Corporations

Summer 2000

Professor David Lipton

Class Outline by

Christopher S. Lee

I.                   Formation

II.                Financing the Corporation

III.             Corporate Structure

IV.              Closely Held Corporations

V.                 Publicly Held Corporations

VI.              Fiduciary Duties

I.                   Formation

A.                   Incorporation

1.      Benefits

a)      Limited Liability

b)      Ability to Raise Capital

c)      Liquidity

d)      Continuity of Existence

e)      Centralization of Management

2.      Drawbacks

a)      Double Taxation

b)      No Flow Through Loss

c)      Limits on Earnings Retention

d)      Requires Regular Filing of Documents

3.      Minimizing Double Taxation

a)      Capital Gains Treatment

b)      Sub Chapter S Corporation

(1)   < 75 Shareholders

(2)   Single Class of Equity Stock

(3)   No Passive Activities Earnings; Max 25% investment in other activities

(4)   Owners taxed regardless of distribution.

c)      Zero-out Income

B.                    Duty of Care

1.      Shareholders

2.      Consumers

3.      Employees

C.                   Ultra Vires

1.      Purpose

2.      Powers

3.      Defective Corporations – Piercing the Veil

D.                   Promoters

E.                    Premature & Defective Corporations

1.      De jure – Papers filed; Inc. not complete

2.      De facto – Colorable attempt to Inc.

3.      Estoppel – Suppliers treat entity as Corp.

F.                    Piercing the Corporate Veil – Generally req. 2 elements

1.      Corporate Form

2.      Disregard/Wrong

3.      Agency

4.      Statute

5.      Insider Advantage

II.                Financing the Corporation

A.                   Equity

1.      Common Stock

a)      Owners of Corporation

b)      Entitled to Pro Rata Distribution of Dividends

c)      Entitled to residual/net assets upon dissolution

d)      Voting Stock

e)      Paid off after Dissolution

2.      Preferred Stock

a)      Priority over Common Stock

(1)   Dividends; and/or

(2)   Liquidation

b)      Percentage of Par Value; Generally Par = $100;

ex) 5% preferred stock = $5 dividend per share

c)      Liquidation rights usually more than par

d)      Can be Cumulative – Accumulates value to be paid out at future date.

e)      Partially Cumulative Preferred – Only accumulates for earnings that year.

f)        Participating v. Not Participating

3.      Preferred Cumulative

4.      Preferred Participating – MBCA 6.01

a)      Preference AND Right to get Pool of Residual Profits as Common Stock right

