Transcript Business associations 1: Acting through others

Business associations
Chapter 1:
Acting through others
Prof. Amitai Aviram
[email protected]
University of Illinois College of Law
Copyright © Amitai Aviram. All Rights Reserved
F15D
Acting through others
Overview of Chapter 1
a. Introduction to BA
–
–
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Administrative details
Grading (the exam / project in lieu of the exam)
Overview of the course
b. Firms
c. Actors
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© Amitai Aviram. All rights reserved.
Introduction to BA
Administrative details
• Accessibility of materials
– Slides, past exams, reading assignments (outline) & syllabus are all posted and
regularly updated on my website
http://www.law.illinois.edu/aviram/
• Student participation
– Participation doesn’t affect grade, but affects my ability to write a
recommendation
– Volunteer participation preferred; I call on students if there are no volunteers
– Questions are very welcome
• Talking to me outside of class
– Room 326; E-mail: [email protected]
– Please e-mail prior to meeting with me
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• Suggest when you would like to meet (not limited to office hours)
• Describe what issues you want to talk about
© Amitai Aviram. All rights reserved.
Introduction to BA
Administrative details
•
Using the PowerPoint slides
– Before class, slides serve as assigned reading
• Review 20 slides ahead to give you a sense of what the class will be about
– In class, slides serve as a bookmark
• If you’re confused about what I’m saying, note what slide we are on.
Review that slide after class, and see if it makes things clearer.
– After class, slides serve as the core of the course outline
• Add your notes from class discussion, assigned reading & practice problems/exams
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© Amitai Aviram. All rights reserved.
Introduction to BA
Administrative details
•
Required reading
– Course slides (on my personal webpage: http://www.law.illinois.edu/aviram/)
• Read 20 slides ahead of where last class ended
– Course materials packet (on law school’s intranet course page)
• Notes, cases, legislation
• I announce next class’ reading assignment at the end of class
•
Optional reading
– Questions regarding agency & partnerships
• Comments in Restatement (Third) of Agency (e.g., on Westlaw: REST 3d AGEN §1.01)
• Bainbridge, Agency, Partnerships & LLCs (Foundation Press, 2004)
– Questions regarding corporations
• Bainbridge, Corporate Law (2nd Ed., 2009)
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© Amitai Aviram. All rights reserved.
Introduction to BA
Grading: The exam
• Take-home exam
– Exams can be picked up between 9-10am on either:
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Weds., Dec. 10
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Thurs., Dec. 11
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Friday, Dec. 12
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Monday, Dec. 15
• Time limit: 24 hours
– Exam responses must be e-mailed to my
administrative assistant (Athena Newcomb) by 10am
on the day following the pick-up day (even if it’s a weekend)
• Exam structure: issue spotter
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Traditional essay-type law school exam question
Word limit: 1,000 words
More info on the exam in the exam prep session (last class of semester)
All past exams (with model answer) available at:
http://www.law.illinois.edu/aviram/Exams.htm
• Deadline for answering student questions (both face-to-face & by email): Friday, Dec. 5, 5pm
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© Amitai Aviram. All rights reserved.
Introduction to BA
Grading: Project in lieu of exam
• Instead of taking the exam, you may submit a project
– Teaching module picks a topic studied in the course (typically, one sub-section; e.g., 1c3
– principal’s liability in torts) & creates alternative or supplemental materials to teach
the same topic
• Module can include new cases, practical application of the material, etc.
• Product you submit should include:
– PowerPoint slides used to teach the material
– Teaching notes that provide information professor needs to know to use slides in class
– Statement explaining why you structured the module the way you did & what you believe are
the strengths of the module compared to the material as it was taught in the course
• Product you submit may include other aids, such as relevant video clips, scanned
images, excel spreadsheets etc.
• Module should provide enough content to teach a 75-minute class (~20 slides)
– Case study (plus teaching notes) for one of the sections of the course
• Case (typically 7-12 pages, plus exhibits): this is the part students read
• Teaching notes: explains to the prof teaching goals, suggested solution, extensions (other
issues that can be addressed by extending the case), how the case developed in reality
• Information on creating a case study is available on my website at:
http://www.law.illinois.edu/aviram/Aviram-Writing_case_studies.pdf
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© Amitai Aviram. All rights reserved.
Introduction to BA
Grading: Project in lieu of exam
• Deadline
– Project is due same time as deadline for questions (Dec. 5, 5pm)
– E-mail project to my administrative assistant (Athena Newcomb) as 1 or more
attached files
• Anonymity
– Projects are graded anonymously (like exams) so the only identifying marks on
them should be the 4-digit exam ID number
– To maintain anonymity, you can’t tell me your specific project, consult with me
about your project or have me look at drafts of your work
• But you may ask me general questions that don’t identify your project
– Due to anonymity, projects don’t qualify for ULWR
• Finality of choice between exam & project
– A student who submitted a project can’t withdraw it & can’t take the exam
– A student who didn’t submit a project by the deadline must take the exam on
one of the days it is administered
• Attendance & participation
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– Must comply with class attendance/participation standard throughout the
entire semester, whether you take the exam or submit a project
© Amitai Aviram. All rights reserved.
Introduction to BA
What is business law?
• A business association (“firm”) is a legal concept designed to let
multiple owners conduct business jointly
• What is business?
– Strategy: identifying a match between • a combination of resources that produce a product/service
• your firm’s competitive strengths in combining these resources
• a market that values the product at or above production price, and in which the
firm’s competitive strengths allow it to capture the most of the surplus value
– Operations: combining the resources to produce & supply the product
(& maximizing surplus value by reducing costs / increasing the product’s value)
– Governance: the rules, process & enforcement mechanisms that coordinate
between people that have the required resources (“stakeholders”)
• Business law facilitates governance (i.e., coordinates stakeholders in
business transactions)
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– Corporate law is the portion of business law that facilitates acting through
others (the legal issues arising from one person acting on another’s behalf)
© Amitai Aviram. All rights reserved.
Introduction to BA
The main segments of this course
• Corporate law is about acting through others: one person (A, the
actor) acts on behalf of another person/group (B, the beneficiaries)
• Acting through others creates two types of issues law must address
– Corporate compliance (external governance): when is B liable to a third party
(T) for contracts/torts between A & T (supposedly on behalf of B)?
• Law needs to balance risk to B (if A disobeys orders) with risk to T (from A’s
actions or T’s reliance on them)
• We will talk about this in part 2 of the course
– Corporate governance (internal governance): how to get A to pursue B’s
interests when acting on B’s behalf (the agency problem)
• Since A decides how to act, but B is the one who could benefit from the act, A
has an incentive to either shirk (not put enough effort) or steal (act in a way
that most benefits A, rather than B)
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© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
1.
2.
3.
4.
What is a firm?
The corporation
The partnership
Constitutional documents
c. Actors
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© Amitai Aviram. All rights reserved.
Firms
What is a firm?
• Firms (business associations) are legal instruments designed to allow
multiple beneficiaries to conduct business jointly
– With multiple Bs, no single person is “the business”, so Bs need to create an
artificial being with an (independent) legal personality
• Implications for external governance
– Asset partitioning: separation of firm’s & Bs’ assets/liabilities (e.g., limited liability)
• Implications for internal governance
– Being artificial, firms can’t control the humans that act on their behalf, except
with other humans. So firms require an additional category of actors, in
addition to agents: organs (actors who control the agents on the firm’s behalf)
– Because firms have multiple Bs, their governances must address:
• beneficiary apathy (some Bs lack ability/incentive to monitor As efficiently)
• beneficiary rivalry (B’s have different incentives regarding firm’s behavior, so
controllers can exploit minority beneficiaries)
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© Amitai Aviram. All rights reserved.
What is a firm?
Legal types of firms
• Corporation (“corp”)
– Public corporation
– Close corporation
• Partnership
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General partnership (“GP” or “partnership”)
Limited liability partnership (“LLP”)
Limited partnership (“LP”)
Limited liability limited partnership (“LLLP”)
• Limited liability company (“LLC”)
– Two defaults for governance: member-managed
(similar to partnership) or manager-managed (similar to corporation)
• Sole proprietorship
– An individual operating a business directly (without using an artificial entity);
sometimes uses a business name (“doing business as” or dba)
• Business trust (based on the common law concept of a trust)
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© Amitai Aviram. All rights reserved.
What is a firm?
