes her share of firm’s value)
• Termination (dissolution)
• Dissociation
• Alienation
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Introduction to BA
6
What is corporate law?
• The second goal of corporate law is to facilitate business activity that
is conducted jointly by multiple people: acting jointly through others
– A business association (“firm”) is a legal concept designed to let multiple
beneficiaries conduct business jointly
• Doing business jointly creates a problem of collective control: making
all Bs speak with one voice
– Difficult if there is:
• High cost to act collectively
• Unequal access to info/expertise
• Differing business interests
– Two dysfunctions (note analogy to the agency problem):
• Beneficiary apathy: some Bs lack ability/incentive to monitor As efficiently
• Beneficiary rivalry: Bs have different incentives regarding firm’s behavior, so
controllers can exploit minority beneficiaries
– Example: Bank of America has thousands of SHs; how can they collectively control
the bank’s agents (employees) and direct the bank’s behavior?
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Introduction to BA
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What is corporate law?
• Impact of collective control dysfunctions
– Corporate compliance: Each B is concerned about her personal assets seized
because of firm’s obligations (& firm is concerned about each B’s obligations).
Do we draw a distinction between firm’s assets/liabilities & B’s? Asset
partitioning (e.g., limited liability) prevents mixing firm’s & B’s assets, but
creates a shielding problem
• B forecloses on shares of a gas station & owns them in lieu of a defaulted $2M
loan. When gas station makes profits, it pays them to B as dividends. Gas
station has a spill that causes $10M in environmental damage. When gas
station is sued for the damage, it doesn’t have money to pay. Must B pay the
damages?
– Corporate governance
• Voice mechanism is not effective to control actors
• So we need delegated control: appoint an uncontrolled actor (autonomous
fiduciary) to control firm on Bs’ behalf
• Bs have an agency problem with this uncontrolled actor, so we need more court
intervention (litigation solutions)
8
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Introduction to BA
Our course’s structure
Chapter 1: Acting through others
a. Introduction to BA (today’s class)
b. Firms
c. Actors
Chapter 2: Corporate compliance (external governance)
a. B’s liability for A’s contracts
b. B’s liability for A’s torts
c. Defendant eugenics (veil piercing, aiding & abetting FD breach)
Chapter 3: Corporate governance (internal governance)
a. Litigation solutions (fiduciary duty)
Duty
Flaws
Standard of review
Application
b. Exit solutions
Alienation
Dissociation
c. Customizing the firm
Dissolution
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Introduction to BA
9
Classes
• Check out the course schedule for class topic & pre-class assignment:
http://www.law.illinois.edu/aviram/BA_out.htm
• There are two class types:
– Lectures (L)
• Before class you read an assigned case(s) from the course materials packet
• In class I lecture & may call on people or ask for volunteers for some questions
• Used mostly for theoretical material
– Application (A)
• Before class you listen to a video of my lecture (on YouTube – the link is on the class schedule)
• Cases/notes in the materials packet are optional for application classes
• In class you work in groups with people next to you on problems that exercise the material
covered in the lecture
• Material for the exam also includes the legislation that’s in the course
packet (for both L & A classes) and my lecture notes, but you don’t
need to prep for that prior to class (just know it for the exam)
© Amitai Aviram. All rights reserved.
Introduction to BA
Resources
• Here, have my lecture notes…
– All of my lecture notes are available online (on PowerPoint slides)
– They are likely to change just before a lecture (as I prep)
– I recommend you read them after each class, to clarify what you didn’t
understand in class & augment your notes (my notes are part of material for
the exam)
• Accessing materials
– Course schedule, lecture notes, past exams, course outline & syllabus are all
posted and regularly updated here: http://www.law.illinois.edu/aviram/
• Talking to me outside of class
– Please e-mail prior to meeting with me
• Suggest when you would like to meet (not limited to office hours)
• Describe what issues you want to talk about
– E-mail: aviram@illinois.edu; Room 326
10
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Introduction to BA
11
Exam
• Take-home exam
– Exam will be e-mailed to you at 10am at your choice among these days:
Thursday, Dec. 10
Friday, Dec. 11
Monday, Dec. 14
– Course deadline: Thursday, Dec. 3 (until midnight)
– You must e-mail my administrative assistant by the course deadline, with your
choice among these three dates; if you didn’t e-mail your choice by the
deadline, you will receive the exam on the first day it takes place
– My administrative assistant is Clyde Gabriel (cgabriel@illinois.edu)
• Time limit
– Exam responses must be e-mailed to my administrative assistant by 10am on
the day following the day it was e-mailed to you (even if it’s a weekend)
• Exam structure: issue spotter (traditional essay-type law school exam question)
– Word limit: 1,000 words
– More info on the exam in the exam prep session (last class of semester)
– Past exams (with model answer) available at: http://www.law.illinois.edu/aviram/Exams.htm
• Course deadline is also the deadline for answering student questions
(both face-to-face & by e-mail)
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Introduction to BA
12
Project in lieu of exam
• Instead of taking the exam, you may submit a project
– Case study (plus teaching notes) for one of the sections of the course
• Case (typically 7-12 pages, plus exhibits): this is the part students read
• Teaching notes: explains to the prof teaching goals, suggested solution, extensions (other
issues that can be addressed by extending the case), how the case developed in reality
• Information on creating a case study is available on my website at:
http://www.law.illinois.edu/aviram/Aviram-Writing_case_studies.pdf
– Teaching module picks a topic studied in the course (typically, one sub-section; e.g., 2b –
principal’s liability in torts) & creates alternative or supplemental materials to teach the
same topic
• Module can include new cases, practical application of the material, etc.
• Product you submit should include:
– PowerPoint slides used to teach the material
– Teaching notes that provide information professor needs to know to use slides in class, plus a
statement explaining why you structured the module the way you did & what you believe are
the strengths of the module compared to the material as it was taught in the course
• Product you submit may include other aids, such as relevant video clips, scanned
images, excel spreadsheets etc.
• Module should provide enough content to teach a 75-minute class (~20 slides)
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Introduction to BA
13
Project in lieu of exam
• Deadline
– Project is due by the course deadline (see “Exam” slide for the deadline)
– E-mail project to my administrative assistant as 1 or more attached files
• Anonymity
– Projects are graded anonymously (like exams) so the only identifying marks on
them should be the 4-digit exam ID number
– To maintain anonymity, you can’t tell me your specific project, consult with me
about your project or have me look at drafts of your work
• But you may ask me general questions that don’t identify your project
– Due to anonymity, projects don’t qualify for ULWR
• Finality of choice between exam & project
– A student who submitted a project can’t withdraw it & can’t take the exam
– A student who didn’t submit a project by the deadline must take the exam on
one of the days it is administered
• Attendance & participation
– Must comply with class attendance/participation standard throughout the
entire semester, whether you take the exam or submit a project
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Introduction to BA
14
Supplemental reading (only if you’re interested)
•
Regarding agency & partnerships
•
•
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Comments in Restatement (Third) of Agency (e.g., on Westlaw: REST 3d AGEN §1.01)
Bainbridge, Agency, Partnerships & LLCs (Foundation Press, 2004)
Regarding corporations
•
•
Bainbridge, Corporate Law (2nd Ed., 2009)
For business & business law immersion
•
•
•
•
•
The Wall Street Journal, Sections C (Money & Investing) & B (Business & Tech.)
