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Potential Problems. Thinking Through Some Issues. Limited liability. General rule: no personal liability Limits ONLY limits liability of owners Sometimes can reach beyond to owners’ assets (e.g. fraud )

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potential problems

Potential Problems

Thinking Through Some Issues

limited liability
Limited liability
  • General rule: no personal liability
  • Limits
    • ONLY limits liability of owners
    • Sometimes can reach beyond to owners’ assets (e.g. fraud)
  • Exception: direct liability of shareholders under contract or tort law if shareholder (a) assumes liability by contract or (b) commits a tort in the conduct of corporation’s business
slide3
Exception: “Piercing the corporate veil”
  • Equitable remedy
  • “Piercing sees to happen freakishly. Like lightning it is rare, severe and unprincipled.”
      • Frank Easterbrook & William Fischel
slide4
Example: Dewitt Truck Brokers, Inc. v. Fleming Fruit Co., 540 F.2d 681 (4th Cir. 1976).
  • Fleming Fruit Company, a close corporation controlled by a single individual.
  • Sells fruit for growers on commission.
  • Defaults on shipping contract with DeWitt Truck.
  • Pres. of Fleming assures DeWitt he will pay if company does not.
slide5
Key factors:
    • Gross “undercapitalization” and “insolvency of the corporation”
    • Failure to observe adequate corporate formalities
    • Nonpayment of dividends
    • Control / domination by Fleming
    • Siphoning of corporate funds by Fleming
    • Nonparticipation by officers, directors, shareholders other than Fleming in affairs of corporation
slide6
Defective incorporation cases
    • De facto corporation - partially formed, serves as shield
      • Colorable compliance
      • Good faith
      • Use of corporate power (e.g. issued stock, held meetings)
    • Corporation by estoppel
      • 3rd party who dealt with entity as a corporation without expectation that shareholders will be liable is estopped
      • Good faith by party asserting defense
common structure of entity law
Common Structure of Entity Law
  • What is “corporate law” / “business organizations law”?
  • Businesses face a fundamentally similar set of problems which legal systems solve with a fundamentally similar set of legal rules and standards.
corporation
“Corporation”
  • Legal personality
  • Limited liability
  • Transferable shares
  • Delegated management under a board structure
  • Investor ownership
slide10
Why?
  • Purpose of these 5 characteristics is to constrain value-reducing forms of opportunism among the constituencies of the corporate enterprise.
  • 3 generic conflicts
    • Managers & shareholders
    • Shareholders & shareholders
    • Shareholders & other constituencies (employees, creditors)
legal personality
Legal Personality
  • Ability of the firm to own assets distinct from property of other persons.
    • Civil law: “separate patrimony”
    • “Affirmative asset partitioning”: shields assets of firm from owners’ creditors
    • “liquidation protection”: protect going concern value of firm against individual shareholders and creditors of shareholders.
limited liability1
Limited Liability
  • Default term in firm’s contract with creditors that limit creditors’ claims.
    • “defensive asset partitioning”
  • Limited liability + legal personality reduce overall cost of capital by facilitating monitoring of assets.
  • Allows isolation of lines of business for obtaining credit.
transferable shares
Transferable shares
  • Permits firm to conduct business uninterruptedly as identity of owners changes.
  • Connected to liquidation protection: value of firm stays constant because of limited liability, legal personality, and transferable shares.
delegated management board
Delegated management + board
  • Centralization of management.
  • Notifies 3rd parties who have authority to bind the firm.
  • Formal separation of board and managers checks opportunism by managers.
  • Means of access to credible information for minority shareholders & other interests.
investor ownership
Investor ownership
  • Right to receive net earnings.
  • Investors are hardest to protect contractually; corporate law solves problem.
  • Investors have (are induced to have) homogenous interests.