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Corporations: Cohn
Chapter 1: Development Of Business Law
• Earliest corporations created for church purposes. To give continuity to ownership of church property.
• Two types
• Public
• Close
• Middle: many shareholders, not involved in management
• 99.5% of all corporations have fewer than 10 shareholders. 100% overlap between shareholders and
management
• Enabling statute: one statute for incorporation, which allows corporation to structure it to fit its needs.
• Almost all corporate law governed by state law
• Model Business Corporation Act: Florida has adopted a version of this
Chapter 2: Business Forms
Handout 1, p. 1
• Potential conflicts: management, distributions
• The attraction of corporation is limited liability, but here, they will probably not get money or supplies as a
corporation. They will probably have to personally guarantee the loans. Get insurance for tort liability.
• How will the additional money be raised? Bank loan, equity investors (what will the form be?)
• Will probably have to find several investors. Structure is becoming more complicated.
• What is your other income. Who is investing what. Projections. How are they going to be distributed.
Pass-through taxation: company doesn’t pay taxes, partners pay taxes on their share of the profits at their rate. Still file income tax forms reporting income, just don’t pay anything
Form Requires Registration
Limited Liability Corporate Structure / Capital Structure
Taxation
General Partnership No No Partnership agree Pass-through Limited Liability Partnership Not a form, it allows general partnership to elect ltd liability status. Must register annually
Yes Yes
Limited Partnership Yes No for General. Yes for Limited
Partnership agreement Pass-through
Limited Liability Ltd Partnership Not a form, allows l. partnership to elect limited liability status. Must register annually
Yes Yes for both
Limited Liability Company Yes Yes Default provisions, few mandatory Allows corporate capital structure
Default is pass- through, but can “check box” and elect corporate taxation Corporation Yes Yes Default provisions which can be drafted around
Corporate
S Corporation Yes Yes Default provisions which can be drafted around
Pass-through
General Partnerships, SS p. 203
- Common law creation, codified in 1914 Uniform Partnership Act (UPA), 1996 RUPA (Revised UPA).
- Made some noteworthy changes
- Adopted entity theory (i.e. previously a change in partners dissolved partnership, problems with property ownership, etc.). Now can be ongoing, like corporation.
- See others p
- Partnership agreement controls nearly all relations among partners, in absence of provision, default governs. Some things cannot be changed, e.g. fiduciary duties
- Common characteristics
- Fully participatory management structure
- Everyone equal for votes, distribution, responsibility (any can enter into contracts), regardless of money put in
- Admission of new partners requires unanimous vote
- A partner’s conveyance of interest to another requires approval
- Personal liability
- Pass-through taxation
- (^) Joint venture: similar to partnership. Usually created to complete a specific project rather than an ongoing enterprise.
Formation
- Only type of formation that doesn’t have to go through the state
- Expressly or by operation of law
- Partnership agreements setting out issues like management and voting are a good idea
Limited Liability Partnership LLP, SS p. 203-204, 231
- Contained within RUPA
- Have to register with state for this yearly.
- LLP is not a form of enterprise; it is a general partnership or limited partnership electing limited liability status.
- 8306(3) provides partners in LLP are not personally liable in contract or tort when acting as a partner.
- When would a partner be liable? When not acting as a partner. Tortious (even negligent) or criminal conduct. Also, when personally guaranteeing something.
- Limits creditors recovery to assets of partnership. It is possible piercing the corporate veil principles will develop here
Limited Partnerships, SS p. 239
- Revised Uniform Limited Partnership Act (RULPA)
- Have to register for this.
- (^) Comprises limited partners, passive investors with liability limited to their investment and general partners who run the business and have unlimited liability
- General partners have the same relationship to each other as partners do in a regular partnership (death of one dissolves, limits on transfers of interest)
- Keeping records of decisions, minutes of meetings
- C: Not a big deal
- Tax treatment
- Double taxation
- (^) C: Most important
- S Corporation: p. 350
- Some corporations meeting specific requirements (<75 shareholders, one class of stock, incorporated in US, shareholders must be individuals, no nonresident aliens, corporation may not be a certain type of business) can qualify as an S corporation, which has pass-through taxation. Having only one class of stock may be the most troublesome.
Professional Services p. 204
- PSC Professional Service Corporation, requires corporation structure. Must be professionally licensed.
- PLLC: Professional Limited Liability Company. Must be professionally licensed.
