Delaware General Corporations Law Chapter 1 GENERAL ... · the names on such records of each other...

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Excerpted from: STATE OF DELAWARE, DELAWARE CODE ONLINE, delcode.delaware.gov

Delaware General Corporations Law Chapter 1

GENERAL CORPORATION LAW Subchapter I Formation

§ 101 Incorporators; how corporation formed; purposes. (a) Any person, partnership, association or corporation, singly or jointly with others, and without regard to such

person's or entity's residence, domicile or state of incorporation, may incorporate or organize a corporation under this chapter by filing with the Division of Corporations in the Department of State a certificate of incorporation which shall be executed, acknowledged and filed in accordance with § 103 of this title.

(b) A corporation may be incorporated or organized under this chapter to conduct or promote any lawful business or purposes, except as may otherwise be provided by the Constitution or other law of this State.

(c) Corporations for constructing, maintaining and operating public utilities, whether in or outside of this State, may be organized under this chapter, but corporations for constructing, maintaining and operating public utilities within this State shall be subject to, in addition to this chapter, the special provisions and requirements of Title 26 applicable to such corporations.

(8 Del. C. 1953, § 101; 56 Del. Laws, c. 50; 70 Del. Laws, c. 186, § 1; 70 Del. Laws, c. 587, § 1; 71 Del. Laws, c. 339, § 1.)

§ 102 Contents of certificate of incorporation. (a) The certificate of incorporation shall set forth:

(1) The name of the corporation, which (i) shall contain 1 of the words "association," "company," "corporation," "club," "foundation," "fund," "incorporated," "institute," "society," "union," "syndicate," or "limited," (or abbreviations thereof, with or without punctuation), or words (or abbreviations thereof, with or without punctuation) of like import of foreign countries or jurisdictions (provided they are written in roman characters or letters); provided, however, that the Division of Corporations in the Department of State may waive such requirement (unless it determines that such name is, or might otherwise appear to be, that of a natural person) if such corporation executes, acknowledges and files with the Secretary of State in accordance with § 103 of this title a certificate stating that its total assets, as defined in § 503(i) of this title, are not less than $10,000,000, or, in the sole discretion of the Division of Corporations in the Department of State, if the corporation is both a nonprofit nonstock corporation and an association of professionals, (ii) shall be such as to distinguish it upon the records in the office of the Division of Corporations in the Department of State from the names that are reserved on such records and from the names on such records of each other corporation, partnership, limited partnership, limited liability company or statutory trust organized or registered as a domestic or foreign corporation, partnership, limited partnership, limited liability company or statutory trust under the laws of this State, except with the written consent of the person who has reserved such name or such other foreign corporation or domestic or foreign partnership, limited partnership, limited liability company or statutory trust, executed, acknowledged and filed with the Secretary of State in accordance with § 103 of this title, (iii) except as permitted by § 395 of this title, shall not contain the word "trust," and (iv) shall not contain the word "bank," or any variation thereof, except for the name of a bank reporting to and under the supervision of the State Bank Commissioner of this State or a subsidiary of a bank or savings association (as those terms are defined in the Federal Deposit Insurance Act, as amended, at 12 U.S.C. § 1813), or a corporation regulated under the Bank Holding Company Act of 1956, as amended, 12 U.S.C. § 1841 et seq., or the Home Owners' Loan Act, as amended, 12 U.S.C. § 1461 et seq.; provided, however, that this section shall not be construed to prevent the use of the word "bank," or any variation thereof, in a context clearly not purporting to refer to a banking business or otherwise likely to mislead the public about the nature of the business of the corporation or to lead to a pattern and practice of abuse that might cause harm to the interests of the public or the State as determined by the Division of Corporations in the Department of State;

(2) The address (which shall be stated in accordance with § 131(c) of this title) of the corporation's registered office in this State, and the name of its registered agent at such address;

(3) The nature of the business or purposes to be conducted or promoted. It shall be sufficient to state, either alone or with other businesses or purposes, that the purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware, and by such statement all lawful acts and activities shall be within the purposes of the corporation, except for express limitations, if any;


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(4) If the corporation is to be authorized to issue only 1 class of stock, the total number of shares of stock which the corporation shall have authority to issue and the par value of each of such shares, or a statement that all such shares are to be without par value. If the corporation is to be authorized to issue more than 1 class of stock, the certificate of incorporation shall set forth the total number of shares of all classes of stock which the corporation shall have authority to issue and the number of shares of each class and shall specify each class the shares of which are to be without par value and each class the shares of which are to have par value and the par value of the shares of each such class. The certificate of incorporation shall also set forth a statement of the designations and the powers, preferences and rights, and the qualifications, limitations or restrictions thereof, which are permitted by § 151 of this title in respect of any class or classes of stock or any series of any class of stock of the corporation and the fixing of which by the certificate of incorporation is desired, and an express grant of such authority as it may then be desired to grant to the board of directors to fix by resolution or resolutions any thereof that may be desired but which shall not be fixed by the certificate of incorporation. The foregoing provisions of this paragraph shall not apply to nonstock corporations. In the case of nonstock corporations, the fact that they are not authorized to issue capital stock shall be stated in the certificate of incorporation. The conditions of membership, or other criteria for identifying members, of nonstock corporations shall likewise be stated in the certificate of incorporation or the bylaws. Nonstock corporations shall have members, but failure to have members shall not affect otherwise valid corporate acts or work a forfeiture or dissolution of the corporation. Nonstock corporations may provide for classes or groups of members having relative rights, powers and duties, and may make provision for the future creation of additional classes or groups of members having such relative rights, powers and duties as may from time to time be established, including rights, powers and duties senior to existing classes and groups of members. Except as otherwise provided in this chapter, nonstock corporations may also provide that any member or class or group of members shall have full, limited, or no voting rights or powers, including that any member or class or group of members shall have the right to vote on a specified transaction even if that member or class or group of members does not have the right to vote for the election of the members of the governing body of the corporation. Voting by members of a nonstock corporation may be on a per capita, number, financial interest, class, group, or any other basis set forth. The provisions referred to in the 3 preceding sentences may be set forth in the certificate of incorporation or the bylaws. If neither the certificate of incorporation nor the bylaws of a nonstock corporation state the conditions of membership, or other criteria for identifying members, the members of the corporation shall be deemed to be those entitled to vote for the election of the members of the governing body pursuant to the certificate of incorporation or bylaws of such corporation or otherwise until thereafter otherwise provided by the certificate of incorporation or the bylaws;

(5) The name and mailing address of the incorporator or incorporators; (6) If the powers of the incorporator or incorporators are to terminate upon the filing of the certificate of

incorporation, the names and mailing addresses of the persons who are to serve as directors until the first annual meeting of stockholders or until their successors are elected and qualify.

(b) In addition to the matters required to be set forth in the certificate of incorporation by subsection (a) of this section, the certificate of incorporation may also contain any or all of the following matters:

(1) Any provision for the management of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, or the governing body, members, or any class or group of members of a nonstock corporation; if such provisions are not contrary to the laws of this State. Any provision which is required or permitted by any section of this chapter to be stated in the bylaws may instead be stated in the certificate of incorporation;

(2) The following provisions, in haec verba, (i), for a corporation other than a nonstock corporation, viz: "Whenever a compromise or arrangement is proposed between this corporation and its creditors or any

class of them and/or between this corporation and its stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this corporation or of any creditor or stockholder thereof or on the application of any receiver or receivers appointed for this corporation under § 291 of Title 8 of the Delaware Code or on the application of trustees in dissolution or of any receiver or receivers appointed for this corporation under § 279 of Title 8 of the Delaware Code order a meeting of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this corporation as consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on

Excerpted from: STATE OF DELAWARE, DELAWARE CODE ONLINE, delcode.delaware.gov 20170604



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all the stockholders or class of stockholders, of this corporation, as the case may be, and also on this corporation"; or (ii), for a nonstock corporation, viz:

"Whenever a compromise or arrangement is proposed between this corporation and its creditors or any class of them and/or between this corporation and its members or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this corporation or of any creditor or member thereof or on the application of any receiver or receivers appointed for this corporation under § 291 of Title 8 of the Delaware Code or on the application of trustees in dissolution or of any receiver or receivers appointed for this corporation under § 279 of Title 8 of the Delaware Code order a meeting of the creditors or class of creditors, and/or of the members or class of members of this corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three fourths in value of the creditors or class of creditors, and/or of the members or class of members of this corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this corporation as consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the members or class of members, of this corporation, as the case may be, and also on this corporation";

(3) Such provisions as may be desired granting to the holders of the stock of the corporation, or the holders of any class or series of a class thereof, the preemptive right to subscribe to any or all additional issues of stock of the corporation of any or all classes or series thereof, or to any securities of the corporation convertible into such stock. No stockholder shall have any preemptive right to subscribe to an additional issue of stock or to any security convertible into such stock unless, and except to the extent that, such right is expressly granted to such stockholder in the certificate of incorporation. All such rights in existence on July 3, 1967, shall remain in existence unaffected by this paragraph unless and until changed or terminated by appropriate action which expressly provides for the change or termination;

(4) Provisions requiring for any corporate action, the vote of a larger portion of the stock or of any class or series thereof, or of any other securities having voting power, or a larger number of the directors, than is required by this chapter;

(5) A provision limiting the duration of the corporation's existence to a specified date; otherwise, the corporation shall have perpetual existence;

(6) A provision imposing personal liability for the debts of the corporation on its stockholders to a specified extent and upon specified conditions; otherwise, the stockholders of a corporation shall not be personally liable for the payment of the corporation's debts except as they may be liable by reason of their own conduct or acts;

(7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. All references in this paragraph to a director shall also be deemed to refer to such other person or persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with § 141(a) of this title, exercise or perform any of the powers or duties otherwise conferred or imposed upon the board of directors by this title.

(c) It shall not be necessary to set forth in the certificate of incorporation any of the powers conferred on corporations by this chapter.

(d) Except for provisions included pursuant to paragraphs (a)(1), (a)(2), (a)(5), (a)(6), (b)(2), (b)(5), (b)(7) of this section, and provisions included pursuant to paragraph (a)(4) of this section specifying the classes, number of shares, and par value of shares a corporation other than a nonstock corporation is authorized to issue, any provision of the certificate of incorporation may be made dependent upon facts ascertainable outside such instrument, provided that the manner in which such facts shall operate upon the provision is clearly and explicitly set forth therein. The term "facts," as used in this subsection, includes, but is not limited to, the occurrence of any event, including a determination or action by any person or body, including the corporation.

(e) The exclusive right to the use of a name that is available for use by a domestic or foreign corporation may be reserved by or on behalf of:

(1) Any person intending to incorporate or organize a corporation with that name under this chapter or contemplating such incorporation or organization;

(2) Any domestic corporation or any foreign corporation qualified to do business in the State of Delaware, in either case, intending to change its name or contemplating such a change;




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(3) Any foreign corporation intending to qualify to do business in the State of Delaware and adopt that name or contemplating such qualification and adoption; and

(4) Any person intending to organize a foreign corporation and have it qualify to do business in the State of Delaware and adopt that name or contemplating such organization, qualification and adoption. The reservation of a specified name may be made by filing with the Secretary of State an application, executed by the applicant, certifying that the reservation is made by or on behalf of a domestic corporation, foreign corporation or other person described in paragraphs (e)(1)-(4) of this section above, and specifying the name to be reserved and the name and address of the applicant. If the Secretary of State finds that the name is available for use by a domestic or foreign corporation, the Secretary shall reserve the name for the use of the applicant for a period of 120 days. The same applicant may renew for successive 120-day periods a reservation of a specified name by filing with the Secretary of State, prior to the expiration of such reservation (or renewal thereof), an application for renewal of such reservation, executed by the applicant, certifying that the reservation is renewed by or on behalf of a domestic corporation, foreign corporation or other person described in paragraphs (e)(1)-(4) of this section above and specifying the name reservation to be renewed and the name and address of the applicant. The right to the exclusive use of a reserved name may be transferred to any other person by filing in the office of the Secretary of State a notice of the transfer, executed by the applicant for whom the name was reserved, specifying the name reservation to be transferred and the name and address of the transferee. The reservation of a specified name may be cancelled by filing with the Secretary of State a notice of cancellation, executed by the applicant or transferee, specifying the name reservation to be cancelled and the name and address of the applicant or transferee. Unless the Secretary of State finds that any application, application for renewal, notice of transfer, or notice of cancellation filed with the Secretary of State as required by this subsection does not conform to law, upon receipt of all filing fees required by law the Secretary of State shall prepare and return to the person who filed such instrument a copy of the filed instrument with a notation thereon of the action taken by the Secretary of State. A fee as set forth in § 391 of this title shall be paid at the time of the reservation of any name, at the time of the renewal of any such reservation and at the time of the filing of a notice of the transfer or cancellation of any such reservation.

(8 Del. C. 1953, § 102; 56 Del. Laws, c. 50; 57 Del. Laws, c. 148, § 1; 65 Del. Laws, c. 127, § 1; 65 Del. Laws, c. 289, §§ 1, 2; 66 Del. Laws, c. 136, § 1; 66 Del. Laws, c. 352, § 1; 67 Del. Laws, c. 376, § 1; 69 Del. Laws, c. 61, § 1; 70 Del. Laws, c. 79, §§ 1-3; 71 Del. Laws, c. 120, § 1; 71 Del. Laws, c. 339, § 2; 72 Del. Laws, c. 123, § 1; 72 Del. Laws, c. 343, § 1; 73 Del. Laws, c. 82, § 1; 73 Del. Laws, c. 329, § 43; 74 Del. Laws, c. 326, § 1; 75 Del. Laws, c. 306, §§ 1, 2; 77 Del. Laws, c. 253, §§ 1-7; 78 Del. Laws, c. 96, §§ 1-3.)

§ 104 Certificate of incorporation; definition. The term "certificate of incorporation," as used in this chapter, unless the context requires otherwise, includes

not only the original certificate of incorporation filed to create a corporation but also all other certificates, agreements of merger or consolidation, plans of reorganization, or other instruments, howsoever designated, which are filed pursuant to § 102, §§ 133-136, § 151, §§ 241-243, § 245, §§ 251-258, §§ 263-264, § 267, § 303, or any other section of this title, and which have the effect of amending or supplementing in some respect a corporation's original certificate of incorporation.

(8 Del. C. 1953, § 104; 56 Del. Laws, c. 50; 67 Del. Laws, c. 376, § 2; 69 Del. Laws, c. 61, § 2; 77 Del. Laws, c. 290, § 1.)

