Chapter 3 Corporate Federalism
Chapter 3 Corporate Federalism
Class Outline
(updated 23 Aug 06)
Chapter 3 Corporate Federalism
A. A Brief History of Corporate Law Federalism
1. Early antecedents
2. Early development of U.S. corporate law
o evolution of corporate attributes
o Trustees of Dartmouth College v. Woodward
3. The modern corporation
o Managerialism before 1980 ("rusty girders ... wind")
o 1980s takeovers
§ emergence of shareholder primacy
§ leveraged buyout
o 1990s mergers and restructurings
§ stock options
o 2005 Hedge fund activism
o state / federal regulatory interaction
B. The Internal Affairs Doctrine
1. Background on the Internal Affairs Doctrine
o Choice of law rule: law of the state of incorporation governs “internal affairs”
o Judicial nature of rule
o Internal affairs v. external affairs
§ internal affairs: shareholder / management relations
§ external affairs: labor, tax, contracts, torts, property
o exceptions:pseudo-foreign corporations
2. Lessons from California and three generations of antitakeover statutes
o “first generation” state antitakeover laws
§ Edgar v. MITE Corp.
o “second generation” state antitakeover laws
§ CTS Corp v. Dynamics Corp of America
o “third generation” state antitakeover laws
§ Amanda Acquisition Corp. v. Universal Foods Corp.
3. The Internal Affairs Doctrine Revisited
o VantagePoint Venture Partners 1996 v. Examen, INC.
C. The State Charter Competition Debate
· choice of state of incorporation
o practical factors
o state competition
§ "race to the bottom"
§ "race to the top"
o preeminence of Delaware –why?
Class Notes
Chapter 3 Corporate Federalism
A. A Brief History of Corporate Law FederalismJustice John Marshall [in Trustees of Dartmouth College v. Woodward (US 1819)]
A corporation is an artificial being, existing only in contemplation of law. Being the mere creature of law, it possesses only those properties which the charter of its creation confers upon it, either expressly, or as incidental to its very existence.
/ Judge Easterbrook (in Amanda Acquisition)
To say that states have the power to enact laws whose costs exceed their benefits is not to say that investors should kiss their wallets goodbye. States compete to offer corporate rules attractive to firms. Laws that in the short run injure investors and protect managers will in the longer run make the state less attractive to firms that need to raise new capital. ... States regulating the affairs of domestic corporations cannot in the long run injure anyone but themselves.
B. The Internal Affairs Doctrine
What is a foreign corporation?
Can a corporation in the business of selling hamburgers be incorporated in Delaware, locate its retail outlets in California, and have its headquarters in North Carolina. How can it operate (with full corporate attributes to own property, enter contracts, sue and be sued, provide limited liability for investors) in each of these states.What is a "foreign corporation"? See MBCA ch. 15.
Could California decide it does not want a hamburger chain selling in its state? Is a corporation a "person" under the US Constitution's privileges and immunities clause? Is a corporation a person under the 14th Amendment's due process and equal protection clauses? Is a corporation a person with respect to the protection of the dormant commerce clause?
/ MBCA § 15.01 AUTHORITY TO TRANSACT BUSINESS REQUIRED(a) A foreign corporation may not transact business in this state until it obtains a certificate of authority from the secretary of state.
(b) The following activities, among others, do not constitute transacting business within the meaning of subsection (a):
(1) maintaining, defending, or settling any proceeding;
(6) soliciting or obtaining orders, whether by mail or through employees or agents or otherwise, if the orders require acceptance outside this state before they become contracts;
(9) owning, without more, real or personal property;
(10) conducting an isolated transaction that is completed within 30 days and that is not one in the course of repeated transactions of a like nature;
(11) transacting business in interstate commerce.
(c) The list of activities in subsection (b) is not exhaustive.
MBCA § 15.03 APPLICATION FOR CERTIFICATE OF AUTHORITY
(a) A foreign corporation may apply for a certificate of authority to transact business in this state by delivering an application to the secretary of state for filing. The application must set forth:
(1) the name of the foreign corporation or, if its name is unavailable for use in this state, a corporate name that satisfies the requirements of section 15.06;
(2) the name of the state or country under whose law it is incorporated;
(3) its date of incorporation and period of duration;
(4) the street address of its principal office;
(5) the address of its registered office in this state and the name of its registered agent at that office; and
(6) the names and usual business addresses of its current directors and officers.
(b) The foreign corporation shall deliver with the completed application a certificate of existence (or a document of similar import) duly authenticated by the secretary of state or other official having custody of corporate records in the state or country under whose law it is incorporated.
What law governs corporations?
What happens if the shareholders of ABC Company are dissatisfied with the firm's management and sue for breaches of fiduciary duties. Which law applies if they sue in --
· North Carolina court, where most of the shareholders reside
· Georgia court, where the company is headquartered
· Delaware court, where the company is incorporated
· California court, where the CEO has winter home
Choice of law - look for interests/contacts? What is the internal affairs doctrine - why do we have it? / Can states change their corporate laws?
Given that corporate law is a matter of incorporation-based private choice, can states changes their corporate laws? What if Delaware decides to change its rules that govern shareholder suits, making it more difficult for shareholders to assert their fiduciary rights? Can Delaware unilaterally change a private arrangement -that is, the corporate relation between investors and managers?
See Del GCL § 394 ; NC Bus Corp Act § 55-1-02. § 55-1-02. Reservation of power to amend or repeal.Why do the states reserve the power to amend their corporate statutes - you don't see this reservation elsewhere in the law!
McDermott Inc. v. Lewis (Del 1987)
McDermott International recapitalized (that is, changed how it was financed) so that 90% of its voting stock was held by public shareholders and 10% was held by its US subsidiary, McDermott Delaware.