The Business Lawyer, American Bar Association Business Law Section
Harvard Law School Forum on Corporate Governance & Financial Regulation
(http://blogs.law.harvard.edu/corpgov/)
Business Law Today, American Bar Association Business Law Section
The Deal Professor Blog (http://dealbook.nytimes.com/category/deal-professor/)
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
1. Types of firms
•
•
Legal & economic types of firms
How firms are created
2. Constitutional documents
3. Control in the firm
c. Actors
15
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Types of firms
16
Economic types of firms
• “Real” firms (allow multiple beneficiaries to conduct business jointly)
– Public firm (many Bs)
•
•
•
•
Delegated control (firm controlled by a board that is elected by Bs)
Restrictive dissolution (difficult for dissenting B to dissolve the firm)
Liberal alienability (easy to sell B’s interest to third parties)
Contractual rigidity (most rules are mandatory)
– Private firm (few Bs)
•
•
•
•
Direct control by Bs
Liberal dissolution (easy for dissenting B to dissolve firm)
Restricted alienability (difficult to sell B’s interest to third parties)
Contractual flexibility (parties can opt out of most rules)
• Quasi-firms
– Passive firm (single B or multiple Bs)
• Firm owns assets but doesn’t operate a business; firm structure used to benefit
from some legal features (e.g., preferable tax treatment; limited liability, etc.)
– Proprietorship (a single B)
• Operates a business but does not have multiple owners
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Types of firms
17
Legal types of firms
Partnership
Corporation
• Public corporation
• Close corporation
• Benefit corporation
General partnership (“GP” or “partnership”)
Limited liability partnership (“LLP”)
Limited partnership (“LP”)
Limited liability limited partnership (“LLLP”)
[Joint venture]
[Joint stock company]
• Limited liability company (“LLC”)
– Two defaults for governance: member-managed (similar to partnership)
or manager-managed (similar to corporation)
• Business trust (based on the common law concept of a trust)
• Proprietorship (aka Sole Proprietorship)
– An individual operating a business directly (without using an artificial entity);
sometimes uses a business name (“doing business as” or dba)
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Types of firms
18
The corporation
• By default, the corporation is optimized to be a public firm
– Delegated control
– Liberal alienability/restricted dissolution
– Contractual rigidity
• Applicable law
– Corporations are governed by state statutory law
• Less uniformity between states than in agency or partnership law
• Public corporations are also subject to federal securities laws
– ABA created a Model Business Corporation Act (“MBCA”)
• Serves as uniform law on which some states base their corporate law
– Majority of publicly-traded companies incorporated in Delaware
• Delaware General Corporation Law (“DGCL”) is dominant for public corps
• Variants of the corporation
– Public corporation (or publicly-traded corporation): corp that issued shares to
the public or that has shares traded on a stock exchange; this is usually defined
by Federal securities laws, not state corporate law
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Types of firms
19
Close corporations
• Some jurisdictions have special rules for close corporations, which
are optimized to be a private firm
• Delaware
– DGCL §342 allows a corporation to elect close corporation status, if:
•
•
•
•
Charter provides that it is a close corporation
Charter provides that it may have no more than 30 SH
Corporation didn’t issue stock in a public offering
Stock is subject to one/more transfer restrictions specified in §202
– DGCL rules unique to close corporations
• Direct control: charter may allow corp to be managed by SHs rather than
directors (DGCL §351)
• Contractual flexibility: SH agreement between SHs who hold a majority of the
outstanding voting stock binds the parties even if it interferes with the board’s
discretion (DGCL §350). Within this scope, directors are relieved from FD and
FD is imposed instead on the SHs party to the agreement
• Liberal dissolution: Charter may give SHs a right to dissolve the corporation, at
will or at the occurrence of a certain event (DGCL §355)
• Common-law close corporations
– In some states (e.g., Mass.) case-law applies different rules if corp is closely-held
– Direct control: FD analysis is more sensitive to risk of oppression of minority SHs
(i.e., more focus on FD to minority SHs that on FD to the firm)
– Liberal dissolution: Courts are less reluctant to order judicial dissolution if
relationship between SHs is dysfunctional
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Types of firms
20
Benefit corporations
• Most jurisdictions require that the purpose of corporate acts is to
maximize shareholders’ financial interests
• Some states (e.g., CA, DE, NY) allow creation of & conversion into a
public benefit corporation (PBC) or a flexible purpose corporation (FPC)
– PBCs need to state in charter they have the purpose of creating a public benefit
• Directors of a benefit corporation may prefer non-SH interests:
– “The board of directors shall manage or direct the business and affairs of the
public benefit corporation in a manner that balances the pecuniary interests of
the stockholders, the best interests of those materially affected by the
corporation's conduct, and the specific public benefit or public benefits
identified in its certificate of incorporation” [DGCL §365(a)]
– A director “will be deemed to satisfy [her] fiduciary duties to stockholders and
the corporation if [her] decision is both informed and disinterested and not
such that no person of ordinary, sound judgment would approve” [DGCL §365(b)]
• What are drawbacks of PBCs/FPCs?
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Types of firms
21
The partnership
• By default, GP is optimized to be a private firm
– Governed in most states by the Uniform partnership act (1997) (“RUPA”)
– A few states still use the Uniform partnership act (1914) (“UPA”)
• Other variations of partnerships
– Limited liability partnership (“LLP”): same as GP except partners have limited
liability (governed by RUPA)
– Limited partnership (“LP”)
•
•
•
•
Two classes of partners: general & limited
General partners have control rights & unlimited liability
Limited partners have limited liability & very limited control rights
Governed by Uniform Limited Partnership Act (“ULPA”)
– Limited liability limited partnership (“LLLP”): same as LP except that all partners
have limited liability (governed by ULPA)
• Mostly obsolete variations of partnerships
– Joint venture
– Joint stock company
© Amitai Aviram. All rights reserved.
Types of firms
How firms are created
• Spontaneous creation (GP)
– Firm is created when Bs act in certain ways, even if they formally don’t act to
(or even want to) create a firm
– Similar to agency (which is created when P&A satisfy R3A §1.01 test)
• Creation by filing (corporation, LLC, LP, LLLP)
– Firm is created when Secretary of State confirms that an entrepreneur (B or
someone who will recruit Bs) filed certain documents
• Creation by conversion (firm of one type become another type)
– Conversion through election (firm converts by voting to do so)
• GP can convert into LLP or LP; LP can convert into GP
– Conversion through merger (firm converts by merging into another firm of a
different legal type)
• Requires statutory authorization (typically, conversion is authorized between
corporation/LP/LLLP/LLC & between GP/LP)
22
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Types of firms
23
Creating a GP
• Definition of a GP
– RUPA §§101(6), 202(a): “an association of two or more persons to carry on as
co-owners a business for profit”
– ‘Co-owners’ means:
• Shared control of the business; and
• Shared profits of the business.
– Spontaneous creation: doing business as co-owners results in creation of
partnership by operation of law
• Fenwick [NJ 1945]
– Fenwick owns a beauty shop; Chesire works as a receptionist
– Chesire demands raise; Fenwick counters with offer to make her a partner, with
a right to 20% of the profits (in addition to her salary). They sign an agreement.
– Why does Unemployment Compensation Commission dispute existence of a partnership?
• If Chesire is employee, # of employees exceeds exemption from paying to the
unemployment compensation fund
– Fenwick relies on RUPA §202(c)(3), which states that a person who receives a
share of the profits is presumed to be a partner
• But the section creates exceptions to this presumption, including when the profits were
received as a compensation of an employee or for services as an independent contractor.
What evidence that this is the case here?
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Types of firms
24
Creating a GP
• Fenwick court’s analysis
–
–
–
–
–
–
Intention of parties: No change in business’ operation (no intent to share control)
Right to share in profits: Chesire gets 20%
Obligation to share in losses: Chesire not obligated
Ownership and control of property and business: Fenwick retains
Community of power in administration: Chesire not involved
Conduct of the parties toward 3rd parties: Filed partnership tax returns, but
didn’t hold themselves out as partners to suppliers & Fenwick licensed their
trade name personally
– Rights of parties on dissolution: Chesire’s dissolution is similar to quitting a job
• How much shared control is enough?