§ 122 Specific powers. Every corporation created under this chapter shall have power to:

* * * (9) Make donations for the public welfare or for charitable, scientific or educational purposes, and in time of war or other national emergency in aid thereof;

* * * (8 Del. C. 1953, § 122; 56 Del. Laws, c. 50; 57 Del. Laws, c. 148, § 3; 64 Del. Laws, c. 112, § 3; 65 Del. Laws,

c. 127, § 2; 71 Del. Laws, c. 339, § 7; 72 Del. Laws, c. 343, § 3.)

§ 124 Effect of lack of corporate capacity or power; ultra vires. No act of a corporation and no conveyance or transfer of real or personal property to or by a corporation shall

be invalid by reason of the fact that the corporation was without capacity or power to do such act or to make or receive such conveyance or transfer, but such lack of capacity or power may be asserted:

(1) In a proceeding by a stockholder against the corporation to enjoin the doing of any act or acts or the




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transfer of real or personal property by or to the corporation. If the unauthorized acts or transfer sought to be enjoined are being, or are to be, performed or made pursuant to any contract to which the corporation is a party, the court may, if all of the parties to the contract are parties to the proceeding and if it deems the same to be equitable, set aside and enjoin the performance of such contract, and in so doing may allow to the corporation or to the other parties to the contract, as the case may be, such compensation as may be equitable for the loss or damage sustained by any of them which may result from the action of the court in setting aside and enjoining the performance of such contract, but anticipated profits to be derived from the performance of the contract shall not be awarded by the court as a loss or damage sustained;

(2) In a proceeding by the corporation, whether acting directly or through a receiver, trustee or other legal representative, or through stockholders in a representative suit, against an incumbent or former officer or director of the corporation, for loss or damage due to such incumbent or former officer's or director's unauthorized act;

(3) In a proceeding by the Attorney General to dissolve the corporation, or to enjoin the corporation from the transaction of unauthorized business.

(8 Del. C. 1953, § 124; 56 Del. Laws, c. 50; 71 Del. Laws, c. 339, § 8.)

Subchapter IV Directors and Officers

§ 141 Board of directors; powers; number, qualifications, terms and quorum; committees; classes of directors; nonstock corporations; reliance upon books; action without meeting; removal.

(a) The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.

* * * (8 Del. C. 1953, § 141; 56 Del. Laws, c. 50; 56 Del. Laws, c. 186, § 3; 57 Del. Laws, c. 148, §§ 5, 6; 57 Del.

Laws, c. 421, § 1; 59 Del. Laws, c. 437, §§ 2-5; 64 Del. Laws, c. 112, § 6; 65 Del. Laws, c. 127, § 3; 66 Del. Laws, c. 136, §§ 2, 3; 70 Del. Laws, c. 79, §7; 70 Del. Laws, c. 186, § 1; 70 Del. Laws, c. 349, § 2; 71 Del. Laws, c. 339, §§ 11-13; 72 Del. Laws, c. 343, §§ 4-6; 73 Del. Laws, c. 298, § 2; 74 Del. Laws, c. 84, § 2; 74 Del. Laws, c. 326, § 2; 75 Del. Laws, c. 30, § 1; 75 Del. Laws, c. 306, §§ 3, 4; 76 Del. Laws, c. 145, § 1; 77 Del. Laws, c. 253, §§ 10-12; 79 Del. Laws, c. 327, § 3.)

Subchapter VII. Meetings, Elections, Voting and Notice §220. Inspection of books and records.

(b) Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from:

(1) The corporation's stock ledger, a list of its stockholders, and its other books and records; and (2) A subsidiary's books and records, to the extent that:

a. The corporation has actual possession and control of such records of such subsidiary; or b. The corporation could obtain such records through the exercise of control over such subsidiary, provided that as of the date of the making of the demand:

1. The stockholder inspection of such books and records of the subsidiary would not constitute a breach of an agreement between the corporation or the subsidiary and a person or persons not affiliated with the corporation; and 2. The subsidiary would not have the right under the law applicable to it to deny the corporation access to such books and records upon demand by the corporation.

In every instance where the stockholder is other than a record holder of stock in a stock corporation, or a member of a nonstock corporation, the demand under oath shall state the person's status as a stockholder, be accompanied by documentary evidence of beneficial ownership of the stock, and state that such documentary evidence is a true and correct copy of what it purports to be. A proper purpose shall mean a purpose reasonably




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related to such person's interest as a stockholder. In every instance where an attorney or other agent shall be the person who seeks the right to inspection, the demand under oath shall be accompanied by a power of attorney or such other writing which authorizes the attorney or other agent to so act on behalf of the stockholder. The demand under oath shall be directed to the corporation at its registered office in this State or at its principal place of business.




BUSINESS STRUCTURES

Third Edition

By

David G. Epstein George E. Allen Chair Professor of Law

University of Richmond

Richard D. Freer Robert Howell Hall Professor of Law

Emory University School of Law

Michael J. Roberts Senior Lecturer and

Executive Director of the Arthur Rock Center for Entrepreneurship

Harvard Business School

George B. Shepherd Professor of La w

Emoiy University School of Law

AMERICAN CASEBOOK SERIES®

WEST® A Thomson Reuters business

Mat #40785241

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A. WHY DOES SOMEONEOR AN INTEREST IN

1. THE EPSTEIN-FREERROBERTS-SHEPHERD

Co-author Epstein believes that mostinterest in a business) to make money. He

businesses why they do so, and gotmoney."

"Remember a few yean ago when everything was sex, sex, sex?"

© 2001 Th e N e w

CHAPTER ONE

WHAT D O BUSINESSES D O AND WHAT D O LAWYERS FOR BUSINESSES D O ?

• H I

OWN A BUSINESS A BUSINESS?

VIEW AND THE VIEW

people own a business (or an asked all of his relatives who

own the same answer from all: "to make

York e r Collodion from cartoonbunk.com. All rights reserved.

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inquire of members why they own He was able to speak with only twothose two gave him the same answer:

Co-authors Roberts and Shepherd,ed economic training than Epsteinstein/Freer view is basically correct,business is some form of activity thatowners. This means that the business but not necessarily in the conventional

First, a business can "make

2 WHAT D O BUSINESSES D O ?

To eliminate the possibility that this empirical research was flawed, co-author Freer went to the exclusive Piedmont Driving Club in Atlanta to

businesses or interests in businesses. people before being asked to leave. But

"to make money."

who suffer from more and Freer, believe that the but incomplete. They say

is organized to "create value" for its must create a profit in some

sense.

money" without creating value. instance, suppose an erstwhile entrepreneur used her hard-earned savings to purchase a business for $100,000, which generated per year. While this may seem like it is "making money," no has been created. She could have put the $100,000 in a savings account at a bank and earned that same 5% interest, without the risks, and work, of starting a business.

Second, a business can create value without "making money." Fast-growing, technology-based businesses often require a long years—of continued investment and reinvestment on the part owners before the business starts throwing off cash—"making Still, if these investments create new products that customers buy, and develop a competitive advantage for the company in its market-place, then ownership in the company will be attractive to purchasers, and the company will be able to sell its stock at an increasing-ly high price. Even if the business is spending profusely and nothing, potential purchasers' willingness to pay a higher price strates the creation of value. Whether it is a person selling tomatoes from a table in the front yard or a joint venture between Google and Verizon, the usual defining characteristic of a business is that economic activity is organized for the purpose of earning a profit.

But co-author Shepherd is a more sensitive guy, and thinks that the goals of businesses can be broader than just earning profit. Businesses can be established not only to make money, but also—or even help people. Some people who are not the least bit greedy start, invest in, and run corporations and other businesses.

For example, several public-interest lawyers may form a professional corporation the purpose of which is to help low-income victims of domestic abuse. Although the lawyers hope to make a modest living from corporation, the business form is used to limit liability, not profits. Likewise, George Steinbrenner may run the New York Yankees to win the most games, even if the team loses money.

The law makes careful distinctions between business These distinctions are based upon who the owners are (a sole proprietor,

CII. 1

sophisticat-Ep-

that a

sense,

For

a profit of $5,000 real value

cycle—many of the money."

want to

potential

earning demon-

primarily—to

their maximize

structures.

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owners. We will study these distinctions understand that businesses—regardlessforum for economic activity, the objective always, to earn an economic return, profit,proprietor.

2. VIEWS OF OTHER "GONTSER

The late Milton Friedman, who won1976, is widely regarded as the leader ofeconomics. He described his views on the

3WHY DOES SOMEONE OWN A BUSINESS? SEC. A

partners, shareholders, etc.), what rights and obligations the owners have, and whether the business itself is a legal ' 'entity" separate from the

later. What is important now is to of their legal structure—are the

of which is often, but not or other increased value to the

MACHERS"*

the Nobel Prize in Economics in the so-called "Chicago School" of

role of business in a New York Times Magazine article:

In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibili-ty to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be [to] make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. * * *

* * * [T]he key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation * * * and his primary responsibility is to them.* * *

Of course, the corporate executive is also a person in his own right. As a person, he may have many other responsibilities that he recognizes or assumes voluntarily—to his family, his conscience, his feelings of charity, his church, his clubs, his city, his country. * * * If we wish, we may refer to some of these responsibilities as "social responsibili-ties." But in these respects he is acting as a principal, not an agent; he is spending his own money or time or energy, not the money of his employers or the time or energy he has contracted to devote to their purposes. If these are "social responsibilities," they are the social responsibilities of individuals, not of business.* * *

* * * [T]he doctrine of "social responsibility" [is] * * * a "fundamen-tally subversive doctrine" in a free society, and [I] have said that in such a society there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without decep-tion or fraud.

Milton Friedman, The Social Responsibility of Business Is to Increase Its Profits, NEW YORK TIMES MAGAZINE, September 13 , 1 9 7 0 .

* You should know that "gontser macher" is a Yiddish expression for "big shot."

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1. Reconsider Professor Friedman'san agent." What is the differenceRestatement (Second) of Agency § 1.01). What is the differencean agent?" What problems canfrom her principal?

2. Would Professor Friedmanout on the Ben & Jerry's Homemade,

Ben & Jerry's gives away ways: The Ben and Jerry'sTeams at five Vermont sites; Director of Social Mission


QUESTIONS

between a "principal" and an "agent"? See § 1 (or Restatement (Third)

between "acting as a principal" and "acting as arise when

agree with this "mission statement" Inc. website in 1998?

7.5 percent of its pre-tax earnings in three Foundation; employee Community action

and through corporate grants made by the Development. We support projects which are

models for social change—projects which exhibit creative problem solving and hopefulness. The Foundation is managed by a nine-member employee board and considers proposals relating to children and families, disadvan-taged groups, and the environment.

Do the company's practices harm shareholders? If they do, would that deter you from purchasing stock in the company?

3. Would Rob Feckner, president of the board of the California Public Employees Retirement System ("CALPERS"), which has over $160 billion dollars to invest to provide for medical care and retirement benefits for California state employees, agree? Should he be permitted to refuse to invest the money in tobacco companies or in non-union companies, even if this might lower returns?

Another gontser macher, Warren Buffett, the noted investor,* viewed business philanthropy in zoological terms:

What many big shots love is what I call elephant bumping. I mean they like to go to the places where other elephants are, because it reaffirms the fact that when they look around the room and they see all these other elephants that they must be an elephant too. * * * So my friend [a fundraiser] always takes an elephant with him when he goes to call on another elephant. [A]s long as the visiting elephant is appropriately large, my friend gets his money. * * * And in the process of raising this eight million dollars from 60 corporations from people who nod and say that's a marvelous idea, it's prosocial, etc., not one CEO has reached in his pocket and pulled out ten bucks of his own to give to this marvelous charity.

* Roberts and Shepherd objected to our explaining who Warren Buffett is until Epstein and Freer assured them that many students would think Warren Buffett was that "Margaritaville guy" their parents listen to. Cf. Time Magazine, July 10, 2000. (Former Secretary of the Treasury Robert Rubin was described as believing that "any normal person would say that Jimmy Buffett

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phrase "acting as a principal, not as

of Agency

an agent has different objectives

set

is Warren Buffett's son.")

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3. VIEWS OF COURTS

In reading the following case, please

1. Who owned the A.P. Smith Mfg.

2. Who is suing whom for what?

3. Why did stockholders of A.P.contribution to Princeton? How did A.P.contributed to Princeton? Why wouldMfg. Co. did with corporate funds? Did

of

their

public

its

W H Y D O E S SOMEONE O W N A B U S I N E S S ? SEC. A

KNIGHTS, RAIDERS AND TARGETS: T H E IMPACT OF HOSTILE TAKEOVERS 14 (John C. Coffee et al. eds. 1988).

as See icy AND LEGISLATURES as

ves consider these questions:

Co.?

set

Smith Mfg. Co. complain about the ree Smith Mfg. Co. get the $1,500 it ion stockholders care what A.P. Smith the the stockholders know that A.P. are Smith Mfg. Co. would make a contribution to Princeton before becoming ing stockholders? Was that relevant to the court? Should it have been? yee

4. Did Hubert F. O'Brien attend Princeton? Was that relevant? an-Should it have been?

hat A.P. SMITH MFG. CO. v. BARLOW Supreme Court of New Jersey, 1953

blic 98 A.2d 581 lion for JACOBS, J.

