Business Organizations

30 June

• Scary pop quiz!
• Default is a member-managed company; if you want to be manager-managed, you must say so in the articles of organization.
• Note also the difference between decisions requiring majority consent and decisions requiring unanimous consent.
• And remember that an action that binds the LLC can still create a claim between the members.
• Haley v. Talcott
  There's a deadlock here, because there are two buyers and no sellers. There's no equitable way to force one to be a buyer and one to be a seller, since there's no way to get out of the personal guarantee. So even the exit mechanism in the operating agreement is ineffectual.

  Was the analogy to corporate law necessary? Probably not, but it lends a little authority, since the LLC statutes are new.

• We will have a question where we have to come up with some structure for a business entity. Don't pick an S-Corp, since that's the wrong answer.
• The NeoClone case study. The angel investment is $90K, but the attorneys' fees to negotiate this was $25K. That's sort of interesting-- there must have been a lot of risk here.

  Note that if a creditor gets a seat on the board, the boardmembers have a fiduciary duty to the company and the shareholders, not the creditor. That sort of an up-in-the air thing: is this a reasonable approach?

  The 3-tiered structure immitates corporate management structure: it's good when you have many investors.

2 July

• So, we're going to use Delaware law mostly, not the model act for corporations. That language is opaque, though, so rely on notes and guidance in class.
• Googling NeoClone we can find an article by a former Foley partner with a nice choice-of-entity grid.
• Anyway, corporations, incorporating and capital structure.
• A corporation is a separate entity. It is owned by shareholders. Shareholders have the right to the equity of the company, but they do not manage the company-- they elect directors. The directors do not act individually, only collectively (this is important for determining breaches of fiduciary duties). This is different from managers of LLCs, each of whom can bind the organization independently. The directors appoint and oversee the officers.
• Mostly we're going to focus on directors.
• Public and private companies operate differently (private = closely held = unlisted). There are also "statutory close corporation:" you can register as this and that means you can maybe eliminate the board of directors and have shareholders fill that role. This is rare, however, so don't worry much about it.
• In public companies, the shareholders have a pretty limited role: usually no one person holds more than 5-10% of the stock (though large funds might: institutional shareholders). But they vote on directors and major issues. In a public company, the directors have a lot of power (and usually the CEO is a director). Often you'll see "director entrenchment:" the directors work to stay on the board.
• In private companies, there are usually fewer shareholders, which means that any one of them might have much more influence, and much more direct contact with the company. Shareholders tend to be officers or employees of the company.
• Typically you have an incorporator (or more than one). The incorporator files the articles of incorporation with the secretary of state. The incorporator acts as the directors (until they are elected), unless the directors are named in the articles.
• The articles of incorporation will state how many shares can be issued, and what classes (and series within classes). They authorize the incorporator or the directors to sell the specified number of shares.
• When you're doing a transaction with a corporation, you want to make sure it exist: you'd like to see the charter (which means the "articles of incorporation or certificate of incorporation," because the language varies by state).
• Different classes of stocks may come with different financial rights and different voting rights. Often "preferred" shareholders get more money, but can't vote on as much. Or A series can elect 3 directors, B series can elect 2, and C series only 1. Stuff like that: it might give different advantages to different shareholders.
• Those rights have to be defined in the articles, and also on the certificates themselves, so people can know what their rights and preferances are.
• § 101(a) - anybody can incorporate in Delaware, for operations anywhere, for any lawful purposes (§ 101(b)). You do have to say what business you're pursuing, but you can just say all kinds of broad things. Some business have to limit themselves, though (law firms, e.g.), or the founders may want to limit what they're doing because they know eventually there will be other owners, and they want to build in some certain direction for the company.
• By the way, Delaware courts incorporation because it's very lucrative (i.e., to the legal profession there).
• § 102: what the articles must contain. you have to say "corporation" or some such in the name, and you have to have a name that distinguishes you from other companies, and you have to have the location where the company can be served in the event of a lawsuit (another cottage industry in Delaware). Also the purpose of the corporation (corporations can be forcibly dissolved or sued for operation ultra vires; that's somewhat archaic, but if a shareholder invests based on the charter, it makes sense for the shareholder to enjoin that activity or hold the directors liable for losses). Classes of stock, and their rights and preferences (par value is also an archaic concept: the original offering price; also the corporate seal). Anything you can put in the bylaws (e.g., how many meetings per year, how directors can be elected/removed, etc.), you can also put in the certificate of incorporation. You might want to put things there that you don't want the directors to be able to change.
• § 102(3). Nobody gets a pre-emptive right unless it's in the certificate (this is a right to purchase some bunch of a new offering of stock, in order to preserve your percentage of ownership).
• Treasury stock: pretty much a meaningless concept, though confusing. Nowadays, stock is either outstanding or it's not (i.e., authorized but unissued). Treasury stock was stock that got sort of "retired."
• § 104(4), (5), (7) measures requiring some super-majority approval, limitations on the duration of corporation, limitation on director liability (exculpation, which is different from indemnification).
• 106, 107: powers of incorporators, and when the corporation commences.
• 108: initial meeting; 109: bylaws (shareholders can always amend; directors can amend only if the articles permit).
• 125: ultra vires and the proceedings that can arise out of it: derivative suits, dissolution, etc.
• 242: amending the articles
• Grant v. Mitchell
  Powers of incorporators (§ 107) and the first meeting (§ 108).

  He may have had a meeting (with himself), but there was nothing in writing. So there are these forms, with signature lines, that make it look like Mitchell was also a director (the foreign corporation certificate). So at least McDermott, Will thought there were two directors.

  Now that doesn't have the legal effect of appointing directors, but this is evidence that Grant acknowledges that Mitchell is a director.

  But then also, the lawyers are doing some pretty egregious stuff.

  But the moral of the story is that when you're creating this sort of entity, know the steps and follow them, or there will be troubles.

• A Foreign Corporation certificate just puts the secretary of state in another state on notice of where you're incorporated.
• A Service Corporation is a corporation that provides professional services. They're limited in what business they can engage in-- this is because of regulation on specific businesses: it puts people on notice that all they can do is provide this one professional services (i.e., we're not organized as a partnership, but we're only going to be accountants or lawyers or whatnot). This is mostly just law firms and accountants.
• Claims on a corporations assets: it's not just for owners.
• Bonds have all sorts of terms, and one of them might include a seat on the board (but then to whom is their allegiance-- what about, e.g., the duty of confidentiality?).
• § 151: issuing multiple classes of stock
• § 152: fully paid and non-assessable: once you've paid for your stock, you can't be assessed for further payment on it.
• § 157: see Grimes v. Alteon: rights and options.
• § 158: stock can be either certificated or uncertificated
• § 160(a): a corporation can deal in its own stock.
• § 161: directors can issue authorized stock and set the price.
• § 173: dividends can take many forms. (see also 170).
• Grimes v. Alteon
  Can a CEO make an enforceable agreement to allow a shareholder without pre-emption rights to buy stock out of a new issuance?

  No.

  § 157 does not allow officers to issue rights: only directors can issue rights. The CEO can't do this.

• Problem 4-1: Creditors thought they were lending to a company with a certain amount of assets, but then it got split up. To whom to the directors owe a duty? The shareholders, not the creditors: if the creditors want there to be a duty, they need to contract for it. It's surprising that that wasn't covered here.