Corporate Formation Organization What is a

Corporate Formation & Organization

What is a corporation? A business entity characterized by the following attributes: Limited liability Centralized decision making Perpetual existence Free transferability of ownership In short, corporations are everything that general partnerships are not Challenge for business planners: construct an entity that provides the best of both worlds

Benefits of the Corporate Form Eliminates messy problems of personal liability: creditors rely on business assets. Allows investors to enter and exit the firm: all they have to do is buy or sell shares. Prevents minority investors from trying to hold up the firm by threatening to dissolve it. Makes it easy for third parties who contract with the firm to know whom they are dealing with as an authorized agent. All they need is a board resolution.

Structural Features of the Corporate Charter Marketplace U. S. firms are not constrained by headquarters, place of business, or other operational factors in choosing where to incorporate. State of incorporation dictates which corporate law rules apply under “internal affairs” doctrine. States charge annual franchise taxes ranging from $10 flat fees to $100, 000+ based on income, assets, etc. Mechanics of reincorporation are straightforward: creation of a new firm in the destination state, followed by tax-free merger of the existing corporation into the new one. Typical reincorporation costs are $70, 000 in 2000. Reincorporation requires shareholder approval.

U. S. Public Corporations (2000) Headquarters State of Incorporation From: Guhan Subramanian, The Influence of Antitakeover Statutes on Incorporation Choice: Evidence on the “Race” Debate and Antitakeover Overreaching, 150 U. Penn. L. Rev. 1795, Figures 1 & 2 (2002). N = 7, 841 companies.

International Comparison -- Europe Germany, France, Portugal apply the “real seat” theory: e. g. , Germany requires a company having its principal place of business in Germany to incorporate under German law; a company that has its headquarters outside of Germany cannot incorporate under German law. Netherlands, Ireland, Denmark, U. K. apply U. S. -style incorporation theory, I. e. , a corporation is regulated by the country in which it is incorporated, which can differ from where it is incorporated or does business. BUT: European Court of Justice in Centros decision (March 1999) and the EC Fourteenth Company Law Directive (proposed but not yet formally tabled for Council of Ministers) likely requires U. S. -style incorporation theory.

Selecting a State of Incorporation Publicly traded corporations: Delaware is home to about half of the Fortune 500 High technology firms seem to choose Delaware at an even higher rate Why Delaware? Statute? Specialized courts? Closely held corporations: home state Corporate law is not as important because the important issues are contracted Maintaining local incorporation is cheaper

Promoter Liability Promoters are personally liable on all pre-incorporation contracts: “All persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this Act, are jointly and severally liable for all liabilities created while so acting. ” MBCA § 2. 04 However, If one party urges another to sign in the name of the corporation, even though both know it does not exist, estoppel may prevail Third party may agree to look to corporation

Incorporation Process Draft articles of incorporation Called “certificate of incorporation” in DE Generic term is “charter” “One or more persons may act as the incorporator or incorporators of a corporation by delivering articles of incorporation to the secretary of state for filing” MBCA § 2. 01 “[T}he corporate existence begins when the articles of incorporation are filed” MBCA § 2. 03

Defective Incorporation Drafters of MBCA § 2. 04 meant to displace de facto corporations, which arise from a “colorable attempt” to form and exercise of corporate power Despite a few cases eliminating the de facto corporation doctrine, many courts still rely on de facto corporations Corporations by estoppel may be used to uphold limited liability Note that this is backwards because the person relying on the false representation is estopped

Post-Incorporation Incorporator usually elects directors, who complete the organization process (MBCA § 2. 05) Adopt by-laws Appoint officers Issue stock The existence of the corporation does not depend on the maintenance of corporate formalities BUT the benefits of limited liability may depend on the maintenance of corporate formalities (see “piercing the corporate veil”)

Drafting the Charter Statutory requirements minimal: Name (indicate corporate status, MBCA 4. 01) Number of shares (check MBCA 6. 01) Registered office and registered agent (MBCA § 5. 01) Incorporator name and address Optional items: Some optional items may be effective only if they appear in the charter (e. g. , limitation on director liability) Most optional items could appear in the bylaws or a board resolution; place them in the charter only if you want to insulate them from change

