1、Business associations Chapter 1: Acting through others,Prof. Amitai Aviram Aviramillinois.edu University of Illinois College of Law Copyright Amitai Aviram. All Rights ReservedF18,Acting through others Overview of Chapter 1,Introduction to BA (overview of the course) Firms Actors,What is business? S
2、trategy: The idea of how to create value: Identifying a match between - Supply: a combination of resources that create a product/service Demand: a market that values the product/service above production costs Competitive advantage in combining the resources, which will allow your firm to capture mos
3、t of the surplus value & will be difficult for rivals to replicate Operations: Optimizing production & supply to maximize surplus value (by reducing production costs & increasing the products value) Governance: The rules, process & enforcement mechanisms that coordinate between people that have the
4、required resources (“stakeholders”) Business law involves governance (rules & process) that is backed by judicial enforcement Corporate law (organizational law) is the portion of business law that facilitates acting through others (legal issues arising from one person acting on anothers behalf) This
5、 course teaches the foundations of corporate law,Introduction to BA What is business law?,The main goal of corporate law is to facilitate acting through others: allowing one person (B, the beneficiary) to have another person (A, the actor) act on their behalf This often involves A dealing with a thi
6、rd party (T) on Bs behalf E.g., Bank of America (B) asks Andy (A) (employee or a real-estate agent), to find & buy an office building in Chicago,Introduction to BA What is corporate law?,Acting through others creates two major problems: The shielding problem: Preventing B from exploiting T by dealin
7、g through A (balanced against Bs interest to limit liability from As reckless behavior) E.g. (contracts), A agrees to buy Ts building for twice the market price. Must B pay? E.g. (torts), when A negotiates to buy Ts building, he loses her patience with T and punches him. Is B liable to T for damages
8、? Law will be covered in Chapter 3,Introduction to BA What is corporate law?,Introduction to BA What is corporate law?,The second goal of corporate law is to facilitate business activity that is conducted jointly by multiple people: acting jointly through others A business association (“firm”) is a
9、legal concept designed to let multiple beneficiaries conduct business jointly Doing business jointly creates a problem of collective control: making all EHs speak with one voice Difficult if there is: High cost to act collectively Unequal access to info/expertise Differing business interests Two dys
10、functions (note analogy to the agency problem): Beneficiary apathy: some EHs lack ability/incentive to monitor As efficiently Beneficiary rivalry: EHs have different incentives regarding firms behavior, so controllers can exploit minority beneficiaries Example: Bank of America has thousands of SHs;
11、how can they collectively control the banks agents (employees) and direct the banks behavior?,Acting jointly through others adds a third problem The shielding problem: Preventing B from exploiting T by dealing through A (balanced against Bs interest to limit liability from As reckless behavior) The
12、(vertical) agency problem: Preventing A from shirking or stealing The principal problem (“horizontal agency problem”): Making EHs speak with one voice (preventing some EHs from exploiting other EHs) When beneficiaries cant speak with one voice (because of apathy or rivalry), we need delegated contro
13、l: appoint an uncontrolled actor (autonomous fiduciary e.g., the board of directors) to control firm on EHs behalf This reduces the principal problem, but increases the agency problem (keeping the autonomous fiduciary accountable to the beneficiaries) The principal problem also complicates the shiel
14、ding problem: Each EH is concerned about her personal assets seized because of firms obligations (& firm is concerned about each EHs obligations). Do we distinguish between firms assets/liabilities & EHs? Asset partitioning (e.g., limited liability) reduces principal problem by doing so, but this in
15、creases the shielding problem E.g.: EH forecloses on shares of a gas station & owns them in lieu of a defaulted $2M loan. When gas station makes profits, it pays them to EH as dividends. Gas station has a spill that causes $10M in environmental damage. When gas station is sued for the damage, it doe
16、snt have money to pay. Must EH pay the damages?,Introduction to BA What is corporate law?,Introduction to BA Our courses structure,Chapter 2: Corporate compliance (external governance) a. Bs liability for As contracts b. Bs liability for As torts c. Reaching better defendants,Chapter 3: Corporate go
17、vernance (internal governance) a. Fiduciary duties,Chapter 1: Acting through others a. Introduction to BA (todays class) b. Firms c. Actors,Acting through others Overview of Chapter 1,Introduction to BA Firms Economic & legal types of firms Creating a firm Constitutional documents Control in the fir