Economic types of firms
• “Real” firms (allow multiple beneficiaries to conduct business jointly)
– Public firm (many Bs)
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Delegated control (firm controlled by a board that is elected by Bs)
Restrictive dissolution (difficult for dissenting B to dissolve the firm)
Liberal alienability (easy to sell B’s interest to third parties)
Contractual rigidity (most rules are mandatory)
– Private firm (few Bs)
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Direct control by Bs
Liberal dissolution (easy for dissenting B to dissolve firm)
Restricted alienability (difficult to sell B’s interest to third parties)
Contractual flexibility (parties can opt out of most rules)
• Quasi-firms
– Proprietorship (a single B)
• Operates a business but does not have multiple owners
– Passive firm (single B or multiple Bs)
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• Firm owns assets but doesn’t operate a business; firm structure used to benefit
from some legal features (e.g., preferable tax treatment; limited liability, etc.)
© Amitai Aviram. All rights reserved.
What is a firm?
How firms are created
• Spontaneous creation (GPs & some business trusts)
– Firm is created when Bs act in certain ways, even if they formally don’t act to
(or even want to) create a firm
– Similar to agency (which is created when P&A satisfy R3A §1.01 test)
• Creation by filing (corporations, LLCs, LPs, LLLPs)
– Firm is created when Secretary of State confirms that an entrepreneur (B or
someone who will recruit Bs) filed certain documents
• Creation by conversion (firm of one type become another type)
– Conversion through election (firm converts by filing some document)
• GP can convert into LLP or LP; LP can convert into GP
– Conversion through merger (firm converts by merging into another firm of a
different legal type)
• Requires statutory authorization (typically, conversion is authorized between
corporation/LP/LLLP/LLC & between GP/LP)
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What is a firm?
Financial terminology
• To finance operations, firms receive money from investors in return
for claims on its assets & future profits
• Capital can mean either side of this transaction
– Firm’s money (and other productive resources)
– Investors’ claims on firm’s assets & future profits
• Capital is categorized as debt or equity, depending on nature of claim
– Debt: Claim to a predetermined stream of money, unrelated to the firm’s
performance (e.g., bonds, loans). Owner of claim is a creditor.
– Equity: Claim to remainder of firm’s assets after paying all other claims
• Units of equity capital are called: shares (in MBCA) or stock (in DGCL) in a corporation;
“(partner’s) interest” in GP/LLP; “distributional interest” in LLC; “units” in some firms
• Owner of claim is called a “shareholder” (“SH”) or “stockholder” in a corporation;
“partner” in a partnership; “member” in an LLC; “beneficiary” in a business trust
• In this course we will refer to equity owners as SHs & equity capital as shares,
regardless of the type of firm
– Some types of capital are hybrids with characteristics of both debt & equity
(e.g., convertible bonds) © Amitai Aviram. All rights reserved.
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What is a firm?
Legal personality: the logic of nonliving entities
• A corporation is a legal entity independent of the people creating it,
acting on its behalf or owning rights in it
– But does that make any sense?
• Hypo: A car hits a pedestrian & kills him
– The investigation reveals that the driver took
proper care in her driving, but the car brakes
malfunctioned
– It’s the car’s fault: the car is imprisoned for
three years for negligent homicide
• It seems silly to make a non-living object a legal entity (capable of
being punished), yet we give legal entity status to firms (which are
not only non-living, but lack physical form)
• Why do we give firms an independent legal personality?
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© Amitai Aviram. All rights reserved.
What is a firm?
Legal personality: the logic of nonliving entities
• Legal personality makes limited liability easier
– Without legal personality, the firm can’t own assets, so we can’t say that a
particular asset belongs to the firm (and therefore can’t be seized by creditors
of a SH)
– Without legal personality, the firm can’t have legal obligations and therefore
can’t borrow; SHs must borrow for it
• But asset partitioning can be done contractually, without the firm
having an independent personality
– Non-recourse loans: SHs take a loan in which creditor agrees it can only collect
interest & principal from specific assets & income related to the business of the
firm (not from SH’s other assets) – effect like limited liability
– Tenancy in partnership: UPA created a special right in partnership property, that
was not alienable unless all partners agreed to sell it (so creditors of a SH can’t
seize that property)
• So there must be another reason for firms’ legal personality…
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© Amitai Aviram. All rights reserved.
What is a firm?
Legal personality: the logic of nonliving entities
• Example 1: Small bakery requires two employees &
one person to finance business
– If organized as set of contracts: 2 relationships (2x1)
• 2 employment contracts w/financier; or
• 2 lending agreements w/employees
– If organized as separate entity: 3 relationships (2+1)
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© Amitai Aviram. All rights reserved.
What is a firm?
Legal personality: the logic of nonliving entities
• Example 2: Mid-size bakery requires 6 employees,
2 people to finance business
– If organized as set of contracts: 12 relationships (6x2)
– If organized as separate entity: 8 relationships (6+2)
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© Amitai Aviram. All rights reserved.
What is a firm?
Legal personality: the logic of nonliving entities
• Example 3: Large bread factory requires 600 employees,
200 people to finance
– If organized as set of contracts: 120,000 relationships (600x200)
– If organized as separate entity: 800 relationships (600+200)
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© Amitai Aviram. All rights reserved.
What is a firm?
Legal personality: the logic of nonliving entities
• The tradeoff
– Contracts offer flexibility to address specific preferences in each bilateral
relationship (separate entity uses more standardized terms)
– But as the number of stakeholders grows, the number of bilateral contracts
required grows exponentially, increasing complexity
• Businesses with a few stakeholders are likely to opt for the flexibility
of contracts
• Businesses with a many stakeholders are likely to opt for the
simplicity of the firm
– Avoid dealing with 120,000 separate relationships
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© Amitai Aviram. All rights reserved.
What is a firm?
Legal personality: the logic of nonliving entities
• Corporations
– Always had a legal personality
• Partnerships
– When UPA was created, a partnership was not considered to have a legal
personality (a partnership was a contractual relationship between people, not a
legal entity)
• Forced UPA to come up with some odd rules (e.g., ownership of partnership
assets, issues with continuing partnership when one partner leaves or dies)
• Later case law moved towards recognizing legal personality
– RUPA explicitly acknowledges independent legal personality
• RUPA §201(a): “A partnership is an entity distinct from its partners.”
• RUPA §203: “Property acquired by the partnership is property of the
partnership and not of the partners individually.”
• Sole proprietorship
– Does not have separate legal personality
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© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
1.
2.
3.
4.
What is a firm?
The corporation
The partnership
Constitutional documents
c. Actors
24
© Amitai Aviram. All rights reserved.
Types of firms
The corporation
• By default, the corporation is optimized to be a public firm
– Delegated control
– Liberal alienability/restricted dissolution
– Contractual rigidity
• Public corporation (or publicly-traded corporation): corp that issued
shares to the public or that has shares traded on a stock exchange
– This is usually defined by Federal securities laws, not state corporate law
• Some corporate laws have special rules for close corporations, which
are optimized to be a private firm
• Applicable law
– Corporations are governed by state statutory law
• Less uniformity between states than in agency or partnership law
• Public corporations are also subject to federal securities laws
– ABA created a Model Business Corporation Act (“MBCA”)
• Serves as uniform law on which some states base their corporate law
– Majority of publicly-traded companies incorporated in Delaware
• Delaware General Corporation Law (“DGCL”) is dominant for public corps
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© Amitai Aviram. All rights reserved.
The corporation
Close corporations (DGCL)
• DGCL §342 allows a corporation to elect close corporation status, if:
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–
–
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Charter provides that it is a close corporation
Charter provides that it may have no more than 30 SH
Corporation didn’t issue stock in a public offering
Stock is subject to one/more transfer restrictions specified in §202
• DGCL rules unique to close corporations
– Direct control
• DGCL §351: charter may allow corp to be managed by SHs rather than directors
– Contractual flexibility
• DGCL §350: SH agreement between SHs who hold a majority of the outstanding
voting stock binds the parties even if it interferes with the board’s discretion
• Within this scope, directors are relieved from FD and FD is imposed instead on
the SHs party to the agreement
– Liberal dissolution
• DGCL §355: Charter may give SHs a right to dissolve the corporation (at will or
at the occurrence of a certain event)
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© Amitai Aviram. All rights reserved.