– According to Day v. Sidley & Austin (1975), Sidley & Austin was managed in the
following way:
• Executive Committee decides on all matters, except for participation, admission
& severance of partners
• The latter require the approval of partners holding a majority of partnership
interests (not majority of partners)
– This minimal shared control was seen as sufficient; S&A is a partnership
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Types of firms
25
Creating a GP: Martin v. Peyton [NY 1925]
• John Hall, a KNK partner, asks friends at investment bank Payton,
Perkins & Freeman (PPF) for help. They strike a deal to lend KNK $2.5M:
–
–
–
–
Do KNK & PPF have the same incentives re managing KNK?
PPF’s maximum expected downside? Note deal terms designed to address this.
PPF lends KNK $2.5M in marketable securities
PPF receives:
Downside
protections
Upside
potential
Control
protections
•
•
•
•
•
•
Collateral: KNK’s speculative securities
Dividends on the securities PPF lent to KNK
40% of KNK’s profits for duration of loan, with minimum & maximum caps
Option to join the firm
Inspection & veto rights; duty on KNK to consult with PPF
Hall manages KNK; all other partners must give KNK option to be bought out
• KNK speculates in foreign currency, loses money & becomes insolvent
• KNK’s creditors sue PPF, claiming it is a partner in KNK
– Arguments for and against this claim?
– Court decides PPF wasn’t a partner, but it’s a close call. If it was a partnership,
what’s PPF’s maximum downside? Protections were clearly inadequate for that.
– What can a lender do for control protections, without becoming partners?
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Types of firms
26
Creating a corporation
• Incorporator chooses the state of incorporation
• Incorporator drafts charter
• Incorporator files charter with the relevant state’s Secretary of State
– The person filing the charter is the incorporator (DGCL §107); an incorporator is
an autonomous fiduciary (owes a fiduciary duty to the corp)
– Once state certifies the filing, corporation has been created (DGCL §106)
• Organizational meeting of incorporator/initial board
– Names directors & adopt bylaws (DGCL §108)
• Board appoints officers
• Board issues shares to SHs
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Types of firms
Creating a corporation: defective corporations
• Corporation is created only when Secretary of State
acknowledges that the charter was filed
• Exception – “defective corporation”: sometimes courts
recognize a corporation even without Secretary of State’s
certification of the charter being filed
– De facto corporation
– Corporation by estoppel
27
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Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
1. Types of firms
2. Constitutional documents
•
•
•
•
Basic concepts about capital
What are constitutional documents?
Contents of constitutional documents
Changing the constitutional documents
3. Control in the firm
c. Actors
28
© Amitai Aviram. All rights reserved.
Constitutional documents
29
Capital: financial terminology
• To finance operations, firms receive money from investors in return
for claims on its assets & future profits
• Capital can mean either side of this transaction
– Firm’s money (and other productive resources)
– Investors’ claims on firm’s assets & future profits
• Capital is categorized as debt or equity, depending on nature of claim
– Debt: Claim to a predetermined stream of money, unrelated to the firm’s
performance (e.g., bonds, loans). Owner of claim is a creditor.
– Equity: Claim to remainder of firm’s assets after paying all other claims
• Units of equity capital are called: shares (in MBCA) or stock (in DGCL) in a corporation;
“(partner’s) interest” in GP/LLP; “distributional interest” in LLC; “units” in some firms
• Owner of claim is called a “shareholder” (“SH”) or “stockholder” in a corporation;
“partner” in a partnership; “member” in an LLC; “beneficiary” in a business trust
• In this course we will refer to equity owners as SHs & equity capital as shares,
regardless of the type of firm
– Some types of capital are hybrids with characteristics of both debt & equity
(e.g., convertible bonds)
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Constitutional documents
30
Capital: how do SHs profit?
• Equity: Claim to remainder of firm’s assets after paying all other claims
– But firm is done paying all other claims only when it is dissolved (rare)
• Most SHs receive money from investing in shares in one of 2 ways:
– Dividends (distributions): payments authorized by the board, from firm to SHs
• Board is never obligated to pay dividends
• Some shares (called preferred shares) have right to get certain amount per year in
dividends; if board doesn’t pay them in a given year, the amount accumulates to the
next year, and until they are paid, no other SH can get a dividend
– Capital gains: selling the shares to someone else for more than the price you
bought the shares (but why is buyer willing to pay more? Presumably because
she believes the firm would be able to pay higher dividends in the future)
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Constitutional documents
31
Capital: Constraints on issuing shares
• Board has the right to issue new shares (DGCL §161)
– Risk of SHs losing value & control, if board issues new shares at cheap price to new SHs
• Protections against this risk:
– Authorized shares: the maximum number of shares that can be issues (stated in
the charter & can only be changed by joint board & SH action)
• Outstanding shares: shares that have been issued to SHs (& not repurchased by firm)
• Example: firm’s charter states firm has 1,000 authorized shares
• Board issues 600 shares to SHs for $1/share (firm receives $600). Firm has 1,000
authorized shares; 600 outstanding shares.
• Now board issues another 400 shares to SHs for $2/share (firm receives $800). Firm
has 1,000 authorized shares; 1,000 outstanding shares
• Board cannot issue new shares without amending the charter
– Par value: the minimum price board may sell a share for
• Example: Charter states firm’s common shares have a par value of $1. Board may issue shares
(up to the authorized number) for $1 or more, but not for less.
• Par value only restricts firm’s selling price. SH may sell the share to another SH for less than $1
• Par value is an optional protection, and doesn’t offer much protection.
– Preemptive rights: if firm issues new shares, those must be first offered (at
same price) to existing SHs
• No such rights by default, but these rights may be created in charter
• This protection is more common in UK & other countries
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Constitutional documents
Types of constitutional documents
• A firm’s constitutional documents regulate the firm’s internal
governance (between the firm, SHs & management)
– Required: firm-specific info (e.g., name of firm, address, # of shares)
– Optional: opting out & replacing default rules
• Two common models
– A single document
• Private document: partnership agreement (in general partnerships)
• Public document: memorandum of association (some non-US corporations)
– Two documents; one public (usually more difficult to change & less
detailed), the other private (easier to change & more detailed)
• In US corporations
– Charter – Articles of Incorporation (MBCA) / Certificate of Incorporation
(DGCL) – public; must contain certain info, may contain more
– Bylaws – private; easier to amend; can’t contradict charter
• In LLCs: articles of organization / operating agreement
• In LLPs: statement of qualification / partnership agreement
32
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Constitutional documents
Hierarchy of legal sources in a corporation
•
•
•
•
•
Country
Laws of physics
Constitution
Laws/regulations
Presidential directive
Decisions of gov’t employees
33
© Amitai Aviram. All rights reserved.