- LLP: retain partnership operations, can be used by anyone, not just professionally licensed
- Professional corporations arose to take advantage of tax and retirement options under corporation, but retain liability to clients
Handout 2, p. 2-
- Examples of tax consequences
- If profits are going to be distributed, pass-through corporation generally better because not taxed at company level, fewer taxes paid. Can manipulate distribution to minimize tax consequences (e.g. pay bigger salaries, which are deducted before taxes are calculated, as opposed to dividends, which come out after taxes)
- Losses are passed through as well, thereby reducing each partner’s tax liability
- Profits retained: corporate taxes less because no dividends paid to shareholders. In pass-through, even if profits are retained, individuals are taxed as if they actually received a distribution. If company is going to retain earnings, c-corporation is the better entity.
- If you are a pass-through, you can amend filing and become a c-corporation. You can go back and forth. Must do it in advance of the tax year.
Sarbanes-Oxley Act of 2002
- Congressional response to Enron
- Incursion into state law. Really affects internal organization and structure of corporations, an area traditionally left to states
- Only applies to publicly held companies
Chapter 3: Incorporation
0201 incorporators
0202 requirements for the Articles (few, but does include number of shares authorized and if preemptive rights are granted) and lists other things which may be included As an enabling statute, corporation can vary their articles from the norm. However, counsel should be aware of those things that must be changed in the articles, or those that can be changed in the bylaws or in shareholder agreements.
0203 process / date of incorporation
0204 preincorporation transactions by promoters
promoter liable on contract if he has actual knowledge that corporation is not formed. However, no liability if other contracting party also knows promoter is “acting on behalf” of corporation not yet formed. Literal reading would preclude promoter liability when 3rd^ party knew, but this is contrary to principles of mutuality because corporation/promoter side has no obligor. The point of the contract is to not preclude promoter and 3 rd party from transacting, as they desire. Should apply only when parties clearly did not intend for promoter to be liable Preincorporation agreements are options to corporation
0205 Actions of incorporators following incorporation : meeting or agreement by written consent
0206 Bylaws. Initial adoption of bylaws to provide for the management of the business, changes governed by 1020.
Promoters’ Contracts
- Promoters: people who organize the start up of a business, often enter into contracts (e.g. office leases) before the corporation has officially been established
Liabilities of Corporation on Promoters’ Contracts
- Corporation is not bound by contract unless it makes the contract its own
- Ratification: retroactive to the time of the promoter’s act. If no corporation existed then, this is impossible.
- Adoption: similar to ratification without retroactivity. Can be adopted formally via BOD resolution, or informally by performing its obligations on the contract.
McArthur v. Times Printing Co.
- Promoter entered into contract with employee in Sept for services to begin on Oct 1. Corporation incorporated Oct. 16 and accepted contract by employing the guy and paying him. Employee fired before contract expired.
- Δ argued contract void for statute of frauds because couldn’t be performed within 1 year of making.
- Court rejected. Differentiated between ratification and adoption. Stated adoption has effect of creating an entirely new contract such that the date of the contract = date of adoption, so no violation of SOF.
Rights and Liabilities of Promoters on Promoters’ Contracts
- Generally personally liable
- Is promoter released from liability when corporation adopts? Not without a novation from the other party releasing the promoter. An automatic one can be included in the contract or one can be done later.
- Another option is for promoter to secure option for corporation to enter into contract
- Either way, promoter must make sure there is consideration.
- Example p. 189-190: Anderson signed lease in name of corporation prior to formation of corporation
- No entity yet, someone has to be responsible for the contract.
- Agent bound to contract entered into on behalf of a non-existent principal.
- Corporation not bound to accept promoter’s contract. Corporation really has an option.
- Need specific language to not bind promoter.
- Promoter not automatically off the contract once the corporation accepts the contract.
■ Must either get a novation from other contracting party, or some contract with corporation to take over
promoter’s liabilities.
- Look to § 607.0204: “acting on behalf of corporation” clearly Anderson is liable on the lease. What about Baker or other partners who knew or authorized the promoter to act? Why should Baker be off the hook just because he didn’t actually sign the contract?
- Begin with the assumption parties intended to create a binding lease and the only party available is Anderson. “Anderson, for Biologistics, a corporation to be formed who will be the obligor.” Court said this means Anderson is on the contract until corporation is formed and contract is adopted.
- (^) 0204 says this is not a contract because promoter not liable on contract because other party knew corporation was not yet formed. This would tend to release promoter from liability. Without promoter liability, no mutuality, no contract. Courts usually assume joint liability.
Where and How to Incorporate
Where
- Substantive provisions of state incorporation law
- Internal Affairs Doctrine: wherever you go, you take the corporate governance and financial structures of the place you incorporated wherever you go. Have recently become pretty uniform, so not a huge factor
- Except California. Has law stating if you have half your assets here, you follow our laws.
- Cost of incorporating other than where it does business
- Still have to qualify to do business in home state and file yearly reports & pay fees in both states.
- Every state where you have principal offices, plants, employees.
- Public or private corporation
- Minimum amount at which company can sell its stock *** this is traditional meaning.