The corporation
Close corporations
• MBCA
– No formal election to be a close corp, but some rules apply when corp’s shares
are not publicly traded
– Contractual flexibility
• Permits SH agreements (if all SHs are parties to it) [MBCA §7.32]
– Liberal dissolution
• Judicial dissolution allowed in cases of deadlock/oppression, if corp is not listed
on stock exchange, has <300 SHs & <$20M value [MBCA §14.30(b)]
• When judicial dissolution is allowed, SH may elect a buy-out in lieu of
dissolution [MBCA §14.34]
• Common-law close corporations
– In some states (e.g., Mass.) case-law applies different rules if corp is closely-held
– Direct control
• FD analysis is more sensitive to risk of oppression of minority SHs (i.e., more
focus on FD to minority SHs that on FD to the firm)
– Liberal dissolution
• Courts are less reluctant to order judicial dissolution if relationship between
SHs is dysfunctional
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© Amitai Aviram. All rights reserved.
The corporation
Creating a corporation
• Choose the state of incorporation
• Draft Charter
• File Charter with the relevant state’s Secretary of State
– The person filing the charter is the incorporator (DGCL §107/MBCA §2.01)
– State will process & certify the filing – Corporation has been created! (DGCL
§106/MBCA §2.03)
• Draft bylaws (DGCL §109/MBCA §2.06)
• Organizational meeting (DGCL §108/MBCA §2.05)
– Name directors
– Adopt bylaws
• Directors convene & appoint officers
• Issue shares
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© Amitai Aviram. All rights reserved.
The corporation
Defective corporations
• Corporation is created only when Secretary of State
acknowledges that the charter was filed
• Exception – “defective corporation”: sometimes courts
recognize a corporation even without Secretary of State’s
certification of the charter being filed
– De facto corporation
– Corporation by estoppel
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© Amitai Aviram. All rights reserved.
The corporation
Liability for pre-incorporation acts
• An incorporator is an organ of the corporation (acts on
behalf of the corporation, but not controlled by it)
– Owes the corporation FD
– Until corporation is formed, incorporator is liable to T as an actor
for a non-existent principal
• Hypo: Incorporator Inga signs contract with third party
Tom, on behalf of C Corp., a corporation not yet created.
Later, Inga creates C.
• How can C become party to the contract?
• Can C ratify the contract?
• Adoption (as opposed to ratification):
– Does not relate back to time of contract’s formation
– Does not release A from liability
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© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
1.
2.
3.
4.
What is a firm?
The corporation
The partnership
Constitutional documents
c. Actors
31
© Amitai Aviram. All rights reserved.
Types of firms
The partnership
• By default, GP is optimized to be a private firm
– Governed in most states by the Uniform partnership act (1997) (“RUPA”)
– A few states still use the Uniform partnership act (1914) (“UPA”)
• Other variations of partnerships
– Limited liability partnership (“LLP”): same as GP except partners have limited
liability (governed by RUPA)
– Limited partnership (“LP”)
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•
•
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Two classes of partners: general & limited
General partners have control rights & unlimited liability
Limited partners have limited liability & very limited control rights
Governed by Uniform Limited Partnership Act (“ULPA”)
– Limited liability limited partnership (“LLLP”): same as LP except that all partners
have limited liability (governed by ULPA)
• Mostly obsolete variations of partnerships
– Joint venture
– Joint stock company
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© Amitai Aviram. All rights reserved.
The partnership
Creating a GP
• Definition of a GP
– RUPA §§101(6), 202(a): “an association of two or more persons to carry on as
co-owners a business for profit”
– ‘Co-owners’ means:
• Shared control of the business; and
• Shared profits of the business.
– Spontaneous creation: doing business as co-owners results in creation of
partnership by operation of law
• Fenwick [NJ 1945]
– Fenwick owns a beauty shop; Chesire works as a receptionist
– Chesire demands raise; Fenwick counters with offer to make her a partner, with
a right to 20% of the profits (in addition to her salary). They sign an agreement.
– Unemployment Compensation Commission disputes existence of a partnership.
Why?
• Fenwick claims he and Chesire are partners. What’s his best argument?
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© Amitai Aviram. All rights reserved.
The partnership
Creating a GP
• Fenwick court’s analysis
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Intention of parties: No change in business’ operation (no intent to share control)
Right to share in profits: Chesire gets 20%
Obligation to share in losses: Chesire not obligated
Ownership and control of property and business: Fenwick retains
Community of power in administration: Chesire not involved
Conduct of the parties toward 3rd parties: Filed partnership tax returns, but
didn’t hold themselves out as partners to suppliers & Fenwick licensed their
trade name personally
– Rights of parties on dissolution: Chesire’s dissolution is similar to quitting a job
• How much shared control is enough?
– According to Day v. Sidley & Austin (1975), Sidley & Austin was managed in the
following way:
• Executive Committee decides on all matters, except for participation, admission
& severance of partners
• The latter require the approval of partners holding a majority of partnership
interests (not majority of partners)
– This minimal shared control was seen as sufficient; S&A is a partnership
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© Amitai Aviram. All rights reserved.
The partnership
Creating a GP: exercise
• Key reason for Fenwick court’s ruling was that the agreement gave
Chesire no management rights. Structure an agreement that gives
her formal management rights but allow Fenwick to ‘run the show’
• Fenwick court noted Chesire didn’t share in losses. Mitigate this
factor while being sensitive to increasing Chesire’s risk
• Suppose Fenwick decides to hire Chesire as a non-employee agent
instead of making her partner. Make
Chesire a non-employee agent without
changing the substance of the relationship
35
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
1.
2.
3.
4.
What is a firm?
The corporation
The partnership
Constitutional documents
c. Actors
36
© Amitai Aviram. All rights reserved.
Constitutional documents
Types of constitutional documents
• A firm’s constitutional documents regulate the firm’s internal
governance (between the firm, SHs & management)
– Required: firm-specific info (e.g., name of firm, address, # of shares)
– Optional: opting out & replacing default rules
• Two common models
– A single document
• Private document: partnership agreement (in general partnerships)
• Public document: memorandum of association (some non-US corporations)
– Two documents; one public (usually more difficult to change & less
detailed), the other private (easier to change & more detailed)
• In US corporations
– Charter – Articles of Incorporation (MBCA) / Certificate of Incorporation
(DGCL) – public; must contain certain info, may contain more
– Bylaws – private; easier to amend; can’t contradict charter
• In LLCs: articles of organization / operating agreement
• In LLPs: statement of qualification / partnership agreement
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© Amitai Aviram. All rights reserved.
Constitutional documents
Hierarchy of legal sources in a corporation
•
•
•
•
•
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Country
Laws of physics
Constitution
Laws/regulations
Presidential directive
Decisions of gov’t employees
© Amitai Aviram. All rights reserved.
Constitutional documents
Hierarchy of legal sources in a corporation
•
•
•
•
•
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Country
Laws of physics
Constitution
Laws/regulations
Presidential directive
Decisions of gov’t employees
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•
•
•
•
Corporation
Applicable federal/state laws
Charter
Bylaws
Board’s resolutions
Decisions of officers
© Amitai Aviram. All rights reserved.
Constitutional documents
Charter: mandatory terms [DGCL §102(a)]
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•
•
•
•
Firm’s name
Address of firm’s registered office and name of its registered agent
Nature of the business to be conducted (“any lawful act or activity”)
Name/address of incorporators and initial directors
Specify if firm is not a stock corporation (in which case, conditions of
membership must either be specified, or refer to bylaws)
• “A statement of the designations and the powers, preferences and
rights, and the qualifications, limitations or restrictions [on firm’s stock]”
• Number of authorized shares & share par value
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© Amitai Aviram. All rights reserved.
Constitutional documents
Charter: optional terms [DGCL §102(b)]
• “Any provision for the management of the business and for the
conduct of the affairs of the corporation, and any provision creating,
defining, limiting and regulating the powers of the corporation, the
directors, and the stockholders […]”
• “Any provision which is required or permitted […] to be stated in the
bylaws may instead be stated in the certificate of incorporation […]”
• SH preemptive rights
• Supermajority requirements for SH or board votes
• Opting out of limited liability or perpetual existence
• Limits on directors’ fiduciary duty
41
© Amitai Aviram. All rights reserved.
Constitutional documents
Bylaws [DGCL §109(b)]
• “The bylaws may contain any provision, not inconsistent with law or
with the [charter], relating to the business of the corporation, the
conduct of its affairs, and its rights and powers or the rights and
powers of its stockholders, directors, officers or employees.”
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© Amitai Aviram. All rights reserved.
