Presentation on theme: "PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 14 REVIEW Business Organizations 2010-2009 Lectures."— Presentation transcript:
PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 14 REVIEW Business Organizations 2010-2009 Lectures
What are we talking about? Two Umbrella Types of Entities: Limited personal liability for owners Limited partnership Limited Liability Company Corporation No protection from personal liability: General partnership Sole proprietorship
Some Basic Terms Partnership Two or more persons (and by “person” we also mean other entities) Share power Share profits Share losses Partnership reports its profits and losses to the partners who each take their percentage on their own tax return (pass through) Partnership itself is not taxed Each partner personally liable Dissolves on death of partner or other No formal registration required with State
Corporation One or more owners No personal liability (assuming formalities met) Registered with Secretary of State Managed by its Board of Directors who are elected by the owners Board names officers who run day-to-day operations Separate existence from its owners (perpetual life) Pays taxes Distributes profits via dividends to owners
Elements of relationship: 1. Principal manifests assent that agent act for principal and be subject to principal’s control 2. Agent manifests consent or otherwise consents to act. Lec. 2, pp. 31-74 Corporations Prof. McCann
Scope of Authority of Agent Derived From Actual authority: that authority which principal has expressly granted to the agent or which agent reasonably believes was granted. Apparent authority: that authority which principal has informed third party has been vested in agent Implied authority: that authority reasonably required to accomplish the objectives of the agency Lec. 2, pp. 31-74 Corporations Prof. McCann
Corp Code 313 Subject to the provisions of subdivision (a) of Section 208, any note, mortgage, evidence of indebtedness, contract, share certificate, initial transaction statement or written statement, conveyance, or other instrument in writing, and any assignment or endorsement thereof, executed or entered into between any corporation and any other person, when signed by the chairman of the board, the president or any vice president and the secretary, any assistant secretary, the chief financial officer or any assistant treasurer of such corporation, is not invalidated as to the corporation by any lack of authority of the signing officers in the absence of actual knowledge on the part of the other person that the signing officers had no authority to execute the same. Lec. 2, pp. 31-74 Corporations Prof. McCann
Importance of Disclosure of Agency Example of Disclosed Principal: Alpha Corporation, Inc. By: ____________________ George Smith, Pres. Other party aware of agency and principal. Principal alone is liable to third party. Lec. 2, pp. 31-74 Corporations Prof. McCann
FYI : California and Agent Liability Lec. 3, pp. 75-119 Corporations Prof. McCann … California courts generally do not employ the Restatement analysis, but appear to hold the agent liable, regardless of his or her disclosure of the fact of agency, unless the name of the principal is disclosed so as to make it appear on the face of the instrument that the parties intended to bind the principal and not the agent. (See Patterson v. John P. Mills Organization (1928) 203 C. 419, 421, Gambord Meat Co. v. Corbari (1952) 109 C.A.2d 161, 162, 240 P.2d 342 [agent liable on personal check sent in payment of principal's obligation]; And a disclosure only of the principal's trade name is not a sufficient disclosure of identity to relieve the agent of personal liability. (W.W. Leasing Unlimited v. Commercial Standard Title Ins. Co. (1983) 149 C.A.3d 792, 796.)
Partially Disclosed Agency Aka “unidentified principal” in Restate. 3 rd Agency Real estate agent represents anonymous purchaser. Why? To keep secret identity of purchaser because of publicity or in order to maintain negotiation advantage. Other party is aware of agency but not identity of principal. Both agent and principal liable to third party. Lec. 2, pp. 31-74 Corporations Prof. McCann
Undisclosed Agency Real estate agent represents that she is purchasing the property for herself. Why? Take advantage of personal relationship with seller to get better price. Other party unaware of agency or existence of principal. Both principal and agent liable. Lec. 2, pp. 31-74 Corporations Prof. McCann
Principal’s Liability for Torts of Agent Liable if agent has actual or apparent authority. Liable if principal ratifies the agent’s acts. Liable if negligent in selecting or supervising the agent Liable if agent negligent in performance of act Liable if agent is employee acting in course and scope. Lec. 2, pp. 31-74 Corporations Prof. McCann
Agent Is a Fiduciary A fiduciary duty is the highest standard of care at either equity or law. A fiduciary is expected to be extremely loyal to the person to whom he owes the duty (the "principal"): he must not put his personal interests before the duty, and must not profit from his position as a fiduciary, unless the principal consents. The word itself comes originally from the Latin fides, meaning faith, and fiducia, trust.standard of careprincipal Latin Lec. 2, pp. 31-74 Corporations Prof. McCann
Aggregation vs Entity Theories Commonlaw (Aggregation) Partners held undivided but separate interests in property Partnership was not an entity distinct from its partners Withdrawing partner entitled to piece of each asset as is her estate Unanimous consent to admit new partner Partnership meant one exact constellation of partners. Any change resulted in dissolution. Lec. 3, pp. 75-119 Corporations Prof. McCann
Aggregation or Entity Theories Lec. 3, pp. 75-119 Corporations Prof. McCann Under Uniform Partnership Act, 1997 Partnership is an entity distinct from the partners Withdrawing partner has no interest in partnership assets but only right to receive pro rata share of the value of assets Entity may continue on despite withdrawal or death of partner
Under Entity Theory Lec. 3, pp. 75-119 Corporations Prof. McCann CAL. CORP. CODE § 16502 : California Code - Section 16502 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. The interest is personal property.