18、m Actors,Private firm (low cost for EHs to speak in one voice; e.g., few EHs) Direct control by EHs Liberal termination/dissociation (firm often must accommodate dissenting EHs exit) Restricted alienability (difficult to sell EHs interest to third parties) Contractual flexibility (parties can opt ou
19、t of most rules) Shielding Problem Agency problem (-) Principal problem (+) Public firm (high cost for EHs to speak in one voice; e.g., many EHs) Delegated control (firm controlled by a board that is elected by EHs) Restrictive termination/dissociation (firm rarely must accommodate dissenting EHs ex
20、it) Liberal alienability (easy to sell EHs interest to third parties) Contractual rigidity (most rules are mandatory) Shielding Problem Agency problem (+) Principal problem (-) Proprietorship (a single EH) Operates a business but does not have multiple owners Shielding Problem Agency problem (-) Pri
21、ncipal problem (X) Passive firm (single EH or multiple EHs) Firm owns assets but doesnt operate a business; firm structure used to benefit from some legal features (e.g., preferable tax treatment; limited liability, etc.) Shielding Problem Agency problem (X) Principal problem (X),Types of firms Econ
22、omic types of firms,Limited liability company (“LLC”) Two defaults for governance: member-managed (similar to partnership) or manager-managed (similar to corporation) Proprietorship (aka Sole Proprietorship) An individual operating a business directly (without using an artificial entity); sometimes
23、uses a business name (“doing business as” or dba) Business trust (based on the common law concept of a trust) Cooperative associations (ownership based on employment/consumption, not capital) Nonprofit associations/corporations,Types of firms Legal types of firms,Partnership General partnership (“GP
24、” or “partnership”) Limited liability partnership (“LLP”) Limited partnership (“LP”) Limited liability limited partnership (“LLLP”) Joint venture Joint stock company,Corporation Public corporation Close corporation Benefit corporation,Types of firms The corporation,By default, the corporation is opt
25、imized to be a public firm Delegated control Liberal alienability/restricted termination different definitions in Federal securities law & state corporate law,Types of firms Close corporations,Some jurisdictions have special rules for close corporations, which are optimized to be a private firm Stat
26、utory close corporation (Delaware) DGCL 342 allows a corporation to elect close corporation status, if: Charter provides that it is a close corporation Charter provides that it may have no more than 30 SH Corporation didnt issue stock in a public offering Stock is subject to one/more transfer restri
27、ctions specified in 202 DGCL rules unique to close corporations Direct control: charter may allow corp to be managed by SHs rather than directors (DGCL 351) Contractual flexibility: SH agreement between SHs who hold a majority of the outstanding voting stock binds the parties even if it interferes w
28、ith the boards discretion (DGCL 350). Within this scope, directors are relieved from FD and FD is imposed instead on the SHs party to the agreement Liberal termination: Charter may give SHs a right to dissolve the corporation, at will or at the occurrence of a certain event (DGCL 355) Common-law clo
29、se corporations In some states (e.g., Mass.) case-law applies different rules if corp is closely-held Direct control: FD analysis is more sensitive to risk of oppression of minority SHs (i.e., more focus on FD to minority SHs that on FD to the firm) Liberal dissolution: Courts are less reluctant to
30、order judicial dissolution if relationship between SHs is dysfunctional,Types of firms Benefit corporations,Most jurisdictions require that the purpose of corporate acts is to maximize shareholders financial interests Some states (e.g., CA, DE, NY) allow creation of & conversion into a public benefi
31、t corporation (PBC) or a flexible purpose corporation (FPC) PBCs need to state in charter they have the purpose of creating a public benefit Directors of a benefit corporation may prefer non-SH interests: “The board of directors shall manage or direct the business and affairs of the public benefit c
32、orporation in a manner that balances the pecuniary interests of the stockholders, the best interests of those materially affected by the corporations conduct, and the specific public benefit or public benefits identified in its certificate of incorporation” DGCL 365(a) A director “will be deemed to
33、satisfy her fiduciary duties to stockholders and the corporation if her decision is both informed and disinterested and not such that no person of ordinary, sound judgment would approve” DGCL 365(b) Drawback of PBCs/FPCs? Potentially unaccountable boards (do what they want & find a stakeholder who b