- Because par value has become so artificial, creditors really don’t use this anymore as a basis for lending. Not a creditor protection tool anymore.
- The states retaining par value may allow no par value stock, but management must determine division between stated and paid-in capital. Can put it all in paid-in. If no designation, then it all becomes stated capital, see DE statute, p. 7 handout
Mechanics
- (^) Stated capital at least par value x number of outstanding shares
- Capital surplus is what was paid over par value
- Earned surplus is retained earnings
- Dividends (return on investment) are paid out of earned surplus
- Distributions (return of investment) come out of capital surplus
- FL has done away with distinction between distributions and dividends. A dividend is considered a distribution, and distributions can be paid from any surplus, earned surplus or capital surplus
- Can transfer funds between capital surplus and stated capital, but stated capital must never drop below par
- If earned surplus is negative, can transfer in from capital surplus, but only enough to bring to 0.
Toms v. Cooperative Management Corporation
- Ms. Tom’s stock was redeemed by corporation for allegedly less than FMV. To settle her suit, company was going to reissue her stock.
- By-laws required any change in stated capital must be approved by 85% stockholders
- Majority of BOD, but not 85% of stockholders voted to reissue her stock for the same price and deposit the funds into the capital surplus account, therefore 85% not required because not going into stated capital
- Δ argues statute allows them to put $0 in stated capital and all proceeds in capital surplus
- Court rejects. At least a portion of proceeds must go into stated capital per plain language of statute
- Δ argues redeemed shares are simply treasury stock being reissued without any effect on stated capital
- Court rejects. Per minutes of meeting, shares were cancelled and stated capital was reduced.
Preferred Stock
- Hybrid. Elements of both debt and equity.
- Equity: permanent investment in company, dividend subject to board approval, subordinated to debt, limited voting rights
- Debt: fixed return, dividend preference, liquidation preference, redeemable, limited voting rights
- Convertible (can be converted to another security at your option, usually to CS, e.g. 1 preferred → 5 CS) Participating (get some additional percentage of what is paid to CS) Cumulative (in any year in which dividend not paid, it is added to next year) Preferred
- If stock is redeemable at $100 and maybe your stock is now worth $160 because of a right to convert to CS, typically have right to convert within 30 days of notice of redemption
- Must have authorized unissued shares available for someone to convert to
- If you are backlogged in dividends, you can change rights of preferred shareholders (lower rate, waive dividend), but only if the class agrees. This is where they do have the right to vote.
- Advantages: attract additional investors, avoid dilution of CS, can offer lower dividend rate – conversion is the incentive, however risk of dilution if PS is converted to CS
Debt
- Investment, just like equity, but with different priorities & consequences
- Sources
- Outside lenders: banks, etc.
- Inside lenders: shareholders, BOD
- Long-term or short-term notes
- Bond
- Bond 1: LTD instrument 5-10 years or more,
- Bond 2: LTD secured by a mortgage or deed on corporate property
- Debenture: unsecured LTD
- Bond/debenture holders protected by an indenture (contract covering a variety of corporate matters), whereas note holders generally are not
Leverage
- Borrowing money at a lower rate of interest, so that your money can be out earning more elsewhere
- Ex. 1 Borrow $50,000 from bank @ 10%, get $50,000 from investors 15% return = $15,000 - $5000 (interest) = $10,000 return for investors, 20%
- $100,000 from investors 15% return = $15,000 return for investors, 15%
- At the same return rate, tying up more of your own money results in a lower return to investors
- Only works when rate of return is greater than the interest rate
Equity Debt
Liquidation residue (last) Liquidation priority Voting Non-voting Appreciation and Growth Fixed Possible tax on redemption (shareholder) Debt repaid without tax consequences (loaner) Dividends paid not tax deductible Interest paid is tax deductible Dividend subject to BOD approval Interest payment mandatory Permanent investment in corporation – no right to get your money back
Repayment obligation
Duly Authorized, Validly Issued, Fully Paid & Nonassessable Stock
- Fully paid: easy enough to determine when paying cash, but in terms of services or labor, the stock is not fully paid until services are rendered.
- Nonassessable: if stock is fully paid, owner cannot be assessed for future payments
Hanewald v. Bryan’s
- Bryan’s: 50 shares of stock of par value $1000 to each of two owners for stated capital of $100,
- Hanewald sold his company to Bryan’s. Bryan’s paid portion of money, but dissolved without paying off rest.
- Hanewald sued corporation and stockholders/owners individually
- Court: Bryan’s owners had not fully paid for stock, personally liable.
- Stocks are issued in consideration for money, property or services, none of which the owners had contributed at time of incorporation.
- Misrepresentation to show $100k in stated capital, which in fact is not there. Other shareholders and creditors rely on this statement.
