Professor Mitchell

CorporationsFall 2003

Corporations

Professor Mitchell

Course Outline

Nature & Purpose of the Corporation
Perpetual Existence: corp. exists until dissolved
Transferability: ownership interests are readily transferable
Trustees of DartmouthCollege v. Woodward (1819) (M6)
Held: NH leg. cannot amend DC charter by legislation, cannot impair the obligation of contracts under the Constitution. Charter is a contract between the corporation & the state.
Marshall:
Constitution protects private property, DC is private corp, tf ct cannot interfere. Corporation is an artificial person, state may not interfere w/corp’s right to own private property just like can’t do it w/real people. Corp. is for the benefit of the corporation itself.
Story (concurring):
Corp. as artificial person. Look at where $$ came from. DC came from private funding, t/f private corporation. When private corp. is created, state cannot interfere. Legislature can amend corp. charters, as long as the power to amend is reserved in the grant.
Consequences
Creates incentive for pp to create corps.
Corp. is an individual, possesses similar constitutional rights to pp.
Now, every state has the reserved power to amend charters in state incorporation statutes.
Dodge v. Ford Motor Co.(1919) (M18)
Ford stops paying dividends & reinvests in corp. Basically, Ford is attempting to “freeze out” the Dodge Bros. (min. SH’s) of his closely held corp, as a result of Ford’s maneuverings, Dodge bros. may only be able to sell to Ford, at a reduced price. Held: Stockholders can compel corp. to pay special dividends, but F. is permitted to continue expansion (River Rouge project), injunction is lifted.
Early application of the business judgment (BJ) rule.
In general, BOD has absolute discretion to allocate corp. $$, here court interferes b/c SH are losing $$.
Corp. is carried out for the SH’s profit. Leads to goal of maximizing profits, resulting in:
Pollution
Lower wages
Externalization of cost of maximizing profit
Corp. is no longer “community of interests.” New view of corps. leaves out unnamed constituents:
Workers, mngs, emp’ees
Other corps. w/financial interests.
Suppliers of the corp.
Customers
General public
Bank/creditors
Smith v. Barlow (1953) (M21)
Corp. makes donation to Princeton. Held: Corp. may contribute to charity as long as it has an indirect benefit to corp.
Corp. power to donate goes beyond “express statutory provisions.”
J. changes the law, disregards statute authorizing NJ to amend charters, states “the genius of our CL has been its capacity for growth and its adaptability to the needs of the times.”
Major political statement: Nation felt threatened by communism, J. has to create laws to save our private institutions, make world safe for democracy.
Berkshire Hathaway model
Warren Buffet: “our form is corporate, our attitude is partnership”
Buffett allowed each shareholder to give $$ to their own chosen charity.
Not a real partnership, but “feels like” a partnership. BH still has centralized management so imp. to corporations. (and each share worth $77k!)
Steinway v. Steinway & Sons (1896) (M30)
P. claims BOD is acting ultra vires and wasteful (throwing $$ away). Held: D’s are acting lawfully, court will not interfere w/corp. act if logically related to purpose (benefit the shareholders). Here, corp. is prospering, t/f no interference.
Logical Relation test (p.32): Corp. power is expanding, corp. act is ok if lawful & for the purpose of benefiting the shareholders, and is reasonably related to that benefit.
Progressive Era (1875-1900)
Moral uplifting of society
Industrialization has impacted the workers, growth in cities, increased immigration.
Social gospel: wealthy are stewards of $$, must give back to society
Moral tone of opinion reflects the social climate of the time.
Implied Consent(alt. basis for decision)
P has ratified this expenditure, cannot bring suit now
Intro to Fiduciary Duty & Underlying Values
Non Stockholders
Simons v. Cogan (Del. 1988) (M34)
P. is convertible bondholder, sues Cogan for breach of fiduciary duty. C merged 2 corps to get rid of public shareholders. Held: Directors do not owe fiduciary duty to debenture holders. P is SOL.
Court is limiting corporate duty to shareholders only, duty will attach here only once the stock is converted to shares.
Why no fiduciary duty? Ct provides no logical reason (but makes sense on some level).
In what sense is stockholder ownership different from any other relationship? SH take bigger risk-thus are more vulnerable to loss.
Preferred Shareholders
Common Stock: basic stock, all rights & privs that stock has-every corp must have at least one class of common stock
Preferred Stock:Preference over common shares in dividends and/or in receipt of assets if corp goes bankrupt. Certain rights apply to these SH’s- specific rights articulated in charter. If conflict concerns preferences stated in charter-involves PSH’s contractual rights & no fiduciary duty attaches; if not, implied & equitable rights of PSH as shareholder involve a fiduciary duty.