34、enefits to justify their actions),Types of firms The partnership,By default, GP is optimized to be a private firm Governed in most states by the Uniform partnership act (1997) (“UPA”) Now included as Article 3 of UBOC Other variations of partnerships Limited liability partnership (“LLP”): same as GP
35、 except partners have limited liability (governed by UPA/Article 3 of UBOC) Limited partnership (“LP”) Two classes of partners: general & limited General partners have control rights & unlimited liability Limited partners have limited liability & very limited control rights Governed by Uniform Limit
36、ed Partnership Act (“ULPA”) / Article 4 of UBOC Limited liability limited partnership (“LLLP”): same as LP except that all partners have limited liability (governed by ULPA / Article 4 of UBOC) Mostly obsolete variations of partnerships Joint venture Joint stock company,Acting through others Overvie
37、w of Chapter 1,Introduction to BA Firms Legal & Economic types of firms Creating a firm Constitutional documents Control in the firm Actors,Creating a firm Methods of firm creation,Creation by filing (corporation, LLC, LP, LLLP) Firm is created when Secretary of State confirms that an entrepreneur (
38、EH or someone who will recruit EHs) filed certain documents Creation by conversion (statutory section allows firm of one type become another type) Conversion through election (firm converts by voting to do so) GP can convert into LLP or LP; LP can convert into GP Conversion through merger (firm conv
39、erts by merging into another firm of a different legal type) Requires statutory authorization (typically, conversion is authorized between corporation/LP/LLLP/LLC & between GP/LP) Spontaneous creation (GP) Firm is created when EHs act in certain ways, even if they formally dont act to (or even want
40、to) create a firm,Creating a firm Creation by filing (creating a corporation),Incorporator chooses the state of incorporation Incorporator drafts charter Incorporator files charter with the relevant states Secretary of State The person filing the charter is the incorporator (DGCL 107); an incorporat
41、or is an autonomous fiduciary (owes a fiduciary duty to the corporation) Once state certifies the filing, corporation has been created (DGCL 106) Organizational meeting of incorporator/initial board (DGCL 108) Adopts bylaws; names directors if initial board was not named in charter Board issues shar
42、es to SHs Board appoints officers and other agents,Corporation is created only when Secretary of State acknowledges that the charter was filedException “defective corporation”: sometimes courts recognize a corporation even without Secretary of States certification of the charter being filed De facto
43、 corporation Corporation by estoppel,Creating a firm Creating a corporation: defective corporations,Creating a firm Spontaneous creation (creating a GP),Definition of a GP UPA 101(6), 202(a): “an association of two or more persons to carry on as co-owners a business for profit” Co-owners means: Shar
44、ed control of the business; and Shared profits of the business. Spontaneous creation: doing business as co-owners results in creation of partnership by operation of law Fenwick NJ 1945 Fenwick owns a beauty shop; Chesire works as a receptionist Chesire demands raise; Fenwick counters with offer to m
45、ake her a partner, with a right to 20% of the profits (in addition to her salary). They sign an agreement. Why does Unemployment Compensation Commission dispute existence of a partnership? If Chesire is employee, # of employees exceeds exemption from paying to the unemployment compensation fund Fenw
46、ick relies on UPA 202(c)(3), which states that a person who receives a share of the profits is presumed to be a partner But the section creates exceptions to this presumption, including when the profits were received as a compensation of an employee or for services as an independent contractor.,Fenw
47、ick courts analysis Intention of parties: No change in business operation (no intent to share control) Right to share in profits: Chesire gets 20% Obligation to share in losses: Chesire not obligated Ownership and control of property and business: Fenwick retains Community of power in administration
48、: Chesire not involved Conduct of the parties toward 3rd parties: Filed partnership tax returns, but didnt hold themselves out as partners to suppliers S&A is a partnership,Creating a firm Spontaneous creation (creating a GP),Acting through others Overview of Chapter 1,Introduction to BA Firms Legal
49、 & Economic types of firms Creating a firm Constitutional documents Capital (some basic concepts) What are constitutional documents? Contents of constitutional documents Changing the constitutional documents Control in the firm Actors,Constitutional documents Capital: financial terminology,To finance operations, firms receive money from investors in return for claims on its assets & future profits Capital can mean either side of this transaction Firms money (and other productive resources) Investors claims on firms assets & future profits,