/est The Chancery Division, in a well-reasoned opinion by Judge Stein, ight determined that a donation by the plaintiff The A. P. Smith Manufactur-

ing Company to Princeton University was intra vires.* * *

The company was incorporated in 1896 and is engaged in the manu-facture and sale of valves, fire hydrants and special equipment, mainly for water and gas industries. Its plant is located in East Orange and Bloom-field and it has approximately 300 employees. Over the years the company has contributed regularly to the local community chest and on occasions to

ean Upsala College in East Orange and Newark University, now part Rutgers, the State University. On July 24, 1951 the board of directors •e it

see adopted a resolution which set forth that it was in the corporation's best interests to join with others in the 1951 Annual Giving to Princeton ' So University, and appropriated the sum of $1,500 to be transferred by the i he corporation's treasurer to the university as a contribution towards it is maintenance. When this action was questioned by stockholders, the corpo-the ration instituted a declaratory judgment action in the Chancery Division rom and trial was had in due course. etc.,

Mr. Hubert F. O'Brien, the president of the company, testified that he This considered the contribution to be a sound investment, that the expects corporations to aid philanthropic and benevolent institutions, that

i and they obtain good will in the community by so doing, and that aville charitable donations create a favorable environment for their business asury uffett operations. In addition, he expressed the thought that in contributing to

liberal arts institutions, corporations were furthering their self-interest in

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corporate employment.board of the Standard Oil Company of tions are expected to acknowledge theirof the essential elements of our free it was not "good business" to disappointpublic expectation," nor was it good substantial benefits from their membershipwhile avoiding the normally acceptedsocial community." * * *

The objecting stockholders havetestimony nor the showing of greatinstitutions of higher learning and

6 WHAT D O BUSINESSES D O ? CII.

assuring the free flow of properly trained personnel for administrative and other Mr. Frank W. Abrams, chairman of the

New Jersey, testified that corpora- public responsibilities in support

enterprise system. He indicated that "this reasonable and justified

business for corporations "to take in the economic community

obligations of citizenship in the

not disputed any of the foregoing need by Princeton and other private

the important public service being rendered by them for democratic government and industry alike. Similar-ly, they have acknowledged that for over two decades there has been state legislation on our books which expresses a strong public policy in favor of corporate contributions such as that being questioned by them. Neverthe-less, they have taken the position that (1) the plaintiffs certificate incorporation does not expressly authorize the contribution and under common-law principles the company does not possess any implied incidental power to make it, and (2) the New Jersey statutes which expressly authorize the contribution may not constitutionally be applied to the plaintiff, a corporation created long before their enactment.

In his discussion of the early history of business corporations Profes-sor Williston refers to a 1702 publication where the author stated flatly that the general intent and end of all civil incorporations is for better government. And he points out that the early corporate charters, particu-larly their recitals, furnish additional support for the notion that the corporate object was the public one of managing and ordering the trade as well as the private one of profit for the members. However, with later economic and social developments and the free availability of the corpo-rate device for all trades, the end of private profit became generally accepted as the controlling one in all businesses other than those classed broadly as public utilities. As a concomitant the common-law rule devel-oped that those who managed the corporation could not disburse any corporate funds for philanthropic or other worthy public cause unless the expenditure would benefit the corporation. During the 19th Century when corporations were relatively few and small and did not dominate country's wealth, the common-law rule did not significantly interfere with the public interest. But the 20th Century has presented a different climate. Control of economic wealth has passed largely from individual entrepreneurs to dominating corporations, and calls upon the corporations for reasonable philanthropic donations have come to be made with creased public support. In many instances such contributions have been sustained by the courts within the common-law doctrine upon liberal findings that the donations tended reasonably to promote theobjectives. * * *

1

of

or

the

in-

corporate

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they discharged their responsibilities charitable purposes. With the transfer ofhands and the imposition of heavy burdens

been unable to keep pace with increased therefore, with justification, turned

modern obligations of good citizenship inCongress and state legislatures have enacted

contributions, and much has recentlycrying need and adequate legal basis therefore.

It seems to us that just as the conditions originally created required that they

7WHY DOES SOMEONE OWN A BUSINESS? SEC. A

When the wealth of the nation was primarily in the hands of individu-als as citizens by donating freely for

most of the wealth to corporate of individual taxation, they

have philanthropic needs. They have to corporations to assume the

the same manner as humans do. laws which encourage corpo-

rate been written to indicate the * * *

prevailing when corporations were serve public as well as private interests, modern conditions require that corporations acknowledge and discharge social as well as private responsibilities as members of the communities within which they operate. Within this broad concept there is no difficulty in sustaining, as incidental to their proper objects and in aid of the public welfare, the power of corporations to contribute corporate funds within reasonable limits in support of academic institutions. * * *

In 1930 a statute was enacted in our State which expressly provided that any corporation could cooperate with other corporations and natural persons in the creation and maintenance of community funds and charita-ble, philanthropic or benevolent instrumentalities conducive to public welfare, and could for such purposes expend such corporate sums as the directors "deem expedient and as in their judgment will contribute to the protection of the corporate interests." * * *

The appellants contend that the foregoing New Jersey statutes may not be applied to corporations created before their passage. Fifty years before the incorporation of The A. P. Smith Manufacturing Company our Legislature provided that every corporate charter thereafter granted "shall be subject to alteration, suspension and repeal, in the discretion of the legislature." * * *

State legislation adopted in the public interest and applied to pre-existing corporations under the reserved power has repeatedly been sus-tained by the United States Supreme Court above the contention that it impairs the rights of stockholders and violates constitutional guarantees under the Federal Constitution. * * *

It seems clear to us that the public policy supporting the statutory enactments under consideration is far greater and the alteration of pre-existing rights of stockholders much lesser than in the cited cases sustain-ing various exercises of the reserve power. In encouraging and expressly authorizing reasonable charitable contributions by corporations, our State has not only joined with other states in advancing the national interest but has also specially furthered the interests of its own people who must bear the burdens of taxation resulting from increased state and federal aid upon default in voluntary giving. It is significant that in its enactments the State has not in any way sought to impose any compulsory obligations

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conditions, even apart from expresssimply constitute helpful andaccompanied by limiting safeguards.

In the light of all of the foregoingthe validity of the donation bywas made indiscriminately or tofurtherance of personal ratherwas made to a preeminent institutionamount and well within the limitationsments, and was voluntarily made the public welfare and advancecorporation and part of the


or alter the corporate objectives. And since in our view the power to make reasonable charitable contributions exists under

statutory provision, its confirmatory declarations of such

the plaintiff. There is no suggestion that it a pet charity of the corporate directors in

than corporate ends. On the contrary, it

imposed by the statutory in the reasonable belief that it would aid

the interests of the plaintiff as a private as community in which it operates. We find

that it was a lawful exercise of the corporation's implied and incidental powers under common-law principles and that it came within the express authority of the pertinent state legislation. * * *

The judgment entered in the Chancery Division is in all affirmed.

QUESTIONS AND NOTES

1. Questions about the law.

1.1 What does intra vires mean? The Revised Model Business Corpora-tion Act (MBCA) uses the term ultra vires in § 3.04. How is intra different from ultra vires? What is a "stockholder"? The MBCA uses the term "shareholder." See MBCA § 1.40(21). The terms are interchangeable.

1.2 Who made the decision to contribute to Princeton? What is a "board of directors"? See MBCA § 8.01; Delaware § 141(a).

1.3 In approving the contribution, was the board of directors acting as an agent or a principal? If it was acting as an agent, who was the principal?

1.4 What is a "certificate of incorporation?" The MBCA uses the phras-es "certificate of existence," § 1.28, and "articles of incorporation," § 2.02. Which, if either, phrase is like a "certificate of incorporation"? Why did the objecting stockholders argue that "[A.P. Smith Mfg. Company's] certificate of incorporation does not authorize the contribution"? What if the certificate of incorporation expressly authorized charitable contributions to universities in New Jersey? What if it expressly prohibited such charitable contributions?

1.5 In A.P. Smith, the court indicated that the applicable New Jersey statute allowed corporations to make charitable contributions that the di-rectors "deem expedient and [which] in their judgment will contribute to the protection of the corporate interests." Today, a typical statute simply provides that a corporation can "make donations for the public welfare or for charita-ble, scientific, or educational purposes." MBCA § 3.02(13). Does such a

CII. 1

corporate modern

enactments power,

we have no hesitancy in sustaining

of higher learning, was modest in enact-

respects

vires

statutory provision permit corporate giving beyond that permitted by the

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managers to give away shareholders' money?

1.6 Roberts owns 100 shares of Unilever Ben & Jerry's. Although Roberts loves Benwith its corporate philanthropy and wantsWhat can Roberts do?

1.7 When A.P. Smith was decided,relatively well-to-do. So a decision by corporateportion of corporate assets for charitablerich people were giving away money that support charitable causes (including richSince then, far more Americans havethrough pension plans and mutual funds,

9SEC. A W H Y DOES SOMEONE OWN A BUSINESS?

reasoning of the court in A.P. Smith? Why would states permit corporate

stock. Unilever is acquiring & Jerry's ice cream, he disagrees

nothing to do with Ben & Jerry's.

stock ownership was largely for the managers to give away some

purposes seemed somehow noble— would otherwise go to rich people to

people's schools like Princeton). become invested in stocks. Indeed,

a considerable proportion of work-ing-class Americans are invested in stocks. So today, corporate philanthropy may consist of a (highly paid) corporate executive giving away money that otherwise might go into a blue-collar worker's pension. What is so noble about that?

1.8 Can corporations make political contributions? The New York Busi-ness Corporation Law (BCL) provides that they can, "irrespective of corporate benefit," § 202(a)(12), but New York Election Law imposes a ceiling of $5,000 per year to any political candidate or organization. New York Elec. Law § 14-116. Why should there be an express statutory ceiling on political contribu-tions but not on charitable contributions? Why would the political contribu-tion provision allow such grants "irrespective of corporate benefit"?

2. Notes.

2.1 Over seven decades ago, Owen D. Young, then the chief executive officer of General Electric, took the position that his obligations were not limited to shareholders:

[I]t makes a great deal of difference in my attitude toward my job as an executive officer of the General Electric Company whether I am a trustee of the institution or an attorney for the investor. If I am a trustee, who are the beneficiaries of the trust? To whom do I owe my obligations?

My conception is this: That there are three groups of people who have an interest in that institution. One is the group of fifty-odd thou-sand people who have put their capital in the company, namely, stockholders. Another is a group of well toward one hundred thousand people who are putting their labor and their lives into the business of the company. The third group is of customers and the general public.

E . Merrick Dodd, Jr., For Whom Are Corporate Managers Trustee? 4 5 HARV.

REV. 1 1 4 9 , 1 1 5 4 ( 1 9 3 2 ) .

Would Professor Friedman agree with Mr. Young?

2.2 The MBCA and other corporate codes now expressly authorize corporations to make charitable contributions. E.g., MBCA § 3.02(13); Dela-ware § 122(9); New York BCL § 202(a) (12). Since 1935, the federal tax laws have made charitable contributions by corporations tax deductible. As Profes-sor Blair explains, the law is clear but the basis for the law is not:

its

L .

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centurycorporations could give away fundslanthropic causes, this question appearedthen, both statutory and case lawofficers and directors have very wide amounts of corporate resources towardtarian causes, even those that have obvious connection at all) to the business firm.

This stance of the law has been defended primarily entity theory of the firm. Under this separate legal "person," with individual

Court Supreme Jersey Newthehow consider Smith if A.P.ruled have would

1 0 W H A T D O BUSINESSES D O ? CII. 1

Although a lively debate raged in the law from the mid-19th century to the mid-20th about whether, and under what circumstances,

to humanitarian, charitable, or phi- to be settled by the 1950s. Since

have made it clear that corporate discretion to direct reasonable

artistic, educational, and humani-only a remote connection (or no

goals and profitability of the

by reference to an theory, the corporation is itself a

rights under the law, and it is therefore appropriate to expect, and even demand, that corporations be "good citizens," and that they behave in "socially responsible" ways, including contributing to "socially responsible" causes. Corporate officers and directors, who act for this entity, must therefore be protected when they expend corporate resources on philanthropy.

But while the law appears to be settled, there is still an influential strand of legal thinking, particularly among scholars steeped in the jurisprudence of law and economics, that argues that corporate giving, if it is permitted at all, should be strictly limited to those situations where the benefit to the firm in the form of higher expected profits is clear and compelling. The argument against corporate philanthropy of a more general nature, as well as against other forms of gratuitous acts by corporations in the name of corporate "social responsibility," was made forcefully by Milton Friedman in 1962 in a famous and often-quoted essay. Friedman's view was that a corporation is a special purpose institution for managing and governing private property—in particular, the private property of the shareholders. For corporate managers and directors to do anything with that property other than what the share-holders want them to do (which, presumably, is to increase profits) would be tantamount to expropriating resources that do not belong to them, and would violate the terms of their employment agreement. Arguments to the same effect by subsequent contractarian legal scholars have generally been couched in terms of "principal-agent" theory (in which the central contractual relationship in a corporation is understood as an agency relationship between the shareholders, who are the real "owners" of the corporation's property and act as "principals," and the directors and managers who serve as their "agents").

Margaret M. Blair, A Contractarian Defense of Corporate Philanthropy, 28 STETSON L . REV. 2 7 - 2 9 ( 1 9 9 8 ) .

2.3 The business in the A.P. Siyiith case was a corporation. While we will spend more time on corporations than on any other business structure, we will study other forms of business structures, such as sole proprietorships in Chapter 2 and partnerships in Chapter 3. When we get into Chapter 2,

Mfg. Co. had been a sole proprietorship and the objecting parties were

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would have ruled if A.P. Smith Mfg. Co.parties objecting to the Princeton contribution

Why is A.P. Smith in the book? Whydo we not simply say: "Corporations have

charitable contributions" and leave it at that?with the introductory "empirical research"

nesses?

One answer to these questions (as well

money to work for the business and receive a salary for her work. We deal here with making specifically in return for one's role as an owner.

SEC. B HOW DOES THE OWNER MAKE MONEY FROM THE BUSINESS? 1 1

employees. And in Chapter 3, consider how the New Jersey Supreme Court had been a partnership and the

were partners.

is it the first case in the book? Why the legal authority to make

What does this case have to do on why people own busi-

as further issues raised by the respective answers) follows: We have included the A.P. Smith case and the questions based on the A.P. Smith case to show students the following general building-block concepts:

• The law views a business, at least a business in the corporate structure, as a separate entity, a separate legal person;

• A body of law—both statutory law and case law—has developed to control the actions of that separate entity or person;

• Real persons act for that corporation—they are "agents";

• A business with more than one owner, at least a business with more than one owner that is a corporation, can distribute and use its funds in ways that are opposed by at least some of its owners.

Accordingly, owners of businesses who want to make money and persons acting as lawyers for owners of businesses who want to make money (and persons studying the law of business structures) should consider questions such as: (i) who makes decisions for the business? (ii) on whose behalf are they acting as agents? (iii) can an owner profitably dispose of her ownership interest in a business if she does not agree with the decisions others are making? and (iv) how does the legal structure of the business affect the answers to the above questions?

B. HOW DOES THE OWNER OF A BUSINESS MAKE MONEY FROM THE BUSINESS?

There are two general ways an owner of the business can make money from the business. First, she can receive distributions of all or part of the money the business has earned. Second, she can sell all or part of her ownership interest in the business for more than she paid for it.* But how does the owner of a business (and her lawyer) know how much money the business has made and how much money the business is worth?

