Transcript Slide 1

Corporate Formation
& Organization
What is a corporation?
 A business entity characterized by the following
 Limited liability
 Centralized decision making
 Perpetual existence
 Free transferability of ownership
 In short, corporations are everything that general
partnerships are not
 Challenge for business planners: construct an entity that
provides the best of both worlds
Benefits of the Corporate Form
 Eliminates messy problems of personal liability: creditors rely
only on business assets.
 Allows investors to enter and exit the firm: all they have to do is
buy or sell shares.
 Prevents minority investors from trying to hold up the firm by
threatening to dissolve it.
 Makes it easy for third parties who contract with the firm to know
whom they are dealing with as an authorized agent. All they
need is a board resolution.
Structural Features of the Corporate
Charter Marketplace
U.S. firms are not constrained by headquarters, place of
business, or other operational factors in choosing where to
State of incorporation dictates which corporate law rules apply
under “internal affairs” doctrine.
States charge annual franchise taxes ranging from $10 flat fees
to $100,000+ based on income, assets, etc.
Mechanics of reincorporation are straightforward: creation of a
new firm in the destination state, followed by tax-free merger of
the existing corporation into the new one. Typical reincorporation
costs are $70,000 in 2000.
Reincorporation requires shareholder approval.
U.S. Public Corporations (2000)
State of Incorporation
Headquarters State
New York
New Jersey
Delaw are
New York
4% California
From: Guhan Subramanian, The Influence of Antitakeover Statutes on Incorporation Choice: Evidence on
the “Race” Debate and Antitakeover Overreaching, 150 U. Penn. L. Rev. 1795, Figures 1 & 2 (2002) . N
= 7,841 companies.
International Comparison -- Europe
Germany, France, Portugal apply the “real seat” theory: e.g.,
Germany requires a company having its principal place of
business in Germany to incorporate under German law; a
company that has its headquarters outside of Germany cannot
incorporate under German law.
Netherlands, Ireland, Denmark, U.K. apply U.S.-style
incorporation theory, I.e., a corporation is regulated by the
country in which it is incorporated, which can differ from where it
is incorporated or does business.
BUT: European Court of Justice in Centros decision (March
1999) and the EC Fourteenth Company Law Directive (proposed
but not yet formally tabled for Council of Ministers) likely requires
U.S.-style incorporation theory.
Selecting a State of
 Publicly traded corporations: Delaware is home to about
half of the Fortune 500
 High technology firms seem to choose Delaware at an even higher
 Why Delaware? Statute? Specialized courts?
 Closely held corporations: home state
 Corporate law is not as important because the important issues are
 Maintaining local incorporation is cheaper
Promoter Liability
 Promoters are personally liable on all pre-incorporation
 “All persons purporting to act as or on behalf of a corporation,
knowing there was no incorporation under this Act, are jointly
and severally liable for all liabilities created while so acting.”
MBCA § 2.04
 However, If one party urges another to sign in the name of the
corporation, even though both know it does not exist, estoppel
may prevail
 Third party may agree to look to corporation
Incorporation Process
 Draft articles of incorporation
 Called “certificate of incorporation” in DE
 Generic term is “charter”
 “One or more persons may act as the incorporator or
incorporators of a corporation by delivering articles of
incorporation to the secretary of state for filing” MBCA
§ 2.01
 “[T}he corporate existence begins when the articles of
incorporation are filed” MBCA § 2.03
Defective Incorporation
 Drafters of MBCA § 2.04 meant to displace
de facto
corporations, which arise from a “colorable attempt” to
form and exercise of corporate power
 Despite a few cases eliminating the de facto corporation doctrine,
many courts still rely on de facto corporations
Corporations by estoppel may be used to uphold limited
 Note that this is backwards because the person relying on the false
representation is estopped
 Incorporator usually elects directors, who complete the
organization process (MBCA § 2.05)
 Adopt by-laws
 Appoint officers
 Issue stock
 The existence of the corporation does not depend on the
maintenance of corporate formalities
 BUT the benefits of limited liability may depend on the
maintenance of corporate formalities (see “piercing the
corporate veil”)
Drafting the Charter
 Statutory requirements minimal:
 Name (indicate corporate status, MBCA 4.01)
 Number of shares (check MBCA 6.01)
 Registered office and registered agent (MBCA § 5.01)
 Incorporator name and address
 Optional items:
 Some optional items may be effective only if they appear in the
charter (e.g., limitation on director liability)
 Most optional items could appear in the bylaws or a board
resolution; place them in the charter only if you want to insulate
them from change
Charter & Bylaws – Typical Contents
Articles of Incorporation: Name of Company, Address,
Purpose (usually “any lawful act”), capital structure
(classes, number of common shares, rights of preferred
shareholders if any), other miscellaneous provisions.
