CH 1 - the Nature & Purpose of the Corporation

CORPORATIONS OUTLINE MITCHELL – FALL 2003

CH 1 - The Nature & Purpose of the Corporation

Section 1 - The Nature of the Corporation

·  Corporation is an artificial form, a legal person; allows diversely talented individuals to come together to act with one voice
·  Corp form is immortal, lives on forever
·  Only constituencies in corp form are shareholders, directors & officers
o  Don’t consider workers, community, customers, etc.
·  Directors have abs power by statute, but its tempered by fiduciary duty
· 
Trustees of Dartmouth College v. Woodward (S.Ct. 1819) [6]
·  chief purpose of the corporation to clothe bodies of men
·  no more a state instrument than a natural person
·  the corporation is private property, a contract that can’t be disturbed by the state unless it reserves the power to alter it
·  the corporation possesses only the power that the charter grants it
·  the trustees of the corporation are like the brain of the artificial person
·  Story’s concur makes the public/private distinction airtight;
DE §394 [16]
·  reserves power for the state to amend corporate charter

Section 2 - The Purpose of the Corporation

Dodge v. Ford Motor Co (Mich. 1919) [18]
·  Ford stopped paying dividends even though profits are very high; wants to reinvest the money back in the business; Dodge Bros. want Ford to pay dividends à money for their competing business
·  Sole purpose of the corporation is to work for the benefit of the shareholders, and the powers of the directors are to be employed toward that end
·  Judges are not business experts, it is up to the directors in good faith to determine what the best course of business is for the corporation; the courts of equity are open to s/h’s with a grievance
A.P. Smith Mfg. Co. v. Barlow (N.J. 1953) [25]
·  early corp charters included public duties for corps; C/L rule developed that corps couldn’t make any charitable contributions that didn’t directly benefit the corporation
·  Courts later began to allow charitable contributions even though there wasn’t a direct benefit, but the corp received indirect benefits (good will, advt, improve edu of worker pool)
·  More need for corp contributions as wealth moves from individuals to corporations; congress and states have enacted laws to encourage;
·  Important means to sustain civic & social institutions
·  Underlying this opinion is fear of the specter of communism
·  Really just making it up, the statutes don’t allow this, but uses C/L argument to change
·  Public policy really driving this opinion: public policy needs far greater than the minor alteration of s/h rights being made here
·  States aren’t supposed to change corp-s/h relations, only state-corp relations

Section 3 - Who Counts Within the Corporation?

Steinway v. Steinway & Sons (N.Y. 1896) [30]
·  s/h alleging that Steinway corp is being wasteful b/c of its large real estate holdings that it operates for the benefit of its employees
·  In gen’l, corp can’t act outside the powers granted to it in the charter; but when an action can fairly be considered as incidental to the purposes of the corporation, it can be taken as valid
·  The corp took this action to increase employee loyalty and ensure their continued service, which can be seen as a valid purpose
·  Another issue here: plaintiff was a member of top mgmt; he didn’t dissent when this was happening, can’t come back and complain now to a court of equity
· 
Simons v. Cogan (Del. 1988) [34] (Creditors/Bondholders)
·  directors don’t owe a fiduciary duty to the bondholders, only to the shareholders
·  bondholders don’t have same standing as s/h for derivative suits
·  unless fraud/insolvency/statutory violation à stick to the terms of the debenture agmt
·  convertible bonds don’t have shareholder rights until converted to stock
· 
Jedwab v. MGM Grand Hotels (Del. Ch. 1986) [38] (Preferred Stockholders)
·  asserting breach of duty of loyalty to treat classes of stockholders differently in apportioning proceeds of merger
·  preferred stockholder rights are contractual in nature and are governed by charter provisions
·  but don’t exclusively look at contractual provisions, a fiduciary duty is still owed to the preferred shareholders
·  Stock in general
o  Company must have at least 1 class of stock
o  Common stock – the basic stock; has all rights & privileges that stock can have (dividends, voting, dissolution rights)
o  Rights are defined in the charter, by statute, case law, internal by-laws
· 
Shareholder Valuism Comment [43]
·  “shareholder valuism”: purpose of the corporation and its mgmt is to achieve the highest stock price possible for the stockholders
·  “managerialism”: corporation run by mgrs w/out significant s/h interference; either “satisficed” – made enough profit to maintain & grow the business; or “empire-building” – constructing huge conglomerates
·  rise of shareholder valuism has made stock price the number one priority; causes managers to underinvest in worker training, R&D and steady, sustainable growth;
·  also helped to bring about more independent boards than in the past
·  Two forms of corporate capitalism:
·  Anglo-American: short-term s/h wealth is the corporate goal
·  Rhenish-Alpine: longer-term view of wealth creation; broad wealth distribution and social service by the corporation