* Of course, an owner of a business can also make money from the business by working for the business and receiving a salary for her work. And one does not have to be an owner of a business

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OF A BUSINESS (AND HER LAWYER) KNOW HOW MUCH MONEY THE

HAS MADE AND HOW MUCHTHE BUSINESS

In the A.P. Smith case, we dealt withright to the money a corporation earned—Princetonowners. The legal question was complicatedA.P. Smith Mfg. Co., a corporation with holders who were not on the board of directors.three groups of persons or entities: (1) the

out company.' a ofopportunities and pitfalls the second a take to plans also[Wasito] He

1 2 WHAT D O BUSINESSES D O ? CII. 1

C. HOW DOES THE OWNER

BUSINESS MONEY

IS WORTH?

the question of who had a legal or the corporation's

by the business structure of a board of directors and share-

Legally, then, there were business; (2) its managers; and

(3) its owners.

While the legal question in A.P. Smith is arguably complicated, the facts were simple—the fight was over $1,500 that had been paid by the corporation to Princeton. In many fights over a business's money, there are very difficult fact questions about where the money is or where the money went. To win these fights for your clients, you will need to understand the business's accounting records and financial statements.

Generally, business entities are required to keep "appropriate ac-counting records" and to make those records available to the owners of the business. See, e.g., MBCA §§ 16.01(b) and 16.02(b)(2); Delaware § 220(b). See also Revised Uniform Partnership Act (RUPA) §§ 403(a) and 403(b). Businesses typically maintain several financial statements, which are provided to investors, the company's managers, and—in the case of large public companies (ones for which the stock is publicly traded)—to the public and to public enforcement authorities. Much as medical instruments measure a patient's vital signs, the financial reports measure the company's financial health. Without accurate reports, the company can sicken or die without managers or the public knowing until too late.

The main financial statements are (1) the income statement, which computes profit during a given period (e.g., month or year) based on data about revenues and costs; (2) the cash flow statement, which measures the cash made available to a business from its operations during a given period; and (3) the balance sheet, which shows the company's assets, liabilities and the owners' "equity" in the business. There are several things you should know about these three statements.*

* An American Lawyer article on the summer work experiences of a Stanford law student [Janar Wasito] supports this view: "Law students throughout the country are clamoring for more training in business as they realize that sex-ving start-ups goes beyond grinding out legal documents . . . 'From what I have seen, the best attorneys are business planners who help chart

accounting class this year, noting that if he can't read a balance sheet, 'I'm just a well-spoken guy

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Accepted Accounting Principles.1 We willrules, but two important generally acceptedmatching: costs or expenses should berevenues those expenditures helped generate, data should be conservative—that is,financial data in an accurate way, but revenues and the value of its assets, andliabilities.

Perhaps the most famous example principle of conservatism is violatedenergy firm engaged in a tactic called

its

THE

idea is to promote a global standard for accounting. See www.sec.gov/rules/proposed/ 8982.pdf.

1 3 SEC. C H o w MUCH MONEY HAS THE BUSINESS MADE ?

Financial statements are prepared according to GAAP—Generally not get into intricate accounting

accounting principles are: (1) "booked" in the same period as the

and (2) conservatism: the they should present the firm's err on the side of understating its

on overestimating its costs and

of what can happen when the is the case of Enron. This large "off-balance-sheet" financing. The

theory of off-balance-sheet financing is that certain activities of the firm may be carried out in other legal entities (e.g., subsidiaries, joint ventures) and that the firm need not show the obligations of those entities on its balance sheet as long as there is no chance that it, the parent company, could be forced to make good on those obligations (this is known as "nonrecourse" debt). When Enron disclosed the existence of the partner-ships it had created as sources of off-balance-sheet financing, it did not disclose the partnership's debt, claiming that the debt in these entities was nonrecourse to Enron.

It turned out, however, that the debt was recourse to Enron under certain conditions after all. That is, the parent could be forced to make good on these obligations. This revelation brought the house of cards tumbling down. Under the principle of conservatism, Enron (and accountants) should have made worst-case assumptions about what might happen, and should have disclosed these obligations to Enron's sharehold-ers. By the time everyone learned of this, it was too late. Enron's stock, which had reached a high of $84 per share, plummeted to less than $1, taking with it the jobs and pensions of many Enron employees.

1. THE INCOME STATEMENT

We begin our analysis with an income statement. In its simplest form, an income statement computes the profit of a business for the period in question—usually one year. The computation involved in an income statement is pretty easy: Profit before taxes equals Revenue minus Costs. Let's take the example of an individual—Melvin Propp—who purchases mouse pads for $1 each and sells them for $2. If he buys and sells a thousand mouse pads in 2010, Propp's income statement looks like this:

who has some contacts. Those are fleeting qualities.' " Susan Orenstein, Golden Boy, AMERICAN LAWYER 80, 82, 84 (October 1999) (emphasis in original).

t T h e Securities and Exchange Commission has proposed what it calls a "roadmap" toward adoption of International Financial Reporting Standards by American companies by 2014. The

2008/33-

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http://www.sec.gov/rules/proposed/

Profit Before Taxes [PBT]

Let's suppose Propp is pleased withwork for him in 2011. If he hires two employeesthem also sells 1,000 mousepads (at statement looks like this:

PM Income Statement 2011 Revenue (sales)

COGS Salaries PBT


Propp's Mousepads (PM) Income Statement 2010 Revenue (from sales) $2,000 ($2 x 1,000)

- Cost of Goods Sold fCOGS 1 1,000 ($1 x 1,000) = $1,000

his profit and hires two people to at $100 each, and each of

$2 per mousepad), Propp's income

$6,000 (3 x 1,000 x $2) - 3,000 ($1 x 3,000) - 200 (2 x $100) = $2,800

Now suppose in 2012 Propp bought a $5,000 mousepad manufactur-ing machine, and the machine was expected to last for five years. If we followed the process we've been using, we would add an item to the income statement for machinery expense and note a $5,000 expense for this item.

But this would be misleading. Profits would be understated in the first year. We would be charging the business's profits for the entire cost of the machine in one year, even though Propp will use the machine over five years. In subsequent years, profits would be overstated because we would be charging the business nothing for the machine, even though we were getting the benefit from its use.

The solution to this problem is to use something called depreciation. For example, we could charge the income statement for one-fifth of the machine ($1,000) each year. This one-fifth figure comes from the fact that the machine has a useful life of five years. Thus, at the end of that time we will have charged the business fully for the machine. This $1,000 figure reflects that the machine is getting less valuable each year, since we are "using" part of it up. The portion that we use up is called deprecia-tion.*

Now let us assume that in 2012 Propp did the following:

• bought the mousepad machine;

• depreciated it at $1,000 a year;

• manufactured and sold 5,000 mousepads for $2 each;

• paid $500 for the materials for the 5,000 mousepads;

• paid someone a salary of $500 to run the machine;

• paid someone a salary of $500 to sell mousepads for him; and

* The approach we used above is called straight-line depreciation. We simply take the value of the equipment, divide it by the number of years of useful life, and then deduct this much each year from the income statement as depreciation. It is called straight-line depreciation because the value of the equipment decreases by the same amount each year in a straight line. Other forms of depreciation, called accelerated methods, deduct proportionally more of the cost of the equipment in the earlier years and less later on.

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& A) expenses.

Propp's income statement would look like

PM Income Statement 2012 Revenue (sales) $10,000

COGS 500 Salaries 1,000

G & A 100 Depreciation 1,000*

PBT $ 7,400

PM Income Statement 2012 Revenue (sales)

- COGS$10,000

500 - Salaries- G & A

1,000 100

- Depreciation 1,000 PBT Taxes

$ 7,400 3,700

= Net Income

1 5 SEC. C H o w MUCH MONEY HAS THE BUSINESS M A D E ?

• paid $100 for phone calls and other general and administrative (G

Then this:

----=

Up to now, we have been ignoring taxes. You simply cannot do that (even if you work for the federal government). For this exercise, we will assume that Propp's tax rate is 50%. We have to add two more lines to the bottom of Propp's 2012 income statement:

$ 3,700

An income statement provides a useful perspective on a business. By looking at an income statement, we can learn a great deal about the operations of a business in a particular year. And looking at income statements for several years allows us to see how a business's performance changes.

One thing we cannot see from an income statement is how much cash a business may be generating or using up in a given year. This is because some entries in the income statement, such as depreciation, do not represent any actual movement of cash. To measure the cash, we need to look at a cash flow statement.

2. THE CASH FLOW STATEMENT: A FIRST LOOK

The cash flow statement is a measure of how much more or less cash a business has at the end of the year than it had at the beginning of that

* Consider the effect of depreciation and depreciation methods on PBT and on taxes. If Propp could choose an accelerated method of depreciation so that he could allocate more of the $5,000 cost of the machine to 2012, his 2012 PBT would be lower, his taxes would be lower, and he could keep more of his 2012 earnings. Of course, in future years, his depreciation would be lower, his PBT would be higher, and his taxes would be higher. But, of course, Propp would rather have the money now. The sooner he gets the money, the sooner he can invest it and begin earning a return on it. This is why business groups lobby hard for accelerated depreciation.

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the bank; cash flow would simply be bank account.

But that is not what happens in hypothetical world of Propp's Mousepads.income statement that Propp could buy

business only $1,000 on the income statement. comes out of the cash at the bank,

expense on the income statement.) Conversely, in the years after Propp buys the machine, he will be charging the income statement $1,000 but he

not have to pay this in cash, because


year. Cash flow would be easy to measure if all of a business's cash went into the change in the amount in the

the real world, or even in the Recall that we saw from Propp's a machine for $5,000 and charge

the (The remaining $4,000 still but it does not show up as an

will he's already paid for the machine. The $1,000 is just a charge for the portion of the machine that was "used up" in that year.

We can readily see how depreciation changes the relationship between the business's income statement and its real cash flow. In our simple model, until we added depreciation, the income statement was also a cash flow statement; whatever the profit after tax was, this amount was also the cash profit the business had made. Now, when we add depreciation, we see this relationship has changed.

In the first year of the machine's use, cash flow is less than profit because we have a cash outflow of $5,000 to buy the machine, but this appears nowhere on the income statement. The only figure we see is a $1,000 charge for depreciation. In future years, cash flow will be more than profit, because we will be charging the income statement $1,000 in depreciation, but there is no real cash outflow for this.

Thus, we can see there are two components to the differences we are talking about. One is the depreciation figure, and we've seen where that comes from. The other figure is called investment. It represents the money spent to purchase equipment. The company's cash declines because it exchanges cash for the equipment. When the business buys something that will be used for more than one year, this is an investment and only the depreciation appears on the income statement. In contrast, if the company buys something that it will use up within the year, it is called an expense, and the total amount appears on the income statement. Salaries, G & A, and COGS are expenses.

Accounting for depreciation, and investment, the general formula that converts an income statement to a cash flow statement is: Cash Flow equals Profit after Tax plus Depreciation minus Investment. We can convert Propp's income statements for the first and second years of the machine's life to cash flow statements:

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Revenue (sales) $10,000 COGS 500 Salaries 1,000 G & A 100 Depreciation 1,000 PBT 7,400 Taxes 3,700 Profit After Taxes $ 3,700 + Depreciation 1,000 Investment 5.000 Cash Flow $ 300

SEC. C H o w MUCH MONEY HAS THE BUSINESS M A D E ? 1 7

PM Cash Flow Statement Year 2012 2013*

$10,000 500

1,000 100

1,000 7,400 3.700

$ 3,700 1,000

- 0 = - $ 4,700

This example shows why both the income and cash flow statements provide valuable information about a business. The income statement indicates the business was just as profitable in 2013 as it was in 2012. From a cash flow perspective, however, the two years are dramatically different. Due to the investment in equipment, there is a severe cash drain on the business in 2012. In 2013, the business is getting the benefit of that piece of equipment, but the business does not have to lay out any additional cash to do so. Although profits are the same in both years, the business might well be able to survive an unexpected crisis better in 2013 than 2012.

To understand the difference between an income statement and a cash flow statement more fully, we need to understand what information is provided by a balance sheet.

3. THE BALANCE SHEET

The last financial statement we will consider is the balance sheet. The income and cash flow statements capture activity during a period, show-ing how much profit or cash flowed into (or out of) the business during the period. In contrast, the balance sheet is a snapshot of a particular moment.

A balance sheet has three main sections. (a) Assets: These are the things that the company owns that have

value. Assets are the business's "stuff." The typical assets on a balance sheet are cash, land, buildings, accounts receivable (money owed to the company by its customers) and machinery and equipment (such as the mousepad machine). When equipment such as the mousepad machine is depreciated, the dollar amount of that depreciation charge is deducted as an expense on the income statement; the same amount is deducted from the value of the asset on the balance sheet. Assets like cash are not depreciated because they don't get used up. Similarly, accounts receivable are not depreciated but may be "written off." For example, if one of Propp's credit customers files for bankruptcy, its accounts payable would likely go unpaid. Propp would then "write off" the account receivable due from the customers. This would ensure that the overall accounts receiv-

* This assumes that business operations in 2013 mirror business operations in 2012.

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(b) Liabilities: Liabilities are thecompany owes. Typical liabilitycompany owes its suppliers), wages debts the company incurs (for example,

(c) Owners' Equity: Owners'subtract the liabilities from the assets. assets minus liabilities.

This is why a balance sheetWhen you put the assets on the left-handthe liabilities and owners' equity onsheet will balance. By definition, it

how much to pay for the business.

1 8 WHAT D O BUSINESSES D O ?

able figure is an accurate reflection of the business's expectations getting paid.

opposite of assets: they are what the items are accounts payable (what

that it owes to its employees, and any when it borrows money).

equity is what is left over after Simply put, owners' equity equals

is called a balance sheet—it side of the balance sheet, and

the right hand side, then the balance must.*

And it makes sense. If the assets are all of the company's things that have value, and the liabilities are all the "claims" on that value, then the difference between the two is the value of the business to the owners—the owners' equity. Even if a company has $1 billion in assets, the value of the owners' equity is zero if the company also has $1 billion in debt. When liabilities exceed assets, the owners' equity is negative—the otherwise known as insolvency.

