Nature and Purpose of Corporation

  1. General Overview
  1. Three Statutory Recognized Groups:
  2. Officers
  3. Directors
  4. Shareholders
  1. Rules governing corporations
  2. Common law rules
  3. DE law
  1. Characteristics of Modern Corporation:
  2. Perpetual life
  3. Limited liability
  4. Separation of ownership from control
  5. Centralized control
  1. The Nature & Purpose of the Corporation
  1. Whether a corporation is private
  2. Trustees of DartmouthCollege v. Woodward (1819): trustees sue state b/c state sought to amend school’s charter and felt state law interfered with articles of incorporation
  3. J. Marshall:
  4. Charter is a contract b/w the state and the corporation. Even though it’s a contract with the state, it’s still a private contract.

(a)If this is a private contract then it can’t be changed by law according to the Constitutional provisions protecting private contracts

  1. Charter = contract to protect private property

(a)Charter is protecting the power of trustees to control the corporation

  1. Corporation as an artificial entity created by a charter
  1. J. Story:
  2. Private funds = private property
  3. Private institutions can have their charters changed but powers must be reserved in advance by legislature (see DE General Corporation Law §394 – p. 15)
  4. Corporation is a collection of individuals; We protect their property because we protect the property of individuals
  5. Minute you describe charter not as a grant of power by the state but as a contract, you are describing a private institution, which gets Constitutional protections
  1. Dodge v. Ford Motor Co.(1919): Ford wants to stop issuing special dividends in order to invest in smelting plant, increase wages, hire more people, and reduce prices
  2. Dodge wants the dividends in order to invest in their own company and be competitors
  3. Dodge would have difficulty selling stock because circumstances of Ford controlling too much of company and not paying off dividends
  4. Ford trying to devalue stock so it will be sold at a lower price to him
  5. Corporation itself is a private entity for the profit of shareholders
  6. Different from Marshall’s view of a contract for protection of private property owned by the corporation b/c that might allow directors to take into account more groups than just shareholders (workers, public, consumers).
  7. Here, corporation is solely the property of shareholders

(a)Corporation is not an entity as envisioned by Marshall but is a collection of shareholder property

  1. Court wants shareholders to have certainty as to their expectations when they invest.
  2. Can harm other interests as long as promoting interest of shareholders
  3. The discretion of directors is to be exercised in the choice of means to attain a profit, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes
  1. Or Public
  2. Berle & Means: “The Modern Corp. & Private Property”
  3. Modern corporation challenges property relationships b/c the separation of ownership from control means you can’t talk about a corporation just as the property of individuals.
  4. B/c the modern corporation is an extremely powerful entity resembling the state, it’s not a typical property relationship. Instead, it has a trust relationship with the community at large.
  5. Separation of ownership and control allows accumulation of great power – this requires that the corporation should act as a public trustee.
  6. When see corporation as nexus of transactions then see every group to have accepted the terms and able to protect themselves
  7. This is alternative view that gives more deference to directors
  8. Ethic of trust v. self protection
  9. When emphasize contractual nature of rights then self protection
  10. When emphasize imbalance of power relations then encourage trust
  1. Modern View:
  2. Most courts still describe corporations as property of shareholders (private) and not having public/social responsibility as Berle & Means described them.
  3. Social responsibility has translated into charitable contributions
  4. ALI Principles of Corporate Governance: Analysis & Recommendation
  5. Says corporations must obey the law, but discusses ethical considerations and charitable contributions in terms of may do so.
  6. Do we want corporations to engage in humanitarian activity? What are the benefits? What are the disadvantages?
  7. The more you see corporation as entity the more likely that you want corporation to give back
  8. The more you see corporations as a collection of individuals then the more you feel shareholders should have final say on whether to give or not
  9. Smith v. Barlow (1953): Stockholders don’t like that company gave charitable contribution to Princeton
  10. Court says corporations have unlimited power to give charitable donations.
  11. Court focuses on how much corporation gives to society- concerned about fact that if they based decision solely on giving statute then it could always be amended by political process and leave out benefits to corporations for giving
  12. This a cold-war case and court wanted to allow companies to give charitable donations to defend against attacks from abroad.
  13. Contributions allowed but not in interest of shareholders, framed as interest of corporation to have a stronger democratic climate
  14. All court had to do was follow Justice Story exception in Dartmouth but chose instead to look at historically how corporations have done things to benefit the community (though they incorrectly look as far back as when corporations were not businesses)
  15. Berle represented shareholders on appeal – why? B/c he realized how hard it is to define the corporations as benefiting the public; easier to make directors responsible to shareholders and regulate their power from there.
  16. Exception:
  17. Steinway v. Steinway & Sons (1896): Shareholder sues b/c company moved plant to suburbs and built churches, homes, etc., for employees; Argued that expenditures are being made outside the corporate charter
  18. Court recognized that corporations can build towns for their employees.
  19. Duty of corporations to give back to workers and to society; duty of a corporation to act morally