Constitutional documents
Creation & amendment
• Creation of constitutional documents
– Charter [DGCL §101(a)]: incorporator
– Bylaws [DGCL §109]
• Until stock is issued – Board
• After stock is issued – SHs, but charter may also authorize board to amend bylaws
• Amendment of constitutional documents
–
Charter [DGCL §242(b)]
•
•
–
Bylaws [DGCL §109]
•
•
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First, board must adopt the proposed amendment
Then, SHs approve the proposed amendment (in some circumstances, SHs vote
in separate groups [DGCL §242(b)(2)])
SHs always allowed to amend
Board not allowed to amend by default, but charter may authorize board to
amend bylaws
© Amitai Aviram. All rights reserved.
Constitutional documents
Assumptions for exam
•
On the exam, assume that the corporations mentioned in the fact
pattern have the following terms in their constitutional documents,
unless the fact pattern states otherwise
Charter
•
–
–
–
–
•
Bylaws
–
–
44
Corp. is a stock corporation, has limited liability & perpetual existence
Corp. may conduct any lawful act or activity
Director FD is limited to the maximum degree allowed under §102(b)(7)
Board may amend bylaws
Chairperson of board is authorized to call a board meeting
Board is authorized to call both annual & special SH meetings
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Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1. Control in the firm
•
•
•
•
2.
3.
4.
5.
6.
45
Rights of a beneficiary under direct control
Dysfunctions of direct control
Rights of a beneficiary under delegated control
Types of actors
Agents
Organs
Beneficiary’s duties to an actor
Authority
Ratification
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Control in the firm
Models of control
Direct control
Delegated control
• Management by consensus
(collective decision-making)
• Works well when Bs have:
– Low cost to act collectively
– Equal access to info/expertise
– Similar business interests
46
• Management by authority
(central decision-making body)
• Needed if Bs have:
– High cost to act collectively
– Unequal access to info/expertise
– Differing business interests
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Control in the firm
Direct control: Rights of a partner in a GP
• Economic rights
– Right to a share of firm’s profits, if they’re distributed: “Each partner is entitled
to an equal share of the partnership profits… [and losses]” [RUPA §401(b)]
– Right to a share of firm’s assets upon dissolution: “Each partner is entitled to a
settlement of all partnership accounts upon winding up the partnership
business.” [RUPA §807(b)]
– Right to (unilaterally) alienate economic rights: “The only transferable interest
of a partner in the partnership is the partner’s share of the profits and losses of
the partnership and the partner’s right to receive distributions.” [RUPA §502]
47
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Control in the firm
Direct control: Rights of a partner in a GP
• Control rights
– No right to alienate control rights: RUPA §401(i)
– Right to participate in collective management: “Each partner has equal rights in
the management and conduct of the partnership business.” [RUPA §401(f)]
• “A partner is not entitled to renumeration for services performed for the
partnership [except in winding up the partnership].” [RUPA §401(h)] So why
bother managing the partnership?
• Actual authority determined by RUPA §401(j).
– Ordinary course of business → majority
– Outside the ordinary course of business → unanimous
• Amendment to the partnership agreement → unanimous
• Example: Ralph, Sarah & Tom are partners in a law firm
– Partnership agreement silent about dividing profits between them
– They vote 2-1 to add a section to the agreement that divides profits: 40%
R, 40% S, 20% T. Is the new section valid?
– They also vote 2-1 not to accept any employment law cases. Is this valid?
– Right & power to act (unilaterally) on firm’s behalf: Each partner is an agent of
the partnership [RUPA §301(1)]
48
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Control in the firm
Direct control: Control rights of a partner in a GP
• RUPA 401(j) addresses the relationship between the partners (actual
authority). What about third parties?
– RUPA §301(1): “…An act of a partner… for apparently carrying on in the
ordinary course the partnership business… binds the partnership, unless the
partner had no authority to act for the partnership in the particular matter and
the person with whom he was dealing knew or had received a notification that
the partner lacked authority.”
– RUPA §301(2): “An act of a partner which is not apparently for carrying on in
the ordinary course the partnership business… binds the partnership only if the
act was authorized by the other partners.”
• In other words:
– Ordinary course of business → Partnership liable if either there’s actual
authority or T doesn’t know/have notice that A lacked authority
– Outside the ordinary course of business → Actual authority required
• This is the same rule as in agency: partnership liable if partner acted
with either actual or apparent authority
– Actual authority: RUPA §401(j)
– Apparent authority: RUPA §301 creates a presumption that a reasonable T would
believe that a partner has authority to act in the ordinary course of partnership
business, and doesn’t have authority to act outside the ordinary course of business
49
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Control in the firm
Direct control: Rights of a partner in a GP
• Partners’ apparent authority to bind the partnership in any contract
that’s in the ordinary course of the partnership’s business is risky
– Hypo: Abe has poor judgment. His partners Becky & Charlie are concerned that
he will bind the partnership to third parties in half-baked transactions.
– What can they do?
• Limiting partners’ apparent authority (RUPA 303)
– Power regarding transfer of real property: GP may file a statement of authority
with the office for recording transfers of that real property. Irrebutable
presumption that T knows the contents of this statement (i.e., this is the
manifestation from P to T regarding authority)
– All other powers: GP may file a statement of authority with the Secretary of
State. If T knows about the statement, T may rely on the statement as a
manifestation from P to T regarding authority, but T is not presumed to know
about the statement.
50
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Control in the firm
Dysfunctions of direct control
a) Inefficiency:
– Direct control is efficient when beneficiaries have:
• Low cost to act collectively
• Equal access to info/expertise
• Similar business interests
– The more Bs a firm has, the greater the cost of acting collectively
– Large & changing B group increases likelihood Bs will have different interests
– Bs with small stakes in the firm likely to be apathetic, lacking incentive to know
firm’s business & participate in the firm’s management (each B has little power
to change things & little to gain from changing things)
• Inefficiency is addressed via:
– Governing by delegated control
• Or, as a step in that direction: SH agreements & voting trusts that require
parties to vote in a particular way or based on a predetermined process
51
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Control in the firm
Dysfunctions of direct control
b) Deadlock: SHs veto each other
–
E.g., 50/50 split with neither side having a majority), causing the firm to be
unable to act
• Deadlock is addressed via:
–
Suit for breach of fiduciary duty
•
–
Dissolution (liquidating the firm) or dissociation (buying out one group of Bs)
•
–
Addressed when we discuss exit solutions
Governing by delegated control
•
52
Addressed when we discuss litigation solutions
Or, as a step in that direction: SH agreements / voting trusts
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Control in the firm
Dysfunctions of direct control
c) Oppression: Controller exploits minority SHs (“MSH”)
–
By tunneling: managing firm in a way that shifts value to controller at MSH’s
expense & pressures MSH to sell shares to controller below their fair value
•
•
•
•
Employ/joint venture with person affiliated with controller
Buy from/sell to person affiliated with controller
Avoid interfering with profitable opportunities for controller
Make investments with spillovers benefiting controller
• Oppression is addressed via:
–
Suit for breach of fiduciary duty
•
–
Dissolution (liquidating the firm) or dissociation (buying out one group of Bs)
•
–
53
Addressed when we discuss exit solutions
Giving MSHs veto power or exclusive authority on certain issues
•
•
–
Addressed when we discuss litigation solutions
This is a form of a voice solution (approval by the MSHs)
This solution runs the risk of MSHs using their rights to extort the majority
Note that governing by delegated control doesn’t solve oppression
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Control in the firm
Delegated control: Rights of SHs in a corporation
• Economic rights
– Right to a share of firm’s profits, if they’re distributed (i.e., if dividends are
declared by the board)
– Right to a share of firm’s residual assets upon dissolution (i.e., if both board &
SHs approve dissolution, or if court orders dissolution)
– Right to (unilaterally) alienate economic rights
• Similar to economic rights under direct control
54
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Control in the firm
Delegated control: Rights of SHs in a corporation
• Control rights
– Right to unilaterally alienate control rights (opposite of GP default rule)
– No right or power to act unilaterally on firm’s behalf (opposite of GP rule)
– Right to participate in collective management (as a SH meeting), but only for
the following acts (much narrower than the GP default rule):
•
•
•
•
•
Electing & removing directors [DGCL 211(b), 141(k); MBCA 8.03(c), 8.08]
Amending charter & bylaws [DGCL 242, 109(a); MBCA 10.03, 10.20]
Approving mergers & major asset sales [DGCL 251,271; MBCA 11.04,12.02]
Approving dissolution of the corporation
Approving corp’s independent auditor
• Why are SH control rights so limited?