Bylaws (sample structure):
Article I: Stockholders
Article II: Board of Directors
Article III: Committees
Article IV: Officers
Article V: Stock
Article VI: Indemnification
Article VII: Miscellaneous
Core Characteristics of the
Corporate Form
Core Characteristics
Investor Ownership
Legal personality
Limited liability
Transferable shares
Centralized management under an elected
Corporate Form – Key Benefits
Benefits of Limited Liability:
1. Reduces need to monitor agents (managers)
2. Reduces need to monitor other shareholders
3. Makes shares fungible (which also facilitates takeovers, see
4. Facilitates diversification (without LL, minimize exposure by
holding only one company)
5. Enlists creditors in monitoring managers (because creditors
bear some downside risk)
Benefits of Transferable Shares:
1. Permits takeovers => disciplines management
2. Allows shareholders to exit without disrupting business
3. And because of LL, shares are fungible => facilitates active
stock markets, increasing liquidity
Derived from: Easterbrook & Fischel, The Rationale of Limited Liability, 52 U. Chi. L. Rev. 8 9(1985)
Basic Decisionmaking Structure
The Board of Directors
“[E]ach corporation must have a
board of directors”
MBCA § 8.01(a)
The Board of Directors
Shareholder agreement may “eliminate
board corporation
of directors or
of directors”
or powersMBCA
of the§board
directors” MBCA § 7.32(a)(1)
The Board of Directors
“All corporate powers …”
MBCA § 8.01(b)
The Board of Directors
“All corporate
= employees
MBCA § 8.01(b)
The Board of Directors
“outside” directors = non-employees
The Board of Directors
“independent” directors =
non-employees without substantial
ties to the corporation
The Board of Directors
“disinterested” directors =
directors without a financial interest
in the relevant transaction
Board Size
 One director is enough (MBCA § 8.03(a))
 Number of directors (or a range) usually fixed by the
charter or a bylaw (MBCA § 8.03(c))
Election of Directors
Directors elected at annual meeting of shareholders (MBCA
§ 8.03(d))
 “Staggered” boards have special rules (MBCA § 8.06)
 Directors hold office until their successors are elected and
Meetings of the Board
 Directors act at regular or special meetings of the board
(MBCA § 8.20(a))
 Directors may act without meeting, by unanimous
written consent (MBCA § 8.21(a))
 Quorum: unless altered by the charter or bylaws, a
majority of the board forms a quorum (MBCA § 8.24(a)
& (b))
 The board of directors acts by majority vote, unless the
charter or bylaws require a supermajority (MBCA §
Board Committees
 The board of directors may act through committees comprised of
fewer than the total number of directors (MBCA § 8.25(a)
The rules governing meetings of the board also govern meetings of
committees (MBCA § 8.25(c))
Committees may be authorized to act on behalf of the whole board
(MBCA § 8.25(d))
Stock exchange rules may require committees and certain
composition of the committee – e.g., audit committee have at least
one financial expert
Federal regulation also has focused on committees (S-OX)
Audit, Nominating, Compensation
Legal Compliance???
Removal of Directors: MBCA
 Directors may be removed by shareholders with or
without cause. MBCA § 8.08(a)
 If a director is elected by a specific class of shares, only
those shares may remove the directors. MBCA § 8.08(b)
 Special rules for cumulative voting. MBCA § 8.08(c)
 Directors may be removed in a judicial proceeding for
bad behavior, if the court finds that removal is in the best
interests of the corporation. MBCA § 8.09
Removal of Directors: DGCL
 Under DGCL, directors may
always be removed for cause
 Under DGCL § 141(k)(1), removal of directors in
staggered board is only for cause
Vacancies and New Directorships
 Vacancies are caused by death, removal, resignation
 Creation of a new directorship functionally the same as a vacancy
 Shareholders or directors may fill vacancies or new
directorships. MBCA § 8.10; DGCL § 223
Basic Decisionmaking Structure
Shareholder Voting Generally
 “[E]ach outstanding share … is entitled to one vote on
each matter voted on at a shareholders’ meeting” (MBCA
§ 7.21(a))
 Subject matter
 Electing of directors (MBCA § 8.03(d))
 Removing of directors (MBCA § 8.08)
 Amending the charter (MBCA § 10.03)
 Amending the bylaws (MBCA § 10.20)
 Approving a merger (MBCA § 11.03)
 Approving sale of all the company’s assets (MBCA § 12.02)
 Approving dissolution (MBCA § 14.02)
 Ratifying conflict-of-interest transactions (MBCA § 8.61(b)(2))
The Voting System -- Basic Features
Shareholders vote on three kinds of matters: (1) election of
directors; (2) “organic” or “fundamental” changes, e.g., mergers,
sales of all assets, corporate dissolutions, charter amendments;
and (3) shareholder resolutions.