- A shareholder is liable to creditors only to the extent his stock is not paid for
Thin Incorporation and Subordination
- Extent to which stockholder loans can be used to finance a corporation (and still be considered debt as opposed to equity)
- Thin on equity, fat on debt issued by shareholder.
- Factors:
- D/E ratio is indicator, but not conclusive.
- Equity should be sufficient to acquire core assets
- Were corporate formalities observed? Debt authorized, debt instrument, interest payments, maturity date. Payments should not be dependent on someone’s discretion or based on earnings
- Material amount of capital should be stock
- Realistic debt structure: look at potential income stream. Repayments should be made from operations, not refinancing
- Collateral: indebtedness should be secured
Obre v. Alban Tractor
- A – L or E
- Net Working Capital
- measures short-term stability
- current assets – current liabilities
- (^) Current Ratio
- used to evaluate adequacy of working capital
- CA/CL
- 2 to 1 is solid for industrial company. Lower ok when lower inventory levels are required or A/R is easily collectible
- Acid Test/Quick Asset Ratio
- Assets available to cover an emergency. Smaller subset of CA.
- QA (cash + marketable securities + current receivables) / current liabilities
- 1.0 generally good. Lower not necessarily terrible.
- Book Value of Shares:
- Has nothing to do with market value. Even shares of privately held companies have book value.
- Assets – liabilities / number of shares or Equity / number of shares
- Asset Coverage of Debt
- How secure the holder of long-term debt is
- Total assets – current liabilities / long-term debt
- Debt/Equity
- Shows what portion of corporation’s permanent capital is borrowed and what is contributed
- Long-term debt / total equity
- Debt requires the payment of interest while payment of dividends is discretionary, so a company with larger amounts of debt are riskier than those with small amounts.
- A high DE ratio means a company is heavily leveraged.
Income Statement (for a period of time)
- Earnings Per Share
- Net income / outstanding shares
- Market value = EPS x industry multiplier
- Return on Equity
- (^) How much the company earns on each dollar of shareholder investment
- Net income / net worth
Chapter 16: Securities Laws
A. Generally: designed to protect investors, no de minimus exception
B. Securities = stock, notes, investment contracts
C. Historical Development of Securities Laws: Securities exchanged for many years without regulation. A lot of
abuse, KS passed first securities law in 1915.
C.1.State Laws (Blue Sky Laws)
C.a. Principal Elements
C.1. Registration of Securities Transactions: full description of company and shares
C.a. Merit review: will examine each offering and if it is too risky will
not allow it to be sold. Paternalistic. Many states are getting away from this. FL retains this. No merit review on federal level.
C.2. Licensing of Sales Agents
C.3. Civil and Criminal Antifraud Provisions: for violation of statutes and failing to give
full disclosure
C.b. Crash in 20-30’s clued people in that state laws were not effective
C.2.Federal Laws (Securities Act of 1933): creates national enforcement scheme. Prospectus must be filed,
but no one at SEC or elsewhere investigates the stuff in the prospectus. Mutual fund, pension managers, read it thoroughly. It is really to limit liability – make sure corporation can't be sued for not giving full disclosure. Must register at Federal Level and in every state going to sell securities in.
C.3.Concurrent Jurisdiction: must comply with both federal and state laws, which don’t necessarily
complement each other.
D. Registration Process: time consuming, expensive, slow
E. Federal Exemptions: try to get an exemption so that only state law will apply
C.4.Statutory
C.c. Intrastate (s. 3(a)(11) and SEC Rule 147)
C.4. All offerees and purchasers must be within the same state
C.5. Issuer doing business within state: incorporated in that state with substantial
revenues generated in that state
C.6. Has nothing to do with interstate commerce
C.d. Private Offering (s. 4(2) and Rule 506)
C.7. Ralston Purina
C.b. Sophistication of investors, can “fend for themselves.”
Executives, institutions e.g. pension funds, mutual funds, etc., what about the rest of us? If one person is deemed by court not sophisticated, can spoil the entire offering and exemption.
C.c. Full disclosure
C.d. No general advertising or solicitation
C.8. Venture capital financing falls into this category
C.9. Burden of proof on person claiming exemption
C.10. §4(2) – Any transaction not involving a public offering
C.e. What is a public offering?
E.i. Everything is a public offering, except in circumstances
where the people involved in the offering don’t need the protection of the registration process. People who can “fend for themselves” Ralston Purina
C.5.Administrative Exemptions (per s. 3(b))
C.e. Regulation D
C.11. Rule 504 – up to $1 million to be raised in 12-month period. Unlimited number of
purchasers and types. Permits general advertising and solicitation, but requires registration at state level.