(a)Court could have just made decision using Dodge – i.e., what trustees did benefited shareholders by keeping highly skilled workers with the company – but court chose not to do so.

(b)Case is an exception to the rule – product of its environment and the time period in which it was decided (progressive era). Law advocating corporations’ duty to workers has not generally been followed

(c)

  1. Ways to Look at Corporations (different debate than public v. private):
  2. The different types of relationships/theories for corporations detail how much the state can regulate the corporation:
  3. Charter – gives a lot of power to the state to regulate; corporations are told exactly what they can and cannot do by the state because entity created by state (Marshall)
  4. Natural Entity
  5. Natural- Focus is on property (Story)
  6. If we treat corporation as an individual, we can punish them as an individual but we also have to give them rights of an individual (i.e., liable via torts)
  7. In cash out merger settings, both shareholders and directors may argue property rights in order to protect their interests

(a)Contract may undermine shareholder interest

(b)Directors will say they are in charge of entity and can take interests in account

  1. Real Entity
  2. Looks to corporation and says this is different from individuals and different from what we know but it is real
  3. Concerned with relationship between corporation and society

(a)Not following traditional common law rules of contract and property

  1. Contract
  2. State has limited power to regulate in this situation b/c if they interfere too much they run the risk of violating the Constitution (sort of a free market approach – all we need to do is let them come together via contract)
  3. Deference to directors in interpretation of contracts
  4. Modern View – Nexus of Contracts
  5. Individuals who make up corporation contract between themselves
  6. By 1970s, shift back to contractual arrangement from real entity had occurred.
  7. Focus on self protection
  1. Who Counts within the Corporation?
  1. Stockholders and Bondholders in a Corporation

Stockholders / Bondholders / Preferred Stockholders
  • Equity divided either through dividends or stock price
  • Participate in management by voting for directors
  • No fixed income
  • Come last in liquidation
  • Short term focused- prefer risk activities that create more return
  • Shareholders are vulnerable because they take the risk and own the company without any contractual protections
/
  • No right to vote
  • Terms set in contract for fixed income and rules of providing credit
  • Come before equity holders in liquidation
  • More long term because of interest collected and fear of asset loss by risky activity
/
  • Some sort of fixed income through priority in dividends
  • Redeemable by corporation
  • Tend to be defined by contractual relationship in charter
  • Dividend rights for preferred are superior, come earlier in liquidation, rarely have voting rights
  • If there is a contract, then no fiduciary duty is owed
  • Fiduciary duties similar to common stock for whatever not stated in contract