This is against the law of Delaware, where McD-Delaware is incorporated, and the law of Louisiana, where McD-Delaware is headquartered and does most of its business. But Panama law, where McD-Int’l is incorporated, allows a company to send voting stock to a sub, even though this gives management the ability to vote stock it never paid fore!
A McD-Delaware shareholder sued to stop the reorganization plan that put voting stock of McD-International in the US sub. The defendants argued “internal affairs doctrine”.
Questions
What is the reason for the prohibition against US companies placing their voting stock in a subsidiary?
What is the Delaware court attitude? / Delaware court:
Delaware’s well established conflict of laws principles require that the laws of the jurisdiction of incorporation – here the Republic of Panama – govern this dispute involving McDermott International’s voting rights.
Under the prevailing conflicts practice, neither courts nor legislatures have maximized the imposition of local corporate policy on foreign corporations but have consistently applied the law of the state of incorporation to the entire gamut of internal corporate affairs. In many cases, this is a wise, practical, and equitable choice.
Given the significance of these considerations, application of the internal affairs doctrine is not merely a principle of conflicts law. It is also one of serious constitutional proportions -- under due process, the commerce clause and the full faith and credit clause -- so that the law of one state governs the relationships of a corporation to its stockholders, directors and officers in matters of internal corporate governance.
CTS Corp v. Dynamics Corp of America (US 1987)
The Indiana legislature didn't much like that corporate raiders were acquiring control of Indiana businesses. To stem the tide, the legislature passed a "control share" statute that said that any shareholder of any Indiana corporation that acquired a controlling interest -- by passing a 20% or 33% or 50% threshold -- could not vote its shares unless it received permission from a majority of other shareholders. How might this prevent coercion in a tender offer? Why does this may takeovers less likely? Doesn't this interfere with the relationship between shareholders and corporate management?
A shareholder of CTS, an Indiana corporation, challenged the Indiana statute under the federal Commerce Clause. What were the arguments? How did the Supreme Court respond? What is the "blueprint" that the Supreme Court outlines for antitakeover statutes?
Discrimination - "the Indiana Act is not [a statute that discriminates against interstate commerce] It has the same effects on tender offers whether or not the offeror is a domiciliary or resident of Indiana" / · Does it make any difference that most corporate raiders are not from Indiana?
· A corporate takeover pits current management against a team of outside managers. Isn't the effect of the legislation is to prefer Indiana managers over outside raiders?
Inconsistent regulation - "so long as each state regulates voting rights only in he corporations it has created, each corporation will be subject to the law of only one state" / · Does this mean that the "internal affairs doctrine" is constitutionally mandated?
· Would it be possible for a state to regulate "pseudo-foreign corporations"? That is, could California decide to protect its investors from Delaware corporate law by requiring that California law corporate apply if most of a company's investors were from California?
Hinder commerce - "The court of appeals failed to appreciate the significance for commerce clause analysis of the fact that state regulation of corporate governance ... is a product of state law" / · What is the "beneficial free market system" that the Court has in mind? What would be the effect if federal courts were to supervise the "hindrance" potential of state corporate law?
· Is the Indiana statue valid because it is beneficial to shareholders? or because it is merely a product of state law? Why should Indiana care about its corporation's shareholders, if many live outside Indiana?
Limit tender offers - "Indiana need not define these commodities [corporate shares] as other states do; it need only provide that residents and nonresidents have equal access to them. / · What is to keep Indiana from deciding to give management full protection against takeovers?
· Could Indiana, for example, repeal its merger provisions? Or provide that only incumbent directors or their successors (a dead hand rule) can agree to any combination with an uninvited bidder?
Amanda Acquisition Corp v. Universal Foods (7th Cir. 1989)
The Wisconsin legislature doesn't like takeovers any more than did the Indiana legislature. Its legislation, similar to that of Delaware's, places a moratorium on the activities of any acquirer of corporate control. Under the statute a bidder who acquires a controlling interest in a Wisconsin corporation must sit on its investment, and for three years is prohibited from merging or acquiring the assets of the company. This discourages any bidder who would borrow money to buy a control block, since the target's assets would be unavailable for three years to repay the loans. As a practical matter the Wisconsin law chills almost all tender offers - its intended effect!
Is the statute pro-shareholder or pro-management? How can the state of Wisconsin impose its will and side with management - what about the corporate contract? Do the law's costs outweigh its benefits? Why is it that a state law that is "economic folly" is tolerated under the Commerce Clause, which is supposed to allow for unhindered economic activities in national markets? What is the nature of judicial review of state corporate law according to CTS?
C. The State Charter Competition Debate
Market for "incorporations"
· Why incorporate in Delaware?
o Delaware has highest franchise taxes
o Delaware Consittution makes amendments to corporate statute difficult
o Delaware has lots of corporate lawyers
· See Delaware's answer. / · Why incorporate in North Carolina?
o North Carolina's legislature follows lead of NC Bar Association, Business Law Section
o North Carolina has specialized Business Law Court
· See North Carolina's answer.
Debate - "race to bottom" vs. "race to top"
· What is the argument by William Cary? What evidence does he marshall that Delaware is engaged in a systematic dilution of shareholder protections, for the benefit of corporate managers?
· What is the response by Ralph Winter? What evidence does Winter use in arguing that Delaware cannot engage in a race to the bottom?
· How might you determine whether Delaware is engaged in a race to top or bottom?
o Incorporation of new IPOs
o Re-Incorporation effect on stock prices
o Takeover defenses / executive compensation / parent-subsidiary dealings / Should there be federal intervention?
(What is Professor Roe's argument?)
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Chapter 3 – Corporate Federalism