Under UPA, Modern P/S a Hybrid Still an aggregation of partners in sense that: Each partner individually (jointly and severally) liable for debts Pass through entity, invisible to taxing authorities – each partner pays on her own income from the partnership Lec. 3, pp. 75-119 Corporations Prof. McCann
Formation Lec. 3, pp. 75-119 Corporations Prof. McCann CAL. CORP. CODE § 16202 : (a)Except as otherwise provided in subdivision (b), the association of two or more persons to carry on as coowners a business for profit forms a partnership, whether or not the persons intend to form a partnership. (Emphasis added.) * * *
Establishing a Partnership Lec. 13, pp 529-576 Corps Prof. McCann Majority: Intent is key, as evidenced by conduct and circumstances. Minority: Requires finding all of the following: 1. A community of interest in the venture 2. An agreement to share profits 3. An agreement to share losses 4. A mutual right of control or management
RECAP OF PARTNER LIABILITY Restatement of Agency A Principal is liable for torts of employee if they are committed within the course and scope of employment “Course and scope” requires that there be some intent in the mind of the agent to serve the purposes of the principal Uniform Partnership Act Partnership is liable if partner is carrying on in the usual way the business of the partnership and has actual or apparent authority NO REQUIREMENT that the partner is motivated to benefit the partnership Lec. 4; pp. 119 -154 Corporations Prof. McCann
“The Usual Way” Lec. 3, pp. 75-119 Corporations Prof. McCann American Rule: partner must be acting consistently with the way that particular partnership operates. English Rule: partner must be acting as do others in that type of business, whether or not usual for that particular partnership. UPA follows English Rule interpretation
Lec. 5 Corporations Prof. McCann California Corporations Code Section 16404 [Excerpt] The fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth [below] A partner's duty of loyalty to the partnership and the other partners includes all of the following: ***(3) To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership. A partner shall discharge the duties to the partnership and the other partners under this chapter or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing. A partner does not violate a duty or obligation under this chapter or under the partnership agreement merely because the partner' s conduct furthers the partner's own interest
The End Game of a Partnership Lec. 4, pp. 119-154 Corporations Prof. McCann Dissolution (or Dissociation) An event triggers the end of the partnership Winding Up The affairs of the partnership are concluded Assets liquidated or earmarked for distribution Taxes paid Creditors paid Partners are paid Termination All affairs are wound up
Dissociating Partner Lec. 3, pp. 75-119 Corporations Prof. McCann Within Rights Under Agreement Share as per agreement or per UPA Price if all assets sold as of date of dissociation at greater of liquidation value or going concern value, with interest In Violation of Agreement or Wrongful Same less Value of Goodwill (discretionary) Offsets for damage caused by wrongful dissociation Any other amounts owed by departing partner
LIMITED PARTNERSHIPS Lec. 13, pp 529-576 Corps Prof. McCann Form allows limited liability to limited partners provided they do not manage 1976 ULPA provided “safe harbor” if acts of limited confined to such things as: Consulting with general partner re partnership affairs Requesting or attending meeting of partners Voting on matter relating to business affairs if subject of vote is one allowing approval or disapproval of limiteds Serving as agent or employee of LP
Lec. 5 Corporations Prof. McCann California Corporations Code Section 17153 The fiduciary duties a manager owes to the limited liability company and to its members are those of a partner to a partnership and to the partners of the partnership.