Section 4 - The Role of the Corporation in Public Life

Charter Township of Ypsilanti v. General Motors Corp (Mi. Ct. App. 1993) [46] (Communities)
·  city approved tax abatements to keep GM plant in town; stayed for a few years, then moved the work elsewhere; city alleges a breach of contract by promissory estoppel – but didn’t condition the tax abatements on GM staying in town
·  GM’s hyperbole & puffery didn’t create a promise
·  Ultimate Message of Case: SELF-PROTECTION (but is this a good social ideal???)
·  Notes: corporation enjoys many of the same benefits & rights as individuals;
John Doe I v. Unocal Corporation (9th Cir. 2002) [52] (Human Rights)
·  ATCA; residents of Myanmar suing b/c Unocal was allegedly complicit in human rights violations there during the construction of a pipeline
·  ATCA held to apply to Unocal’s actions in Myanmar (didn’t require that Unocal be a state actor) – proceedings still going on
Section 5 - The Legal Structure of the Corporation [68]
Three constituent groups of corporations:
(1)  shareholders – put up risk capital to finance corp’s activities and are entitled to share of its residual wealth
(2)  directors – empowered by state and elected by s/h to oversee corp activities on their behalf
(3)  officers – act as agents of board to carry out day-to-day business of corporation
Board used to be charged w/ managing the corporation; now they are just monitors of the officers
·  problem: they’re essentially monitoring themselves b/c they were frequently filled w/ insiders; directors were nominated by board – self perpetuating
·  boards of independent directors are more likely to have their decisions deferred to be the courts than boards filled w/ insider directors (became a problem w/ takeovers in the 80s – boards trying to protect themselves)
·  monitoring board has become the shareholder value board – kicking out CEOs much more often when stock performance isn’t up to their stds
·  rise of institutional investors has promoted the rise of the shareholder value board
o  thought that concentration of power w/ institutions would make corps more responsible, hasn’t really worked out that way
o  institutions don’t often exercise the power they are granted
·  Quick look at equity markets
o  Primary market: where the corporation raises capital and money goes directly to corporation
o  Secondary Market: the trading market (NYSE, NASDAQ);
o  Might think that corp shouldn’t be concerned w/ secondary mkt performance b/c it doesn’t raise money there à but it does create problems b/c people look to secondary market when the corp wants to borrow money; issue more stock; also measure of mgmt performance;
Mitchell’s Comments
·  Corporation is a political and social institution in addition to its economic role; gains power as great as (if not greater) than the sovereign state (determines how economy is ordered)
·  American corp approach: powerful BoD; officers; shareholders; very efficient equity/debt markets
o  Capital moves to highest value at the least possible cost
o  Info possessed by millions of s/h contribute to the stock price
o  Broadest base of equity holders of any country; (reflects our ideal of the pursuit of self-interest
·  Societal shift from maximizing public welfare to maximizing private wealth
o  Just b/c society has more money doesn’t mean it’s a better society
Section 6 - A Global Perspective [71]
Difficult to determine which corporate governance system provides the best competitive advantage (if any?)
·  Other forms of capitalism besides the US form
o  US: extreme market form
o  Germany: employees/creditors are stronger constituents; banks & corps hold majority of equity (only 14% private, compare to US 50%)
o  Japan: similar to Germany; employment is one of the most important goals to Japanese corporations
o  France: corporations run by former gov’t workers; corps are means to serve the public
·  Characteristics of the systems
o  US: more immoral, creative, destructive, volatile
o  Euro: more stable, resistant to shocks, socially conscious
·  Dangers of one world market/form à no insulation from problems of others

CH 2 - The Duties of Directors and Officers

General Discussion of Boards
·  Considering the corporation as property is unusual b/c the owners really don’t have any meaningful property rights & extremely limited control rights
·  Only really have power once a yr a board meetings
·  Mitchell: although he’s critical of boards, directors usually act out of good faith
o  2 qualifications to that stmt
o  (1) the job is very narrowly defined, so they should keep their role in mind
o  (2) the law creating role creates incentives/disincentives
·  What are s/h relying on if they’re willing to hand their money over?
o  Good faith of directors
o  Social Captial
§  Very low in US, but counterbalanced by highly effective legal enforcement
·  In general, it’s economically efficient
o  Separation of owners/controllers allows controllers to act w/out constant owner consultation
o  But restraining mechanisms are necessary