C.f. Conflicts with FL, which limits # of non-accredited and doesn’t allow
advertising
C.12. Rule 505 – up to $5 million in 12-month period. Up to 35 non-accredited
purchasers. Accredited = fat cats and institutions
C.13. Rule 506 – private offering exemption, see above. This is the only one that
preempts state law.
C.f. Regulation A - $5 million (modified registration)
C.14. Prepares disclosure document and send to SEC, but it is not as extensive as
regular registration statement.
C.15. Can sell to anyone, allows general solicitation, no limit on number
C.16. Not widely used because you have put yourself on SEC radar screen.
F. States Exemptions
C.6.Even with federal exemptions, state laws still apply. Have to register in state, unless there is a state
exemption as well.
C.7.ULOE: uniform limited offering exemption. Adopted by 35 states, not Florida, similar to Rule 505. Adds
requirement that issuer believes this investment is “suitable” for the particular investor. Paternalistic.
C.8.Florida Ch. 517.061(11):
C.g. No more than 35 non-accredited in any 12 month period
C.h. Full disclosure to every offeree
C.i. No commission to unlicensed salesperson
C.j. No general advertising or solicitation
C.k. Three day right of rescission: if you don’t tell them, this right runs until SOL runs
G. Cohn: Federal and state exemptions are too strict, too difficult for small companies to raise money, pay too much
attention to technical requirements. Emphasis should be on fraud.
H. Federal laws are entirely disclosure oriented, so it is possible for federally registered offering to be denied state
registration, because state is paternalistic
I. FL law more favorable to Πs
C.9.negligence standard for non-disclosure
■ Directed SEC to look into adopting provisions for creating a process to allow shareholders to
nominate directors
- Moving from state to fed law
0820 Meetings: BOD may have meetings, (4) allows BOD member to attend via conference call and will be considered present in person. Majority required to take action O701 – Must have annual shareholder meeting with BOD, when directors have to face shareholders. 0702 – Special meeting – can be called by president, BOD, or a shareholder who holds more than 10% of outstanding stock. – Shareholder special meeting won’t be to take action, it’ll be for publicity purposes, letting the BOD know that they’re not happy.
0821 Action of BOD without meeting: only if unanimous and with written consent describing action and signed by each director
0824 Quorum and voting
- Usually a majority, but can be as few as 1/3, of the number prescribed by articles. Vacancies do not change quorum
- Affirmative vote of majority present required to pass, unless articles requires supermajority
- 3 exceptions to meeting in person: 0821, 0820, 0825
- Notice: 1 director does not necessarily equal 1 vote.
0825 BOD Committees: committees authorized to do things on behalf of BOD. Committees can do almost anything BOD can do with few exceptions (1)(a-e), e.g. fill vacancies, making decisions belonging to shareholders, change bylaws, etc. Executive committee almost always present in corporations – does almost everything the BOD does… other committee’s (audit, finance, etc.)
08401 Required officers : secretary, someone to take minutes and authenticate records – must attest to third party that there has been corporate action/approval
0841 Authority and duties of officers: section refers only to actual authority
Commentary on Authority
- Actual: reasonable belief of agent, based upon conduct of principal, that agent had authority. If agent reasonably believes authority exists, it does. Doesn’t matter what principal believes.
■ express (statutory laws, charter, bylaws, BOD. Delegation by someone with authority to act) or
■ implied (either because incidental to express authority or past course of conduct of corporation)
- Apparent authority: third party’s reasonable belief agent had authority to act because principal allowed third party to think that.
■ Doesn’t matter what agent thinks his authority is. Agent “bootstrapping” his authority is not
enough, based on actions of corporation toward 3rd^ party, e.g. clothed agent with a certain title
- Reasonableness may depend on type of K, officer involved, usual manner of business, size of corporation and number of stockholders, etc. 0842 Resignation and removal of Officers :
0843 Contract Right of Officers:
1601 Corporate Records
1602: Inspection of Records: (1) allows shareholders to inspect any item in 1601(5), really a bunch of nothing. (2) allows inspection of some more interesting documents (3) requires proper purpose & disclosure of purpose
- still uphill battle for shareholders. Corporation will stall for awhile, e.g. you have not stated a proper purpose, you have not stated your purpose with particularity & named documents you want. Shareholder may have to take corporation to court. How many shareholders have the resources to do this?
- Can inspection rights be changed? This statute doesn’t say, “unless otherwise provided.” Look at § 607.0732, corporation with fewer than 100 shareholders, can do anything you want by unanimous vote, so appears you can change inspection rights here.
- Proper purpose does not include using corporate info for purely personal reasons. Must be made in good faith & with reasonable particularity, does not allow fishing expeditions
- Just need one purpose to be proper
Functions and Authority of Shareholders
- Varies according to the number of shareholders. If large corporation with lots of shareholders, probably not much involvement with management.