California Corporations Code Section 17001 Lec. 5 Corporations Prof. McCann (z) "Membership interest" means a member's rights in the limited liability company, collectively, including the member's economic interest, any right to vote or participate in management, and any right to information concerning the business and affairs of the limited liability company provided by this title.
California Corporations Code Section 17001 Lec. 5 Corporations Prof. McCann (n) "Economic interest" means a person's right to share in the income, gains, losses, deductions, credit, or similar items of, and to receive distributions from, the limited liability company, but does not include any other rights of a member, including, without limitation, the right to vote or to participate in management, or, except as provided in Section 17106, any right to information concerning the business and affairs of the limited liability company.
LLC Re-Cap Creature of Contract Variation between states as to what the operating agreement can do with respect to: Eliminating fiduciary duties, namely Duty of Care Duty of Loyalty California, for example, Cannot entirely eliminate duty of loyalty in operating agreement But can specify certain acts which will not constitute breach if not “manifestly unreasonable.” Lec. 6 pp. 196-238 Corporations Prof. McCann
Duty of Loyalty Duty to account for property or profit or benefit derived by the member from LLC property. Duty not to appropriate an LLC opportunity Duty to avoid conflicts of interest Duty to refrain from competing Acts in violation require consent of the members. Lec. 6 pp. 196-238 Corporations Prof. McCann
Duty of Care Duty to refrain from grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law. Agreement cannot unreasonably reduce this duty of care. Lec. 6 pp. 196-238 Corporations Prof. McCann
Promoters and Pre-incorporation Liability Lec. 13, pp 529-576 Corps Prof. McCann Liability that of promoters until corporation adopts pre-incorporation agreements and other party agrees to novation, replacing promoter with corporation Contract language indicating promoter not to be personally liable may exonerate promoter
Overview of Corporate Structure Shareholders PresidentSecretaryTreasurer Directors
Incorporation Process Review Lec. 7, pp 239-286 Corps Prof. McCann
Incorporation Process Review Lec. 7, pp 239-286 Corps Prof. McCann Articles filed By laws prepared First meeting held of shareholders Elect Directors Make subchapter S election Directors meeting Adopt pre-existing agreements Appoint officers Authorize issuance of stock Authorize banking relationships
The Debt-Equity Relationship Lec. 7, pp 239-286 Corps. Prof. McCann Control (Equity) Liquidity (Debt)
Why Capitalize with Debt? Lec. 7, pp 239-286 Corporations Prof. McCann You can keep (i.e., leverage) the cash you have. You retain ownership (control) of the business Interest payments are tax-deductible Generally easier to sell debt because you don’t have to convince someone that the company will grow, only have to convince them that they’ll get paid back (and they get paid first). Lender is first in line to get paid if must liquidate assets Have a good return on investment (ROI)
Advantages of Selling Equity Lec. 7, pp 239-286 Corporations Prof. McCann Motivate buyer to pull for the success of the company Doesn’t use precious cash No obligation to re-pay Can “print” more when needed
Disadvantages of Selling Equity Lec. 7, pp 239-286 Corporations Prof. McCann Usually requires giving up at least some control Allows “camel’s nose under the tent” Dividends are not deductible from corporate tax
Types of Equity Lec. 7, pp 239-286 Corps Prof. McCann Common Stock Preferred Stock Convertible preferred stock Warrants
Status of Shares Lec. 13, pp 529-576 Corps Prof. McCann Validly Issued Board has authorized and Dept of Corporations has issued authorization Fully Paid All consideration has been received Non-assessable The holder of the shares has no obligation to honor any assessments against the shares
Common Stock Lec. 7, pp 239-286 Corps Prof. McCann Required to be issued Usually carries voting power May or may not have “par” value First in line in terms of control, last in line in terms of getting paid on liquidation
Preferred Stock Lec. 7, pp 239-286 Corps Prof. McCann Preference given as to Dividends Liquidation of the company’s assets May also allow certain rights if the dividends are not paid (such as electing a number of directors)
Convertible Preferred Stock Lec. 7, pp 239-286 Corps Prof. McCann Preferred stock that carries with it right to convert to common stock
Warrants Lec. 7, pp 239-286 Corps Prof. McCann Are issued by the corporation Give the owner the right to acquire common stock in the future for a specified price Usually added as an enticement to lenders but may be sold independently
Capital Contribution Issues Lec. 13, pp 529-576 Corps Prof. McCann Watered Stock Shareholder liable to creditors to extent stock has not been paid for Measured by difference between share’s value and what was (was not) paid Comes up where: Did not pay par for the stock or Value of the consideration given was overstated
Concept of Par Lec. 13, pp 529-576 Corps Prof. McCann Originally a tool to control maximum and minimum capitalization of the corporation Evolved into baseline reserve to protect creditors Today largely meaningless
THE PLAYERS, REVISITED Lec. 8, pp 286-342 Corps Prof. McCann SHAREHOLDERS Elect directors Usually must ratify certain acts of directors Resolution to dissolve Resolution to merge with another entity Resolution to sell principal assets Resolution to change corporate purpose Resolution to amend by-laws or charter
VOTING Lec. 13, pp 529-576 Corps Prof. McCann Statutory (or Regular) Voting One vote per share, each directorship voted on independently i.e., Jim has 500 shares, there are 3 directorships up for election. Jim can vote his 500 shares for each of the 3, but cannot accumulate his “1500” votes and put all on one directorship. Cumulative Voting One vote per share multiplied by the number of directorships up for election. Total number of votes can be allocated as shareholder wishes i.e., Jim can cast all 1500 votes for one director.
