LEGL 4750 - The Corporation and its Purpose Pt.2

Exam 1

Corporate Bylaws and Structures

• Bylaws are not issued by a state or submitted to a state. They are internal documents

• The bylaws organize the rules of a corporation, including voting structures by boards and S/Hs

  • E.g., must a decision be approved unanimously or by majority (directors or S/Hs).

  • The “gap filler” provision—meaning, if the bylaws lack an express rule– is that shareholders or boards vote by majority rule

• The bylaws will also list the corporation’s officers such as a President, Treasurer, CEO etc.

• Others items in the bylaws include:

  • Quorum requirements

  • Shareholder voting rights (different classes of stock can vest different voting rights)

  • Meeting procedures

  • # of directors (there can be a board of 1) as well as how they’re elected

• The power to amend the bylaws lie in the SHAREHOLDERS (one of their few rights).

What is the purpose of a corporation?

• Most corporations list “any lawful purpose,” which does still require “lawful”

• “ultra vires” means outside the scope of a corporation.

• Typically, corporations seek to make money or conduct some business for a profit.

• May a corporation be primarily in the business of advancing a social cause? Charity? Religious goal? Can a corporation give away its assets?

• So what would typically be outside the scope of a corporation?

Corporate Personnel and Corporate Purpose

• If a corporation acts outside of its purpose, why might SHAREHOLDERS sue? And what do shareholders typically want their corporations to do?

  • Shareholders are often angered when the DIRECTORS and their OFFICERS squander corporate assets, which decreases the value of the corporation.

  • The assumption is that shareholders want corporations to make money and create value.

  • Is this, in today’s day, accurate? Are shareholders, consumers, and others willing to sacrifice value for the purpose of advancing a social cause, religious belief, or other non-monetary goals?

  • In other words, a corporation must typically advance the core purposes of a corporation (such as making money for shareholders). After all, directors and officers have fiduciary duties to the S/Hs.

• Why must directors act in the shareholders’ best interest?

  • Fiduciary duties.

  • Other doctrines such as waste: a corporation cannot typically engage in “waste,” referring to the squandering of corporate assets.

• Should corporations advance “other” goals or help “stakeholders”

  • We’ll discuss in greater detail later, but this is currently a HUGE issue in corporate law.

In Re McDonalds - Facts

An executive of McDonalds, Mr. Easterbrook, had repeatedly been alleged of sexual harassment by subordinates. He had also created a boozy “boys club” in the corporate offices, leading to plenty of inappropriate behavior. The Board of McDonalds’ was aware of Mr. Easterbrook’s conduct in light of investigations by the EEOC and other regulatory bodies. Mr. Easterbrook had previously been warned about his alcohol consumption. The Board opted to reach a termination agreement “without cause,” which paid Mr. Easterbrook over $47,000,000. Had they fired him “for cause,” then they could have paid him nothing--just merely fired him.

In Re McDonalds - Shareholders’ Anger

• Shareholders objected to the substantial payment, given that the company have fired Mr. Easterbrook at no cost. Further, the shareholders believed that the directors feared litigating against Mr. Easterbrook because it would have shined light on the directors’ own bad behaviors.

• The shareholders alleged that the directors breached their duty to the corporation by placing their own best interests (e.g., avoiding embarrassment) over the corporation and, importantly, wasting corporate assets.

• After all, paying a person $47,000,000 for no good reason would seem to be in contradiction of the corporate purpose to make money for shareholders if no value is created.

In Re McDonalds - Court and Holding

• Waste: To plead a waste claim, a plaintiff must identify a transaction that is so one-sided that no rational person would approve it. Typically, that involves a transaction in which one side receives no meaningful consideration.

  • Waste derives from the ultra vires doctrine of being outside of the corporate purpose

• Court:

  • No support for a claim of waste.

  • “Through the separation agreement, the Board secured Easterbrook's swift exit with a letter of apology, a release from Easterbrook of potential claims against the Company (without giving Easterbrook a release in return), and a commitment to cooperate with the Company on post-termination matters. The separation agreement included noncompetition, non-solicitation, and non-disclosure provisions.”

  • “By reaching agreement with Easterbrook, the Board hoped the Company could avoid potentially costly and embarrassing litigation that would highlight problems with sexual harassment and misconduct that the Board was trying to address and put in the past.”

  • “In an effort to undermine the Director Defendants’ decision to terminate Easterbrook without cause, the plaintiffs point out…”

• Holding: no waste. The deal wasn’t so unreasonable to constitute a violation of corporate purpose.