– When Bs can’t effectively exercise direct control, firm delegates control to an
actor that can effectively exercise direct control: low cost to act collectively,
equal access to info/expertise, similar business interests
– This actor can’t be subject to Bs’ control (since Bs can’t effectively exercise
collective control), so it is an organ rather than an agent
55
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Control in the firm
Types of actors
• All corporate actors act on behalf of the firm
• Agents act on behalf of firm & are subject to its control
– Including officers, who do the day-to-day management
• Organs act on behalf of firm, are not subject to its control, but are
required to pursue the interests of the firm
– Board: ultimate responsibility for managing the firm
• In small firms, board tends to be executive: manages the firm
• In larger firms, board tends to be supervisory: oversees agents who manage the firm
– Board committee: part of the board; acts on behalf of the entire board
– Incorporator: acts on behalf of the firm before the firm is created
– SH meeting: acts on behalf of the firm when authorized, but shareholders may
pursue their self interest (except when they control the board)
56
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Control in the firm
Why does identifying an agent matter?
• Agency law governs situations (including interactions with third
parties (T)) in which one person (A) acts on behalf of another (P) and
subject to the other’s control
– Example: P hires real-estate agent A to buy a house
• Legal issues
I
N
T
E
R
N
A
L
E
X
T
E
R
N
A
L
57
– Does an agency relationship exist between P & A?
• This is a preliminary issue for addressing the three legal issues below
– A’s duties to P: How to deal with A’s agency problem (shirking/stealing)
• E.g., A is offered a $1,000 payment from T if she causes P to buy T’s house.
Can she accept this payment?
– Contracts: Will P be liable for contracts A signed with T?
• E.g., if A signs agreement to buy T’s house & P doesn’t like it, must P pay?
– Torts: Will P be liable for torts committed by A?
• E.g., when A negotiates to buy T’s house, she loses her patience with T and
punches him. Is P liable to T for damages?
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1. Control in the firm
2. Agents
• Creating an agency relationship
• Relationships similar to agency (but that are not agency)
• Officers
3.
4.
5.
6.
58
Organs
Beneficiary’s duties to an actor
Authority
Ratification
© Amitai Aviram. All rights reserved.
Agents
Definition
Restatement (Third) of Agency (“R3A”), §1.01: An agency relationship is
created when A & P manifest assent that A shall act 1.
2.
On P’s behalf
Subject to P’s control
R3A §1.02: Parties’ labeling & popular usage do not control
R3A §4.03: An agency relationship may be created retroactively by P’s
ratification, if A purported to act as P’s agent
The parties:
• Principal (P): person for whom act is to be taken
• Agent (A): person who is to act
• Third Party (T): person who deals with agent
59
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Creating an agency relationship
A . Gay Jenson Farms v. Cargill [MN, 1981]
•
•
Who are P, A & T in Cargill, according to the plaintiff?
What’s the evidence for an agreement that A shall act
–
–
60
On P’s behalf?
Subject to P’s control?
© Amitai Aviram. All rights reserved.
Creating an agency relationship
Cargill: the court’s reasoning
Court finds control from the combined weight of 9 factors:
1.
2.
3.
Cargill’s constant recommendations to Warren by telephone
Cargill’s right of first refusal on Warren’s grain
Warren’s inability to enter into mortgages, to purchase stock or to pay dividends
without Cargill’s approval
Cargill’s right of entry onto Warren’s premises for periodic audits
Cargill’s correspondence & criticism regarding Warren’s finances, officers’ salary
& inventory
Cargill’s determination that Warren needed “strong paternal guidance”
Provision of forms to Warren upon which Cargill’s name was imprinted
4.
5.
6.
7.
–
8.
9.
61
FN 7: Warren pays for the grain with drafts (checks) drawn on Cargill
Financing all of Warren’s purchases of grain & operating expenses
Cargill’s power to discontinue the financing of Warren’s operations
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Creating an agency relationship
Cargill: managing risk of becoming a principal
• Creditor’s challenge in managing the risk of becoming a principal
– Diverging interests
• Creditors want firm to be managed conservatively
• Equity holders want to take risks (& they manage the firm…)
– Creditors protect their interests via contractual provisions
• Techniques include: covenants & acceleration; convertibility; collateral;
guarantees; insurance
• If these techniques are seen as giving creditors control over the debtor and
resulting in the debtor being the creditor’s agent, then creditors become liable
for the debtor’s debts
• Can we disclaim the risk in the contract?
– Many contracts expressly say that “this agreement does not create an agency
relationship”
– R3A §1.02: parties’ labeling & popular usage do not control
– So why are such disclaimers so common?
62
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Creating an agency relationship
Cargill: explaining the outcome
• A reasonable interpretation of R3A §1.01?
– Right of first refusal + financing = on P’s behalf? [Probably not]
– Allowing supplier to pay T with P’s checks = on P’s behalf? [Senseless]
• “Gatekeeper liability”: creating an incentive to monitor Warren?
– Who is more able to prevent Warren’s risk taking: Cargill or the farmers?
– This may be a good policy reason, but it’s not the test in R3A §1.01
• Cargill culpable in making farmers think it was backing Warren?
– Cargill caused farmers to believe an agency relationship existed by allowing
Warren to use Cargill’s forms (such as checks)
– But why stretch the definition of agency rather than applying estoppel?
• We will discuss estoppel at end of the subsection on P’s liability in contracts
63
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Relationships similar to agency
Corporate organs
• “Organs” of a firm act on behalf of the firm as the firm’s voice, and
control the firm’s agents
– E.g., a corporation is managed by a board of directors (“board”), consisting of
one or more directors
– Organs are usually collective bodies composed of several individuals
– The board as a whole is the actor (an individual director has no authority to act
on behalf of the firm)
• Organs aren’t a firm’s agents (nor are individual directors)
– Organs & directors aren’t subject to the firm’s control (instead, they control the firm)
– When might an individual director be an agent of a corporation?
• Organs aren’t legal entities (though individual directors are)
– So an organ can’t owe a FD
– To keep the organ accountable, a director owes a FD to the corporation
64
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Relationships similar to agency
Power given as security
• Hypo: transferring control in a firm
–
–
–
–
C owns Acme Corp. C signs a contract to sell Acme to B for $1B
The deal requires regulatory approval, which will take several months
Until deal closes, C controls Acme. Will C act to maximize Acme’s value?
Solution: in the contract, C gives H (B’s trusted friend) the power to vote C’s
Acme shares (at H’s discretion)
• Purpose of the relationship is not to serve C, but to assure B
• C is the creator of the power; H is the holder; B is the beneficiary
• Power given as security is a contractual relationship similar to agency
(one person (H) is given power to affect legal relationships of another person (C))
• But it is unlike agency in that:
– H isn’t subject to C’s control – that would thwart the arrangement’s purpose
– H acting on behalf of C? Perhaps, but purpose is to assure B, not serve C
• B’s vulnerability: if C can unilaterally terminate this relationship, he
could deprive B of this contractual protection
65
– To be effective, C must not be able to unilaterally terminate the relationship
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Relationships similar to agency
Power given as security
• R3A §3.13(2): to protect B’s interests, powers given as security are
generally immune from termination – By C’s unilateral revocation
– By H’s surrender of the power (unless B approves)
– By either C’s or H’s death/loss of capacity
• An agreement appointing H to vote C’s securities is known as a proxy
– H is the proxy holder, but sometimes also called “the proxy”
– If C can’t cancel the proxy, it is known as an irrevocable proxy
– Irrevocable proxies eliminate the exit governance solution, so we want to allow
them only when they are necessary to facilitate a power given as security)
• R3A §3.13(1): Irrevocable proxies/powers given as security are
terminated by an event that either – Discharges/terminates the secured obligation/interest
• E.g., C concludes the sale of Acme to B
– Makes the execution of the power illegal or impossible
• E.g., if H’s control of Acme would violate antitrust laws
– Constitutes a surrender of the power by B
66
• E.g., B decides she doesn’t need irrevocable proxy anymore & tells C it’s cancelled
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Agents
Officers
•
Officers are a sub-class of a firm’s agents
–
•
I.e., all officers are firm’s agents, but not all firm’s agents are officers
What distinguishes officers from other agents is:
–
(Actual) authority of the ‘office’ is determined by law, bylaws or board
•
•
–
Some laws impose duties/liabilities specifically on officers
•
67
Allowing an actor to hold the ‘office’ is also a manifestation from the firm to T,
affecting the officer’s apparent authority
Officer may hold multiple offices
E.g., securities laws, environmental laws, service of process
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Agents
Common officers
•
Chief executive officer (CEO)
–
•
Chairperson of the board
–
Administers board’s activities
–
If Chairperson is affiliated with management, firm sometimes also has ‘lead director’
•
Chief operating officer (COO)
–
•
Responsible for firm’s day-to-day business operations
Chief financial officer (CFO)
–
•
Responsible for accounting & financial operations
Treasurer
–
•
Same as CFO, or subordinate responsible for managing firm’s cashflow
Secretary
–
•
Keeps minutes of board/SH meetings & authenticates corporate records
President
–
68
#1 officer in the hierarchy
Head of a business unit (or entire firm, overlapping COO or CEO)
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
6.