THE PLAYERS, REVISITED Lec. 8, pp 286-342 Corps Prof. McCann DIRECTORS Charged with day-to-day operations of entity Hire and Fire Officers Bear ultimate responsibility for conduct and misconduct of the corporation
The Corporation’s Foundational Documents Lec. 8, pp 286-342 Corps Prof. McCann Articles (Charter) By Laws Shareholder Agreements Between Themselves Buy-sell Agreements Aka Cross-purchase Agreements Survivor Purchase Agreement Corporations Agreements To Repurchase Stock Stock purchase Agreement Aka Redemption Agreement
“Closely Held” vs Statutory Close Corporation Lec. 8, pp 286-342 Corps Prof. McCann Any corporation can be held by a small number of shareholders. One shareholder is not uncommon. A “closely held” corporation is a term with no particular legal significance other than to mean: Few shareholders Most of whom participate in management No general market for the stock (because of limitations on control and liquidity) and Some limitations on transfer of the stock Courts now widely allow shareholders to control management via controlling director’s powers.
Statutory Close Corporation Lec. 8, pp 286-342 Corps Prof. McCann Specifically so-identified in Articles Limited as to number of shareholders possible, usually 30 or 35. Stock certificates must bear “legend” detailing that there are restrictions on transfer Prohibited from making a public offering If adhere to rules, statutes allow exemption from claims regarding improper limits on directors’ powers Delaware allows shareholders to manage directly without a board of directors.
When You Need Shareholder Agreements Lec. 8, pp 286-342 Corps Prof. McCann To maintain exemption from securities registration requirements i.e., a restriction that shareholder cannot transfer to a citizen of another state (triggering interstate sales issue); To maintain subchapter “S” status i.e., a restriction that you cannot sell to a partnership or corporation which would exceed limit of 75 shareholders To maintain professional corporation status i.e., cannot sell to unlicensed person
When You Need Shareholder Agreements Lec. 8, pp 286-342 Corps Prof. McCann To Maintain Effectiveness of a Pooling Agreement i.e., if parties pool shares under agreement to keep X off the board, important no one conveys their shares to X.
Restrictions Lec. 8, pp 286-342 Corps Prof. McCann May be absolute: Prohibits transfer altogether (usually unenforceable) May require others consent Typically requires director or shareholder approval May limit class of possible transferees Must be family members Must be CPA Must be non-competitor
Examples of Restrictions Lec. 8, pp 286-342 Corps Prof. McCann Buy-Out Agreements Whereby anyone desiring to sell must offer to designated others on same terms, so-called “right of first refusal.” Whereby someone who may lose control of stock in a divorce is obliged to sell to other shareholders or to the corporation Whereby the estate of a deceased shareholder must sell to the others
Pricing the Shares Lec. 8, pp 286-342 Corps Prof. McCann Three usual approaches: Book Value What do the accounts show the shares are worth if you divide the number of outstanding shares into the number you get when you subtract the liabilities from the assets? Liquidation Value What would you get if you closed the doors, sold all the assets, paid all the debts, and divided the money up? Cash Flow or Earnings What would an investor be willing to pay today to own a company that generates the profits your company generates?