Charter & Bylaws – Typical Contents Articles of Incorporation: Name of Company, Address, Purpose (usually “any lawful act”), capital structure (classes, number of common shares, rights of preferred shareholders if any), other miscellaneous provisions. Bylaws (sample structure): Article I: Stockholders Article II: Board of Directors Article III: Committees Article IV: Officers Article V: Stock Article VI: Indemnification Article VII: Miscellaneous

Core Characteristics of the Corporate Form Core Characteristics GP LLC Corp. Investor Ownership X X X Legal personality X X X Limited liability X X Transferable shares X X Centralized management under an elected board X

Corporate Form – Key Benefits of Limited Liability: 1. Reduces need to monitor agents (managers) 2. Reduces need to monitor other shareholders 3. Makes shares fungible (which also facilitates takeovers, see below) 4. Facilitates diversification (without LL, minimize exposure by holding only one company) 5. Enlists creditors in monitoring managers (because creditors bear some downside risk) Benefits of Transferable Shares: 1. Permits takeovers => disciplines management 2. Allows shareholders to exit without disrupting business 3. And because of LL, shares are fungible => facilitates active stock markets, increasing liquidity Derived from: Easterbrook & Fischel, The Rationale of Limited Liability, 52 U. Chi. L. Rev. 8 9(1985)

Basic Decisionmaking Structure Shareholders Directors Officers

The Board of Directors Shareholders Directors “[E]ach corporation must have a Officers board of directors” MBCA § 8. 01(a)

The Board of Directors Shareholder agreement may “eliminate “[E]ach of directors must have a the board corporation or restrict the board of directors” MBCA § 8. 01(a) discretion or powers of the board of directors” MBCA § 7. 32(a)(1)

The Board of Directors “All corporate powers …” MBCA § 8. 01(b)

The Board of Directors “All corporate = employees “inside” directorspowers …” MBCA § 8. 01(b)

The Board of Directors “outside” directors = non-employees

The Board of Directors “independent” directors = non-employees without substantial ties to the corporation

The Board of Directors “disinterested” directors = directors without a financial interest in the relevant transaction

Board Size One director is enough (MBCA § 8. 03(a)) Number of directors (or a range) usually fixed by the charter or a bylaw (MBCA § 8. 03(c))

Election of Directors elected at annual meeting of shareholders (MBCA § 8. 03(d)) “Staggered” boards have special rules (MBCA § 8. 06) Directors hold office until their successors are elected and qualified

Meetings of the Board Directors act at regular or special meetings of the board (MBCA § 8. 20(a)) Directors may act without meeting, by unanimous written consent (MBCA § 8. 21(a)) Quorum: unless altered by the charter or bylaws, a majority of the board forms a quorum (MBCA § 8. 24(a) & (b)) The board of directors acts by majority vote, unless the charter or bylaws require a supermajority (MBCA § 8. 24(c))

Board Committees The board of directors may act through committees comprised of fewer than the total number of directors (MBCA § 8. 25(a) The rules governing meetings of the board also govern meetings of committees (MBCA § 8. 25(c)) Committees may be authorized to act on behalf of the whole board (MBCA § 8. 25(d)) Stock exchange rules may require committees and certain composition of the committee – e. g. , audit committee have at least one financial expert Federal regulation also has focused on committees (S-OX) Audit, Nominating, Compensation Legal Compliance? ? ?

Removal of Directors: MBCA Directors may be removed by shareholders with or without cause. MBCA § 8. 08(a) If a director is elected by a specific class of shares, only those shares may remove the directors. MBCA § 8. 08(b) Special rules for cumulative voting. MBCA § 8. 08(c) Directors may be removed in a judicial proceeding for bad behavior, if the court finds that removal is in the best interests of the corporation. MBCA § 8. 09

Removal of Directors: DGCL Under DGCL, directors may always be removed for cause Under DGCL § 141(k)(1), removal of directors in staggered board is only for cause

Vacancies and New Directorships Vacancies are caused by death, removal, resignation Creation of a new directorship functionally the same as a vacancy Shareholders or directors may fill vacancies or new directorships. MBCA § 8. 10; DGCL § 223

Basic Decisionmaking Structure Shareholders Directors Officers

Shareholder Voting Generally “[E]ach outstanding share … is entitled to one vote on each matter voted on at a shareholders’ meeting” (MBCA § 7. 21(a)) Subject matter Electing of directors (MBCA § 8. 03(d)) Removing of directors (MBCA § 8. 08) Amending the charter (MBCA § 10. 03) Amending the bylaws (MBCA § 10. 20) Approving a merger (MBCA § 11. 03) Approving sale of all the company’s assets (MBCA § 12. 02) Approving dissolution (MBCA § 14. 02) Ratifying conflict-of-interest transactions (MBCA § 8. 61(b)(2))