69
Control in the firm
Agents
Organs
Beneficiary’s duties to an actor
Authority
Ratification
© Amitai Aviram. All rights reserved.
Organs
The Board of Directors
• Size [DGCL §141(b) / MBCA §8.03]
– Board consists of 1 or more natural persons
– Board size specified in / fixed in accordance with charter or bylaws
• Term in office
– By default, directors are elected in each annual meeting (i.e., they serve a term
of 1 year, renewable) [MBCA §8.03(c)]
– Exception: charter may create a staggered board, dividing directors into 2 or 3
groups; one group elected each year [DGCL §141(d); MBCA §8.06]
• Removal [DGCL §141(k) / MBCA §8.08]
– Directors may be removed by SHs for cause
– Directors may be removed by SHs without cause, if charter does not say
otherwise (MBCA) or if firm does not have staggered board (DGCL)
– Board may not remove a director
• Filling vacancies [DGCL §223 / MBCA §8.10]
– SHs or board may fill vacancies on the board
• Meetings
– Board of a typical public company meets 8 times a year; compensation & audit
committees typically meet
another 6-9 times a year
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70
Organs
Status of individual directors
• The board is a corporate organ, individual directors are not
– Individual directors have no authority to act for the corporation, unless
they are granted authority by the board to act as a board committee
(which may consist of a single director)
– Likewise, the SH meeting is an organ, individual SHs are not
• Directors (and the board) are not the firm’s agents as such
– Because they are not subject to SH control (same goes for SHs & SH meeting)
• Directors individually owe FD to the firm
– This is derived from their status as directors
• Procedural quirk: you can’t sue the board (or a board committee)
– When challenging the act a collective organ (board, board committee), plaintiff
sues the individual directors, not the board or committee
– E.g., when we (figuratively) say “X sued the board”, we really mean that X sued
each of the directors on the board
– Why can’t X (literally) sue the board?
71
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Organs
Board committees
• Appointing committee members [Steigerwald (IL 1956)]
–
Committee must consist only of directors
•
–
Otherwise, Board majority can delegate authority to someone unelected by SHs
Members must be selected by the board (directors can’t delegate nomination
to someone else, such as the CEO)
• Common Board committees
–
–
–
–
Executive committee: Manages day-to-day operations/decisions
Nominating committee: Picks the directors that board recommends to SHs
Compensation committee: Negotiates/approves officer/director compensation
Audit committee: Oversight of financial reporting & disclosure (sometimes also
oversees regulatory compliance & risk management)
– Risk committee: Oversees institution’s risk management practices
– Above committees are typical standing (permanent) committees; Board may also
create ad hoc (temporary, single-issue) committees
• Ad hoc committees typically used to avoid conflicts of interest (e.g., in deciding
on a lawsuit or transaction in which some directors have conflicts)
72
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Organs
How collective actors act: consent & meeting
• Collective actors act by approving resolutions, in one of two ways:
– Written consent
• Board or board committee may act by written consent if consent is
unanimous [DGCL §141(f)]
• SHs may act by written consent if consent is signed by “holders of
outstanding stock having not less than the minimum number of votes that
would be necessary to authorize or take such action at a meeting at which
all shares entitled to vote thereon were present and voted” [DGCL §228]
– Many corporations have a provision in their charter that eliminates SHs’
ability to act by written consent
– MBCA default requires unanimity [MBCA §7.04]
– Meeting: three elements to a valid meeting
a.
b.
c.
73
Call (authority to call meeting + notice requirements)
Quorum
Vote
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Organs
How collective actors act: (a) Call
• Authority to call a meeting
– Board/committee: Charter, bylaws or board resolution may schedule regular
(e.g., monthly, annually) meetings and may create a procedure for calling
special meetings (e.g., chair may call special meeting); Board resolution may
call a special meeting (e.g., at end of previous board meeting, or by written consent)
– SH meeting: Annual SH meeting – as stated in bylaws [DGCL §211(b)], and court
may order a meeting, if none was called for 13 months [§211(c)]; special SH
meeting: board resolution + as stated in bylaws/charter [§211(d)]
• Notice requirements (did the call provide sufficient info & advance notice?)
– Board/committee: DGCL has no notice requirements, but abuse may breach FD
• In contrast, MBCA §8.22(b) creates a default 2-day notice of date, time & place
of meeting, but not of meeting’s purpose
– SH meeting: notice must be given no less than 10 days or more than 60 days
before the meeting; notice must be in writing and specify place, date & time of
meeting, means of remote communications [DGCL §222]
74
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Organs
How collective actors act: (b) Quorum
• SH meeting: by default, majority of shares entitled to vote; charter or
bylaws can opt out of default, but never less than ⅓ [DGCL §216(1)]
– Presence via proxy (appointing an agent to vote on one’s behalf) is allowed
• Board/committee: by default, majority of total # of directors; charter
or bylaws may opt out of default, but no less than ⅓ [DGCL §141(b)]
– Presence via proxy is not allowed
– Presence via teleconference [DGCL §141(i)]: board meetings & board
committee meetings may be held via conference telephone or “other
communications equipment by means of which all persons participating in the
meeting can hear each other”
75
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Organs
How collective actors act: (c) Vote
• Board/committee: vote of majority of directors present at a meeting
(unless charter/bylaws require supermajority) [DGCL §141(b)]
• SH meeting: varies depending on the type of vote
– Default standard: majority of shares present [DGCL 216(2)]
• Bylaw amendments
• Precatory SH resolutions
– Majority of disinterested shares present
• Ratifying breach of FD [DGCL 144(a)(2)]
– Majority of shares entitled to vote
• Mergers [DGCL 251(c)]
• Sale of all or substantially all of C’s assets [DGCL 271]
• Charter amendments [DGCL 242(b)]
– Plurality of shares present
• Electing directors [DGCL 216(3)]
76
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Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
6.
77
Control in the firm
Agents
Organs
Beneficiary’s duties to an actor
Authority
Ratification
© Amitai Aviram. All rights reserved.
B’s duties to A
Contractual duties
•
•
P’s duties to A are contractual in nature (R3A §§8.13, 8.14(1))
In addition to express terms of the agreement between P & A, P is
liable to A for:
–
–
–
•
Implied terms
–
78
Implied terms (R3A §8.13)
Breach of duty to deal in good faith (R3A §8.15)
Default terms re indemnification (R3A §8.14(2))
Terms that a reasonable person would infer from the express language of the
agreement
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B’s duties to A
Duty of good faith & fair dealing
•
•
•
Duty to deal fairly and in good faith (R3A §8.15)
–
Protects agreed common purpose & A’s justified expectations
Common application (1): frustrating A’s justified expectations
–
P must avoid unreasonable conduct that harms A, when:
• Contract lacks specific language governing the issue; and
• Conduct frustrates purposes reflected in contract’s express language
– E.g., Prof agrees with RA that he will get an extra $100 if he shows up at prof’s
office at 8am. Prof later changes mind, locks office doors so RA can’t enter
office at 8am.
Common application (2): duty to warn
–
–
P breaches duty if P fails to provide A with info about unreasonable risks
involved in the agency, if risk is foreseeable to P & A is unlikely to become
aware of risk on his own
Risks include physical harm, pecuniary loss, and possibly also harm to business
reputation & reasonable self-respect
•
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E.g., P sends A to sign up investors for an investment that P knows (but A doesn’t
know) is a Ponzi scheme. When A is implicated in the Ponzi scheme, his business
reputation is tarnished and he cannot get another job. P may be liable to A for the
harm suffered by A. © Amitai Aviram. All rights reserved.