Recording the Corporate History Lec. 8, pp 286-342 Corps Prof. McCann All States Require Minutes be Maintained Calif Corps Code 314 The original or a copy in writing or in any other form capable of being converted into clearly legible tangible form of the bylaws or of the minutes of any incorporators', shareholders', directors', committee or other meeting or of any resolution adopted by the board or a committee thereof, or shareholders, certified to be a true copy by a person purporting to be the secretary or an assistant secretary of the corporation, is prima facie evidence of the adoption of such bylaws or resolution or of the due holding of such meeting and of the matters stated therein.
By Laws Lec. 8, pp 286-342 Corps Prof. McCann Must conform to the Articles Must conform to the law e.g., by-law prohibiting any transfer of interest would be unenforceable
California Corps Code 204 Lec. 8, pp 286-342 Corps Prof. McCann The articles of incorporation may set forth: (a) Any or all of the following provisions, which shall not be effective unless expressly provided in the articles: * * * (5) A provision requiring, for any or all corporate actions … the vote of a larger proportion or of all of the shares of any class or series, or the vote or quorum for taking action of a larger proportion or of all of the directors, than is otherwise required by this division.
Calif. Corporations Code Section 603(d) Lec. 8, pp 286-342 Corps Prof. McCann (d) Notwithstanding subdivision (a), directors may not be elected by written consent except by unanimous written consent of all shares entitled to vote for the election of directors; provided that the shareholders may elect a director to fill a vacancy, other than a vacancy created by removal, by the written consent of a majority of the outstanding shares entitled to vote.
Postscript on Consents Lec.11, PP 436-478 Corps Prof. McCann Model Act now allows electronic or other consents without unanimity and without notice to all shareholders if: Articles of Incorporation provide for passage by majority vote, and The action is approved by consents signed, even electronically, by a majority of eligible voters By default, Directors are to be elected by “plurality” (rather than cumulative vote or majority vote) True both under Model Act and Delaware law BUT, bylaws may provide for majority or other constraint
Pillsbury v Honeywell Lec. 9, pp 339-395 Corps Prof. McCann Shareholders Rights Right to review corporate records is not unlimited Must be for “a proper purpose germane to his interest as a stockholder” Del. Code, Title 8, § 220. “Proper purpose” means a concern relating to “investment return” BUT investment return can include shareholder motivated by desire to take control of the corporation
Who Has the Power to Act for Shareholder? Lec. 9, pp 339-395 Corps Prof. McCann Shareholder “of record” Proxy Assignee (Pledgee) if assignment or pledge so allows
The Powers and Duties of the Board Lec. 9, pp 339-395 Corps Prof. McCann It is a Board, not a gathering of Generals No director has any power acting alone Their only power derives from decisions they make acting as a Board and which are recorded in the minutes of the corporation Power of directors is “original and undelegated.” Their powers are not granted by others but originate with their election to the Board. Directors’ power comes from the state, if anywhere. The relation of directors to shareholders is that of trustee to beneficiaries.
The Powers and Duties of the Board Lec. 9, pp 339-395 Corps Prof. McCann May Delegate Some of Its Duties Where large board, usual to allow for subcommittees to operate with relative autonomy “Executive Committee” is common device, organized to handle decisions or required resolutions (such as approval of significant contract) when full board cannot be readily convened. In Public Corporations, Usually See “Inside” and “Outside” Directors Inside: are also officers of corporation Outside: are recruited from other corporations, public service, etc.
The Powers and Duties of the Board Lec. 9, pp 339-395 Corps Prof. McCann Key Functions: Provide advice and counsel Instill discipline in the decision-making of the corporation Oversee crises Monitor the conduct of Management
REMOVAL OF DIRECTORS Lec.10, PP 395-436 Corps Prof. McCann Tension between treatment of shareholders who are also directors They want security against removal And treatment of directors who are not shareholders Shareholders do not want to have any impediment to voting such directors out. RULE: Under Model Act statutes, cannot deny shareholders right to remove with or without cause. May require supermajority to remove shareholder-director without cause, however.