b)      Provides Security of Preferred Stock

c)      Option to enjoy large stock growth

d)      Option of Convertible Stock

e)      More expensive Rate of Return

5.      Preferred Partially Cumulative

a)      Generally non-voting; unless permitted by K

b)      May be redeemable – buyback option with redemption formula

c)      Less Risky

d)      Less Controlled

e)      Fixed amount of income unless there is a Participation Right

B.                    Debt

1.      Fixed Rate of Return – Predictable

2.      No Control

3.      No Share of Additional Profits

4.      Priority on Liquidation

5.      Creditors, not Owners

6.      Allows for greater offset of profit/loss

7.      Interest Deductible

8.      Classes

a)      Maturity – Timed to Repayment

b)      Notes – Shorter

c)      Bonds – Longer

d)      Security

(1)   Secured – Mortgage-Backed Bonds

(2)   Unsecured – Debentures

9.      Advantages

a)      Priority over other Creditors

b)      Ordinary loss v. Capital Loss

c)      Profits deductible to Corporation

10.  Factors

a)      Who is assuming the risk? – Equity = Risk

b)      Profits trigger payouts – Equity

c)      No Right to call Default – Equity

d)      Debt holder made subordinate to other creditors – Equity

C.                   Security

1.      Indebtedness

2.      Investment Contracts

3.      Certificates of Interest with Profit Sharing Agreements

D.                   Investment Contract

1.      Invests money

2.      Common Enterprise

3.      Led to expect profits

4.      Solely from efforts from others

E.                    Limits on Distributions

1.      Rare – CT’s reluctant to invade domain of BOD

2.      Must Prove

a)      Bad Faith

b)      Surplus

c)      Non-Distribution of Dividends

3.      CT’s may not change purpose of Corporation

F.                    Federal Regulation

1.      Securities Act of 1933

2.      Securities Act of 1934

a)      Allocate Capital – Means

b)      Reduce Cost of Raising Capital – Goal

c)      Means

(1)   Disclosure

(2)   Dissemination

(3)   Anti-Fraud

(4)   Regulation of Brokers

III.             Corporate Structure

A.                   Traditional Model

B.                    Shareholders’ Role

C.                   Board of Directors

D.                   Authority to Bind

IV.              Closely Held Corporations

A.                   Control & Elements

1.      Small number of SH; or

2.      Lack of ready market; or

3.      Substantial participation by Maj. SH

B.                    Devices

1.      Super Majority

2.      Vote Pooling

3.      Cumulative Voting

a)      Per Share as many votes for slots to fill BOD

b)      Shareholders can allocate aggregate votes in any form

c)      Gives minority SH opportunity to exercise some power

d)      Divorces Control and Ownership

e)      General Presumption against Cumulative Voting

(1)   Opt-in

(2)   CT – Invades privacy of BOD

4.      Voting Trusts

a)      Generally Valid

b)      Enforced by:

(1)   Proxy or Irrevocable Proxy; or

(2)   Specific Performance – R 7.31(b)