U.S. Small Business Association v. Feinsod - Facts

• Facts:

  • The US Small Business Association (SBA) makes loans to certain types of qualifying small businesses. As a legal condition of a loan, a qualifying small business can’t give away the loans to third parties, engage in ‘self-dealing,’ or do other prohibited acts UNLESS the SBA approves the transactions

  • Ameritrans formed a subsidiary, Elks, to receive loans through the SBA (it received over $9,000,000 worth)

  • When Ameritrans began to struggle, Elks transferred almost all of its capital—including loans received through the SBA—to Ameritrans.

  • “Ameritrans received significant financial support from Elk, including through (1) Elk's payment of Ameritrans' expenses; (2) cash transfers; and (3) a $4.5 million board-approved loan .”

  • “Elk's financial statements filed with the SBA, as well as Elk's general ledger, reflect that Ameritrans' liability to Elk grew from $418,595 in 2009 to $10,901,847 in 2012, the majority of the liabilities being unpaid expenses. In the last nine months of 2012, Elk also paid an additional $2,800,000 of Ameritrans' expenses without any reimbursement. Further, between April 1, 2013 and April 24, 2013, defendants “approved and/or caused Elk to pay an additional $226,043 of Ameritrans' expenses with no consideration.” Ameritrans' last reimbursement to Elk was in 2011, for $38,000.…

  • “The majority of the cash transferred from Elk to Ameritrans came from the sale of Elk's investments that had been made with SBA funds. Instead of depositing the cash with IDB as required, the cash was wired to a different Elk bank account, and then to Ameritrans, without the required notice to the SBA or Elk's other lenders.”

• The shareholders of ELK got mad due to the giving away of corporate assets.

U.S. Small Business Association v. Feinsod - Issue ad Holding

• Issue: the Directors of Elk breach their duties to the shareholders and corporation—as well as potentially violated federal law—by giving Elk’s assets away, at almost no value, to Ameritrans?

• Ultra Vires:

  • The shareholders allege that the illegal transfers (potentially violated federal law) are ultra vires because the company couldn’t lawfully engage in them. After all, a corporate is organized for “any lawful purpose.”

  • Court: yes, the transactions were potentially ultra vires since the company couldn’t lawfully do them, making them outside of the scope of the corporation’s legal activities.

• Waste: Elk wasted assets by transferring them to Ameritrans for almost no consideration.

• Fiduciary Duties: We’ll discuss this another day. But, the directors seem to have violated their duty of loyalty to Elk by engaging in transactions that harmed Elk and its shareholders.

• Holding: liability for ultra vires, waste, and breach of fiduciary duties.

More on Shareholders

• Owners of the company who vote on the directors—and it’s the directors who possess management power.

• Shareholders do NOT typically owe fiduciary duties

  • After all, S/Hs are almost always passive.

• As such, S/Hs are almost never “personally” liable for the liabilities of a corp. A plaintiff must typically sue the corp for the corp’s assets, but can’t reach beyond the corp to the S/H

• Shareholders do have some rights: 1) vote on the BoDs, 2) voting on mergers, 3)vote on changing the corp’s bylaws, 4) vote to dissolve the corp, 5) vote to sell substantially all of the corp’s assets (a de facto merger, 6) inspect books 7 records

• A S/H is more likely to owe fiduciary duties, or even to become liable, when a S/H controls the corp (by virtue of owning a majority of the shares) and ”controls” the corp--more on this shortly...

Shareholder Liability

• Shareholders of a corporation enjoy limited liability: This means that debtors of a corporation must sue the corporation, not the S/Hs. If the corporation lacks enough assets to cover the debtors’ debts, that’s unfortunate and not the problem of shareholders. This is true even if a corporation is entirely owned and run by a singular person

• Parent corps and subsidiary corps (i.e., a corporation that owns another corp), even if it owns 100% of its shares, enjoys limited liability, distinct from its subsidiary.

• Except, courts can—BUT RARELY– “pierce the corporate veil”

  • When a court disregards the corporate form and holds S/Hs’ liable for frauds and illegal activities perpetrated by the S/Hs themselves

  • In Georgia: to disregard the corporate entity because a corporation is a mere alter ego, it should have been used as a subterfuge so that to observe it would work an injustice. To prevail based upon this theory it is necessary to show that the S/Hs disregarded the corporate entity and made it a mere instrumentality for the transaction of their own affairs... The concept of piercing the corporate veil is applied in Georgia to remedy injustices which arise where a party has over extended his privilege in the use of a corporate entity in order to defeat justice, perpetuate fraud...

  • Courts will almost never pierce the veil if a corporation made an honest, or even sloppy, attempt to run a business.

  • The key is generally whether a s/h (or a few) used the corporate form to run an illegal enterprise.