B’s duties to A
Duty to indemnify
•
Indemnifying agents – default rule (R3A §8.14(2))
–
When the agent makes a payment
•
•
within the scope of the agent's actual authority, or
that is beneficial to the principal, unless the agent acts officiously in making the
payment
–
–
When the agent suffers a loss that fairly should be borne by the principal in
light of their relationship
•
While this is vague, a duty to indemnify typically arises when A’s loss is:
–
–
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Officious (“voluntary”) payments are ones in which the agent has a reasonable
opportunity to receive P’s authorization, but makes a payment without seeking
authorization
In connection with the agency relationship; and
Not a result of A's own negligence, illegal acts, or other wrongful conduct
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
6.
81
Control in the firm
Agents
Organs
Beneficiary’s duties to an actor
Authority
Ratification
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Authority
What is authority?
• Authority is the legal right to act on behalf of another person
– An authorized act of A is legally considered to be an act of B
– Corporate compliance implication: B is liable to T for a contract or tort created
by an authorized act
• This is not the only way B may be liable; we will discuss other ways in Chapter 2
– Corporate governance implication: A is liable to B for acting without authority
• This is not the only way A may be liable to B; A may be liable for an authorized
act that violates fiduciary duties (we will discuss this in Chapter 3)
• An actor can have authority in three ways
– Grant of authority by law
– Grant of authority by agreement (in charter/bylaws/valid SH agreement)
– Grant of authority by approval (unilateral behavior of/attributed to B, either
before A’s act (prior consent) or after (ratification))
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Authority
Authority of the board
• Board’s authority granted by law
– DGCL §141(a): “The business and affairs of [a corporation] shall be managed by
or under the direction of a board of directors…”
• Board’s authority granted by agreement & approval
– Usually irrelevant because under DGCL §141(a) board already has authority to
take almost any act the firm can take
• Board’s power to delegate authority
– The board may delegate management authority and tasks to officers or other
agents of the corporation, but may not delegate authority that law, charter or
bylaws specifically assign to the board [DGCL §141(a) / MBCA §8.01(b)]
• For this reason, directors cannot vote by proxy in a board meeting
– Board may delegate to a board committee authority that was specifically
assigned to board, with exceptions (see next slide) [DGCL §141(c) / MBCA §8.25(e)]
– If authority is delegated, board maintains oversight responsibility but may rely
in good faith on agent’s/committee’s/expert’s reports [DGCL §141(e) / MBCA
§8.30(f)]
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Authority
Authority of a board committee
• Board committee authority granted by law: not relevant in this course
• Board committee authority granted by agreement: check charter/bylaws
• Board committee authority granted by approval [DGCL §141(c)]
– The board may designate committees, each consisting of 1 or more directors
– Committee may receive, in board resolution or bylaws, any powers or authority
of the board except:
• Approving, adopting or recommending to SHs any matter that is subject to SH
approval (other than election/removal of directors)
• Adopting, amending or repealing a bylaw
– Different exceptions in MBCA §8.25: approving distributions; filling board vacancies
84
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Authority
Authority of the SH meeting
•
SH meeting’s authority usually limited to the following:
–
Exclusive to SHs
•
•
•
–
Jointly with the board
•
•
•
•
–
Charter amendments
Mergers / sale of all or substantially all of the firm’s assets
Dissolution of the firm
Ratification of certain unauthorized corporate actions (DGCL §204)
Either SHs or the board
•
•
85
Electing & removing directors
Ratifying selection of corporation’s independent auditor
Precatory (non-binding) SH resolutions
Bylaw amendments
Ratifying breach of FD
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Authority
Authority of officers & other agents
•
All agents (including officers) have actual authority as determined
by agency law
–
–
•
Officers & actual authority
–
–
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Manifestations by P that are perceived by A
These manifestation cause A to reasonably believe that A is authorized to act
in a certain way on behalf of P
The manifestation by P that A has a particular office (e.g., she is the CFO)
makes A reasonably believe she has any authority granted to this office by
law or by agreement (in the charter or bylaws)
Like any other agent, officers may also have actual authority derived from
other manifestations of the corporation (e.g., delegation of authority from
the board)
© Amitai Aviram. All rights reserved.
Authority
(Actual) authority vs. apparent authority
• Authority (of an actor) is the legal power of A to bind P
– When A has actual authority, A has the right to bind P, so P is bound to T by A’s
act, and also P cannot sue A for his act (even if P is unhappy about A’s act)
– When A has only apparent authority (but not actual authority), A has the
power, but not the right, to bind P: P is bound to T by A’s act, but P can sue A
for acting without (actual authority)
• Regarding a specific act of A:
1.
2.
Manifestations by P that are perceived by A/T
These manifestation cause A/T to reasonably believe that A is authorized to
act in a certain way on behalf of P
• Actual authority [P»A] [R3A § 2.01]
– E.g., dean tells professor to teach class
• Apparent authority [P»T] [R3A § 2.03]
– Why do we need apparent authority? (Did you hear the dean tell me I teach BA?)
• Actual authority is relevant for both internal & external governance;
apparent authority is relevant only for external governance
87
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Authority
Firm’s authority (ultra vires)
• Ultra vires (Latin for “beyond its powers”) is a (mostly obsolete)
doctrine regarding the corporation’s powers
– History & erosion of ultra vires doctrine
• Doctrine of ultra vires originally stated that an act of the corporation that was not
specifically authorized in the charter was void, meaning that it did not bind the
corporation or third parties and could not be ratified by SHs
• Doctrine steadily eroded through liberal interpretation of “implied powers” & expansion
of statutorily specified powers (e.g., DGCL §122)
• Eventually, statutes allowed corporations to state that they had the power to “conduct or
promote any lawful business or purposes” (DGCL §101(b) & 102(a)(3)) or “engag[e] in
any lawful business” (MBCA §3.01(a))
– Today, ultra vires may still occur when firm acts in violation of its charter
• E.g., in SEPTA v. Volgenau [Del. Ch. 2012], firm merged & gave different consideration to
some SHs, when charter stated that all SHs will receive equal consideration in a merger
• DGCL 124/MBCA 3.04 allows raising ultra vires claims only in:
– Suits by state Attorney General to dissolve corp or enjoin ultra vires act
– Suits by SHs to enjoin the ultra vires act
– Suits by corporation (itself or derivatively by SHs) against the actor for damages
from ultra vires act
• DGCL §124 limits ultra vires challenges to authority, but the same
action may also breach FD, and §124 doesn’t limit such suits [Volgenau]
88
© Amitai Aviram. All rights reserved.
Acting through others
Overview of Chapter 1
a. Introduction to BA
b. Firms
c. Actors
1.
2.
3.
4.
5.
6.
89
Control in the firm
Agents
Organs
Beneficiary’s duties to an actor
Authority
Ratification
© Amitai Aviram. All rights reserved.
Ratification
General principles
• Approval is behavior by (or attributed to) B, that cures a legal flaw in
A’s behavior
– If approval takes place after A’s behavior, it is called ratification
– If approval takes place before A’s behavior, it is called prior consent
• Rules for prior consent are mostly similar to ratification (I will point out differences)
• Revoking approval
– Valid ratification can’t be revoked (i.e., once ratified, act can’t be un-ratified)
– Prior consent can’t be revoked after the act takes place; whether it can be
revoked before the act takes place depends on the agency agreement (by
default, yes)
• Rights of “fourth parties” (parties other than P, A & T)
– Prior consent doesn’t diminish rights of persons not parties to the transaction,
as a general matter of contract law
– Ratification doesn’t diminish pre-ratification rights of persons not parties to the
transaction, under R3A § 4.02(2)(c)
• E.g., A is P’s financial manager. Without actual/apparent authority, A gives T an
option to purchase P’s Google shares for $50K. P then agrees to sell the shares
to S for $40K. When T tells P he wants to exercise the option, P ratifies A’s
agreement with T. S can enforce his contract to buy the shares for $40K (but P is
also liable to T for damages for breach of contract, because he ratified)
90
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Ratification
Elements of ratification
1.
Appropriate approver
• Identity (B or person w/authority to approve & no CoI)
• Attributability (A’s behavior is attributable to B)
• Capacity
2.