The Voting System -- Basic Features Shareholders vote on three kinds of matters: (1) election of directors; (2) “organic” or “fundamental” changes, e. g. , mergers, sales of all assets, corporate dissolutions, charter amendments; and (3) shareholder resolutions. Registered shares: each share has a holder of record, which facilitates getting in touch with the ultimate beneficial holder (unlike bearer system in France & Germany). Proxy system: if you can’t attend the annual shareholder meeting (ASM), you can still vote by finding a representative (proxy) who goes to the meeting and votes on your behalf. State law mandatory rules: all state statutes except one require an annual meeting for election of directors; quorum requirements. State law default rules: all state statutes permit special meetings and action by written consent, though default varies.

Voting Rules Director elections Straight Voting v. Cumulative Voting Plurality wins Other matters One share, one vote Majority wins, unless supermajority specified

Cumulative Voting -- Mechanics Cumulative Voting: each shareholder gets votes equal to number of shares owned times number of seats to be filled. Example: Family Corp. has 300 shares outstanding; A owns 199 shares and B owns 101 shares. Family Corp. has a three -person board elected to annual terms. Straight Voting: A would win each seat 199 to 101. Cumulative Voting: B casts 303 shares all for one candidate => guaranteed to get one seat on the board, because A’s 597 votes cannot be divided three ways so that all three are greater than 303. Implication: Cumulative voting system improves likelihood of minority representation on the board.

Shareholder Meetings Two types: annual (MBCA § 7. 01) and special (MBCA § 7. 02) Special Meetings: DGCL § 211(d) allows board to call a special meeting. RMBCA § 7. 02 allows board or 10% of shareholders to call a special meeting. Modern statutes also allow for written consent: MBCA § 7. 04(a): requires unanimous consent DGCL § 228: number of votes required in meeting Shareholders may vote in person or by proxy (MBCA § 7. 22(a))

Calling a Shareholder Meeting Annual Meetings MBCA § 7. 01(a): in accord with bylaws (if silent, presumably by board) DGCL § 211(a): in accord with charter or bylaws; if silent by board Special Meetings MBCA § 7. 02: called by board or other person authorized by charter or bylaws; 10% shareholders (or a different percentage not in excess of 25%) may demand DGCL § 211(d): called by board or other person authorized by charter or bylaws (note that no default provision for shareholder action)

Setting an Annual Meeting Date MBCA § 7. 01(a): in accord with bylaws Court may order if meeting is not held within 6 months of the end of the fiscal year or 15 months after its last annual meeting (§ 7. 03(a)(1)) DGCL § 211(b): in accord with bylaws If not held within 30 days after the designated date, the court may order a meeting (§ 211(c)) If no date is designated and 13 months have passed since the last annual meeting (or written consent in lieu thereof), the court may order a meeting (§ 211(c)

Setting a Special Meeting Date Special Meetings (MBCA): Board must give notice no fewer than 10 nor more than 60 days before the meeting date (§ 7. 05(a)) Court may order if notice is not given within 30 days of shareholder demand or the meeting was not held (§ 7. 03(a)(2)) Under MBCA, board has 90 days after shareholder demand to hold the meeting Special Meetings (DGCL): Board must give notice no fewer than 10 nor more than 60 days before the meeting date (§ 222(b)) But DGCL § 211(d) does not provide for shareholder right to call special meetings; therefore, date regulations are less critical here

Fiduciary Limits on Setting the Meeting Date General Principle: directors must act in the interests of shareholders, not for the purpose of entrenchment Two situations Setting the date: boards are given broad discretion Changing the date: courts want specific evidence of shareholder benefit Fiduciary duties fill gaps left by the statute and organizational documents (charter and bylaws)

Record Dates The record date is the date on which the right to vote is determined MBCA § 7. 07(a) in accord with bylaws; absent bylaw provision, the board sets a “future date” Not be more than 70 days before the meeting (§ 7. 07(b)) If no date is set, it is the day before notice of the meeting DGCL § 213(a): board fixes record date Cannot precede the date of the board resolution Not more than 60 nor less than 10 days before meeting If no date is set, it is the day before notice of the meeting