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corporate law: extensive summary of the lectures for final exam (GRADE: 9)
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extensive summary of the lectures for final exam, UvA year 2
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corporate law: full summary of the book (GRADE: 9)
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Business Law for IBA
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Summary lecturesLearning objectives:
1. differentiate the five key legal attributes for corporations in all jurisdictions (legal personality, limited liability, delegated management,
transferable shares and investor ownership)
2. characterize and compare the common structure of corporate (or company) law in comparative investigation
3. identify the general functions of corporate law
4. characterize and compare conflicts of interest (three agency problems) among corporate constituencies
5. detect the basic governance structure and conflicts in the interests of (minority) shareholders
6. identify the (legal) position of the stakeholders in creditor, related-party and control transactions
Corporate law is a broad area of law that includes the laws and regulations that are relevant to companies, such as rules on the establishment of a
company and on its termination. But also about cooperation, financing, contracts, privacy, liability and bankruptcies
Organizing a business in corporate form: allows a company to function independently from the owners of the business.
What is corporate law?
Company law can help business or it can hinder them
Owners have nothing to say in day-to-day decisions, B.O.D does.
Company law can encourage entreprene. urship, promote growth, enhance international competitiveness and create conditions for
investment and commitment of resources, whether of savings or employment.
Or it can frustrate entrepreneurs, inhibit growth, restrict competitiveness and undermine the conditions for investment
Economic activity is dominated not by natural persons, but by legal personalities. Legal personalities are distinct from their owners
(assets, contracts, liability). Particularly present since 200 years
Principal function corporate law = provide business enterprises with a legal form that possesses five core arttributes. By making this
form widely available and user-friendly, corporate law enables business participants to transact easily through medium of corporate
entity, and thus lowers cost of conducting business
Principal focus of book = reducing ongoing costs of organizing business through corporate form. Done by facilitating coordination
between participants and reducing scope for value-reducing forms of opportunism among different cosntituencies
Limited liability = shielding the owner’s assets from corporate creditors. Can be established by contract
Asset partitioning = shielding the assets of the firm from the owner’s creditors. Requires legal framework
Law and practice move side by side and evolve continuously. Legal distinctions between the assets and creditors of the firm vs the
assets and creditors on the other need to codevelop. Legal framework for the distinctions necessary to police
Scope:
- mostly practical comparative law
- in search of solutions between international jurisdictions (google: Jurisdiction refers to the power of a state to affect persons,
property, and circumstances within its territory)
- most common jurisdictions: Brazilian, French, German, Italian, Japanese, British, and American
- highlight the similarities, rather than emphasizing the differences
- example of Steinhoff international Group
The corporate organs:
1. shareholders: investors, owners
2. board of directions: management
3. supervisory board: supervision, one tier/two tier
Agency problem:
An agency problem is a conflict of interest inherent in any relationship where one party is expected to act in another's best interests. In
corporate finance, an agency problem usually refers to a conflict of interest between a company's management and the company's
stockholders
- basics: shareholders are principals that provide capital to an enterprise, and managers are agents that use that capital to run the
enterprise
- conflicts between managers and shareholders, conflicts between controlling and non-controlling shareholders, conflicts between
shareholders and corporation’s stockholders
- the shareholder primacy norm consists of two principles:
1. maximizing long-term shareholder value is the only legitimate objective of the corporation
2. designing ways to assist shareholders in exerting control through their powers will minimize the agency costs that result from the
separation of ownership from control in publicly traded and diffusely held corporations
Other stakeholders and law: the underlying assumption here is that the protection of other corporate stakeholders (employees,
consumers, creditors, depositors, and others) belongs to other realms of law, such as employment contracts, consumer protection law,
debt contracts, banking law, etc; in contrast, shareholders do not get any such protection from other areas of law (stakeholder model)
A shareholder owns the shares of the company. A stakeholder is a member of group that has interest in the company’s business for
multiple reasons apart from just stock performance and can affect or be affected by the business
Shareholders enjoy limited liability, partnerships do not.