- Extremely limited powers: elect BOD, remove BOD, amend by-laws, amend articles (two-step process BOD recommends, shareholders vote), power to inspect records, approve major transactions: mergers, sale of all assets, etc, non-voting shares have right to vote if impending action affects their class of shares 1004(4)
- If it is a BOD action, even 100% approval of shareholders does not substitute for directors.
- Not agents of corporation
Gashwiler v. Willis – what hat is BOD/shareholder wearing?
- Everyone in corporation wants to sell property and there is a buyer.
- Shareholder meeting, everyone shows up, including 3 trustees (BOD). 100% vote in favor.
- Trustees go and execute. Then someone complains.
- This was not a shareholders decision, but a BOD decision. Even though trustees were there and voted in favor of transaction, they were acting as shareholders and not directors.
- BOD has different perspective and function than shareholders. BOD has to think of the corporation first, whereas shareholders likely think of themselves first.
Handout 11 Can Sandy (20% shareholder and D) execute valid purchase agreement without BOD approval?
- No bright line test. Depends on magnitude of transaction. BOD votes against. Sandy calls shareholder meeting and 73% vote in favor.
- This is a BOD decision. Shareholders can't take it into their own hands and control transaction.
Hoschett v. TSI
- Court is dealing with what it perceives as a conflict between statutes similar to 0701 and 0704.
- 0701 requires shareholder meeting to elect BOD
- 0704 allows shareholder action without meeting with written consent.
- Court could have said consent provision trumps annual meeting, but instead court said annual meeting cannot be avoided. Want corporate democracy, chance to be heard.
Pillsbury (person not company) v. Honeywell – right to inspect corporation records
- Honeywell involved in manufacture of napalm bombs for use in Vietnam
- Pillsbury bought shares then requested inspection of corporate records. Wanted to send proxy solicitation for non-binding resolution of shareholders asking corporation to stop making bonds.
- Court denied Pillsbury access because he was only a nominal shareholder and not really interested in benefiting company, he was out to make a social point. Proper purpose really requires something that will economically benefit company. Court noted this may have been a valid request from a longtime shareholder or someone with a larger percentage of shares. Notes:
- This case is not justified. Court made a political decision by not opening Honeywell up to political activism.
- Proper purpose does include social cause.
Handout 11, p.
- Jones owns non-voting preferred stock and corporation is considering amending articles to add a preferred class with liquidation above his. Jones complains.
- 1004(4): gives shareholders voting right (overrides shareholder agreements and articles) on issue affecting your class of shares.
Functions and Authority of Directors
- No proxy voting for directors
- Not agents of corporation
- P. 313, powers of BOD
- List a: select and evaluate executive management, oversee corporation’s business, review major plans, review principles in preparation of financial statements, other functions provided in statute (BOD probably does these, they are supervisory.)
- Corporation was estopped from denying the validity of the secretary’s authentication.
- Apparent Authority: Principal held person out as secretary, allowed people to believe agent had authority.
Treasurer
- Internal operations: Account for funds, disburse funds, reports to BOD
Jacobus v. Jamestown
- Does treasurer have authority to sign note on behalf of corporation
- If BOD asked him to do it (express authority) or if treasurer had been signing notes already (implied authority)
Chapter 7: Corporate Control
0707 Record Date for voting purposes
0722 Proxies. Process, effective when received, for up to 11 months unless longer specified, revocable unless appointment stated to be irrevocable coupled with an interest. Commentary: fiduciary relationship, proxy holder cannot vote shares contrary to instructions of shareholder. No state regulation of standards for obtaining proxies (unlike federal which has extensive disclosure requirements),
0728 Voting straight voting, unless articles provide otherwise. Plurality
0730 Voting trusts : transfer record ownership of shares to voting trustee. Trust instrument directs trustee how to vote shares. Copy of agreement filed with corporation and all other shareholders are entitled to see it. Previously, statute restricted trust to 10 years. Little case law addressing remedies if trustee breaches duty.
0731 Shareholder pooling agreements : owners retain ownership and vote shares themselves. Agreement is specifically enforceable. Do not have to disclose to company.
0804 Group Voting: election of directors by voting groups, e.g. classes. Still has quorum requirements. If elected by a group, can only be removed by that group. Voting power of BOD members does not have to be equal, e.g. class C gets to elect director, but that director only counts for one vote, whereas class A’s director gets two. Quorum adjusted to reflect number of votes, not bodies
0805 Terms of directors. Unless staggered, terms are for generally one year, from one shareholder meeting to the next. Even if term expires, directors stay on until successor elected, potential to stay on indefinitely.