Constitutional documents
Hierarchy of legal sources in a corporation
•
•
•
•
•
Country
Laws of physics
Constitution
Laws/regulations
Presidential directive
Decisions of gov’t employees
•
•
•
•
•
Corporation
Applicable federal/state laws
Charter
Bylaws
Board’s resolutions
Decisions of officers
34
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Constitutional documents
35
Charter: mandatory terms [DGCL §102(a)]
•
•
•
•
•
Firm’s name
Address of firm’s registered office and name of its registered agent
Nature of the business to be conducted (“any lawful act or activity”)
Name/address of incorporators and initial directors
Specify if firm is not a stock corporation (in which case, conditions of
membership must either be specified, or refer to bylaws)
• “A statement of the designations and the powers, preferences and
rights, and the qualifications, limitations or restrictions [on firm’s stock]”
• Number of authorized shares & share par value
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Constitutional documents
36
Charter: optional terms [DGCL §102(b)]
• “Any provision for the management of the business and for the
conduct of the affairs of the corporation, and any provision creating,
defining, limiting and regulating the powers of the corporation, the
directors, and the stockholders […]”
• “Any provision which is required or permitted […] to be stated in the
bylaws may instead be stated in the certificate of incorporation […]”
• SH preemptive rights
• Supermajority requirements for SH or board votes
• Opting out of limited liability or perpetual existence
• Limits on directors’ fiduciary duty
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Constitutional documents
37
Bylaws [DGCL §109(b)]
• “The bylaws may contain any provision, not inconsistent with law or
with the [charter], relating to the business of the corporation, the
conduct of its affairs, and its rights and powers or the rights and
powers of its stockholders, directors, officers or employees.”
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Constitutional documents
38
Creation & amendment
• Creation of constitutional documents
– Charter [DGCL §101(a)]: incorporator
– Bylaws [DGCL §109]
• Until stock is issued – Board
• After stock is issued – SHs, but charter may also authorize board to amend bylaws
• Amendment of constitutional documents
–
Charter [DGCL §242(b)]
•
•
–
First, board must adopt the proposed amendment
Then, SHs approve the proposed amendment (in some circumstances, SHs vote
in separate groups [DGCL §242(b)(2)])
Bylaws [DGCL §109]
•
•
SHs always allowed to amend
Board not allowed to amend by default, but charter may authorize board to
amend bylaws
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Constitutional documents
39
Assumptions for exam
•
On the exam, assume that the corporations mentioned in the fact
pattern have the following terms in their constitutional documents,
unless the fact pattern states otherwise
Charter
•
–
–
–
–
•
Corp. is a stock corporation, has limited liability and perpetual existence
Corp. may conduct any lawful act or activity
Director FD is limited to & director/agent right to indemnification is extended
to the maximum degree allowed by law
Board may amend bylaws
Bylaws
–
–
Chairperson of board is authorized to call a board meeting
Board is authorized to call both annual & special SH meetings
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
1. Types of firms
2. Constitutional documents
3. Control in the firm
•
•
•
•
Control and authority
Rights of a beneficiary under direct control
Dysfunctions of direct control
Rights of a beneficiary under delegated control
c. Actors
40
© Amitai Aviram. All rights reserved.
Control in the firm
41
Control and authority
• Control in the firm is allocated to actors by giving them authority
• Authority (=actual authority): the right to do a certain act on firm’s behalf
– When an actor acts with authority, the act is considered to be the act of the
firm, and the actor is not liable to the firm (or its SHs) for undertaking the act
• When an actor acts without authority, either:
– The act will not be considered to be the act of the firm (so the firm will not be
liable to third parties for the act) [in this case we say that the actor did not have
the power to act for the firm]
or
– The act will be considered the act of the firm (so firm is liable to third parties
for the act), but the actor is liable to the firm for acting without authority, and
will have to pay for any damages suffered by the firm [in this case we say that
the actor had the power but not the right to act for the firm]
• Section 2a addresses the law determining when the firm is liable for
an unauthorized act (i.e., when an actor has control powers)
• Section 1c (in discussing authority) & this sub-section discusses
control rights
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Control in the firm
42
Models of control
Direct control
Delegated control
• Management by consensus
• Management by authority
(central decision-making body)
(collective decision-making)
• Bs jointly control the firm’s other • Bs select a person/group
(autonomous fiduciary) that can
actors (agents)
exercise direct control
effectively, to control firm’s
other actors (agents)
• Needed if Bs have:
• Works well when Bs have:
– Low cost to act collectively
– Equal access to info/expertise
– Similar business interests
– High cost to act collectively
– Unequal access to info/expertise
– Differing business interests
© Amitai Aviram. All rights reserved.
Control in the firm
43
Direct control: Rights of a partner in a GP
• Economic rights
– Right to a share of firm’s profits, if they’re distributed: “Each partner is entitled
to an equal share of the partnership profits… [and losses]” [RUPA §401(b)]
– Right to a share of firm’s assets upon dissolution: “Each partner is entitled to a
settlement of all partnership accounts upon winding up the partnership
business.” [RUPA §807(b)]
– Right to (unilaterally) alienate economic rights: “The only transferable interest
of a partner in the partnership is the partner’s share of the profits and losses of
the partnership and the partner’s right to receive distributions.” [RUPA §502]
© Amitai Aviram. All rights reserved.
Control in the firm
44
Direct control: Rights of a partner in a GP
• Control rights
– No right to alienate control rights: RUPA §401(i)
– Right to participate in collective management: “Each partner has equal rights in
the management and conduct of the partnership business.” [RUPA §401(f)]
• “A partner is not entitled to renumeration for services performed for the
partnership [except in winding up the partnership].” [RUPA §401(h)] So why
bother managing the partnership?
• Actual authority determined by RUPA §401(j).
– Ordinary course of business → majority
– Outside the ordinary course of business → unanimous
• Amendment to the partnership agreement → unanimous
• Example: Ralph, Sarah & Tom are partners in a law firm
– Partnership agreement silent about dividing profits between them
– They vote 2-1 to add a section to the agreement that divides profits: 40%
R, 40% S, 20% T. Is the new section valid?
– They also vote 2-1 not to accept any employment law cases. Is this valid?
– Right & power to act (unilaterally) on firm’s behalf: Each partner is an agent of
the partnership [RUPA §301(1)]
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Control in the firm
45
Dysfunctions of direct control
a) Inefficiency:
– Direct control is efficient when beneficiaries have:
• Low cost to act collectively
• Equal access to info/expertise
• Similar business interests
– The more Bs a firm has, the greater the cost of acting collectively
– Large & changing B group increases likelihood Bs will have different interests
– Bs with small stakes in the firm likely to be apathetic, lacking incentive to know
firm’s business & participate in the firm’s management (each B has little power
to change things & little to gain from changing things)
• Inefficiency is addressed via:
– Governing by delegated control (control on behalf of the beneficiaries, by
someone who can exercise direct control)
• Or, as a step in that direction: SH agreements & voting trusts that require
parties to vote in a particular way or based on a predetermined process
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Control in the firm
46
Dysfunctions of direct control
b) Deadlock: SHs veto each other
–
–
E.g., 50/50 split with neither side having a majority), causing the firm to be
unable to act
When would you have a serious problem of deadlock without a serious
problem of inefficiency?