Let's look at what a balance sheet for Propp's Mousepad might look like. First, assume that on January 15, 2011, Propp invested $666 of his own money in the business. In that case, the balance sheet would look like this:

PM Balance Sheet January 15, 2011

Assets Liabilities & Equity

Cash $666 Liabilities $0

Equity $666 Total $666 Total $666

Or Propp could have lent the money to the business, in which case the balance sheet would look like:

PM Balance Sheet January 15, 2011

Assets Liabilities & Equity

Cash $666 Note due Propp $666

Equity $0 Total $666 Total $666

* Note that the principle of conservatism means that assets appear on the balance sheet at the lower of cost or market. So, a piece of land purchased in 1950 would appear on the balance sheet with a value equal to its original purchase price. Thus, the balance sheet may not reflect the current market value of the company's assets and might not tell a prospective buyer

CII. 1

for

the

you

balances.

condition

accurately

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$1,000. Assuming for a minute that thiswould have built up in the Propp's Mousepads'course of the year, and thus, at year end,looked like:

PM Balance Sheet December 31, 2011

Assets Liabilities

Cash $1,666 Liabilities

Equity

123,000

* This assumes that Propp lent the business the initial $666.

SEC. C H o w MUCH MONEY HAS THE BUSINESS M A D E ? 1 9

After the first year of operation, we said that Propp had a profit of was equal to cash flow, that cash

bank account over the the balance sheet would have

& Equity

$666

$1,000 Total $1,666 Total $1,666

Note that profits accrue to equity. Let's suppose that, just before year-end, Propp has decided Propps Mousepads should pay back his loan. He could write himself a check for $666, and then both cash and liabilities would decrease by $666, and the balance sheet would still balance. If Propp instead decided to have Propps Mousepads distribute $100 of the profits to himself—as owner of the business—these would be a deduction from owners' equity.*

After several years of business operation and expansion, a more complete balance sheet for Propp's business might look like this:

PM Balance Sheet December 31, 2015

Assets Cash 5,000 Accounts Receivable 22,000 Inventory 33,000 Security Deposits 6,000 Current Assets 66,000 Equipment—Gross 147,000 Depreciation 24,000 Equipment—Net Total Assets

Liabilities & Equity Accounts Payable Taxes Payable Total short-term liabilities Bank Note Liabilities

Net Total Equitv

Total Liabilities + Equity

189,000

19,000 5,000

24,000 85,000

109,000

80,000

189,000

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relatively low on cash, having only $5,000(Accounts Payable) which it must payrelatively heavy user of debt* (the bankcompany's equity; that is, the note is$80,000—so the note is for 106% of $147,000 on equipment, and charged

4. THE CASH FLOWA SECOND

In our first view of cash flow statements,

personal indebt like is just world business the in Debt* are you money, borrowyou When life.


Let's see what we can learn from this balance sheet. For example: PM is to satisfy $19,000 in "bills"

to its suppliers; and PM is a note is for more than 100% of the for $85,000, while the equity is

the equity); and PM has spent $24,000 in depreciation against it.

STATEMENT: LOOK

we compared the impact of purchasing and depreciating equipment on both the income statement and cash flow statement. Now we need to see the possible impact of changes on balance sheet items on a cash flow statement.

Consider for example the impact of changes in accounts receivable on the cash flow statement. Assume that in 2015 Propp's credit sales are approximately $22,000 every month and that typically his customers pay within 30 days. If in December of 2015, Propp's collections from prior credit sales total only $18,000 instead of the anticipated $22,000, Propp's cash entry on his balance sheet for December 31, 2015, will be $4,000 lower and the accounts receivable entry on his December 31, 2015 balance sheet will be $4,000 higher. More important, Propp's cash flow statement for 2015 will show that the business produced $4,000 less cash. In sum, an increase in a balance sheet asset account other than cash results in a decrease in cash flow. The business owns the other asset (here the accounts receivable) instead of cash.

In contrast, an increase in a balance sheet liability account can result in an increase in the cash account on the balance sheet and an increase in cash flow. Suppose Propp borrows $20,000 in December of 2015. That increases liability shown on the December 31, 2015 balance sheet by $20,000 but also increases the balance sheet cash account by $20,000. And that increase in liability increases cash flow by $20,000. Obviously (we hope), if Propp spent the $20,000 he borrowed in December of 2015 to buy inventory in December of 2015, that $20,000 inventory expenditure would increase the inventory account on the balance sheet by $20,000 and reduce the cash account and eliminate the $20,000 from the cash flow statement.

Likewise, suppose that the business sold shares of its stock for $100,000. This would appear on the balance sheet as increase in cash of $100,000, and an increase in shareholder equity of the same amount.

in debt. PM used a lot of borrowed money.

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transaction has a balancing effect: anliability) also creates an increase in cash money is deposited in the company's banking—or bookkeeping—is often called transaction has two effects, which always

Accordingly, the definition of a cash to include the effect of changes in balance

Cash flow equals profits from incomeminus net change in balance sheet assetchange in liabilities and funds from new

And, accordingly, in reviewing a cash

2 1 SEC. D SARBANES-OXLEY ACT & CORPORATE GOVERNANCE

Note that not only do the balance sheet totals balance, but every increase in bank borrowings (a

(an asset) when the borrowed account. This is why account-

a "double entry" system: every serve to balance.

{low statement should be expand-ed sheet accounts:

statement plus depreciation accounts other than cash plus net issues of stock.

flow statement for a particular year, it is helpful to look at the balance sheets for several years and compare the changes in asset accounts and liabilities.

5. FINANCIAL STATEMENTS AND THE VALUE OF A BUSINESS

Is it helpful to review the financial statements in determining what a business is worth? Please consider the following problems.

PROBLEMS: USE OF FINANCIAL STATEMENTS

1. Review the PM balance sheet for December 31, 2015. In January of 2016, would you recommend that a client buy Propp's business for $189,000? For $80,000? Does the balance sheet help a prospective buyer determine how much she should pay for the business? Does the balance sheet help a prospective investor determine how much he should pay for a share of the business? Does the balance sheet help a prospective lender determine how much it can safely lend to the business? How?

2. Review the PM cash flow statements for 2012 and 2013. In January of 2014, would you recommend to Propp that he sell the business for $3,700? For $4,700? For $20,350? Does the cash flow statement help a prospective buyer determine how much she should pay for the business? Does the cash flow statement help an investor determine how much she should pay for a share of the business? Does the cash flow statement help a prospective lender determine how much it can safely loan the business?

D. THE SARBANES-OXLEY ACT AND CORPORATE GOVERNANCE

The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley," "Sarbox," or "SOX") was passed by the 107th Congress in reaction to the widely perceived breakdown of financial accounting and corporate accountability in the wake of the financial scandals in the 2000 time frame. (Note that the phrases "corporate governance" and "corporate accountability" apply

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organizations,certainly the most widely known financialone.

Before describing the intent and effect understanding for a minute, both themotivation—for these accounting frauds.

As backdrop, it is important to understandtranspired in public companies; that is, publicly traded and held broadly by thepossible to have accounting fraud in privatelycorporate entities, but Congress and the

analyze system whole The transaction.every of amountfair a upon relies


to all forms of business not just corporations.) Enron was scandal, but far from the only

of Sarbanes-Oxley, it is worth general nature—and the general

that these frauds all companies whose shares were

investing public. It is certainly held companies and in non-

regulatory agencies are much more concerned with frauds perpetrated on the general public.

These frauds have as their main feature the use of false financial statements—the balance sheet, income and cash flow statements that we have been discussing in this chapter. In well-functioning corporate gover-nance systems, the public shareholders rely upon the board of directors, who in turn delegate a fair amount of responsibility for the oversight of the company's accounting to its audit committee (a subcommittee of the board). The audit committee oversees the work of the company's financial accounting staff (typically under the direction of a chief financial officer), chooses an auditor, oversees their work auditing the firm's accounting statements, engages with the auditors in any discussion of accounting issues that arise, and ultimately, recommends to the board that they accept the firm's audited financials for inclusion in the firm's SEC filings (e.g., the quarterly 10-Q reports, or the annual 10-K filings).

When auditors audit a firm's financials, they look to see that the firm's stated accounting policies have been consistently applied, they assess the reasonableness of these policies, and they "test" the data that the firm's financial statements are based upon. That is, for example, they look and see if the sales transactions reported did in fact occur. They check and see that the company really does have a bank account with $12 million dollars in it, if that's what the company's financial statements say.

Of course, it is impossible to test every single piece of data, and the audit firm relies upon the principle of "sampling" certain random transac-tions, as well as looking at any transactions that look suspicious or are the types of transactions the auditors know are prone to mistakes or even fraud.

Auditors have always been careful to say that their audit cannot be guaranteed to find fraud. That is, a group of smart people, who set out to defraud a company, can usually fool the auditors for at least some period. The auditors simply don't have the time to look at every piece of data. Similarly, an audit committee cannot spend the time to look at and

trust in management by both the auditors and the audit committee.

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As we have discussed, the financialcompany's financial statements to assesssuch information as an important input

value of a company's stock. If the numberstal performance is good, then the price

of an oversimplification, but not by incentive to put out good numbers to

us would prefer to make the people upset at us. However, managers often some cases, they earn cash bonuses for deliveringmany cases, senior managers own stock

is

SEC. D SARBANES-OXLEY ACT & CORPORATE GOVERNANCE 2 3

1. THE MOTIVATION FOR FRAUD

markets look carefully at the its business prospects, and use

to coming to a point of view on the are good, then fundamen-

of the stock should go up. That is a bit much. So, managers at firms have an satisfy their investors, just as all of we work for happy as opposed to

have another set of incentives. In good financial results. In

in the company, or have stock options, that are worth more when the price of the company's stock rises.

2. TYPES OF FRAUD

There are various types of fraud. In the Enron case, the company engaged in various forms of "off-balance-sheet" transactions where it tried to move liabilities off its balance sheet through a complicated series of steps. There may have been some thread of legitimacy at each step but, in sum, the overall result clearly misrepresented the company's financial state. In the footnotes to the financials—where such complex machina-tions should be disclosed so that at least investors understand what is going on—the descriptions were less than transparent. It seems as though the fraud was pervasive at various layers of management, and was condoned by the auditors. These transactions also involved serious con-flicts of interest, in that some officers of the company were owners of the entities that the company was conspiring with, and these executives made substantial sums from these transactions.

There are a host of other types of fraud, but most come down to either representing the company's financial condition as better than it is, or misappropriating the wealth of the company for private gain. It worth pointing out that, when executives or board members sell stock during a time period when they have misrepresented the company's financial status, this is a form of securities law violation as well, as the executives could be deemed to be trading based upon inside information i.e., information that was not generally known in the market.

3. THE INTENT OF SARBANES-OXLEY

Sarbanes-Oxley attempts to clarify certain responsibilities of auditors, company management, and boards and audit committees, as well as impose new process and responsibilities on these parties.

For example, the Act specifies that companies must disclose whether expert"— their audit committees have an "audit committee financial

someone whose experience makes her qualified to deal with the range of

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One of the most important partsspecifies that the company must evaluatethat it must do so with a set of proceduresthose controls as well as test their section requires that auditors then audit opine on the state of internal controls

Another section of the Act requiresFinancial Officer "attest to the accuracyments." That is, to sign a statement—underverifying that the statements are accurate.

All of these rules are designed to

and

to

or

2 4 WHAT D O BUSINESSES D O ? CII.

accounting issues and practices at the company. It also requires that other members of the audit committee have a degree of financial literacy that was previously not required.

of the act is "Section 404" which its own internal controls, and

that both evaluate the design of operating effectiveness. The same

management's assessment at the company.

that the CEO and the Chief of the firm's financial state-

threat of criminal liability—

prevent much of the finger pointing, blame shifting and lack of accountability that frustrated investigators and analysts as they tried to get to the bottom of fraud situations: that is, CEOs saying, 'T didn't understand the company's financial statements and trusted the CFO."

Other aspects of the Act address the perceived conflicts that developed within an auditing firm. That is, many accounting firms do other kinds of financial consulting work. In many of the fraud situations, these account-ing firms were making lots of money from these non-audit services. There was a belief that this compromised their independence i.e., made it much less likely for them to blow the whistle on poor accounting out of a fear of losing all of this other profitable work at the client. The Act specifies both the degree to which firms could do other work for audit clients and the procedures which would need to be followed when such work was done. The Act also specifies that the partner running the audit must rotate off of the account at least every five years, in an attempt to prevent a too-cozy relationship from developing between the auditor and the client.

E. WHAT DOES A LAWYER FOR A BUSINESS DO?

If we are right in saying that a person usually owns a business make money, then that business owner hires an attorney (1) to help the business make money or (2) to help her get money from the business (3) to help the business and her protect that money from the claims of others. Ralph Nader put it less charitably. According to Nader (who is a lawyer), "lawyers for businesses are largely responsible for the perversion of justice in America":

Power attorneys crush the powerless populace and smaller businesses to assure that their clients prevail. The tools they use and the places they control twist the nation's political economy to serve corporate purposes. These attorneys do not have to go on television to adver-tise—their image precedes them on the corporate grapevine.

1

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legitimize,nize, shield, and entrench. For thesecentral organizers and catalysts forsuch as accountants and even scientists,The complex systems and structuresconstructed over the past 130 yearstical achievements. Hardly a fractionsion was ever arrayed on the side ofmuch less workers, the environment,the poor.

Corporate attorneys developed dazzling investing capital, avoiding accountability

SEC. E W H A T DOES A LAWYER FOR A BUSINESS D o ? 2 5

In a society officially dedicated to the rule of law, economic power needs its counselors to mystify, facilitate, extend, immu-

services, attorneys are the the entry of other professions,

advancing corporate agendas. that corporate attorneys have

are intellectual as well as prac- of the brainpower of the profes-

shareholders or small businesses, consumers, citizens, voters, or

techniques of raising and and disclosure, concentrat-

ing power within and outside of companies, limiting liability from the early stages of corporate chartering to the recent maneuvers of voluntary Chapter 11 bankruptcy. Rarely do historians attribute to the work of these attorneys the difficulties faced by labor, consumers, suppliers, franchisees, shareholders, and local communities dealing with corporate management. Simply stated, these attorneys are mas-terminds of choreographing contests that are, in fact, no contest at all. To many corporate lawyers such deeds are their finest hour.

Ralph Nader and Wesley J . Smith, No CONTEST—CORPORATE LAWYERS AND

THE PERVERSION OF JUSTICE IN AMERICA xxiv-xv ( 1 9 9 6 ) .