Jedwab v. MGM Grand Hotels, Inc. (Del. 1986)(M38)
Preferred SH brings class action suit against BOD. Merger in question wd give cash instead of stock to preferred SH’s. P claims unfair apportionment bc under deal, common SH’s get more $$ than preferred. Held: Here, merger not in express K agreement, tf SH rights involved and ct finds FD.
Rule: Contract rights are contractual/legal; shareholder rights are equitable.
Problem: BOD’s interpret preferences in corp. charter, tf BOD’s interpret whether there is FD. If case goes unlitigated (many do) then BOD’s get to decide when there is a FD.
Shareholder Valuism
Idea that duties are owed to corporation evolves into idea that SH’s are sole beneficiaries of corporation.
Idea becomes dominant in the 1980’s w/proliferation of hostile takeovers (where SH’s can immediately capture the short-term value of corp). Congress changed tax code in ’83-cannot pay execs more than $1 mill., tf corps pay D’s in stock. Now, execs’ interests are aligned w/SHs’ interests- bc D’s want more $$.
Rise in institutional investment-portfolio theory, diversification in order to eliminate risk. Directors now have incentives to raise stockprices to benefit SH’s in short term-but may be damaging to long term health of the corporation.
M’s remedy?
Change investment habits to focus on long-term profits, through economic incentives, sliding scale capital gains tax, increase attractiveness of long-term investments, and penalize pension & 401k holders for trading w/n the plans, make this taxable.
Role of the Corporation in Public Life
Ypsilanti v. GM (Mich. 1993)(M1, 46)
Town (P) gives D 12 yr. property tax abatement on corp’s $175 mill investment for new car D planned to mfr in P town, D changes plans, wants to make car in Tx. P sues claiming breach of K, PE, unjust enrichment. Lower ct found D liable under PE claim, GM must produce new car in P town. Held: Reversed. Just bc corp accepted tax abatements, they have not promised anything (no promise, no deal). But ct analyzes case in terms of contract doctrine, not from equitable perspective. (maybe cd have implied a promise taking equitable considerations into acct).
Results: This opinion encourages towns to get K, encourages self-protection when no help available from the law.
Intersection of Corp Law & International Human Rights Law
Steinhardt: Transnational corp has remained immune from reg. under intnt’l human rts laws-most treaties address gov’t conduct, not conduct of multint’l corps. Unocal suggests that atty does clients disservice by ignoring human rts in corp. law.
4 regimes of corp responsibility:
Market
Corps compete by conforming w/ IHR’s laws (voluntarily). Market-based effort to attract consumers & investors.
Domestic Regulation
Suppressing corp. presence in certain countries
Internt’l “Regulation”
Through orgs. such as OECD, Global Compact adopted by UN, HRC in Geneva.
Int’l financial institutions such as World Bank & IMF- corps must improve lives of constituents.
Litigation/Liability
Creates floor for market actors
ATCA (Alien Torts Claims Act): adopted by First Congress in 1789 to give aliens access to US courts.
Various US courts have ruled that corp may be liable for HR violations by gov’t with which they do business.
Corps want to legislate a corp carve out w/n statute, don’t want us to be able to sue corps for genocide, slavery, piracy, etc.
Ex. Holocaust cases: Claims brought in US against corps to recover looted assets for slave labor in Nazi camps. (Some litigated, some impeded by procedural reasons)
Nike cases: Consumer sued for false advertising claiming reliance on assertion that Nike complied w/HR stds. CA SC’s decision controls (bc SC said cert improvidently granted) tf corp can be held liable for lying to public.
Criticism of liability regime:
No adequate notice to corps.
Forum non Conveniens (US not appropriate forum to litigate)
Imposes liability on some corps w/o bad intentions.
Some HR attys object- private liability shifts to economic rights & ignores political rights.
John Doe I v. Unocal Corporation(9th Cir. 2002)(M52)
P sued Myanmar (Burma) corp, claiming D corp. subjected villagers to forced labor, murder, rape, and torture. DC granted SJ to Unocal, P appealed. Held: reversed (only on claims for forced labor, murder & rape- not torture), (1) D violated law of nations; (2) P’s claims not barred by act of state doctrine.
Concurring (Reinhardt): Unocal’s 3d party tort liability shd be decided under fed. common law tort principles, not international crim. law aiding & abetting std.