• Deadlock is addressed via:
–
Suit for breach of fiduciary duty
•
–
Dissolution (liquidating the firm) or dissociation (buying out one group of Bs)
•
–
Addressed when we discuss litigation solutions
Addressed when we discuss exit solutions
Governing by delegated control
•
Or, as a step in that direction: SH agreements / voting trusts
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Control in the firm
47
Dysfunctions of direct control
c) Oppression: Controller exploits minority SHs (“MSH”)
–
By tunneling: managing firm in a way that shifts value to controller at MSH’s
expense & pressures MSH to sell shares to controller below their fair value
•
•
•
•
Employ/joint venture with person affiliated with controller
Buy from/sell to person affiliated with controller
Avoid interfering with profitable opportunities for controller
Make investments with spillovers benefiting controller
• Oppression is addressed via:
–
Suit for breach of fiduciary duty
•
–
Dissolution (liquidating the firm) or dissociation (buying out one group of Bs)
•
–
Addressed when we discuss exit solutions
Giving MSHs veto power or exclusive authority on certain issues
•
•
–
Addressed when we discuss litigation solutions
This is a form of a voice solution (approval by the MSHs)
This solution risks MSHs using their rights to extort the majority
Note that governing by delegated control doesn’t solve oppression
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Control in the firm
48
Delegated control: Rights of SHs in a corporation
• Economic rights
– Right to a share of firm’s profits, if they’re distributed (i.e., if dividends are
declared by the board)
– Right to a share of firm’s residual assets upon dissolution (i.e., if both board &
SHs approve dissolution, or if court orders dissolution)
– Right to (unilaterally) alienate economic rights
• Similar to economic rights under direct control
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Control in the firm
49
Delegated control: Rights of SHs in a corporation
• Control rights
– Right to unilaterally alienate control rights (opposite of GP default rule)
– No right or power to act unilaterally on firm’s behalf (opposite of GP rule)
– Right to participate in collective management (as a SH meeting), but only for
the following acts (much narrower than the GP default rule):
•
•
•
•
•
Electing & removing directors [DGCL 211(b), 141(k); MBCA 8.03(c), 8.08]
Amending charter & bylaws [DGCL 242, 109(a); MBCA 10.03, 10.20]
Approving mergers & major asset sales [DGCL 251,271; MBCA 11.04,12.02]
Approving dissolution of the corporation
Approving corp’s independent auditor
• Why are SH control rights so limited?
– When Bs can’t effectively exercise direct control, firm delegates control to an
actor that can effectively exercise direct control: low cost to act collectively,
equal access to info/expertise, similar business interests
– This actor can’t be subject to Bs’ control (since Bs can’t effectively exercise
collective control), so it is an autonomous fiduciary rather than an agent
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1. Types of actors
• Agents (controlled fiduciaries)
– Creating an agency relationship
– Officers
• Autonomous fiduciaries
• Stewards
2.
3.
4.
5.
How collective actors act
Beneficiary’s duties to an actor
Authority
Ratification
50
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Types of actors
51
Three types
• All corporate actors act on behalf of the firm
• Agents (controlled fiduciaries) act on firm’s behalf & are subject to its control
– Includes officers, who do the day-to-day management
• Autonomous fiduciaries act on behalf of firm, are not subject to its
control, but are required to pursue the interests of the firm
– Board: ultimate responsibility for managing the firm
• In small firms, board tends to be executive: manages the firm
• In larger firms, board tends to be supervisory: oversees agents who manage the firm
– Board committee: part of the board; acts on behalf of the entire board
– Incorporator: acts on behalf of the firm before the firm is created
– Controller (controlling SH): in general, SHs are not fiduciaries, but shareholders
who control the board owe a fiduciary duty (this will be covered in the M&A
course, but not in the BA course)
• Stewards (non-fiduciary actors) act on firm’s behalf but aren’t subject
to its control, nor legally required to pursue the firm’s interests
– SH meeting
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Types of actors
52
Agents: the agency relationship
Restatement (Third) of Agency (“R3A”), §1.01: An agency relationship is
created when A & P manifest assent that A shall act 1.
2.
On P’s behalf
Subject to P’s control
• Spontaneous creation: parties’ labeling doesn’t control (R3A §1.02)
• An agency relationship may be created retroactively by P’s
ratification, if A purported to act as P’s agent (R3A §4.03)
The parties:
• Principal (P): person for whom act is to be taken
• Agent (A): person who is to act
• Third Party (T): person who deals with agent
53
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Types of actors
Agents: creating an agency relationship
A . Gay Jenson Farms v. Cargill [MN, 1981]
Parties
Description
Principal (P)
Person for whom act is to be taken (beneficiary)
???
Agent (A)
Person who is to act (actor)
???
Third Party (T) Person who deals with the agent
•
What’s the evidence that A acted
–
–
On P’s behalf?
Subject to P’s control?
Identity (according to
plaintiff in Cargill)
???
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Types of actors
54
Agents: creating an agency relationship
Cargill: the court’s reasoning
Court finds control from the combined weight of 9 factors:
1.
2.
3.
Cargill’s constant recommendations to Warren by telephone
Cargill’s right of first refusal on Warren’s grain
Warren’s inability to enter into mortgages, to purchase stock or to pay dividends
without Cargill’s approval
Cargill’s right of entry onto Warren’s premises for periodic audits
Cargill’s correspondence & criticism regarding Warren’s finances, officers’ salary
& inventory
Cargill’s determination that Warren needed “strong paternal guidance”
Provision of forms to Warren upon which Cargill’s name was imprinted
4.
5.
6.
7.
–
8.
9.
FN 7: Warren pays for the grain with drafts (checks) drawn on Cargill
Financing all of Warren’s purchases of grain & operating expenses
Cargill’s power to discontinue the financing of Warren’s operations
© Amitai Aviram. All rights reserved.
Types of actors
Agents: creating an agency relationship
Managing creditor’s risk of becoming a principal
• Creditor & debtor have diverging interests
– Creditors want firm to be managed conservatively
– Debtors want to take risks (& they manage the firm…)
• Creditors protect interests by monitoring/covenants/acceleration
– This gives creditors some control over debtor. If this results in debtor being
creditor’s agent, then creditors become liable for debtor’s debts
• Can creditor disclaim being a principal?
– Many contracts say “this agreement does not create an agency relationship”
– R3A §1.02: parties’ labeling & popular usage do not control
– So why are such disclaimers so common?
• Deters some plaintiffs from suing
• Psychologically affects understanding of the transaction
• Creates a factual dispute to survive summary judgment
• Other creditor protections against debtor incentives
–
–
–
–
Convertibility
Collateral
Guarantees
Insurance
55
© Amitai Aviram. All rights reserved.
Types of actors
Agents: creating an agency relationship
Explaining the outcome in Cargill
• What does “on P’s behalf” (R3A §1.01) mean?
– Right of first refusal + financing = on P’s behalf? [Probably not]
– Allowing supplier to pay T with P’s checks = on P’s behalf?
• Cargill culpable in making farmers think it was backing Warren?
– But this isn’t done so Warren acts on Cargill’s behalf; rather, to make the
farmers think Warren was acting on Cargill’s behalf.
– Why stretch the definition of agency rather than applying estoppel?
• We will discuss estoppel in section on B’s liability in contracts (section 2a)
56
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Types of actors
57
Officers
•
Officers are a sub-class of a firm’s agents
–
•
I.e., all officers are firm’s agents, but not all firm’s agents are officers
What distinguishes officers from other agents is:
–
(Actual) authority of the ‘office’ is determined by law, bylaws or board
•
•
–
Allowing an actor to hold the ‘office’ is also a manifestation from the firm to T,
affecting the officer’s apparent authority
Officer may hold multiple offices
Some laws impose duties/liabilities specifically on officers
•
E.g., securities laws, environmental laws, service of process
© Amitai Aviram. All rights reserved.
Types of actors
Common types of officers
•
Chief executive officer (CEO)
–
•
#1 officer in the hierarchy
Chairperson of the board
–
Administers board’s activities
–
If Chairperson is affiliated with management, firm sometimes also has ‘lead director’
•
Chief operating officer (COO)
–
•
Responsible for firm’s day-to-day business operations
Chief financial officer (CFO)
–
•
Responsible for accounting & financial operations
Treasurer
–
•
Same as CFO, or subordinate responsible for managing firm’s cashflow
Secretary
–
•
Keeps minutes of board/SH meetings & authenticates corporate records
President
–
Head of a business unit (or entire firm, overlapping COO or CEO)
58
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Types of actors
59
Autonomous fiduciaries: Board of directors
• The board is a corporate actor; individual directors are not
– Individual directors have no authority to act for the corporation, unless
they are granted authority by the board to act as a board committee
(which may consist of a single director)
• Neither directors nor the board are the firm’s agents as such
– Because they are not subject to the firm’s control
• Directors individually owe FD to the firm
– This is derived from their status as directors
• Procedural quirk: you can’t sue the board (or a board committee)
– When challenging the act of a collective actor (board, board committee),
plaintiff sues the individual directors, not the board or committee
– E.g., when we (figuratively) say “X sued the board”, we really mean that X sued
each of the directors on the board
– Why can’t X (literally) sue the board?