Jointly owned enterprise faces coordination costs and engenders conflicts (agency)
Five legal characteristics for almost all large scale businesses:
1. legal personality:
- nexus of contracts = corporations are nothing more than a collection of contracts between different parties (shareholders, suppliers,
customers, employees)
- corporation will continue to live even if for example all shareholders die, as a counterparty for all the contracts
,- nexus for contracts = corporation is permitted to serve as the common counterparty in many contracts, distincting the individuals who
own or manage the firm from the firm as a single counterparty
- corporations as a nexus for contracts is called separate patrimony: the assets of the owners (shareholders) of the firm are separate
from the assets of the firm (entitlement of ownership includes making the firm’s assets available for creditors (and right to use/sell))
- entity shielding (core function of separate patrimony) = the firm’s assets are unavailable for the owners’ personal creditors. 2 rules of
law: priority rule & liquidation protection
Priority rule (priority for business creditors) = a claim on the firm’s assets is prior to the claim of the claims of the personal creditors of
the firm’s owners (rule applies including partnerships) grants to creditors of firm. Shared by modern legal forms incl. partnerships
Liquidation protection = individual owners of the firm cannot withdraw their share of the firm at will; and personal creditors cannot
foreclose on the owners’ share of the firm at will. Withdrawal/foreclosure would force partial/complete liquidation of firm. Not shared
by modern legal forms incl. partnerships
- entity shielding:
Strong-form: if both rules apply (priority and liquidation protection rule). Strong-form firm facilitates tradability of shares (3rd
characteristic) because of the isolation of the value of the firm
Weak-form: only the priority rule applies (e.g. partnerships)
- for a legal personality to serve effectively as a contracting party, there are 2 more rules of law:
Authority-delegated management = who has authority in the corporation to buy and sell assets in the name of the firm and enter into
contracts that are bonded by those assets
Procedures = corporations are subject to law suits, not the individual owners
- 3 foundation rules of the separate legal personality: entity shielding, authority-delegated management and procedures (require
doctrines to be effective).
The law serves to reduce costs of doing business and to create common expectations on (potential) creditors; authority on transferring
rights relating to corporate assets; and procedures for lawsuits (specified by the state) but for lawyers (practioners) the legal personality
is an instrument, not a necessary condition
- company is itself a person, in eyes of law, straightforward to deduce that it should be capable of entering into contracts and owning its
own property; capable of delegating authority to agents; capable of suing and being sued in own name.
- Steinhoff NV-introduction:
-
2. limited liability
- corporate form provides default term in contracts between firm and its creditors whereby creditors limited to making claims against
assets that are held in name of (or owned by) firm itself, and have no claim against assets that the firm’s shareholders hold in own
names
- limited liability is a contracting tool and financing advice, which shields the firm’s owners from creditors’ claims. This facilitates
diversification. Imposes finite cap on downside losses, making feasible for shareholders to diversify holdings. Lowers risk of
shareholders’ portfolio’s, reducing risk premium they will demand and so lowers firm’s cost of equity capital.
- owner shielding (low risk) is the opposite of entity shielding. Entity shielding protects assets of firm from creditors of firm’s owners,
while limited liability (owner shielding) protects assets of firm’s owners from claims of firm’s creditors.
- asset shielding: owner shielding (limited liability), entity shielding (protecting the firm’s assets from personal creditors). Together
ensure that business assets are pledged as security to business creditors, while personal assets of business owners are reserved for the
owners’ personal creditors.
- limited liability in default provisions
- limited liability in contract, i.e. to creditors of the firm (=not limited liability to third parties who have been injured as a result of
negligent behavior)
- weak form:
Unlimited liability = risk is depending on how the business has been done. Active shareholders to keep the risk under control. Owners
are personally responsible for unpaid firm debts up to some multiple of their initial investments
Partnership with pro-rata liability = each owner of the firm is personal liable for firm debts, to a fraction of the firm’s unpaid debt,
determined by the owners’ share in firm profits.
- firms are usually build as a group; with multiple subsidiaries. Transparency as to the location of the assets can be reduced.