Stds that courts use for imposing liability:
Benefits (from torts- apartheid cases)?; and
Knowledge of abuse/HR violations; and
Intent (K between corp & gov’t); and
Control (corp equivalent to gov’t?).
Mitchell: Argument that enforcing HR’s is good for business is flawed argument b/c takes business outside of the realm of justice.
Comparative Corporate Governance
United States
Market System
Equity & debt market. Efficiency: capital moves to its highest valued use at the lowest possible cost- our system requires this kind of market.
Enlightenment liberalism: freedom of contract, our founding principles. Compels pp to accumulate for sake of accumulation.
Adam Smith (classical economist): Theory of Moral Sentiments & The Wealth of Nations. S. actually hated corps wanted gov’t reg.
Post Adam Smith (neo-classicists): Humans out for own self-interest & morally good to want to be rich. Attys attempt to merge descriptive science (econ) w/normative science (law), & give us idea that humans shd want to maximize wealth bc it is most efficient.
Law & Economics: Wealth maximization shd be the ultimate goal of the law. (assumes that wealth has intrinsic value).
Comparative Corporate Models: relationship structures as opposed to our market corporate structure.
Germany
Corps. used to better society- not just about SH, but about workers’ stable emp’t.
Difft ownership structure: interrelationships among German industry & German finance (most equity owned by banks) leads to oversight by pp w/more info.
Hostile takeovers are considered inappropriate- only 4 hostile takeovers in this cent.
Germ. corps pay taxes, go to promote level of social welfare.
Japan
Corps provide stability in emp’t & stability in production
Corps principally owned by banks (like Germany).
France
Best & brightest French corps are emp’d by gov’t & run corps.
Corps retain close ties w/gov’t.
Russian Corps
Voucher systems
BB drafted American corp. law for Russia- Russian economy fell apart 1 yr late-we created disaster in emerging capitalist world.
Duties of the BOD’s & Officers
Authority of the Board
Complete control over corp by BOD’s. Sep. of ownership from control in American corp- alleged owners of corp. (SH’s) really don’t have any meaningful property/control rights.
Board represents state-delegated power over corporation. Only control state has over corps is its ability to regulate board through corp. law.
Why such complete control? Bc BOD’s do not have to consult SH’s for every decision, corps are able to act quickly & efficiently.
Del. GCL §141: (M2, 2-5)
(a): Affairs of corp. managed by BOD, except as otherwise provided in statute or in cert. of incorporation.
(b): BOD consists of 1 or more pp. No. of D’s fixed by (or provided by) bylaws or certificate of incorporation. Maj. of D’s is quorum unless cert or bylaws require more. Maj. vote if quorum present is act of BOD unless cert of incorporation or bylaws require more pp.
Manice v. Powell (NY 1911)(M2, 6)
Relationship btwn D’s & SH’s are that of “trustee & cestui que trust.” Corp owns property, but D’s possess & act as if they owned corp.
BOD’s created from statutory laws of state legislature – original powers created by state.
D’s get elected to BOD by SH vote. But institution of board is not created by SH’s. BOD itself is conceptual abstraction.
Grimes v. Donald (Del. 1996)(M2, 7)
P. SH claims that D’s (CEO & BOD) breached fid. duty, failed to exercise due care, and wasted corp’s funds. BOD entered into emp’t K w/ CEO- K states CEO is resp. for gen. management of corp’s affairs. CEO gets big $$ (severance) if BOD’s unrsbly interfere w/his GF judgment.
Held: BJ rule applies to BOD’s actions- may enter into K’s w/CEO. BOD still has ultimate power to run corp.
M’s reading: Formalistic corp. jurisprudence here. Ct says BOD cannot formally delegate power, but they have effectively delegated power here. Benefits of formalism? Certainty- BOD’s can act w/o interference.
Derivative Litigation
What is it?
Equitable device- brought by SH’s (rarely convertible bondholders have standing to sue).
These suits have probs getting to the merits.
Procedure:
Pre-suit demand: P drafts SH letter to BOD. This req. is to avoid litigation. BOD must notify SH of rejection.
SH may argue demand excused b/c futile (seeGrimes Part III below).
When is demand futile?
Aronson test: Must allege w/particularity that rsbl doubt exists that BOD is capable of making independent decision, when:
Maj. of BOD has material financial or familial interestincapable of acting independently (bc of domination or control)
Underlying trans. is not product of valid exercise of BJ.
SH may claim demand was wrongfully refused.
Same as demand futile, must show rsbl doubt that BOD acted independently- but this claim is brought after demand is refused.