QUESTIONS AND NOTES

1. Principles of professional ethics provide that a lawyer has an obli-gation to represent his or her client zealously. See ABA MODEL RULES OF

PROFESSIONAL CONDUCT 1.3 a n d A B A MODEL CODE OF PROFESSIONAL RESPONSIBILITY

DR 7-101(A)(l). Are Mr. Nader and Mr. Smith arguing that an attorney for a corporation or other business should not zealously represent her client? Cf. George A. Riemer, Zealous Lawyers: Saints or Sinners, 59 ORE. ST. BAR BULL.

31, 32 (1998) ("While every human activity is subject to extremes, we should not water down the core duty of lawyers: to be zealous advocates on behalf of clients.").

2. Who is the client the business attorney is to represent zealously? Assume, for example, that your firm represents A. P. Smith Mfg Co. Who is your client: Mr. O'Brien? the board of directors? the stockholders? the employees? the community? Can your client be a combination of these?

3. A partner in a large Philadelphia law firm, i.e., a "power lawyer," suggests two problems with Ralph Nader's views:

First, it undermines what one would think Nader would believe to be fundamental tenets of our society—that everyone, including the largest conglomerate in America, is entitled to effective legal representation no matter how unpopular, so long as they are pursuing nonfraudulent, noncriminal goals. Moreover, they are entitled to that representation

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Second, Nader offers ussupposed to decide when thesetions on their representationslimitations are. If we were towould not be allowed, for example,tort deform process." But is itevery morning to find out where

Lawrence J. Fox, Lawyers' Ethics Clients Beware, 1 2 GEO. J . LEGAL ETHICS

4. Ralph Nader's No CONTEST

lawyers"—at least not as practicing

2 6 W H A T D O BUSINESSES D O ?

from a lawyer whose loyalty is not compromised by representation other clients that are adverse to the first group.

no guidance as to (a) how other societal considerations act as limita- of clients and (b) who decides what those leave it to Nader, we

to participate in what he calls "the Nader that each lawyer is to consult with

the limitations are?

According to Nader: Let the 3 6 7 , 3 7 2 - 7 3 ( 1 9 9 9 ) .

is not really a book about lawyers use that term. Practicing lawyers

think of business lawyers as "deal lawyers." It is more a book about the trial lawyers who represent businesses in their litigation. If a business lawyer is doing her job right, litigation should be a small part of her work.

5. As the following excerpt from Ronald Gilson, Value Business Lawyers: Legal Skills and Asset Pricing, 9 4 YALE L . J . 2 3 9 ,

( 1 9 8 4 ) , suggests, business lawyers are criticized not only by activists Ralph Nader, but even by their clients:

What do business lawyers really do?

Clients have their own, often quite uncharitable, view of business lawyers do. In an extreme version, business lawyers ceived as evil sorcerers who use their special skills and professional magic to relieve clients of their possessions.

Clients frequently advance other more views of the business lawyer that also should be familiar to most practi-tioners. Business lawyers are seen at best as a transaction cost, part of a system of wealth redistribution from clients to lawyers; legal fees repre-sent a tax on business transactions to provide an income program for lawyers. At worst, lawyers are seen as continual raising of obstacles, without commensurate solutions, ultimately causes transactions to collapse under their weight.

Lawyers, to be sure, do not share these harsh evaluations of their role. When my question—what does a business lawyer really do—is put to business lawyers, the familiar response is that they "protect" clients, that they get their clients the "best" deal. But both sides do seem to agree on the appropriate standard by which the business lawyers should be judged: If what value, a transaction must be worth more, net of legal fees, as a result of the lawyer's participation.

6. Despite the criticism, most business lawyers are justifiably proud of what they do. They spend most of their time helping distinctly middle-class clients start, manage, grow, and ultimately sell small and medium-size busi-nesses. The businesses, in turn, provide the products and services that people

CII. 1

of

lawyers are

know that lawyers

Corporate

"business

Creation By 2 4 1 - 4 3

like

what are per-

charitable but still negative

maintenance deal killers whose

effort at finding own

their

performance of a business lawyer does has

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indirectly, AIDS drugs, organic healthy

F. WHAT ARE THE LEGALFOR BUSINESSES?

For the most part, the rest of this book structures for businesses. By way of

overview of what co-author Roberts teachesschool (which we call "client school" because

gone there) about the legal structures

The decision regarding a business structure

usi-Dple individual reports all income and deductible expenses for the business on

SEC. F LEGAL STRUCTURES FOR BUSINESSES 2 7

need and enjoy. Lawyers can take pride that they help produce, perhaps a bit foods, and the movie Wassup Rockers.I

•e a- STRUCTURES ;e rs le is about the various forms of ;h legal preview, the following is an

people going to business many of your clients will te

have for businesses.

ss is driven chiefly by the •rs objectives of the business's founder and the firm's investors, in terms of lal tax status, exposure to legal liabilities, and flexibility in the operation and is financing of the business. The choices are made difficult by the inherent

tradeoffs imposed by the law. To get the most favorable tax treatment, one may sometimes have to give up some protection from liability exposure, By flexibility or both. 4 3

ke

1. WHAT CHOICES ARE AVAILABLE?

The basic legal forms of business organization include: lat er- The sole proprietorship

gic The partnership

• general partnership ive • limited partnership ;ti-

The corporation .f a re- The limited liability company (LLC) ace For the owner, the two most important differences in these various ose

business structures are (1) tax treatment of the business's profits and (2) ing

liability exposure of the owners for the business's debts and other poten-•wn tial liabilities. These differences can be seen most readily by comparing sole proprietorships and corporations. Other business structures such as

leir partnerships, limited partnerships, and limited liability companies are, in tto a sense, combinations of features from the corporation and partnership leir structures. jem

of a. The Sole Proprietorship has

The sole proprietorship is the oldest and simplest form of organiza-t of tion: a person undertakes a business without any of the formalities associated with other forms of organization; the individual and the busi-

i of ness are one and the same for tax and legal liability purposes. lass

The proprietorship does not pay taxes as a separate entity. The

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cash. There is no vehicle for "sheltering"

For liability purposes, the individualand the same. Thus, legal claimants can

simply the assets used in the business.

The Corporation The corporation is the most common

nesses.* One major advantage of the corporation, proprietorship, is that a corporation's ownersers) are generally protected from personal

In exchange for this protection, the


her personal income tax return. These earnings of the business are taxed to the individual regardless of whether they are actually distributed in

income from tax.

and the business are also one pursue all assets of the owner,

not

b. legal structure for large busi-

compared to the sole (stockholders or sharehold-

liability.

corporation is considered a tax-paying entity. A corporation must pay taxes on its income, just like a real person.

And, because the business does not get any deduction for dividends paid, the earnings of a corporation are, in essence, taxed twice. First, the corporation pays a tax on its income. Second, the owners of the corpora-tion pay a tax on the part of the corporation's earnings that is distributed to them as dividends.

The current maximum income taxation rate on corporate income is 35%; the maximum rate on individual income is likely to be approximately 40% when federal and state taxes are considered. Thus, $1.00 of pre-tax corporate income becomes $0.39 when it is distributed as dividends and taxed at the personal level [1.00 x ( 1 - . 3 5 ) x (1 - .40 ) ] .

This double taxation of corporations—taxation first of the corpora-tions on its earnings and then second of its shareholders on their divi-dends—creates powerful incentives for enterprises that anticipate distrib-uting earnings to use a form of business structure which is not taxed on its earnings, such as a partnership or limited liability company.

Other forms of organization can best be understood in relation to the sole proprietorship and the corporation. Do not think of these business forms as hermetically sealed; in fact, there is a great deal of overlap among them, and a lawyer may be able to suggest more than one potential business structure to achieve the client's goals. It is helpful to note that the law continues to evolve, and one reason for the multiple business forms is that states have reached various stages of development. Eventual-ly, some people believe, there will be only two basic business forms, the corporation for large businesses and the limited liability company for small ones. The law is not there yet, though, so the lawyer must be facile with the characteristics of various business structures.

c. The (General) Partnership Partnerships are businesses that consist of two or more owners. A

partnership is treated like a sole proprietorship for tax and liability

* We refer here to " C " corporations. We briefly discuss " S " corporations a bit further down.

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paid only personal income (this is called "pass-through"

purposes, each of the partners is jointly and party may pursue one or more of the

claim need not be proportional to invested earnings.

The Limited Partnership Limited partnerships are a hybrid form

partnership or sole proprietorship for tax purposes. corporation for liability purposes. A limitedthat has both limited and general partners.

nothinglose Thethe firm.in investments theirthan from varies law

SEC. F LEGAL STRUCTURES FOR BUSINESSES 2 9

purposes. Earnings are distributed according to the partnership agree-ment, and taxes are at the level on the partner's share of that taxation). For liability

severally liable. Thus, an injured partners for any amount. The capital or to the distribu-tion of

d. of organization. It is like a

And, it is somewhat like a partnership is a partner-ship The general partner assumes the management responsibility and unlimited liability for the business. The limited partner has little voice in management and is not individually liable for the company's debts. The limited partner thus looks a lot like a shareholder in a corporation.

e. The Limited Liability Company (LLC) The limited liability company is a business structure developed to

provide both the protection from liability of a corporation and the protec-tion from double taxation of a partnership. The owners of a limited liability company are not individually liable for the company's debts. The limited liability company is not a tax paying entity. Income taxes are only paid once—by the owners of the limited liability company when a part of the company's earnings is distributed to them.

The existence of an LLC depends on compliance with the state limited liability company law. These laws differ from state to state.*

f. The S Corporation and Not-For-Profit Corporations Although we won't discuss them further in this book, you should

know a little about two additional business forms. Like the LLC, the S Corporation is afforded the tax status of a partnership, but the protection from legal liability of a corporation. This advantageous tax treatment comes at a cost. To qualify for S Corporation tax status, the business must meet a number of rather restrictive conditions in the Internal Revenue Code, including being a domestic corporation, owned wholly by human (not entity) citizens of the United States, with 100 or fewer stockholders.

The IRS and individual states have established that certain corpora-tions that, in narrowly specified ways, operate for the public benefit need not pay corporate income tax. In addition, individuals can deduct gifts to these "non-profit" corporations from their tax returns. Internal Revenue

* Similar to an LLC, a Limited Liability Partnership (LLP) is a general partnership that files the documents required by state law to provide partners with limited liability—that is, the partners, who ordinarily would be liable for partnership debts, are not personally liable; they can

more state-to-state on whether this freedom from liability is total or partial, depending on the type of claim asserted.

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businesses do not qualify.

2. HOW DO YOU

The right choice depends upon a balance light of the client's needs:

Persons setting up any business mustincluding (1) who will own the business,who will reap any profit, (4) who will bearwho will pay income tax on any business ment of [various] forms of business

3 0 W H A T D O BUSINESSES D O ? CII. 1

Code 501(c)(3). Churches and universities are examples. Most normal

CHOOSE?

of factors to be assessed in

address certain core questions, (2) who will manage it, (3) the risk of any loss, and (5)

profit. * * * The develop-organization in the United States

is largely the story of attempting to maximize benefit while reducing risk. One example might be assessing the possibility of whether an owner could limit his liability for business debts while sharing in profits and decision-making.

Richard D . Freer, Business Organizations, OXFORD COMPANION TO AMERICAN

LAW 77 (2002), edited by Kermit Hall, copyright by Oxford University Press, Inc. Used by permission of Oxford University Press, Inc.

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I. CORPORATIONS MODEL BUSINESS CORPORATION ACT

(with selected Official Comments)

Comments copyright © American Bar Foundation and Law and Business, Inc. reproduced with permission.

Contents

CHAPTER 1. GENERAL PROVISIONS SUBCHAPTER D. DEFINITIONS

§1.40 Act Definitions In this Act:

(1) ‘‘Articles of incorporation’’ means the original articles of incorporation, all amendments thereof, and any other documents permitted or required to be filed by a domestic business corporation with the secretary of state under any provision of this Act except section 16.21. If an amendment of the articles or any other document filed under this Act restates the articles in their entirety, thenceforth the articles shall not include any prior documents.

* * * (21) ‘‘Shareholder’’ means the person in whose name shares are registered in the records of a corporation or the

beneficial owner of shares to the extent of the rights granted by a nominee certificate on file with a corporation.

CHAPTER 2. INCORPORATION §2.02 Articles of Incorporation

(a) The articles of incorporation must set forth: (1) a corporate name for the corporation that satisfies the requirements of section 4.01; (2) the number of shares the corporation is authorized to issue; (3) the street address of the corporation’s initial registered office and the name of its initial registered agent

at that office; and (4) the name and address of each incorporator.

(b) The articles of incorporation may set forth: (1) the names and addresses of the individuals who are to serve as the initial directors; (2) provisions not inconsistent with law regarding:

(i) the purpose or purposes for which the corporation is organized; (ii) managing the business and regulating the affairs of the corporation; (iii) defining, limiting, and regulating the powers of the corporation, its board of directors, and

shareholders; (iv) a par value for authorized shares or classes of shares; (v) the imposition of personal liability on shareholders for the debts of the corporation to a

specified extent and upon specified conditions; (3) any provision that under this Act is required or permitted to be set forth in the bylaws; (4) a provision eliminating or limiting the liability of a director to the corporation or its shareholders for

money damages for any action taken, or any failure to take any action, as a director, except liability for (A) the amount of a financial benefit received by a director to which he is not entitled; (B) an intentional infliction of harm on the corporation or the shareholders; (C) a violation of section 8.33; or (D) an intentional violation of criminal law; and

(5) a provision permitting or making obligatory indemnification of a director for liability (as defined in section 8.50(5)) to any person for any action taken, or any failure to take any action, as a director except liability for (A) receipt of a financial benefit to which he is not entitled, (B) an intentional infliction of



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harm on the corporation or its shareholders, (C) a violation of section 8.33, or (D) an intentional violation of criminal law.

(c) The articles of incorporation need not set forth any of the corporate powers enumerated in this Act. (d) Provisions of the articles of incorporation may be made dependent upon facts objectively ascertainable

outside the articles of incorporation in accordance with section 1.20(k).

CHAPTER 3. PURPOSES AND POWERS §3.02 General Powers Unless its articles of incorporation provide otherwise, every corporation has perpetual duration and succession in its corporate name and has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs, including without limitation power:

* * * (13) to make donations for the public welfare or for charitable, scientific, or educational purposes;

* * * §3.04 Ultra Vires

(a) Except as provided in subsection (b), the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act.