Section 1 - The Authority of the Board

DE §141 [2]
·  Board is the supreme authority in the corporation; it’s empowered by the state (not the s/h)
·  But board cannot change its power; it can delegate to appropriate subcmtes, but will still continue to have ultimate responsibility for the business & affairs of the corporation
·  §141 – Board of Directors Statute
o  (a) power of board generally
o  (b) 1 or more members; majority for quorum;
o  (c)(1) pre-1996 committee delegation; can do everything but amend certificate of incorporation
o  (c)(2) post-1996 corporation (or if pre-96 chooses to follow) committee delegation;
o  (d) director terms/classes
o  (e) directors protected for good faith reliance on the corp records and any presentation made to board by officers/employees/committees/experts selected w/ reas care
o  (f) don’t have to have meeting to take corp action if dirs consent
o  (g) can hold meetings and have offices outside DE
o  (h) BoD has authority to set director compensation
o  (i) meeting by phone is same as meeting in person
o  (j) 1/3 quorum if no authority to issue capital stock
o  (k) removal w/ or w/out cause by vote of majority of shares except when
§  (1) if bd org’d according to 141(d) à only remove for cause
§  (2) special exception for cumulative voting rights
·  §142 – Officers Statute
People ex rel. Manice v. Powell (N.Y. 1911) [6]
·  Board is not legally the agent of the shareholders; the board can act w/in its power to run the corporation, even if a majority of shareholders disapprove
·  The powers of the BoD are “original” and “undelegated”
o  “original”: the BoD powers are created by the state; its power derives from the state, not the s/h
o  “undelegated”: their decisions to run the corporation don’t come from s/h; they are original as to the board and can’t be redelegated
·  But think about this, if they act as “trustees”, this analogy takes away the idea that the power they hold is state created;
Grimes v. Donald (Del. 1996) [7]
·  Did the board of directors abdicate its fiduciary duty by giving CEO large golden parachute if the board got in his way?
·  Formalistic Reasoning: Court finds that haven’t technically given up their power, they’ve just made themselves less likely to exercise it
·  BJR Presumption unless facts show waste or that actions didn’t show exercise of valid business jgmt
·  In gen’l, corporate jurisprudence is very formalistic; creates more certainty
·  Contrast to Mitchell (substance guy): using substance creates uncertainty, reduces efficiency
·  Decision preserves Manice, but allows corporate mgmt flexibility (?????)

Section 2 - Derivative Litigation

Derivative Suits in General
·  Can only be brought by shareholders; notice that its taking power away from board thought to be absolute
o  Provides a check on abuse of the board’s power; board obviously isn’t going to challenge its own abuse
·  Technically, two suits
o  (1) stockholder plaintiff sues the corporation to compel it to bring suit against the directors (can also compel corp to sue 3rd parties – RARE)
o  (2) corporation actually brings suit under control of stockholder and his counsel
·  Direct Suit: shareholder suing to recover in his own right
a. Distinction b/w Derivative and Direct Actions
Eisenberg v. The Flying Tiger Line Inc. (2d Cir. 1971) [11]
·  Eisenberg pleaded that form of the reorganization took away shareholders right to vote
·  If complaint alleges an injury to the corporation à derivative; if the injury is to the plaintiff as a stockholder à direct;
·  Because this was a personal (direct) action, Eisenberg didn’t have to post security costs, so he got to continue his suit;
Grimes v. Donald (Del. 1996) [14] (Demands)
·  the abdication of duty by the board of directors is a direct claim as pleaded here
·  Pre-Suit Demand: letter by shareholder to board asking them to follow a certain course of action
o  Why? – efficiency, may avoid need for a suit; also need way to emasculate the board
o  The board will consider the demand, (refuses), (sends notification of demand rejection)
o  When is demand futile?
§  “reasonable doubt” exists that the board is capable of making an independent decision
§  Normal Bases:
·  (1) majority of board has material/familial interests w/ corporation
·  (2) majority of board incapable of acting independently b/c of some reason for domination and control
·  (3) underlying transaction is not product of valid exercise of business jgmt
o  If you don’t make demand when it wouldn’t be futile à get dismissed
o  If you make demand and its rejected, can’t come back and argue it was futile
·  Plaintiff can’t bifurcate legal theories based on same set of facts when demand was refused (demand = agmt propriety; suit = waste, due care)
·  For direct suit, plantiff must allege more than an injury resulting from wrong to corporation; must state either injury distinct from that suffered by other s/h or wrong involving a contractual right of a s/h which exists independently of any right of the corporation
·  Direct more likely if seeking only injuctive/prospective relief
· 
· 
·  [17 n.3] plaintiffs lawyer real pary in interest in a derivative suit
·  Mitchell alleges anti-Semitism for bias against derivative suits
· 
b. Security for Expenses
Baker v. McFadden Publications Inc. (N.Y. 1950) [15]
c. Demand on the Board
Grimes v. Donald (Del. 1996) [18] (See Grimes above for more on this section)
·  make demand à conceding that the board was in a position to consider and act upon demand (can’t come back and then say the demand was excused)
·  corporation can’t take a neutral position in response to the demand
· 
Fiduciary Duties of Directors and Officers [21]
Business Judgment Rule
·  if directors act in good faith, w/ due care and in the best interests of the corporation --- the court will not interfere w/ their decision and the won’t be held liable for the consequences
Good faith – really a separate claim in corporate litigation; usually only w/ corp/dir illegality (crimes)
Duty of Care
·  NOT FIDUCIARY – not critical to establishing a relationship
·  Duty of Loyalty is fiduciary – someone is relying on you as director to act in best interests; provides a power balance to the beneficiary to hold directors accountable
Getting past due care (see above picture)
·  stupid, careless, irresponsible decision made by directors
·  get damages (except w/ Cede, which is DE law)
Getting past “best interests of corporation”
·  show directors have been self dealing
·  but establishing conflict of interest only “opens up the seawall”
·  if directors can prove results were FAIR, plaintiff gets nothing
·  if director can’t prove it was fair, corporation collects damages from directors for unfairness
Duties of care and loyalty are rarely enforced through direct litigation (unless closed corporations, parent-sub tx, takeovers); almost always derivative w/ a public corporation

Section 3 - Duty of Care