  1. Simons v. Cogan (1988): Merger condition said convertible debenture holders no longer allowed to convert to stock and had to convert to cash.
  2. Cogan wants no minority shareholders so he won’t have to take their views into account; therefore, doing merger with corporation that he has majority shares in subsidiaries of
  3. Corporation owe fiduciary duties only to shareholders and not bond holders. No fiduciary duty simply for having the expectancy/possibility of becoming a shareholder.
  4. Bond holders have a contractual relationship, while shareholders have a trust relationship involving a fiduciary duty b/c the relationship b/w shareholders and the corporation is about property.
  5. Court is pushing the deeper idea of who can self-protect:
  6. Bondholders have ability to protect themselves in a contract, while court sees shareholders as more vulnerable. Shareholders don’t have a contract, so court says “we’ll protect you.”
  1. Jedwab v. MGM Grand Hotels (1986): Preferred stockholders sue majority shareholder for breach of fiduciary duty in merger situation
  2. Court puts preferred stockholders’ interests below common stock since they can self-protect. Preferred stock is both an equity relationship to which a fiduciary duty is owed and a contractual one to which no duty is owed:
  3. Fiduciary duty comes from relationship of power where directors have power over shareholders’ property; expectation is that directors will put shareholders’ interest above their own.
  4. In a contractual relationship, there is supposedly equal bargaining power where you fill gaps that may be there by looking at intent of parties. Fiduciary duty asks more of its participants
  5. Preferred stockholders, like bondholders, should protect themselves by making express provisions in a contract.
  6. Rights of preferred stockholders are defined in their contract- if a right is not defined in the contract, then it is the same as those for common stock
  7. Where there are contractual rights then there are no fiduciary duties
  8. One issue here though is that in contractual situations, directors owe nothing more than the contract states and are the ones who get first chance at interpreting the provisions. Courts give much leeway to directors in interpreting contracts.
  9. If interpreting contract- directors have to act in good faith
  10. In contract when acting in good faith, must balance interests; Difference with fiduciary obligation is that if conflict between director and shareholder then have to favor shareholder
  11. Nexus of contracts & self-protection go hand in hand
  1. CT General Statutes Annotated §33-756NY Bus. Corporations Law §717
  2. Statutes are constituency statutes because they define whom a director has obligations to
  1. Shareholder Valuism: The New Business “Ethic”
  2. Up until 1970s, managerialism was dominant idea – considered the long-term value of the stock.
  3. Notion that corporations were run by their managers, without interference by stockholders
  4. Shareholder valuism- purpose of the corporation and its management was to achieve the highest stock price possible for the stockholders
  5. Emphasis on maximizing short term profit
  6. By 1980s and rise of takeovers, message sent to raise the short-term price in order to keep shareholders from selling.
  7. Also a rise in institutional investors (i.e., mutual funds) who pushed for more profit.
  8. Trend with valuating stock has been to tie to marketplace as a whole – thereby to a certain extent disassociating it with the corporation.
  9. Boom in executive stock option compensation, which leads to the pursuit of self- interest in stock prices leads to short term business strategies
  10. Trend towards short-term value/profit good or bad?
  11. Good = making profit is good
  12. Bad = losing workers, closing plants, etc.
  13. Thinking about it in terms of which legal regime you would want – one where everyone self protects or one based on trust.
  1. The Role of the Corporation in Public Life
  1. Poletown Neighborhood Council v. Detroit (1981):
  2. Court treated corporation almost like a public entity, saying city could give GM the land for the plant b/c of the public benefit to having the plant in the city.
  3. Public purpose = alleviate unemployment and benefit the community at large.
  4. Purpose of GM is to make money for shareholders, so no guarantee that they will actually create the benefits the city is looking for
  1. Ypsilanti v. General Motors (1993): After GM received tax abatements from city, GM had sales problems and decided to move operations to another city.
  2. Corporation can move w/o taking into account the interests of the city it’s moving away from b/c city didn’t protect itself via contract.
  3. Court said no promise made and since contract doesn’t require them to stay, then they can leave
  4. Fact that corporation solicits tax benefits in exchange for assurance of jobs is not evidence of a promise