c)      Validity

(1)   Maximum Term – 10 Years

(2)   Public Disclosure

(3)   In Writing

d)      Strict Compliance

5.      Classes of Stock

6.      Irrevocable Proxies

7.      Transfer Restrictions

8.      Restraints on Directors’ Discretion

C.                   Dispute Resolution

D.                   Preemptive Rights - Proportional Ownership Right

1.      Rights to newly authorized shares

2.      Specific amount of time must passed before right triggers

3.      No preemptive right to treasury stock

4.      Maintains control for original shareholders

5.      Benefits smaller corporations

6.      Disadvantages

a)      May scare away investors

b)      Slows financing

c)      Expensive

E.                    Distributions – Dodge v. Ford Motor Company

1.      CT may not change purpose of corp.

2.      Statutory Limitation on Distributions

3.      Statutes Compel Distribution

4.      Reasons to Retain Earnings

a)      Increase Size

b)      Increase Earnings

c)      Satisfy Creditors

d)      Shore up Working Capital

e)      Avoid Double Taxation

5.      No contractual or property right to distribution

6.      Discretionary to Directors

7.      Courts rarely compel distribution

8.      Elements of Abuse of Discretion

a)      Bad Faith

b)      Surplus

c)      No Distribution

F.                    Tests

1.      Earned Surplus Test

2.      Delaware Surplus Test

3.      Nimble Dividend Test

a)      Net Profit / Loss over years of Net profit

b)      Earnings must be paid before prior deficits

c)      Must apply before 2 years have passed

4.      Capital Surplus Test – Amount of issuance price exceeding par

5.      Cash Flow (Equity) Insolvency Test

6.      Bankruptcy Insolvency Test

a)      Surplus Test

b)      Assets Available >= Liability

G.                   Share restrictions

1.      Reasons

a)      Closed Corp. & no passive investors

b)      No inheritance by children/non-managers

c)      Private placement restrictions

2.      Used by:  Managers, families, S Corps, Securities Laws

H.                   CT’s more lenient on closed than large corporations

I.                      Dissention and Deadlock

1.      Defense provisions can be used offensively to generate deadlock

2.      CT’s uphold Super Majority voting more than Super Maj Quorums

3.      Bylaws should identify remedies and specifics on breaking deadlocks

4.      Dissolution

a)      Voluntary

b)      Involuntary

c)      State-Imposed

5.      Arbitration

6.      Buyout

V.                 Publicly Held Corporations

A.                   Definition – Section 12 of the 1934 Act

1.      Traded on a national exchange; or

2.      Assets of more than $5 million; AND 500 SH

B.                    Shareholders’ Role

1.      Shareholders can call meeting on own, with proper reason

a)      Amendment of Bylaws

b)      Removal of Directors

c)      Activities Valid

d)      Ex) mergers, dissolution, sale of assets

2.      Voting

a)      Cumulative Voting – Protects SH interest in Corp

(1)   Per share as many votes for slots to fill in BOD

(2)   SH can allocate aggregate votes in any form

(3)   Gives minority SH some level of control

(4)   Divorces control and ownership

(5)   Diversity in large corps.

(6)   Generally opt-in option

(7)   Invades privacy of BOD

b)      Irrevocable Proxy – Proxy coupled with Interest

c)      Voting Trust

C.                   Tender Offer

1.      Background

a)      Device for gaining control of corp.

b)      Winning control via pocketbook

c)      No statutory or regulatory definition

d)      Test

(1)   Large amount

(2)   Short time

(3)   Significant Premium

(4)   All or none

(5)   Non-negotiated

(6)   Wide Spread Solicitation

(7)   Sense of Pressure

2.      Squeeze out – MBCA 11.03

a)      Control

b)      After control obtained, share value drops

c)      Squeeze out permitted by CT’s

d)      Squeeze out & unfair dealing not permitted by CT’s

e)      Limits

(1)   Fair Pricing

(2)   Fair Dealing

3.      Unocal v. Mesa Petroleum

a)      Tender offer isn’t required to be offered to all shareholders

b)      Business Judgment Rule

4.      Reasonableness Test

5.      Poison Pill Test

a)      Perceived Threat – reasonable belief of threat to corp.

b)      Relation to threat imposed

c)      Qualifications/Exceptions

(1)   Company already up for sale; can’t impose rule on 1

(2)   Pre-planned merger isn’t auction

(3)   Can’t preclude good offers

D.                   Proxy Regulation – Rule 14a-8

1.      Background

a)      One issue constituencies

b)      Power of Investors

c)      Bridges Owners and Agents

d)      Revocable

e)      Protection device over self-regulating BOD’s

f)        Disclosure – Touchstone of Proxy Regulation

2.      Regulations

3.      Disclosure

a)      What

(1)   Accounting

(2)   Directors

(3)   Proposals

(4)   Material information must be disclosed

(5)   Causation = Materiality

(6)    

b)      Whom

(1)   “Any Person” requirement

(2)   More than 10 People

(3)   Interstate Commerce

(4)   Section 12

(a)    Registered & Publicly traded

(b)   $10 Million

(c)    500 SH

(d)   SEC Exemptions

c)      When

d)      Why

(1)   Required by Regulation

(2)   75% Meeting Rule

(3)   Standing Committees

(4)   Disclosure by molding corporate behavior

(5)   Disclosure by corporations

e)      J.J. Case v. Borak

(1)   Implied Private Remedy for Private Individuals

(2)   Insures integrity of disclosure under Proxy Rules

f)        Implied Private Remedies – Cort v. Ash – Election Law

(1)   Is P member of class to be protected by legis?

(2)   Is there implication of such right in legis history?

(3)   Is grant consistent with under legis. purpose?

(4)   Does State law cover matter?

4.      Formal Requirements

5.      Shareholder Initiatives

a)      Rule 14a-8 – Permits SH to include proxy statements

b)      Exceptions

(1)   Rule 14a-8(c)(8) – SH can’t put opposing view on BOD

(2)   Mgmt must inform SEC if turns down SH Proxy move

6.      Private Action to Challenge Proxy Fraud – Section 14(a)

VI.              Management Fiduciary Duties

A.                   Duty of Care

1.      8.30(a)

a)      Good Faith

b)      Best Interests of Corp.

c)      Reasonable Care

2.      8.42(a) – Discretionary Authority

B.                    Business Judgment Rule

1.      Levels of Protection

a)      Shields directors from personal liability

b)      Insulates BOD decisions from review

2.      Defeating BJR

a)      Fraud, illegality, or conflict of interest

b)      Lack of rational business purpose

c)      Gross negligence

d)      Cort v. Ash – SH have no implied cause of action to enforce federal campaign spending laws.