Registered shares: each share has a holder of record, which
facilitates getting in touch with the ultimate beneficial holder (unlike
bearer system in France & Germany).
Proxy system: if you can’t attend the annual shareholder meeting
(ASM), you can still vote by finding a representative (proxy) who
goes to the meeting and votes on your behalf.
State law mandatory rules: all state statutes except one require
an annual meeting for election of directors; quorum requirements.
State law default rules: all state statute statutes permit special
meetings and action by written consent, though default varies.
Voting Rules
 Director elections
 Straight Voting v. Cumulative Voting
 Plurality wins
 Other matters
 One share, one vote
 Majority wins, unless supermajority specified
Cumulative Voting -- Mechanics
Cumulative Voting: each shareholder gets votes equal to
number of shares owned times number of seats to be filled.
Example: Family Corp. has 300 shares outstanding; A owns
199 shares and B owns 101 shares. Family Corp. has a
three-person board elected to annual terms.
Straight Voting: A would win each seat 199 to 101.
Cumulative Voting: B casts 303 shares all for one candidate
=> guaranteed to get one seat on the board, because A’s
597 votes cannot be divided three ways so that all three are
greater than 303.
Implication: Cumulative voting system improves likelihood of
minority representation on the board.
Shareholder Meetings
 Two types: annual (MBCA § 7.01) and special (MBCA §
 Special Meetings: DGCL § 211(d) allows board to call a
special meeting. RMBCA § 7.02 allows board or 10% of
shareholders to call a special meeting.
 Modern statutes also allow for written consent:
 MBCA § 7.04(a): requires unanimous consent
 DGCL § 228: number of votes required in meeting
 Shareholders may vote in person or by proxy (MBCA §
Calling a Shareholder Meeting
 Annual Meetings
 MBCA § 7.01(a): in accord with bylaws (if silent, presumably by
 DGCL § 211(a): in accord with charter or bylaws; if silent by board
 Special Meetings
 MBCA § 7.02: called by board or other person authorized by
charter or bylaws; 10% shareholders (or a different percentage not
in excess of 25%) may demand
 DGCL § 211(d): called by board or other person authorized by
charter or bylaws (note that no default provision for shareholder
Setting an Annual Meeting Date
 MBCA § 7.01(a): in accord with bylaws
 Court may order if meeting is not held within 6 months of the
end of the fiscal year or 15 months after its last annual meeting (§
 DGCL § 211(b): in accord with bylaws
 If not held within 30 days after the designated date, the court may
order a meeting (§ 211(c))
 If no date is designated and 13 months have passed since the last
annual meeting (or written consent in lieu thereof), the court
may order a meeting (§ 211(c)
Setting a Special Meeting Date
 Special Meetings (MBCA):
 Board must give notice no fewer than 10 nor more than 60 days
before the meeting date (§ 7.05(a))
 Court may order if notice is not given within 30 days of
shareholder demand or the meeting was not held (§ 7.03(a)(2))
 Under MBCA, board has 90 days after shareholder demand to
hold the meeting
 Special Meetings (DGCL):
 Board must give notice no fewer than 10 nor more than 60 days
before the meeting date (§ 222(b))
 But DGCL § 211(d) does not provide for shareholder right to call
special meetings; therefore, date regulations are less critical here
Fiduciary Limits on Setting the
Meeting Date
 General Principle: directors must act in the interests of
shareholders, not for the purpose of entrenchment
 Two situations
 Setting the date: boards are given broad discretion
 Changing the date: courts want specific evidence of shareholder
 Fiduciary duties fill gaps left by the statute and
organizational documents (charter and bylaws)
Record Dates
 The record date is the date on which the right to vote is
 MBCA § 7.07(a) in accord with bylaws; absent bylaw
provision, the board sets a “future date”
 Not be more than 70 days before the meeting (§ 7.07(b))
 If no date is set, it is the day before notice of the meeting
 DGCL § 213(a): board fixes record date
 Cannot precede the date of the board resolution
 Not more than 60 nor less than 10 days before meeting
 If no date is set, it is the day before notice of the meeting