(b) A corporation’s power to act may be challenged: (1) in a proceeding by a shareholder against the corporation to enjoin the act; (2) in a proceeding by the corporation, directly, derivatively, or through a receiver, trustee, or other legal

representative, against an incumbent or former director, officer, employee, or agent of the corporation; or

(3) in a proceeding by the Attorney General under section 14.30. (c) In a shareholder’s proceeding under subsection (b)(1) to enjoin an unauthorized corporate act, the court may

enjoin or set aside the act, if equitable and if all affected persons are parties to the proceeding, and may award damages for loss (other than anticipated profits) suffered by the corporation or another party because of enjoining the unauthorized act.

CHAPTER 8. DIRECTORS AND OFFICERS SUBCHAPTER A. BOARD OF DIRECTORS

§ 8.01 Requirement for and Functions of Board of Directors (a) Except as provided in section 7.32, each corporation must have a board of directors. (b) All corporate powers shall be exercised by or under the authority of the board of directors of the corporation,

and the business and affairs of the corporation shall be managed by or under the direction, and subject to the oversight, of its board of directors, subject to any limitation set forth in the articles of incorporation or in an agreement authorized under section 7.32.

(c) In the case of a public corporation, the board’s oversight responsibilities include attention to: (1) business performance and plans; (2) major risks to which the corporation is or may be exposed; (3) the performance and compensation of senior officers; (4) policies and practices to foster the corporation’s compliance with law and ethical conduct; (5) preparation of the corporation’s financial statements; (6) the effectiveness of the corporation’s internal controls; (7) arrangements for providing adequate and timely information to directors; and (8) the composition of the board and its committees, taking into account the important role of independent

directors.



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CHAPTER 16. RECORDS AND REPORTS SUBCHAPTER A. RECORDS

§16.01. Corporate Records (a) A corporation shall keep as permanent records minutes of all meetings of its shareholders and board of

directors, a record of all actions taken by the shareholders or board of directors without a meeting, and a record of all actions taken by a committee of the board of directors in place of the board of directors on behalf of the corporation.

(b) A corporation shall maintain appropriate accounting records. (c) A corporation or its agent shall maintain a record of its shareholders, in a form that permits preparation of a

list of the names and addresses of all shareholders, in alphabetical order by class of shares showing the number and class of shares held by each.

(d) A corporation shall maintain its records in written form or in another form capable of conversion into written form within a reasonable time.

(e) A corporation shall keep a copy of the following records at its principal office: (1) its articles or restated articles of incorporation, all amendments to them currently in effect and any

notices to shareholders referred to in section 1.20(k)(5) regarding facts on which a filed document is dependent;

(2) its bylaws or restated bylaws and all amendments to them currently in effect; (3) resolutions adopted by its board of directors creating one or more classes or series of shares, and fixing

their relative rights, preferences, and limitations, if shares issued pursuant to those resolutions are outstanding;

(4) the minutes of all shareholders’ meetings, and records of all action taken by shareholders without a meeting, for the past three years;

(5) all written communications to shareholders generally within the past three years, including the financial statements furnished for the past three years under section 16.20;

(6) a list of the names and business addresses of its current directors and officers; and (7) its most recent annual report delivered to the secretary of state under section 16.22.

§16.02. Inspection of Records by Shareholders (a) A shareholder of a corporation is entitled to inspect and copy, during regular business hours at the

corporation’s principal office, any of the records of the corporation described in section 16.01(e) if he gives the corporation written notice of his demand at least five business days before the date on which he wishes to inspect and copy.

(b) A shareholder of a corporation is entitled to inspect and copy, during regular business hours at a reasonable location specified by the corporation, any of the following records of the corporation if the shareholder meets the requirements of subsection (c) and gives the corporation written notice of his demand at least five business days before the date on which he wishes to inspect and copy:

(1) excerpts from minutes of any meeting of the board of directors, records of any action of a committee of the board of directors while acting in place of the board of directors on behalf of the corporation, minutes of any meeting of the shareholders, and records of action taken by the shareholders or board of directors without a meeting, to the extent not subject to inspection under section 16.02(a);

(2) accounting records of the corporation; and (3) the record of shareholders.

(c) A shareholder may inspect and copy the records described in subsection (b) only if: (1) his demand is made in good faith and for a proper purpose; (2) he describes with reasonable particularity his purpose and the records he desires to inspect; and (3) the records are directly connected with his purpose.

(d) The right of inspection granted by this section may not be abolished or limited by a corporation’s articles of incorporation or bylaws.



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(e) This section does not affect: (1) the right of a shareholder to inspect records under section 7.20 or, if the shareholder is in litigation with

the corporation, to the same extent as any other litigant; (2) the power of a court, independently of this Act, to compel the production of corporate records for

examination. (f) For purposes of this section, ‘‘shareholder’’ includes a beneficial owner whose shares are held in a voting

trust or by a nominee on his behalf.



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Excerpted from: JUSTIA US LAW, 2014 NEW JERSEY REVISED STATUTES, law.justia.com/codes/new-jersey/2014/title-14a/

NEW JERSEY REVISED STATUTES

TITLE 14A – CORPORATIONS, GENERAL CHAPTER 1

§14A:1-2.1 As used in this act, unless the context otherwise requires, the term:

* * * (f) "Certificate of incorporation" includes:

(i) the original certificate of incorporation or any other instrument filed or issued under any statute to form a domestic or foreign corporation, as amended, supplemented or restated by certificates of amendment, merger or consolidation or by other certificates or instruments filed or issued under any statute; and

(ii) a special act or charter creating a domestic or foreign corporation, as amended, supplemented or restated.

CHAPTER 2 – PURPOSES §14A:2-7. Certificate of incorporation

(1) The certificate of incorporation shall set forth: (a) The name of the corporation; (b) The purpose or purposes for which the corporation is organized. It shall be a sufficient

compliance with this paragraph to state, alone or with specifically enumerated purposes, that the corporation may engage in any activity within the purposes for which corporations may be organized under this act, and all such activities shall by such statement be deemed within the purposes of the corporation, subject to express limitations, if any;

(c) The aggregate number of shares which the corporation shall have authority to issue; (d) If the shares are, or are to be, divided into classes, or into classes and series, the designation of

each class and series, the number of shares in each class and series, and a statement of the relative rights, preferences and limitations of the shares of each class and series, to the extent that such designations, numbers, relative rights, preferences and limitations have been determined;

(e) If the shares are, or are to be, divided into classes, or into classes and series, a statement of any authority vested in the board to divide the shares into classes or series or both, and to determine or change for any class or series its designation, number of shares, relative rights, preferences and limitations;

(f) Any provision not inconsistent with this act or any other statute of this State, which the incorporators elect to set forth for the management of the business and the conduct of the affairs of the corporation, or creating, defining, limiting or regulating the powers of the corporation, its directors and shareholders or any class of shareholders, including any provision which under this act is required or permitted to be set forth in the bylaws;

(g) The address of the corporation's initial registered office, and the name of the corporation's initial registered agent at such address. On or after the effective date of this 1989 amendatory and supplementary act, the address of the registered office as shown on the certificate of incorporation shall be a complete address, including the number and street location of the registered office and, if applicable, the post office box number;

(h) The number of directors constituting the first board and the names and addresses of the persons who are to serve as such directors;

(i) The names and addresses of the incorporators; (j) The duration of the corporation if other than perpetual; and

https://law.justia.com/codes/new-jersey/2014/title-14a

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(k) If, pursuant to subsection 14A:2-7(2), the certificate of incorporation is to be effective on a date subsequent to the date of filing, the effective date of the certificate. (2) The certificate of incorporation shall be filed in the office of the Secretary of State. The corporate

existence shall begin upon the effective date of the certificate, which shall be the date of the filing or such later time, not to exceed 90 days from the date of filing, as may be set forth in the certificate. Such filing shall be conclusive evidence that all conditions precedent required to be performed by the incorporators have been complied with and, after the corporate existence has begun, that the corporation has been incorporated under this act, except as against this State in a proceeding to cancel or revoke the certificate of incorporation or for involuntary dissolution of the corporation.

(3) The certificate of incorporation may provide that a director or officer shall not be personally liable, or shall be liable only to the extent therein provided, to the corporation or its shareholders for damages for breach of any duty owed to the corporation or its shareholders, except that such provision shall not relieve a director or officer from liability for any breach of duty based upon an act or omission (a) in breach of such person's duty of loyalty to the corporation or its shareholders, (b) not in good faith or involving a knowing violation of law or (c) resulting in receipt by such person of an improper personal benefit. As used in this subsection, an act or omission in breach of a person's duty of loyalty means an act or omission which that person knows or believes to be contrary to the best interests of the corporation or its shareholders in connection with a matter in which he has a material conflict of interest.

CHAPTER 3 – GENERAL POWERS §14A:3-2. Ultra vires transactions No act of a corporation and no conveyance or transfer of real or personal property to or by a corporation shall be invalid by reason of the fact that the corporation was without capacity or power to do such act or to make or receive such conveyance or transfer, but such lack of capacity or power may be asserted:

(a) In a proceeding by a shareholder against the corporation to enjoin the doing of any act or acts or the transfer of real or personal property by or to the corporation. If the unauthorized acts or transfer sought to be enjoined are being, or are to be, performed or made pursuant to any contract to which the corporation is a party, the court may, if all of the parties to the contract are parties to the proceeding and if it deems the same to be equitable, set aside and enjoin the performance of such contract, and in so doing may allow to the corporation or to the other parties to the contract, as the case may be, compensation for the loss or damage sustained by either of them which may result from the action of the court in setting aside and enjoining the performance of such contract, but anticipated profits to be derived from the performance of the contract shall not be awarded by the court as a loss or damage sustained.

(b) In a proceeding by the corporation, whether acting directly or through a receiver, trustee, or other legal representative, or through shareholders in a representative suit, against the incumbent or former officers or directors of the corporation.

(c) In a proceeding by the Attorney General, as provided in this act, to dissolve the corporation, or in a proceeding by the Attorney General to enjoin the corporation from the transaction of unauthorized business.

§14A:3-4. Contributions by corporations (1) Any corporation organized for any purpose under any general or special law of this State, unless

otherwise provided in its certificate of incorporation or by-laws, shall have power, irrespective of corporate benefit, to aid, singly or in cooperation with other corporations and with natural persons, in the creation or maintenance of institutions or organizations engaged in community fund, hospital, charitable, philanthropic, educational, scientific or benevolent activities or patriotic or civic activities conducive to the betterment of social and economic conditions, and the board may authorize the making of contributions for those purposes in money, securities, including shares of the corporation, or other property, in such


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reasonable amounts as the board may determine; provided, that a contribution shall not be authorized hereunder if at the time of the contribution or immediately thereafter the donee institution shall own more than 10% of the voting stock of the donor corporation or one of its subsidiaries.

(2) The provisions of this section shall not be construed as directly or indirectly minimizing or interpreting the rights and powers of corporations, as heretofore existing, with reference to appropriations, expenditures or contributions of the nature above specified.

CHAPTER 5 – PLACE OF SHAREHOLDERS’ MEETINGS §14A:5-28. Books and records; right of inspection

(1) Each corporation shall keep books and records of account and minutes of the proceedings of its shareholders, board and executive committee, if any. Unless otherwise provided in the bylaws, such books, records and minutes may be kept outside this State. The corporation shall keep at its principal office, its registered office, or at the office of its transfer agent, a record or records containing the names and addresses of all shareholders, the number, class and series of shares held by each and the dates when they respectively became the owners of record thereof. Any of the foregoing books, minutes or records may be in written form or in any other form capable of being converted into readable form within a reasonable time. A corporation shall convert into readable form without charge any such records not in such form, upon the written request of any person entitled to inspect them.

(2) Upon the written request of any shareholder, the corporation shall mail to such shareholder its balance sheet as at the end of the preceding fiscal year, and its profit and loss and surplus statement for such fiscal year.

(3) Any person who shall have been a shareholder of record of a corporation for at least six months immediately preceding his demand, or any person holding, or so authorized in writing by the holders of, at least 5% of the outstanding shares of any class or series, upon at least five days' written demand shall have the right for any proper purpose to examine in person or by agent or attorney, during usual business hours, its minutes of the proceedings of its shareholders and record of shareholders and to make extracts therefrom, at the places where the same are kept pursuant to subsection 14A:5-28(1).

(4) Nothing herein contained shall impair the power of any court, upon proof by a shareholder of proper purpose, irrespective of the period of time during which the shareholder shall have been a shareholder of record, and irrespective of the number of shares held by him, to compel the production for examination by such shareholder of the books and records of account, minutes, and record of shareholders of a corporation. The court may, in its discretion prescribe any limitations or conditions with reference to the inspection, or award any other or further relief as the court may deem just and proper. The court may order books, documents and records, pertinent extracts therefrom, or duly authenticated copies thereof, to be brought within this State and kept in this State upon whatever terms and conditions as the order may prescribe. In any action for inspection the court may proceed summarily.

(5) Holders of voting trust certificates representing shares of the corporation shall be regarded as shareholders for the purpose of this section.

CHAPTER 6 – BOARD OF DIRECTORS §14A:6-1. Board of Directors

(1) The business and affairs of a corporation shall be managed by or under the direction of its board, except as in this act or in its certificate of incorporation otherwise provided. Directors shall be at least 18 years of age and need not be United States citizens or residents of this State or shareholders of the corporation unless the certificate of incorporation or by-laws so require. The certificate of incorporation or by-laws may prescribe other qualifications for directors.

(2) In discharging his duties to the corporation and in determining what he reasonably believes to be in


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the best interest of the corporation, a director may, in addition to considering the effects of any action on shareholders, consider any of the following: (a) the effects of the action on the corporation's employees, suppliers, creditors and customers; (b) the effects of the action on the community in which the corporation operates; and (c) the long term as well as the short-term interests of the corporation and its shareholders, including the possibility that these interests may best be served by the continued independence of the corporation.

(3) If on the basis of the factors described in subsection (2) of this section, the board of directors determines that any proposal or offer to acquire the corporation is not in the best interest of the corporation, it may reject such proposal or offer. If the board of directors determines to reject any such proposal or offer, the board of directors shall have no obligation to facilitate, remove any barriers to, or refrain from impeding the proposal or offer.


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Excerpted from: FindLaw, codes.lp.findlaw.com/nycode/BSC

NEW YORK BUSINESS CORPORATION LAW ARTICLE 1. SHORT TITLE; DEFINITIONS; APPLICATIONS;

CERTIFICATES, MISCELLANEOUS §102. Definitions

(a) As used in this chapter, unless the context otherwise requires, the term: * * *

(3) "Certificate of incorporation" includes (A) the original certificate of incorporation or any other instrument filed or issued under any statute to form a domestic or foreign corporation, as amended, supplemented or restated by certificates of amendment, merger or consolidation or other certificates or instruments filed or issued under any statute; or (B) a special act or charter creating a domestic or foreign corporation, as amended, supplemented or restated.