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Types of actors
60
Autonomous fiduciaries: Board of directors
• Size [DGCL §141(b) / MBCA §8.03]
– Board consists of 1 or more natural persons
– Board size specified in / fixed in accordance with charter or bylaws
• Term in office
– By default, directors are elected in each annual meeting (i.e., they serve a term
of 1 year, renewable) [MBCA §8.03(c)]
– Exception: charter may create a staggered board, dividing directors into 2 or 3
groups; one group elected each year [DGCL §141(d); MBCA §8.06]
• Removal [DGCL §141(k) / MBCA §8.08]
– Directors may be removed by SHs for cause
– Directors may be removed by SHs without cause, if charter does not say
otherwise (MBCA) or if firm does not have staggered board (DGCL)
– Board may not remove a director
• Filling vacancies [DGCL §223 / MBCA §8.10]
– SHs or board may fill vacancies on the board
• Meetings
– Board of a typical public company meets 8 times a year; compensation & audit
committees typically meet another 6-9 times a year
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Types of actors
61
Autonomous fiduciaries: Board committees
• Appointing committee members [Steigerwald (IL 1956)]
–
–
•
Committee must consist only of directors
Otherwise, Board majority can delegate authority to someone unelected by SHs
Members must be selected by the board (directors can’t delegate nomination
to someone else, such as the CEO)
• Common Board committees
– Executive committee: Manages day-to-day operations/decisions
– Nominating committee: Picks the directors that board recommends to SHs
– Compensation committee: Negotiates/approves officer/director compensation
• Exchange Act §10C (created in Dodd-Frank Act) requires stock exchanges’ listing rules to
require that all members of the compensation committee be independent directors
– Audit committee: Oversight of financial reporting & disclosure (sometimes also
oversees regulatory compliance & risk management)
– Risk committee: Oversees institution’s risk management practices
• Dodd-Frank Act §165 directs Fed to require publicly-traded non-bank financial institutions &
publicly-traded bank holding companies with over $10B in assets to establish a risk committee
– Above committees are typical standing (permanent) committees; Board may also
create ad hoc (temporary, single-issue) committees
• Ad hoc committees typically used to avoid conflicts of interest (e.g., in deciding
on a lawsuit or transaction in which some directors have conflicts)
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Types of actors
62
Stewards
• Stewards (non-fiduciary actors) act on firm’s behalf, but aren’t subject
to its control, nor legally required to pursue the firm’s interests
– SH meeting: has limited authority in the typical firm, but within that authority
(and subject to any contractual duties they may have agreed to), SHs may act
self-interestedly (except when they are controllers, but this will not be
addressed in the BA course)
• Why doesn’t a steward owe a fiduciary duty (a legally enforceable
duty to pursue the firm’s interests)?
– FD strikes down authorized acts that are taken for an impermissible purpose
– When permissible purposes are narrowly defined (e.g., maximize SH profit), an
independent party may be able to detect impermissible purposes
– But when permissible purposes are broadly defined (e.g., maximize SH profit
and/or maximize benefits to employees from employment and/or maximize
benefits to society from firm’s business, etc.), managers can do whatever they
want & pick a stakeholder that happens to benefit; so FDs do little to maintain
accountability (yet are costly to litigate)
– Yet sometimes we want actors to consider broad and diverse purposes, even if
it makes them less accountable (e.g., in government positions)
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
Types of actors
How collective actors act
Beneficiary’s duties to an actor
Authority
Ratification
63
© Amitai Aviram. All rights reserved.
How collective actors act
64
Consent & meeting
• Collective corporate actors (e.g., board, board committee, SH
meeting) act by approving resolutions, in one of two ways:
– Written consent
• Board or board committee may act by written consent if consent is
unanimous [DGCL §141(f)]
• SHs may act by written consent if consent is signed by “holders of
outstanding stock having not less than the minimum number of votes that
would be necessary to authorize or take such action at a meeting at which
all shares entitled to vote thereon were present and voted” [DGCL §228]
– Many corporations have a provision in their charter that eliminates SHs’
ability to act by written consent
– MBCA default requires unanimity [MBCA §7.04]
– Meeting: three elements to a valid meeting
a.
b.
c.
Call (authority to call meeting + notice requirements)
Quorum
Vote
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How collective actors act
65
Meeting: (a) Call
• Authority to call a meeting
– Board/committee: Charter, bylaws or board resolution may schedule regular
(e.g., monthly, annually) meetings and may create a procedure for calling
special meetings (e.g., chair may call special meeting); Board resolution may
call a special meeting (e.g., at end of previous board meeting, or by written consent)
– SH meeting: Annual SH meeting – as stated in bylaws [DGCL §211(b)], and court
may order a meeting, if none was called for 13 months [§211(c)]; special SH
meeting: board resolution + as stated in bylaws/charter [§211(d)]
• Notice requirements (did the call provide sufficient info & advance notice?)
– Board/committee: DGCL has no notice requirements, but abuse may breach FD
• In contrast, MBCA §8.22(b) creates a default 2-day notice of date, time & place
of meeting, but not of meeting’s purpose
– SH meeting: notice must be given no less than 10 days or more than 60 days
before the meeting; notice must be in writing and specify place, date & time of
meeting, means of remote communications [DGCL §222]
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How collective actors act
66
Meeting: (b) Quorum
• SH meeting: by default, majority of shares entitled to vote [DGCL §216(1)]
– Charter or bylaws may opt out of default, but never less than ⅓
– Presence via proxy (appointing an agent to vote on one’s behalf) is allowed
• Board/committee: by default, majority of total # of directors [DGCL §141(b)]
– Charter or bylaws may opt out of default, but no less than ⅓
– Presence via proxy is not allowed
– Presence via teleconference [DGCL §141(i)]: board meetings & board
committee meetings may be held via conference telephone or “other
communications equipment by means of which all persons participating in the
meeting can hear each other”
© Amitai Aviram. All rights reserved.
How collective actors act
67
Meeting: (c) Vote
• Board/committee: vote of majority of directors present at a meeting
(unless charter/bylaws require supermajority) [DGCL §141(b)]
• SH meeting: varies depending on the type of vote
– Default standard: majority of shares present [DGCL 216(2)]
• Bylaw amendments
• Precatory SH resolutions
– Majority of disinterested shares present
• Ratifying breach of FD [DGCL 144(a)(2)]
– Majority of shares entitled to vote
• Mergers [DGCL 251(c)]
• Sale of all or substantially all of C’s assets [DGCL 271]
• Charter amendments [DGCL 242(b)]
– Plurality of shares present
• Electing directors [DGCL 216(3)]
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
Types of actors
How collective actors act
Beneficiary’s duties to an actor
Authority
Ratification
68
© Amitai Aviram. All rights reserved.
B’s duties to A
69
Contractual duties
•
•
B’s duties to A are contractual in nature (R3A §§8.13, 8.14(1))
In addition to express terms of the agreement between B & A, B is
liable to A for:
–
–
–
•
Implied terms (R3A §8.13)
Breach of duty to deal in good faith (R3A §8.15)
Default terms re indemnification (R3A §8.14(2))
Implied terms
–
Terms that a reasonable person would infer from the express language of the
agreement
© Amitai Aviram. All rights reserved.