3. transferable shares
- transferable shares allow a business to run as usual while owners change (=transferability) -> avoiding complications of member
withdrawal -> enhances liquidity of shareholders’ interests, easier to construct/maintain diversified investment portfolios
, - distinguishes corporation from partnership and other standard-form legal entities
- the bundle of contracts that constitute a firm are held together through transferable shares, so no need for rule requiring owners to
continue to participate. If becomes sole proprietor (absence of legal entity), counterparties concerned that assignment of their
contracts reduces value of their expected performance and restrict it. For these reasons, jurisdictions have default rule prohibiting
assignment contracts without prior consent of other contracting party. But these requirements make more difficult to sell business and
liquidate investment. Legal personality addresses these issues by (sim. Transfer):
- bundle assignability is the simultaneous transfer of all (but no less than all) of a firm’s contracts by transferring the corporation’s
shares (=free transferability of all form’s conrtacts taken together, term: bundle assignability), while preserving default rule (non-
assignable without consent contractual counterparty)
- without legal personality, the transfer of contracts needs the consent of the counterparty (default rule)
- fully transferable is not the same as freely transferable
- Even if shares are transferable, they may not be tradable without restriction in public markets, but rather just transferable among
limited groups of individuals or with the approval of the current shareholders or of the corporation. Free tradability maximizes the
liquidity of shareholdings and the ability of shareholders to diversify their investments. It also gives the firm maximal flexibility in raising
capital. However, free tradability can also make it difficult to maintain negotiated arrangements for sharing control and participating in
management -> mechanisms provided for restricting transferability
- free trade maximizes capital raised for the firm; liquidity of shareholders and ability to diversify their investments open or public
corporations = freely tradable shares; stock exchange; listed or publicly trade corporations; possibility to restrict trade in statutes
closed or private corporations = restrictions on tradability; closely held shares
- globally: all standard corporations have these same features.
- transferability of shares closely connected w/liquidation protection that is feature of strong-form legal personality and limited liability.
Absent of either of these features could change firm’s creditworthiness (partnerships lack all these features)
Conventional general partnerships lack strong-form legal personality, limited liability and transferable shares
4. delegated management with board structure
- standard legal forms for enterprise organizations differ in allocation of control rights, including authority to bind firm to contracts,
authority to exercise powers granted to firm by its contracts, and authority to direct uses made of assets owned by the firm.
- principal authority in a board of directors (periodically elected by the firm’s shareholders):
> 1. Board separate from operation management; BoD is separate from decisions that don’t need shareholder approval. Separation
between initiation and execution of business decisions, and monitoring and ratification of decisions and hiring of officers.
> 2. BoD elected by the shareholders and as such responsive to the interest of the firm’s owners
> 3. BoD formally distinct from the shareholders; all but most fundamental decisions have to be approved by the shareholders,
economizing the cost. Also permits board to serve as mechanism for protecting interests of minority shareholders and stakeholders(?)
(other term: corporate constituencies)
> 4. multiple persons in the BoD facilitates mutual monitoring and checks idiosyncratic decision-making
5. investor ownership
- key elements ownership: (i) right to control the firm (voting and approving major transactions) (ii) right to receive the firm’s earnings
- proportional to the amount of capital contributed (above)
- further specialization in investor-owned companies for hybrid firms, for instance for social objectives, state-owned enterprises (SOEs)
or worker codetermination (non-investor participation) – controversies
Most international jurisdictions contain statutes that enable firms to adopt these characteristics
Sources of corporate law: most jurisdictions have statutory forms to form a closed corporation, or quasi-corporate statutory forms, or
to permit formation of public corporations(where some of the five characteristics are added by contract), examples:
- google: statutory forms = a document that registered companies have to complete with information on their business activities and
then file with a governmental authority
Special and partial corporate forms:
1. major jurisdictions have at least one distinct statutory form specialized for formation of closed corporations or limited liability
companies. They differ from open/public companies because their shares not traded freely in public market
2. some jurisdictions have in addition to special closed corporation forms, quasi-corporate statutory forms that can be used to form
business corporations with all five core characteristics, though some characteristics must be added by contract
Sources of corporate law: other bodies of law
Bodies of law contained in statutes or case law separate from the core corporation statutes, and from special and quasi-corporation
statutes just described. examples:
- these supplemental sources of law necessary part of overall structure corporate law.
- constraints imposed on companies by bodies of law designed to serve objectives:
Law versus Contract in corporate affairs
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