  5. Court essentially tells the town to self-protect – should have put everything in a contract.
  6. Problem is that if GM were forced to put something in writing, they would likely have just gone to another town; the town is the vulnerable party and the court is not protecting them.
  7. Opens huge door for corporations to say whatever they want and still go ahead and move/close plants.
  8. Court sees power relationship similar to that of shareholders- court would have to establish fiduciary obligations to those who are vulnerable to corporate decisions
  9. Law says corporations are to maximize shareholder benefits which leads to assumption of courts that corporate activities should be assessed in this context only
  10. Defendants should have self protected through their contract
  11. Strengths to progressive law:
  12. Allows directors to take into account community and public – doesn’t force companies to do anything but changes the incentives the law gives directors. Law like Ypsilanti prevents directors from looking at community b/c of their fiduciary duty to shareholders.
  1. John Doe v. Unocal (2002): Suit against company for hiring military force for pipeline project.
  2. Defendants may be liable for aiding and abetting the state government in forced labor, rape & murder. Corporation, as a private actor, can be subject to liability just as individuals can.
  3. Alternatively, court can try to impose duties treating company as a public entity b/c of its relationship/collaboration with the states and impose duties on the corporation as if it were a state.
  4. Courts beginning to look at how much power corporations have and beginning to think that they can exercise more control over their international environments
  5. Forms of regulation for corporations & human rights:
  6. Free market – i.e., promising customers not to use sweatshops or child labor and thereby tying it to corporate profit. Theory is that if we show corporations that it will be more profitable not to violate human rights, they will do so.
  7. Problem with market is the information gap in market and race to the bottom
  8. International regulation – international organizations & corporations voluntarily agreeing not to violate human rights
  9. Domestic regulation – e.g., Tort Claims Act, getting courts involved and telling corporations what they can and can’t do.
  10. Punish directors so that they are no longer shielded by corporation and their self interest would be changed
  11. Create a fiduciary duty of care to international law
  12. Discussion questions:
  13. Should we tell corporations they should do things b/c it benefits their bottom line or b/c it benefits society?
  14. Are corporations more like individuals or state? Which regulations should we impose – market or actual regulation? Should they be viewed as public or private entities?
  15. Unlike individuals, corporations have more power and greater reach
  16. When you start with external regulation you are imposing certain duties and requirements while at the same time telling them their purpose is to make profit
  17. If that is their incentive they will find ways to fulfill the letter of the law, but not necessarily the spirit
  1. The Legal Structure of the Corporation
  2. Equity markets
  3. Primary markets- where the corporation raises its capital and consists of issuances of stock by the corporation itself to investors whose money goes directly to the corporation
  4. Secondary markets- trading market- where people buy and sell shares of stock
  5. Importance of secondary market
  6. Prices at which a stock is trading not only affects the prices at which corporations can issue stock in the future if they choose to do so, it also affects things like the rates at which they can borrow money
  7. Stock price is the basis upon which corporate managers are judged
  8. Stock prices affect consumer perceptions about the health of a corporation

Duties of Directors& Officers

  1. The Authority of the Board
  1. Generally:
  2. Directors:
  3. Have absolute power (via statute)
  4. Also means they have duties – cannot abdicate their power or limit their discretion (although there are cases where that has been decided in a very formalistic way)
  5. Role of directors has changed- used to have a monitoring role
  6. Role has started to shift to become more short term maximization- result of takeovers and stock option grants
  1. People ex rel. Manice v. Powell (1911)
  2. Shareholders cannot control the board – powers of the board are “original and undelegated.”
  3. Undelegated = Board of Director power is not a delegated power; shareholders don’t delegate this power to them
  4. Original = created in a statute from the state; essentially an absolute power
  5. By describing powers as originating from statute, it’s like Dartmouth in that corporation created by power from state – brings corporations back into realm of the public.

(a)Statute creates board of directors and defines its power