ARTICLE 2. CORPORATE PURPOSES AND POWERS §202. General powers

(a) Each corporation, subject to any limitations provided in this chapter or any other statute of this state or its certificate of incorporation, shall have power in furtherance of its corporate purposes:

* * * (12) To make donations, irrespective of corporate benefit, for the public welfare or for community

fund, hospital, charitable, educational, scientific, civic or similar purposes, and in time of war or other national emergency in aid thereof.

* * * §203. Defense of ultra vires

(a) No act of a corporation and no transfer of real or personal property to or by a corporation, otherwise lawful, shall be invalid by reason of the fact that the corporation was without capacity or power to do such act or to make or receive such transfer, but such lack of capacity or power may be asserted:

(1) In an action by a shareholder against the corporation to enjoin the doing of any act or the transfer of real or personal property by or to the corporation. If the unauthorized act or transfer sought to be enjoined is being, or is to be, performed or made under any contract to which the corporation is a party, the court may, if all of the parties to the contract are parties to the action and if it deems the same to be equitable, set aside and enjoin the performance of such contract, and in so doing may allow to the corporation or to the other parties to the contract, as the case may be, such compensation as may be equitable for the loss or damage sustained by any of them from the action of the court in setting aside and enjoining the performance of such contract; provided that anticipated profits to be derived from the performance of the contract shall not be awarded by the court as a loss or damage sustained.

(2) In an action by or in the right of the corporation to procure a judgment in its favor against an incumbent or former officer or director of the corporation for loss or damage due to his unauthorized act.

(3) In an action or special proceeding by the attorney-general to annul or dissolve the corporation or to enjoin it from the doing of unauthorized business.

ARTICLE 4. FORMATION OF CORPORATIONS §402. Certificate of incorporation; contents

(a) A certificate, entitled "Certificate of incorporation of ...... (name of corporation) under section 402 of the Business Corporation Law", shall be signed by each incorporator, with his name and address included in such certificate and delivered to the department of state. It shall set forth:

(1) The name of the corporation.

https://codes.lp.findlaw.com/nycode/BSC

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(2) The purpose or purposes for which it is formed, it being sufficient to state, either alone or with other purposes, that the purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under this chapter, provided that it also state that it is not formed to engage in any act or activity requiring the consent or approval of any state official, department, board, agency or other body without such consent or approval first being obtained. By such statement all lawful acts and activities shall be within the purposes of the corporation, except for express limitations therein or in this chapter, if any.

(3) The county within this state in which the office of the corporation is to be located. (4) The aggregate number of shares which the corporation shall have the authority to issue; if such

shares are to consist of one class only, the par value of the shares or a statement that the shares are without par value; or, if the shares are to be divided into classes, the number of shares of each class and the par value of the shares having par value and a statement as to which shares, if any, are without par value.

(5) If the shares are to be divided into classes, the designation of each class and a statement of the relative rights, preferences and limitations of the shares of each class.

(6) If the shares of any preferred class are to be issued in series, the designation of each series and a statement of the variations in the relative rights, preferences and limitations as between series insofar as the same are to be fixed in the certificate of incorporation, a statement of any authority to be vested in the board to establish and designate series and to fix the variations in the relative rights, preferences and limitations as between series and a statement of any limit on the authority of the board of directors to change the number of shares of any series of preferred shares as provided in paragraph (e) of section 502 (Issue of any class of preferred shares in series).

(7) A designation of the secretary of state as agent of the corporation upon whom process against it may be served and the post office address within or without this state to which the secretary of state shall mail a copy of any process against it served upon him.

(8) If the corporation is to have a registered agent, his name and address within this state and a statement that the registered agent is to be the agent of the corporation upon whom process against it may be served.

(9) The duration of the corporation if other than perpetual.

(b) The certificate of incorporation may set forth a provision eliminating or limiting the personal liability of directors to the corporation or its shareholders for damages for any breach of duty in such capacity, provided that no such provision shall eliminate or limit:

(1) the liability of any director if a judgment or other final adjudication adverse to him establishes that his acts or omissions were in bad faith or involved intentional misconduct or a knowing violation of law or that he personally gained in fact a financial profit or other advantage to which he was not legally entitled or that his acts violated section 719, or

(2) the liability of any director for any act or omission prior to the adoption of a provision authorized by this paragraph.

(c) The certificate of incorporation may set forth any provision, not inconsistent with this chapter or any other statute of this state, relating to the business of the corporation, its affairs, its rights or powers, or the rights or powers of its shareholders, directors or officers including any provision relating to matters which under this chapter are required or permitted to be set forth in the by-laws. It is not necessary to set forth in the certificate of incorporation any of the powers enumerated in this chapter.


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ARTICLE 6. SHAREHOLDERS §624. Books and records; right of inspection; prima facie evidence

(a) Each corporation shall keep correct and complete books and records of account and shall keep minutes of the proceedings of its shareholders, board and executive committee, if any, and shall keep at the office of the corporation in this state or at the office of its transfer agent or registrar in this state, a record containing the names and addresses of all shareholders, the number and class of shares held by each and the dates when they respectively became the owners of record thereof. Any of the foregoing books, minutes or records may be in written form or in any other form capable of being converted into written form within a reasonable time.

ARTICLE 7. DIRECTORS AND OFFICERS §701. Board of directors Subject to any provision in the certificate of incorporation authorized by paragraph (b) of section 620 (Agreements as to voting; provision in certificate of incorporation as to control of directors) or by paragraph (b) of section 715 (Officers), the business of a corporation shall be managed under the direction of its board of directors, each of whom shall be at least eighteen years of age. The certificate of incorporation or the by-laws may prescribe other qualifications for directors.


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Excerpt from Restatement (Second) of Agency §1

Restatement (Second) of Agency § 1 (1958)

Restatement of the Law - Agency

Chapter 1. Introductory Matters

Topic 1. Definitions

§ 1 Agency; Principal; Agent

(1) Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act. (2) The one for whom action is to be taken is the principal. (3) The one who is to act is the agent.

Comment on Subsection (1):

a. The relation of agency is created as the result of conduct by two parties manifesting that one of them is willing for the other to act for him subject to his control, and that the other consents so to act. The principal must in some manner indicate that the agent is to act for him, and the agent must act or agree to act on the principal’s behalf and subject to his control. Either of the parties to the relation may be a natural person, groups of natural persons acting for this purpose as a unit such as a partnership, joint undertakers, or a legal person, such as a corporation.

b. Agency a legal concept. Agency is a legal concept which depends upon the existence of required factual elements: the manifestation by the principal that the agent shall act for him, the agent’s acceptance of the undertaking and the understanding of the parties that the principal is to be in control of the undertaking. The relation which the law calls agency does not depend upon the intent of the parties to create it, nor their belief that they have done so. To constitute the relation, there must be an agreement, but not necessarily a contract, between the parties; if the agreement results in the factual relation between them to which are attached the legal consequences of agency, an agency exists although the parties did not call it agency and did not intend the legal consequences of the relation to follow. Thus, when one who asks a friend to do a slight service for him, such as to return for credit goods recently purchased from a store, neither one may have any realization that they are creating an agency relation or be aware of the legal obligations which would result from performance of the service. On the other hand, one may believe that he has created an agency when in fact the relation is that of seller and buyer. See § 14J. The distinction between agency and other relations, such as those of trust, buyer and seller, and others are stated in Sections 14A to 14O. The distinction between the kind of agent called a servant and a non-servant agent is stated in Section 2.

When it is doubtful whether a representative is the agent of one or the other of two contracting parties, the function of the court is to ascertain the factual relation of the parties to each other and in so doing can properly disregard a statement in the agreement that the agent is to be the agent of one rather than of the other, or a statement by the parties as to the legal relations which are thereby created. See § 14L. The agency relation results if, but only if, there is an understanding between the parties which, as interpreted by the court, creates a fiduciary relation in which the fiduciary is subject to the directions of the one on whose account he acts. It is the element of continuous subjection to the will of the principal which distinguishes the agent from other fiduciaries and the agency agreement from other agreements. The characteristics which tend to indicate an agency or a non-agency relation are stated in Sections 12 to 14O.

Illustrations: Illustrations:

1. P and A enter into an agreement which is stated to be a “contract of sale.” It provides that for one year A shall purchase a specified amount of goods from P; that the risk of loss of such goods

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after purchase is upon P, if A uses care in their custody; that A is to pay for and to sell them at prices to be fixed by P from time to time and is to keep the proceeds as a separate account, remitting monthly 90 per cent. and keeping the remainder for himself; that unsold goods can be returned to P; and that P will pay A one-half of A’s selling expenses. A is P’s agent. 2. B, wishing to borrow money, goes to A, the local representative of an insurance company employed by it to lend money and collect interest, and signs a document which states that A is B’s agent for the purpose of borrowing money from the company, for which B is to pay A one per cent. of the money borrowed, and that payments of interest are to be made to A. Both B and A understand that A is primarily to protect the interests of the company. A is not B’s agent, and payment of interest by B to A is payment to the insurance company. 3. A, the secretary of the local branch of a fraternal organization, collects money from the members of the branch, remitting it each month to the national body. The rules of the order provide that the members must pay their dues in this manner; that the local secretary is subject to the orders of the national organization as to the collection and disposition of dues, but that in receiving and forwarding dues he is the agent for the members of the local branch. It may be found that, for the collection of dues, he is the agent of the national organization and not of the members of the local branch.

Comment:

c. Confusion of terms. It is sometimes said that agency does not exist until the agent does something for the principal. In fact, the relation may exist before such time. Reciprocal duties between the parties together with a power of the agent to bind the principal are normally created at the time of the agreement. This is true although there is no binding contract between the parties. See § 16. Thus, where one asks another to purchase property for him which the other gratuitously promises to do, the other immediately has a power to bind the first by the purchase of the property and immediately becomes subject to a fiduciary duty not to buy it on his own account. This is true irrespective of the fact that either can properly terminate the relation at any time.

The agency relation is to be distinguished from other relations sometimes called agency but which do not include the elements here stated. Thus, there is sometimes said to be an “agency by necessity”, in cases in which the so-called agent has no duty to respond to the will of the principal. See §§ 14I and 141. Sometimes a power of attorney given for security has been thought to be a form of agency although the power holder has no duty to respond to the will of the one creating the power. See §§ 14H, 138, 139. In such cases the rules of agency as herein stated do not apply.


d. “Principal” is a word used to describe a person who has authorized another to act on his account and subject to his control. It includes, therefore, both a person who has directed another to act on his account in business dealings or to represent him in hearings or proceedings, but who has no control or right of control over the other’s physical conduct, and also a person who employs another to act in his affairs, having such control or right to control over his conduct that the other is termed a servant, whether or not he renders merely manual service. The word “master” as defined in Section 2 is not used in contrast to the word “principal,” but is included within it. Thus, the owner of a business is a principal not only with regard to brokers who, as to their physical acts, are independent of his supervision, but also with regard to salesmen who conduct business transactions under supervision as to such conduct and who therefore come within the definition of servant. Likewise, the owner of a house is the principal as well as the master of the janitors whom he employs and whose jobs are confined to the performance of manual acts on the premises under the owner’s supervision. The word “principal,” therefore, includes both persons who are masters and persons who are principals but not masters.


e. “Agent” is a word used to describe a person authorized by another to act on his account and under his control. Included within its meaning are those who, whether or not servants as described in Section 2, act in business transactions and those who perform only manual labor as servants. An agent may be one for

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whose physical acts the employer is not responsible and who is called an independent contractor in order to distinguish him from a servant, also an agent, for whose physical acts the employer is responsible. Thus, the attorney-at-law, the broker, the factor, the auctioneer, and other similar persons employed either for a single transaction or for a series of transactions, are agents, although as to their physical activities they are independent contractors. These are to be contrasted with others, such as clerks, train conductors, and others who conduct transactions with third persons but who fall within the category of servants. Likewise, the janitor of a building or the driver of a truck is an agent, as that word is used in the Restatement of this Subject, if he is employed under such circumstances that he becomes a servant. For many purposes it is immaterial whether or not one who is an agent is also a servant. However, the liability of a master for the torts of his servant is greater in extent than the liability of a principal for the torts of an agent who is not a servant (see §§ 219- 255), and a master’s duties to servants are different from those of a principal to agents who are not servants. See §§ 472- 528.

f. Statutory use. Whether the word “agent” as used in a statute corresponds to the meaning here given depends, with other factors, upon the purpose of the statute. Thus, the purpose of statutes providing for substituted service of process on a public official is to satisfy the due process requirement of the United States Constitution. Although such a statute may label the public official an “agent” for receiving service of process, he is not an agent in the sense used herein. He is not in fact designated by the one on whose account he “accepts service”, nor does he respond to that person’s directions. So, in a statute which fixes the method of payment of all “public officers and agents”, the word “agents” may be interpreted in a restricted sense to exclude a clerk employed by the state. The word “agent” in a criminal statute does not normally include other fiduciaries such as receivers, although some statutes may be interpreted to include them.

g. Power holders not agents. The language of agency has been used to describe as agents persons who bind others, or even act in the name of others, but do so for their own purposes. This has resulted from various causes. Thus, at a time when contracts were considered to be purely personal relations between the parties, a contractor could not transfer his right to another. However, one could appoint an agent to collect money due on the contract, the document of agreement being called a power of attorney. When economic reasons made it desirable to recognize assignments, it was not too difficult to hold that one could agree with an “attorney” that the latter should keep the proceeds. In accordance with this point of view, a mortgagee was given a “power of attorney” to sell the mortgagor’s interests in the mortgaged property. In doing this the courts created a power for security. Such a power is not an agency power and the holder of one is not an agent of the one who created it. See § 138.

Restatement of the Law -- Agency Restatement (Third) of Agency

Current through April 2006

Copyright © 2006 by the American Law Institute

Chapter 1. Introductory Matters Topic 1. Definitions And Terminology

§ 1.01 Agency Defined Agency is the fiduciary relationship that arises when one person (a "principal") manifests assent to another

person (an "agent") that the agent shall act on the principal's behalf and subject to the principal's control, and the agent manifests assent or otherwise consents so to act.

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