B’s duties to A
70
Duty of good faith & fair dealing
•
•
•
Duty to deal fairly and in good faith (R3A §8.15)
–
Protects agreed common purpose & A’s justified expectations
Common application (1): frustrating A’s justified expectations
–
B must avoid unreasonable conduct that harms A, when:
• Contract lacks specific language governing the issue; and
• Conduct frustrates purposes reflected in contract’s express language
– E.g., Prof agrees with RA that he will get an extra $100 if he shows up at prof’s
office at 8am. Prof later changes mind, locks office doors so RA can’t enter
office at 8am.
Common application (2): duty to warn
–
–
B breaches duty if B fails to provide A with info about unreasonable risks
involved in the agency, if risk is foreseeable to B & A is unlikely to become
aware of risk on his own
Risks include physical harm, pecuniary loss, and possibly also harm to business
reputation & reasonable self-respect
•
E.g., B sends A to sign up investors for an investment that B knows (but A doesn’t
know) is a Ponzi scheme. When A is implicated in the Ponzi scheme, his business
reputation is tarnished and he cannot get another job. B may be liable to A for the
harm suffered by A.
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B’s duties to A
71
Duty to indemnify
•
Indemnifying agents – default rule (R3A §8.14(2))
–
•
•
–
•
•
•
When A makes a payment
within the scope of A's actual authority, or
that is beneficial to B, unless A had a reasonable opportunity to receive B’s
authorization, but made payment without seeking authorization
When A suffers a loss that fairly should be borne by the principal in light of
their relationship; caselaw interprets this as requiring indemnification when:
A’s loss is in connection with the agency relationship; and
A’s loss is not a result of A's own negligence, illegal acts, or other wrongful conduct
Litigation indemnification in a Delaware corporation (DGCL §145)
–
–
–
Covered proceedings: expenses from litigation or threatened litigation
premised on A serving as director/agent of the firm (or of another firm, at the
indemnifying firm’s request) if A:
•
•
•
Reasonably believed to be in or not opposed to the firm’s best interests
In criminal suit, no indemnification if A had reasonable cause to believe conduct was unlawful
In derivative action, no indemnification if A was adjudicated liable to the firm
•
•
•
•
Majority of non-conflicted directors (directors not party to the litigation)
Committee designated by majority of non-conflicted directors
Written opinion of independent counsel
SHs
Mandatory indemnification for directors/officers if they won the suit
Optional indemnification: firm can extend indemnification to all covered
proceedings by charter/bylaw or by decision of either:
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Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
Types of actors
How collective actors act
Beneficiary’s duties to an actor
Authority
Ratification
72
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Authority
73
What is authority?
• Authority is the legal right to act on behalf of another person
– An authorized act of A is legally considered to be an act of B
– Corporate compliance implication: B is liable to T for a contract or tort created
by an authorized act
• This is not the only way B may be liable; we will discuss other ways in Chapter 2
– Corporate governance implication: A is liable to B for acting without authority
• This is not the only way A may be liable to B; A may be liable for an authorized
act that violates fiduciary duties (we will discuss this in Chapter 3)
• An actor can have authority in three ways
– Grant of authority by law
– Grant of authority by agreement (in charter/bylaws/valid SH agreement)
– Grant of authority by approval (unilateral behavior of/attributed to B, either
before A’s act (prior consent) or after (ratification))
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Authority
74
Authority of the board
• Board’s authority granted by law
– DGCL §141(a): “The business and affairs of [a corporation] shall be managed by
or under the direction of a board of directors…”
• Board’s authority granted by agreement & approval
– Usually irrelevant because under DGCL §141(a) board already has authority to
take almost any act the firm can take
• Board’s power to delegate authority
– The board may delegate management authority and tasks to officers or other
agents of the corporation, but may not delegate authority that law, charter or
bylaws specifically assign to the board [DGCL §141(a) / MBCA §8.01(b)]
• For this reason, directors cannot vote by proxy in a board meeting
– Board may delegate to a board committee authority that was specifically
assigned to board, with exceptions (see next slide) [DGCL §141(c) / MBCA §8.25(e)]
– If authority is delegated, board maintains oversight responsibility but may rely
in good faith on agent’s/committee’s/expert’s reports [DGCL §141(e) / MBCA
§8.30(f)]
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Authority
75
Authority of a board committee
• Board committee authority granted by law: not relevant for this course
• Board committee authority granted by agreement: check charter/bylaws
• Board committee authority granted by approval [DGCL §141(c)]
– Committee may receive, in board resolution or bylaws, any powers or authority
of the board except:
• Approving, adopting or recommending to SHs any matter that is subject to SH
approval (other than election/removal of directors)
• Adopting, amending or repealing a bylaw
– Different exceptions in MBCA §8.25: approving distributions; filling board vacancies
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Authority
Authority of the SH meeting
•
SH meeting’s authority usually limited to the following:
–
Exclusive to SHs
•
•
•
–
Jointly with the board
•
•
•
•
–
Electing & removing directors
Ratifying selection of corporation’s independent auditor
Precatory (non-binding) SH resolutions
Charter amendments
Mergers / sale of all or substantially all of the firm’s assets
Dissolution of the firm
Ratification of certain unauthorized corporate actions (DGCL §204)
Either SHs or the board
•
•
Bylaw amendments
Ratifying breach of FD
76
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Authority
77
Authority of agents [R3A §§2.01/3.01]
1.
2.
Manifestations by P that are perceived by A
These manifestation cause A to reasonably believe that A is
authorized to act in a certain way on behalf of P
• R3A §2.02(1): A has actual authority for acts that are “necessary or
incidental” to achieving the principal’s objectives
– Practical tip: if you find there’s actual authority for act Z under R3A §2.01, you can
use R3A §2.02(1) to expand actual authority to other acts that are “necessary or
incidental” to act Z
•
Authority of officers
–
If the law, charter, bylaws or board resolution specify the authority of the
office, that’s an express manifestation by P (that gives both authority for what
is expressly said, and for anything A can reasonably believe is implied from
the express language)
© Amitai Aviram. All rights reserved.
Authority
Authority of agents
• Hypo: Patty owns an apartment building & hires Andy to manage it
– P tells A to hire someone to fix the elevators
– A invites Tim to the manager’s office of the building, tells T he is Patty’s
apartment manager & hires T to fix the elevators
– A also hires T to clean the apartment building (P said nothing about it)
– T does jobs & bills P $60 for fixing the elevators, $40 for cleaning
– P refuses to pay. T sues P for breach of contract. Discuss T’s suit.
a) Is Andy Patty’s agent? (R3A §1.01)
b) Did A have authority to enter the contract between A & T?
• Some case law calls 1st situation (fixing elevators) “express actual
authority” or “express authority”, and 2nd situation (cleaning)
“implied actual authority” or “implied authority”
– This is an unnecessary distinction; both are actual authority
78
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
Types of actors
How collective actors act
Beneficiary’s duties to an actor
Authority
Ratification
79
© Amitai Aviram. All rights reserved.
Ratification
80
• Approval is behavior by (or attributed to) B, that cures a legal flaw in
A’s behavior
– If approval takes place after A’s behavior, it is called ratification
– If approval takes place before A’s behavior, it is called prior consent
• Rules for prior consent are mostly similar to ratification
• Revoking approval
– Valid ratification can’t be revoked (i.e., once ratified, act can’t be un-ratified)
– Prior consent can’t be revoked after the act takes place; whether it can be revoked
before the act takes place depends on the agency agreement (default: yes)
• Rights of “fourth parties” (parties other than B, A & T)
– Approval doesn’t diminish pre-ratification rights of persons not parties to the
transaction [R3A § 4.02(2)(c)]
• E.g., A is B’s financial manager. Without authority, A gives T an option to
purchase B’s Google shares for $50K. B then agrees to sell the shares to S for
$40K. When T tells B he wants to exercise the option, B ratifies A’s agreement
with T. S can enforce his contract to buy the shares for $40K (but B is also liable
to T for damages for breach of contract, because he ratified)
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Ratification
81
The “checklist”
Elements of ratification
1.