0806 Staggered or classified boards. One, two or three classes (really just two or three, so either1/2 or 1/3 elected each year). No minimum number of directors required for staggering. Not the norm
0807 Resignation of Director. Effective upon delivery
0808 Removal of Directors. Shareholder may remove with or without cause, no provision allowing BOD to remove a director. Special protection for directors elected pursuant to voting group or cumulative voting, just keep your constituents happy. Articles may provide removal only for cause. The class that elects a director, is the class that has to remove director. Removal of any officer with or without cause – 607.0842 – ex. Horace Mann CEO who is now in jail on drunken driving charges. .0843 – contract rights of officers, an officer’s removal does not affect contract rights, so there can be damages.
1004 Covers voting by class and voting by non-voting shares when the issue affects rights of class of shares, e.g. new class of shares having preference, limit or deny preemptive rights,
1430 Judicial dissolution. No provision for oppression. Limited to deadlock, misapplication of assets, illegal or fraudulent conduct. Relief granted cautiously. Model act include oppression under subsection 3.
1431 Procedure for Judicial Dissolution. Venue, intended to deter frivolous suits, etc.
1432 Receivership or Custodianship. Receivers wind up and liquidate, custodians manage through or in place of BOD. Appoint for time between filing of petition for dissolution and the courts determination. Temporary.
1433 Judgment of Dissolution.
1434 Alternative remedies to dissolution. Equitable power of court to fashion remedies, including buyout, having a receiver run the corporation until the shareholders come to an agreement. Subsection 4 – ANY equitable relief
1435 Provisional director. Adds an additional, independent, full powered member to the BOD. May be good in case of deadlock. Less intrusive on management than receiver or custodian.
1436 Election to Purchase/Buyout. Corporation or shareholders may elect to purchase shares or complaining shareholder at FMV. After election filed, suit cannot be discontinued without court approval. Parties first try to determine FMV, but if they can't, court will. Payment of an order subject to 06401, distributions
- Very important in closely-held corporations because shareholders usually participate in management, shareholders rely on corporation for livelihood and little market value for shares.
- Hard for shareholders to get out of these situations, so important to structure company so that minority interests are taken into account without paralyzing a corporation.
Straight Voting
- If there are 4 spots and you own 25 shares, you have 25 votes you can vote 4 times. Put your 25 on 4 different candidates.
- This is the norm unless in articles.
- Shareholder or group with majority can elect all directors
- 0728 provides for straight voting. Plurality.
Cumulative Voting
- Multiply number of shares by number of directors. In the above example, 100 votes that can be allocated in any way. All 100 to one candidate or any other variation.
- Process of allocating in such a way as to assure minority they can get a seat on the board.
- Not the norm
- X = S x N + 1 D + 1 X = number of shares needed to elect N directors S = number of shares to be voted by all shareholders N = number of directors a shareholder/group is trying to elect D = number of directors to be elected at meeting
Classification/Staggered Directors
- (^) Reasons for:
- Can be used to overcome cumulative voting, because reduced number of directors to be elected at each meeting
- Used as anti-takeover device. Will take several years to gain control of board.
- Continuity.
- 0806: two or three classes authorized. No minimum number on BOD required for staggered terms
- Not the norm
Class Voting and Weighted Voting
- If there are different classes of stock, class voting rights ensures each class has the ability to elect a certain number of directors
- Weighted voting gives more than one voted per share. Often used against takeovers.
- Can have different voting rights between classes, but not between shareholders of the same class, e.g. discriminating against large shareholders
- (^) Drawbacks, members of one class can sell shares to person who is jerk, he elects himself, everyone else is screwed. Can only be removed by class that elected
- 0804
Removal of Directors
- Generally, shareholders can remove any director with or without cause. “Cause” is usually gross abuse of office.
- Elected by cumulative, must be removed by cumulative
- (^) No matter how terrible D behavior, BOD cannot remove
- 0808
- 0807
Auer v. Dressel
- Courts were struggling with what shareholders could do. Here, issue is removal of directors.
- Majority of class A stockholders wanted to call special meeting, one reason being removal of directors.
- Class A stockholders elect 9 of 11 BOD (common elect remaining 2). Wanted to amend bylaws to allow them to remove their own directors and replace them.
- Removal requires notice, specific charges, opportunity to meet accusations
- Court enforces the agreement…deal with it Estrada
- Estradas’ claim agreement was oppressive, court rejects. They were experienced business people.
Shareholder Agreements Allocating Control
Galler v. Galler
- Π sued Δ for specific performance of agreement and accounting
- Appellate court wouldn’t enforce because duration of agreement so long and no public policy reason`
- Galler forward looking opinion, court recognized close corporation don’t always do things by book. No harm no foul.