Appropriate approval
• Unambiguous
• Informed
• Timely
• Appropriate scope
Elements in blue must always be discussed; other elements should be
discussed if fact pattern suggests they are an issue
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Ratification
Appropriate approver (identity)
• Appropriate approvers are:
– The beneficiary (person on whose behalf A acted or purported to act)
– Person who has authority to approve on behalf of B & doesn’t have CoI with B
regarding the behavior that is approved
• Authority to approve: may be assumed if person has authority to conduct on
behalf of the beneficiary the same behavior that is subject to approval (unless
specifically prohibited from approving or delegating that behavior)
– Example 1: Suppose Amy’s unauthorized purchase of Blackacre was ratified not
by Paul but by Alex (another agent of Paul). Alex is an appropriate approver if
Paul authorized him to buy property at $210K (or to ratify such deals)
– Example 2: if Paul authorized Alex to buy property at $210K, but specifically
prohibited him from delegating the purchase to others, the authority to
approve is not assumed (since if he approved Amy’s act it would amount to a
delegation of his authority to Amy)
• No CoI with beneficiary
92
– E.g., In example 1 above, if Alex gets a commission if the sale goes through but
not if it doesn’t, he can’t approve the transaction
– Rule means that approver
(other than beneficiary) can’t approve his own acts
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Ratification
Appropriate approver (attributability & capacity)
• Actor’s behavior is attributable to beneficiary
–
A must have acted or purported to act on B’s behalf [R3A §4.03]
•
E.g., if Amy bought Blackacre for someone other than Paul (such as for herself), Paul
can’t ratify
– B must exist at the time of the act [R3A §4.04]
• E.g., if Amy bought Blackacre for PaulCo, a corporation that she is about to form
(but hasn’t yet formed), PaulCo isn’t bound by the deal (P couldn’t create
manifestations of authority) & can’t ratify it (PaulCo didn’t exist when Amy signed
deal to buy Blackacre)
– No public policy reasons to prevent B from approving
• This limitation has significance for organs’ actions; will be addressed in Section 2b4
(Firms: internal governance – voice solutions)
• Approver must have legal capacity at time of approval [R3A §4.04]
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Ratification
Appropriate approval (unambiguous)
• R3A §4.01(2) – B approves an act by:
– Manifesting assent that the act shall affect B’s legal relations; or
– Conduct that justifies a reasonable assumption that B consents
• E.g., B knowingly accepts the benefits of A’s act, even if B manifests
disagreement to accepting the act’s legal consequences
• Approval requires objective or externally observable indication that B
consents to A’s act
• Related to ambiguity, R3A §4.02(2)(b) makes ratification ineffective in
favor of A if B ratifies to avoid a loss
– So, if B ratifies to avoid a loss, B is liable to T, but A may be liable to B
– E.g., A is B’s financial manager. A lends B’s money to T without actual/apparent
authority. T becomes insolvent & B files a claim in T’s bankruptcy proceeding.
Filing the claim doesn’t release A from liability for exceeding actual authority.
– Not relevant for prior consent (if B gave prior consent, she wasn’t “trapped”
into approving by the threat of a loss)
94
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Ratification
Appropriate approval (informed)
• Approval is valid only with “knowledge of [all] material facts involved
in the original act” [R3A §§4.06, 8.06(1)(a)(ii)]
– Unless B was aware of such lack of knowledge
– Probably “all material facts” refers only to those facts A is aware of (since there
are always some uncertainties that neither A nor B know of)
– Material facts: Facts that a reasonable person would consider relevant to the
decision whether to approve
• Related to this, R3A §4.02(2)(a) says ratification is ineffective in favor
of a person who causes it by misrepresentation or other conduct that
would make a contract voidable (duress, undue influence)
– E.g., A buys car for B from T without actual or apparent authority. T persuades
B to ratify by falsely telling him car has a new engine. B not bound to T.
95
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Ratification
Appropriate approval (timely)
• Ratification ineffective if “circumstances that would cause the
ratification to have adverse and inequitable effects on the rights of
[T]” occurred [R3A § 4.05]
– T withdraws from the transaction
• B hires A to identify houses B might want to purchase. A sees that T is asking for
a very low price for his house, so she buys the house from T on B’s behalf with
no actual or apparent authority. T learns there was no authority & notifies B he
withdraws from the transaction. B then ratifies. Ratification is ineffective.
– Material change of circumstances that makes it inequitable to bind T
• E.g., A sells B’s house without actual or apparent authority. B’s house then
burns down. B cannot ratify the sale.
– Ratification after rights have crystallized (ratification timed so that T is deprived
of a right or subjected to liability)
• E.g., T gives B an option to buy stock, which expires on May 3rd. Without actual
or apparent authority, A purports to exercise the option on B’s behalf on May
2nd. B ratifies on May 4th. T is not bound by the ratification.
• Prior consent is always timely
96
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Ratification
Appropriate approval (appropriate scope)
• Ratification (but not prior consent) must encompass “the entirety of
an act, contract or other single transaction” [R3A §4.07]
• Approval of self-dealing (ratification/prior consent) must address a
specific act/transaction or acts/transactions of a specified type that
could reasonably be expected to occur in the ordinary course of the
agency [R3A §8.06(1)(b)]
• Approval of authority cannot exceed the authority the approver has
97
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Ratification of an organ’s act
Elements
• Ratification is more restricted for organ acts than for agent acts.
Why?
• Elements (same as agency, except for differences in elements colored blue, which
will be explained in following slides)
1. Appropriate approver
–
–
–
Identity
Attributability
Capacity
2. Appropriate approval
–
–
–
–
98
Unambiguous
Informed
Timely
Appropriate scope
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Ratification of organ’s act
Appropriate approver (identity)
• In the context of an organ’s behavior, appropriate approvers are:
– The beneficiary
• Firm is beneficiary, but can’t approve (someone has to approve on its behalf)
– A person who has authority to approve on behalf of the beneficiary
• Board
– Board can approve behavior of corporate actors (based on its plenary
authority under DGCL §141(a) & on DGCL §144, 204)
– As with agency law, board can’t approve its own acts & can’t approve acts
regarding to which board has CoI (e.g., no approval of controlling SH’s behavior)
• SH meeting
– SH meeting can cure directors’/officers’ self-dealing by approval (DGCL §144)
» Not clear if SH meeting can approve other behavior of corporate actors; even
if it lacks authority to approve, approval may be construed as waiving a SH’s
right to sue for the legal flaw that was purportedly approved
– When approving, vote must be specifically designated as a ratification, and
SH meeting can only approve acts that don’t require a SH vote to become
legally effective [Gantler v. Stephens (Del. 2009)]
99
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Ratification of organ’s act
Appropriate approver (attributability)
• Same as agency, except for public policy reasons preventing B from
approving:
– Void acts (can’t be ratified)
• Lack of corporation authority (ultra vires)
– But unanimous SH ratification insulates the board from future SH challenge
• Bad faith actions (illegal acts & corporate waste)
• Probably also conscious disregard of duty
– Voidable acts (can be ratified): lack of actor authority, negligence, self-dealing
& failure to disclose
100
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Ratification of organ’s act
Appropriate approval (unambiguous)
• Implied approval is interpreted from the approver’s behavior, rather
than expressly framed as an approval (same as agency)
– E.g.: ratification implied by unambiguous acquiescence
– Implied approval by the board is possible if it is unambiguous, but implied
approval by SHs is probably impossible (inherently ambiguous)
• Express approval is framed as an approval
– To be unambiguous, express approval must comply with formal procedures for
call, quorum & vote
– There are specific statutory rules for the process of approval of a transaction
flawed by self-dealing or lack of authority (see next slide)
101
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Ratification of organ’s act
Appropriate approval (unambiguous)
• Approval procedure
– Lack of authority: DGCL §204 (approval by board & in some situations also by
the SH meeting) (effective April 1, 2014)
– Transactions in which a director/officer has CoI: DGCL §144(a), either:
• Approval by a majority of disinterested directors (even if disinterested directors
do not compose a quorum)
• Approval “in good faith by vote of the shareholders” (in Fliegler the court said
this requires a vote of the majority of disinterested SH)
– Any other act: no statutory authorization for approval, but approval is possible
under the board’s plenary powers (DGCL §141(a))
• Follows the normal process for board acts (written consent / call+quorum+vote)
• Hypo
– Hypo: Acme’s board consists of A, B, C, D & E. They vote to ratify a contract
between Acme & A’s husband (B, C & D do not have CoI). Only A, B and C show
up for the vote. Do they have a quorum? [Note DGCL §141(b), §144 (b)]
– A, B & C all vote in favor of the contract. Was it approved? [Note §141(b), §144(a)(1)]
102
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