2.
3.
4.
5.
6.
7.
Appropriate approver
Attributability
Approval: Unambiguous
Approval: Informed
Approval: Uncoerced
Approval: Appropriate scope
Approval: Timely
Exam tip: if ratification is an issue, describe the behavior that may be
ratification, then discuss only the elements that are not clearly satisfied
(“unambiguous” element almost always requires discussing)
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Ratification
82
Appropriate approver
• Appropriate approvers are:
– The beneficiary (person on whose behalf A acted or purported to act)
– Person who has authority to approve on behalf of B & doesn’t have CoI with B
regarding the behavior that is approved
• Approval of authority cannot exceed the authority the approver has
– Authority to approve may be implied if person has authority to conduct on
behalf of the beneficiary the same behavior that is subject to approval (unless
specifically prohibited from approving or delegating that behavior)
• Approver must have legal capacity at time of approval [R3A §4.04]
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Ratification
83
Appropriate approver
• When a firm is the beneficiary, someone must approve on its behalf.
Appropriate approvers are:
– Board
• Board can approve behavior of corporate actors (based on its plenary authority
under DGCL §141(a) & on DGCL §144, 204), as long as it doesn’t have CoI with
the firm regarding the behavior that is approved
– SH meeting
• SH meeting can cure directors’/officers’ self-dealing by approval (DGCL §144)
• SH meeting (together with board) can approve unauthorized acts that would
have required a SH vote to be properly authorized (DGCL §204)
• When approving, SH vote must be specifically designated as a ratification; SHs
can only approve acts that don’t require a SH vote to become legally effective
[Gantler v. Stephens (Del. 2009)]
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Ratification
84
Attributability
• Actor’s behavior (subject of the approval) is attributable to B
–
A must have acted or purported to act on B’s behalf [R3A §4.03]
•
E.g., if A bought a car for someone other than B (such as for A herself), B can’t ratify
– B must exist at the time of the act [R3A §4.04]
• E.g., if A bought a car for B-Co, a corporation that she is about to form (but hasn’t
yet formed), B-Co isn’t bound by the deal (since B didn’t exist) & can’t ratify it
• Firm can adopt (rather than ratify) a pre-incorporation act:
– Adoption doesn’t relate back to time of contract’s formation
– Adoption doesn’t release A from liability
– Act doesn’t have a flaw that renders the act void (rather than voidable):
• Illegality
• Corporate waste
• Lack of corporation authority (ultra vires): but unanimous SH ratification insulates
the board from future SH challenge
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Ratification
85
Unambiguous
• R3A §4.01(2) – B approves an act by either:
– Express approval: manifesting assent that the act shall affect B’s legal relations
• Express approval must comply with formal procedures (e.g., call/quorum/vote)
• There are specific statutory rules for the process of approval of a transaction
flawed by self-dealing or lack of authority (see next slide)
– Implied approval: conduct justifying a reasonable assumption that B consents
• E.g., B knowingly accepts the benefits of A’s act, even if B manifests
disagreement to accepting the act’s legal consequences
• When B is a firm, implied approval possible by the board, but not by SHs (SH
acquiescence is inherently ambiguous)
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Ratification
86
Unambiguous
• Approval procedure when B is a Delaware corporation
– Lack of authority: DGCL §204 (approval by board & in some situations also by
SH meeting and/or court) (effective since 2014)
– Transactions in which a director/officer has CoI: DGCL §144(a), either:
• Approval by a majority of disinterested directors (even if disinterested directors
do not compose a quorum)
• Approval “in good faith by vote of the shareholders” (in Fliegler the court said
this requires a vote of the majority of disinterested SH)
– Any other act: no statutory authorization for approval, but approval is possible
under board’s plenary powers (DGCL §141(a)), following common law of agency
• Follows the normal process for board acts (written consent / call+quorum+vote)
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Ratification
87
Informed
• Approval is valid only with “knowledge of [all] material facts involved
in the original act” [R3A §§4.06, 8.06(1)(a)(ii)]
– Unless B was aware of such lack of knowledge
– Material facts: Facts that a reasonable person would consider relevant to the
decision whether to approve
– “All material facts” refers only to those facts A knows/has notice of
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Ratification
88
Uncoerced
• Approval is ineffective in favor of a person who causes it by
misrepresentation or other conduct that would make a contract
voidable (duress, undue influence) [R3A §4.02(2)(a)]
• Ratification is ineffective in favor of A if B ratifies to avoid a loss [R3A
§4.02(2)(b)]
– So, if B ratifies to avoid a loss, B is liable to T, but A may be liable to B
– E.g., A is B’s financial manager. A lends B’s money to T without authority. T
becomes insolvent & B files a claim in T’s bankruptcy proceeding. Filing the
claim doesn’t release A from liability for exceeding actual authority.
– Not relevant for prior consent (if B gave prior consent, she wasn’t “trapped”
into approving by the threat of a loss)
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Ratification
89
Appropriate scope
• Ratification (but not prior consent) must encompass “the entirety of
an act, contract or other single transaction” [R3A §4.07]
• Prior consent of self-dealing must address a specific act/transaction
or acts/transactions of a specified type that could reasonably be
expected to occur in the ordinary course of the agency [R3A
§8.06(1)(b)]
– Not likely to be relevant to ratification, because ratification is typically of
specific acts (if specific acts were not disclosed, ratification is likely uninformed)
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Ratification
90
Timely
• Ratification ineffective if “circumstances that would cause the
ratification to have adverse and inequitable effects on the rights of
[T]” occurred [R3A § 4.05]
– T withdraws from the transaction
• B hires A to identify houses B might want to purchase. A sees that T is asking for
a very low price for his house, so she buys the house from T on B’s behalf with
no authority. T learns there was no authority & notifies B he withdraws from
the transaction. B then ratifies. Ratification is ineffective.
– Material change of circumstances that makes it inequitable to bind T
• E.g., A sells B’s house without authority. B’s house then burns down. B cannot
ratify the sale.
– Ratification after rights have crystallized (ratification timed so that T is deprived
of a right or subjected to liability)
• E.g., T gives B an option to buy stock, which expires on May 3rd. Without actual
authority, A purports to exercise the option on B’s behalf on May 2nd. B ratifies
on May 4th. T is not bound by the ratification.
• Prior consent is always timely
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Ratification
91
Effect of ratification on future authority
• Ratification without notice to A that the act was unauthorized may
result in A having authority in future similar acts
– Suppose that Patty told Andy expressly, in front of Tim, that Andy may not hire
Tim. Nonetheless, Andy hires Tim, who fixes the elevator.
– Patty pays Tim (maybe feeling it’s unfair to leave Tim uncompensated), without
reprimanding Andy. Did Patty ratify Andy’s act of hiring Tim?
– When the elevators break again, Andy hires Tim for another job. This time Patty
objects, claiming she specifically prohibited hiring Tim.
– Andy may have authority to hire Tim the second time, because Andy may have
reasonably believed that Patty’s acquiescence in the first hire indicates she was
OK with Andy to hiring Tim (i.e., acquiescence changed Andy’s authority)
• Similarly, lack of notice to T that the act was unauthorized may result
in apparent authority
– I.e., Tim may reasonably believe Andy had authority to hire him, based on the
fact that Patty paid the previous time Andy hired Tim