Tools for Dealing with Deadlock or Misconduct Lec.10, PP 395-436 Corps Prof. McCann Judicial Dissolution Buyout of dissenting shareholder Appointment of custodial director or manager Arbitration provision in bylaws or other contract
VOTING TRUSTS Lec.10, PP 395-436 Corps Prof. McCann Under Model Act, requires Writing Setting out provisions 10 yr limit (can be extended by some or all) Delivery to corporation’s principal office
POOLING AGREEMENTS Lec.10, PP 395-436 Corps Prof. McCann Widely used to “pool” smaller stock holdings into a unit having power to influence Board or corporate actions Generally provide for process to “pre-vote” an issue put to the shareholders, then cast all shares in pool for winner of the internal vote. Agreements are contracts and enforced as such Equitable relief now available via statute Previously courts could only remedy breach by damages
Shareholder Agreements Lec.11, PP 436-478 Corps Prof. McCann Liberally construed in closely held corporations BUT, under Model Act, Must be included in writing filed with the corporation Must be unanimously approved by all shareholders at time of creation Must be included in articles or bylaws or in a separate writing BUT Cannot eliminate fiduciary duties of officers and directors, Are not binding on creditors or third parties Are not binding on shareholders without knowledge
GALLER V GALLER Lec.11, PP 436-478 Corps Prof. McCann Held: Shareholder agreement not violative of public policy unless Violates an express statement of policy or Is “manifestly injurious” to public welfare and Where corrupt or dangerous tendency clearly appears on face of agreement or is part of a corrupt scheme and disguised to conceal true nature of the transaction
Sea-Land Rule Lec.11, PP 436-478 Corps Prof. McCann Corporate entity will be disregarded and veil of limited liability pierced if: There is a unity of interest and ownership such that the separateness of the personalities of the entity and the individual (or other entity) no longer exists; Circumstances must be such that adherence to the fiction of separateness would SANCTION A FRAUD PROMOTE INJUSTICE
Sea-Land Rule – “Promote Injustice?” Lec.11, PP 436-478 Corps Prof. McCann Means more than that a creditor will go unpaid. There must be a wrong beyond creditor’s inability to correct, e.g., Unjust enrichment to person or entity who looted corporation Scheme to move assets to one entity and liabilities to another Must be sufficient to “merit the evocation” of the court’s equitable powers.
Piercing Based on Agency Analysis Lec.11, PP 436-478 Corps Prof. McCann Where person uses a corporation as a shield to pursue the person’s interests and activities, effectively same conduct as if used any other agent: Therefore, liability imposed on principal via respondeat superior No matter if agent’s wrongdoing arises in contract or tort
Declaring Dividends Lec. 12, pp 479-528 Corporations Prof. McCann Highlights the tension between creditors and shareholders CREDITORS do not want money taken out of the corporation until they have been paid SHAREHOLDERS like dividends because (a) represents a return on investment that is no longer subject to market forces; (b) declaring a dividend signals optimism about the future and often drives the share price higher.
Basic Policy Objective: Protect the Creditor Lec. 12, pp 479-528 Corporations Prof. McCann Limit so that dividends can only be paid from “surplus” after sufficient capital held in reserve to pay debts.
Solely Within Authority of Directors Lec. 12, pp 479-528 Corporations Prof. McCann Holders of common shares have no vested right to a dividend Some preferred shares carry right to a dividend and enforcement power (such as right to name directors) if required dividend is not paid to preferred shareholders Courts will not interfere with directors’ decision to declare or withhold dividend absent showing of fraud, bad faith or abuse of discretion by directors BUT once a dividend is declared, shareholders may enforce in court
TYPES OF SURPLUS Lec. 12, pp 479-528 Corporations Prof. McCann Capital surplus Excess portion of price received by corporation for its stock after subtracting the par value Plus any amount directors deem necessary (sometimes required by creditors) Earned surplus Earning of the company from operations after subtracting liabilities and net of capital accounts Reduction surplus The amount directors vote to take out of Stated Capital (e.g., by reducing par or because augmented from capital surplus and now unwinding Revaluation surplus The amount of previously unrealized appreciation directors choose to recognize (and which moves into earned surplus)
Stock Dividends Lec. 12, pp 479-528 Corporations Prof. McCann Issue additional shares in lieu of cash. Reasons: Don’t want to spend the cash but want to appease shareholders Want to increase voting rights of pro-board shareholders in case of takeover bid Need to issue more shares to make an offering work and must issue stock dividends to keep voting rights intact Drives down stock price somewhat (because more shares over which ratios operate, such as “earnings per share”)
Directors’ Duty of Care Lec. 12, pp 479-528 Corporations Prof. McCann Francis v United Jersey Bank: Director is fiduciary of the corporation and its shareholders And in the context of the business of the corporation, may be a fiduciary to its creditors Where there is constructive or actual trust Director must “discharge duties in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions”
Francis v United Jersey Bank Lec. 12, pp 479-528 Corporations Prof. McCann Where director breaches duty, personally liable if negligence was a proximate cause of a loss to the creditor or shareholder or corporation Plaintiff has burden of showing loss would have been avoided if defendant had performed her duties Analysis includes determination of “reasonable steps” director should have taken BUT causation will be inferred where reasonable to conclude particular result from a failure to act and that result has occurred.