3.      Basic Care = BJR Protection

4.      CT’s will consider interests of SH

5.      CT’s reluctant to make business judgments

6.      No-Profit deals will draw CT scrutiny

7.      CT prefers disinterested SH

8.      Derivative Suits

a)      SH/Class Action – May seek redress on behalf of Corp.

b)      Elements

(1)   Compels Corporation to Sue

(2)   Asserted by SH that Corp. wrong for not suing

c)      SH must demand BOD caused alleged claim

(1)   BOD may reject claim

(2)   BOD may deny claim

d)      SH Conflict of Interest; No BJR

e)      Examples

(1)   Sue BOD for failure to use due care

(2)   Suit for officer self-dealing

(3)   Excessive Compensation

(4)   Usurped Corporate Opportunity

9.      Futility Test

a)      No business purpose; and

b)      Conflict

10.  Self-Dealing Test – Permitted when fair to Corp.

a)      Approved by disinterested BOD; or

b)      Good faith vote of SH; or

c)      Fair to Corporation & Approved by BOD

11.  Intrinsically fair K are not void/voidable

a)      DE – May vote owned shares

b)      MBCA – Uninterested owners may vote “qualified” shares

C.                   Duty of Loyalty

D.                   Responsibility of Controlling Shareholders

E.                    Sale of Control

F.                    McQuade v. Stoneham

1.      CT dismisses damages and specific performance allegations

2.      Invasion of discretion of BOD

3.      No evidence of poor results

4.      Oversight role demolished by agreement

G.                   Clark v. Dodge

1.      No attempt to sterilize BOD

2.      Only 2 shareholders

H.                   Long Park v. Trenton

1.      Too far beyond original agreement

I.                      Galler v. Galler

1.      Some invasion of discretion okay

2.      Total invasion of discretion not permitted

3.      CT – Closed corps treated differently

J.                      Agency

1.      Real – Granted

2.      Apparent – Repeated

3.      Inherent – Radiates

K.                   Fraud

1.      Material Misstatement

2.      Reliance

3.      Intentionality

4.      Loss

5.      Constructive Fraud

a)      Duty

b)      Harm

c)      Intentionality

d)      No Verbal Exchange

L.                    Insider Trading

1.      Con

a)      Impacts Knowledge

b)      Liquidity

c)      Capital Raising

2.      Pro

a)      Discounts

b)      Incorporates future events faster

3.      16(b) – Buys and Sell stock within 6 months

4.      12(b) & 10(b) – Companies excluded

5.      10b-5 – Lipton

a)      Purchaser or Seller

b)      Non-Public Information

c)      Special/Fiduciary Relationship

d)      Scienter – Intent to deceive; defraud

e)      Reliance and Causation

f)        Interstate Commerce

6.      10b-5 – Aspen

a)      Material Misinformation

b)      Scienter

c)      Reliance

d)      Causation

7.      Breach of Duty

a)      Insider Information

b)      Unavailable to Others

c)      Must demonstrate relationship between corp. and trader

8.      Causes of Action

a)      Insiders must:

(1)   Abstain; or

(2)   Disclose

b)      Rule 14e-3 – Any inside information on Tender Offer

c)      Constructive Insiders

d)      Misappropriation Theory

(1)   Duty to protect market

(2)   Integrity of Market

e)      Tippee

(1)   Giving for Benefit

(2)   Knowing for Breach

9.      Non-Trading Tippers – Tipper must tip for benefit

a)      Pecuniary Gain

b)      Reputational Benefit

c)      Knowledge of Insider’s Responsibility

10.   Misstatements of Fraud must be intentional for liability