If demand requirements not met, right to sue is waived.
After demand rejected, SH then sues corp. to compel it to sue BOD.
Corp. sues under control of P SH.
Security for Expenses (see Baker, below): Some states req. SH’s to post security for rsbl litigation expenses, including atty’s fees, for all D’s.
Problem: takes pwr of BOD and gives it to SH.
Difference from Direct Litigation?
Direct: Injury to P as individual SH- need injury sep. & distinct from other SH’s (but can have CA’s). Ex. P seeks contractual rights.
Derivative: Injury to corp as entity. P here is really corp- no one directly benefits except the atty’s.
Eisenberg v. Flying Tiger Line, Inc.(2d Cir. 1971)(M2, 11)
FT merges into FTL. FTL gets FT’s assets & liabilities, FT SH’s get stock in FTC (FTL’s parent). P claims merger deprived min SH’s of control over business.
Issue: Does P have to post security for costs (required in deriv. litigation)?
Held: No, here suit is direct b/c about right to vote, losing right to vote is harm to SH, not to corp.
“If the gravamen of complaint is injury to corp the suit is derivative, but ‘if the injury is one to the P as a SH and to him individually and not to the corp’ the suit is individual in nature and may take the form of a representative class action.”
Grimes v. Donald Part II(Del. 1996)(M2, 14)
Claims?
Derivative: Due Care, Waste, Excessive Compensation (to CEO).
Direct: Abdication of D duty (see Part I). Direct b/c SH’s seek to invalidate emp’t K’s to CEO, corp gets no $$ as a result.
Baker v. McFadden(NY 1950)(M2, 15)
P’s own 1% of stock in corp. NY stat. says P’s in deriv. litigation must post security unless they represent at least 5% of corp’s shares. Ct says it can amend order to post security if more SH’s are joined –basically goes around statute to allow suit.
Why this legislation restricting deriv suits? NY WASPs hate the Jew P’s attys.
Grimes v. Donald Part III(M2, 18)
P made presuit demand on BOD to cancel K’s. Then P claimed demand was excused and sued for waste, excessive comp, & due care. When P makes demand, right to claim excusal is waived, thus P is SOL.
Duty of Care
Sometimes classified as part of fid. duty, but not really part of FD. Why not? BOD’s are not req’d to be careful bc of their position w/r/t SH’s (whereas duty of loyalty arises b/c of trustee relationship). Just have to use care in general w/r/t corporation.
Business Judgment Rule: As long as BOD acts in GF, court will not look into their actions as long as D was fully informed & rationally believed that his judgment was in the corp’s best interest. (NA to self-interested transactions).
Justification? We need BOD’s to take risks. If rules were too stringent, then no risks & no progress.
BOP? P always has BOP that BJ rule doesn’t apply (if no conflict of interest- must be arms length transaction). To overcome BJ rule, must prove BOD’s acted in BF or breached DOL.
Kamin v. American Express(NY 1976)(M2, 23)
Min. SH’s sue derivatively for waste & breach of DOC. BOD bought corp for $29 mil worth 4 mil, SH’s want BOD to sell to get tax break on loss.
Held: BOD’s are entitled to the protection of the business judgment rule. BJ: Ct won’t interfere if BOD acts w/GF.
Duty of Care: Ct seems to say that need to show fraud, dishonesty, or malfeasance to prove DOC violation.
Note: Economic Sociology (insert notes pp. 26-28).
Network theory
Structural Bias
Weak Ties
Joy v. North(2d Cir. 1982)(M28)
Ct justifies BJ rule. SH’s take on risk of bad business judgment. Says SH’s can look out for themselves- but ct sets bottom beyond which BOD’s behavior cannot fall. Why BJ rule- why do we let BOD’s off the hook?
Market Efficiency: encourage risk taking for max. efficiency. (EMH, see pp. 30-31)
Case encourages diversification of stock- if can’t afford it- shd invest in mutual funds/pension plans.
Problem w/this? Managers of mutual funds pressure CEO to increase profit. Concentration of capital in small amt of hands- no close monitoring of investments as before.
Cede v. Technicolor, Inc.(Del. 1993)(M2, 31)
Lower ct required P to show duty, breach, cause & injury.
Flawed analysis: Ct collapses duty of care into fid. duty in analysis. They state: BJ rule applies if BOD acts in GF. To succeed, SH must rebut by showing breach of DOC, DOL, or duty of GFFD. If BJ rebutted, BOD’s can still prevail by showing entire fairness (fair dealing & fair price) of transaction.
Held: No cause & injury req’d.