Employment Contracts
- Since one thing an officer/owner of a close corporation may want and expect is continued employment, an employment contract may provide some protection
- Usually person will not get specific performance, but rather damages
- Another way a corporation tries to force someone out is with a change of duties. To protect against that, have contract describe job in terms of duties, opposed to title
Deadlocks, Oppression and Dissolution
- Hall, Donohue, Kemp: in all three problems could have been foreseen
- Hall: Contract ahead of time, when brother dies shares bought back
- Donohue: provide for repurchasing across the board.
- Kemp: guarantee employment for those owning certain percentage, don’t change dividend policy
- These are all board decisions, by contracting via 0732 , shareholders make these decisions.
- If these corporations could have protected themselves and didn’t, but now come to courts for help. Hard cheese. You should have protected yourselves.
- 3 approaches:
- statutory provision: court can order dissolution
- judicial
■ fairness (Donahue approach)
■ hard cheese if you had tools available to you and chose not to use them (Nixon)
Deadlocks
- Can occur at either shareholder or director level. Sometimes results in corporation’s inability to act
- President can usually act on corporation’s behalf on usual matters, even during a deadlock, so possibility that Pres. can implement wishes of one faction.
- Worst deadlocks occur when shareholders are deadlocked and cannot replace a board dominated by one shareholder faction
- This may occur when half the votes are held by one shareholder and half by the other shareholder.
- A shareholder may have a hard time getting a quorum for a meeting.
- The shareholders may become deadlocked and be unable to replace a board dominated by one shareholder faction.
Hall v. Hall
- E & H each owned half the stock of corporation
- E died and H appointed his wife as the other director and then appointed themselves Pres and VP. He was the only remaining director and the majority of the remaining directors may fill vacancies.
- E’s wife called for annual meeting. H & wife refused and have continued in their capacity.
- No way to compel H into participating in shareholder meetings, distinguishing characteristic of corporation is separation of shareholders and management
- Wife could try to dissolve corporation.
- Cohen thinks the wife had a poor lawyer, who failed to state a true cause of action
- Failure to plan ahead in this case
- Could have had provisions providing
- Mandatory dividend/salary
- That surviving brother has to purchase the other 50%
- Convert the shares to preferred shares, with no voting right but high dividend
■ If dividends not paid, the severe sanctions
Oppression and Dissension
- Really when majority conduct substantially defeats expectations that, objectively viewed, were reasonable under circumstances and central to petitioner’s decision to join in venture.
- Death, termination, retirement, forced retirement are all foreseeable. Court may not have sympathy for these.
- Problems that may occur include:
- freezeouts
- no dividends, increase salaries and bonuses to majority
- deprive minority of offices and employment
- (^) cause corporation to sell assets at inadequate price
Donahue v. Rodd
- When Rodd retired, the corporation bought back shares. Donahue sought similar repurchase and was denied.
- Good description of closely-held p. 358
- Court holds shareholders in closely-held corporations to strict good faith standard which is more stringent than standard fiduciary duty for corporation
- (^) When controlling group repurchases shares from a member of controlling group, must offer everyone opportunity to sell ratable portion at same price.
- Even though the price set was fair, allowing one to sell, but not others, disadvantages the minority. Creates a market for shares where none previously existed and gives person opportunity to use corporate funds for personal use.
Tillis v. United Parts (FL 1981) (LP notes)
- Close corporation purchased shares from controlling shareholder without making buyback available to others
- Court: controlling shareholder used position to get preferential distribution of assets. All shareholders should have equal opportunity.
- Similar result, but maybe not as broad
Chesterton Co. v. Chesterton
- Extended fiduciary duty to minority shareholder who wanted to sell shares to a corporation, which would defeat company’s S status.
In re Kemp & Beatley
- Πs, former employees brought action for dissolution because new dividend policy offered shareholders no possibility of any ROI. The only way they would get any money was upon sale of assets
- Oppressive conduct should be deemed to arise only when the majority conduct 1) defeats reasonable expectations (at time of commitment) that 2) were central to petitioner’s decision to join the corporation.
- Must be objectively oppressive
- Burden on Δ, who is against dissolution, to show adequate alternate remedy
- Conditional dissolution, which would allow company to purchase shares as an alternate way out.
- (^) What if parties can't come to agreement. Can wind up back in court. Courts very involved.
- What happens upon dissolution? Marshal assets, pay off creditors, anything left over paid to shareholders. Plants, equipment, inventory, etc., either distributed to shareholders or put up for public auction. Often, existing shareholders bid on this so that they can continue operations.
Nixon v. Blackwell
- Shareholders of a class of corporate stock contended that the directors breached their fiduciary obligations by offering certain liquidity devices to corporate employees but not to minority shareholders.
- Every person going into close corporation has opportunity to protect himself, you didn’t do it, don’t come running to us. P377, part 6
- Complete denial of judicial role seen in Donohue and Tillis.
- Fair does not have to mean equal. But when classes are treated differently, are differences justifiable? Employees v. non employees