Caremark Lec. 13, pp 529-576 Corps Prof. McCann Director liability can be grounded on several theories: Liability following poor decision by board because decision was negligent and ill advised Liability based on failure to act where due diligence would prevent the loss BUT, “absent cause for suspicion there is no duty…to install and operate a system of corporate espionage to ferret out wrongdoing that they have no reason to suspect exists.”
Caremark cont’d Lec. 13, pp 529-576 Corps Prof. McCann There must be a system in place adequate to assure the board that appropriate information will come to its attention in a timely manner Failure to insist upon and maintain such a system may render a director liable
Caremark cont’d Lec. 13, pp 529-576 Corps Prof. McCann Plaintiffs must show: Director knew or Should have known were violations of law Took no steps to prevent or remedy Failure proximately caused the loss
The Business Judgment Rule Lec. 13, pp 529-576 Corps Prof. McCann Applies when what is at issue is a business decision made by the directors Does not come into play where directors are accused of failing to monitor or similar derelictions of the duty of care, only when making a business decision
The Rule Lec. 13, pp 529-576 Corps Prof. McCann Absent fraud, illegality or conflict of interest, a director who acts in good faith is not personally liable for mere errors of judgment short of CLEAR AND GROSS NEGLIGENCE Shlensky v Wrigley 237 N.E. 2d 776 (Ill. 1968) Unless director(s) had an interest in the subject of the decision or Unless decision constitutes illegal conduct (e.g., decision to pay a bribe)
ALI Version Lec. 13, pp 529-576 Corps Prof. McCann No liability for a business judgment reached in good faith provided: 1. Director or officer was disinterested 2. Director or officer was informed as to the subject of the decision to a degree the director or officer reasonably believes appropriate; and 3. Rationally believes decision is in the best interests of the corporation
SMITH V VAN GORKOM Lec. 13, pp 529-576 Corps Prof. McCann "Informed" within meaning of "due care" means board reviewed all material information reasonably available Liability under Business Judgment Rule arises only where there is a showing of gross negligence, meaning something more careless than ordinary negligence. E.g., failure to even read a report which was itself deficient
Delaware Gen Corp Law Sec. 141 Lec. 13, pp 529-576 Corps Prof. McCann (e) A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.
Shareholder Ratification Lec. 13, pp 529-576 Corps Prof. McCann Shareholders may ratify acts of even interested directors PROVIDED shareholders are “fully informed” Burden is on directors to establish shareholders were fully informed
Model Act Lec. 13, pp 529-576 Corps Prof. McCann SECTION 8.30. GENERAL STANDARDS FOR DIRECTORS (a) A director shall discharge his (sic) duties as a director, including his (sic) duties as a member of a committee: (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner he (sic) reasonably believes to be in the best interests of the corporation. (b) In discharging his (sic) duties a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by: (1) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented; (2) legal counsel, public accountants, or other persons as to matters the director reasonably believes are within the person's professional or expert competence; or (3) a committee of the board of directors of which he (sic) is not a member if the director reasonably believes the committee merits confidence. (c) A director is not acting in good faith if he (sic) has knowledge concerning the matter in question that makes reliance otherwise permitted by subsection (b) unwarranted. (d) A director is not liable for any action taken as a director, or any failure to take any action, if he (sic) performed the duties of his (sic) office in compliance with this section.
Calif. Corp Code Sec. 309 Lec. 13, pp 529-576 Corps Prof. McCann (a) A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. (b) In performing the duties of a director, a director shall be entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by [officers, consultants, etc]. (c) A person who performs the duties of a director in accordance with subdivisions (a) and (b) shall have no liability based upon any alleged failure to discharge the person's obligations as a director. In addition, the liability of a director for monetary damages may be eliminated or limited in a corporation's articles to the extent provided in paragraph (10) of subdivision (a) of Section 204.