business associations chapter 1: acting through others prof. amitai aviram [email protected]...

Business associationsChapter 1:

Acting through othersProf. Amitai [email protected]

University of Illinois College of LawCopyright © Amitai Aviram. All Rights Reserved

F15D

Acting through othersOverview of Chapter 1

a. Introduction to BA– Overview of the course– Administrative details about the course

b. Firmsc. Actors

© Amitai Aviram. All rights reserved. 2

• What is business?– Strategy: identifying a match between -

• a combination of resources that produce a product/service• your firm’s competitive strengths in combining these resources• a market that values the product at or above production price, and in which the

firm’s competitive strengths allow it to capture the most of the surplus value– Operations: combining the resources to produce & supply the product

(& maximizing surplus value by reducing costs / increasing the product’s value)– Governance: the rules, process & enforcement mechanisms that coordinate

between people that have the required resources (“stakeholders”)• Business law facilitates governance (i.e., coordinates stakeholders in

business transactions)– Corporate law (organizational law) is the portion of business law that facilitates

acting through others (legal issues arising from one person acting on another’s behalf)– This course teaches the foundations of corporate law

Introduction to BAWhat is business law?


• The main goal of corporate law is to facilitate acting through others: allowing one person (B, the beneficiary) to have another person (A, the actor) act on their behalf– This often involves A dealing with a third party (T) on B’s behalf– E.g., Bank of America (B) asks Andy (A) (employee or a real-estate agent), to

find & buy an office building in Chicago• Acting through others creates two major problems:

1. The shielding problem: Preventing B from exploiting T by dealing through A (balanced against B’s interest to limit liability from A’s reckless behavior)• E.g. (contracts), A agrees to buy T’s building for twice the market price. Must B pay?• E.g. (torts), when A negotiates to buy T’s building, she loses her patience with T and punches

him. Is B liable to T for damages?• Law & practices dealing with the shielding problem are called corporate

compliance (or external governance); will be covered in Chapter 22. The agency problem: Preventing A from shirking or stealing

• E.g., Tony (T) offers A $1M if he causes B to buy T’s building. Can A accept this payment?• Law & practices dealing with the agency problem are called corporate

governance (or internal governance); will be covered in Chapter 3

© Amitai Aviram. All rights reserved. 4Introduction to BAWhat is corporate law?

• The agency problem: solutions– Bonding solutions (align A’s welfare with B’s welfare)

• Morality/identity• Joint ownership• Performance-based compensation

– Voice solutions (let B unilaterally express dissent in a manner that may affect A’s behavior)• Approval (affirmative approval/veto power)• Protest

– Litigation solutions (Have a third party (a judge) enforce appropriate behavior by A)• Authority (suing actor for exceeding authority)• Fiduciary duties

– Exit solutions (let B unilaterally end association with firm & takes her share of firm’s value)• Termination (dissolution)• Dissociation• Alienation

© Amitai Aviram. All rights reserved. 5Introduction to BAWhat is corporate law?

Introduction to BAWhat is corporate law?

• The second goal of corporate law is to facilitate business activity that is conducted jointly by multiple people: acting jointly through others– A business association (“firm”) is a legal concept designed to let multiple

beneficiaries conduct business jointly• Doing business jointly creates a problem of collective control: making

all Bs speak with one voice– Difficult if there is:

• High cost to act collectively• Unequal access to info/expertise• Differing business interests

– Two dysfunctions (note analogy to the agency problem):• Beneficiary apathy: some Bs lack ability/incentive to monitor As efficiently• Beneficiary rivalry: Bs have different incentives regarding firm’s behavior, so

controllers can exploit minority beneficiaries– Example: Bank of America has thousands of SHs; how can they collectively control

the bank’s agents (employees) and direct the bank’s behavior?


Introduction to BAWhat is corporate law?

• Impact of collective control dysfunctions– Corporate compliance: Each B is concerned about her personal assets seized

because of firm’s obligations (& firm is concerned about each B’s obligations). Do we draw a distinction between firm’s assets/liabilities & B’s? Asset partitioning (e.g., limited liability) prevents mixing firm’s & B’s assets, but creates a shielding problem• B forecloses on shares of a gas station & owns them in lieu of a defaulted $2M

loan. When gas station makes profits, it pays them to B as dividends. Gas station has a spill that causes $10M in environmental damage. When gas station is sued for the damage, it doesn’t have money to pay. Must B pay the damages?

– Corporate governance• Voice mechanism is not effective to control actors• So we need delegated control: appoint an uncontrolled actor (autonomous

fiduciary) to control firm on Bs’ behalf• Bs have an agency problem with this uncontrolled actor, so we need more court

intervention (litigation solutions)


© Amitai Aviram. All rights reserved. 8Introduction to BAOur course’s structure

Chapter 2: Corporate compliance (external governance)a. B’s liability for A’s contracts

b. B’s liability for A’s tortsc. Asset partitioning

Chapter 3: Corporate governance (internal governance)a. Litigation solutions (authority, fiduciary duties)

b. Exit solutions

c. Customizing the firm

Flaws Duty Standard of review Application

Chapter 1: Acting through othersa. Introduction to BA (today’s class)

b. Firmsc. Actors

Alienation Dissociation Dissolution

• Check out the course schedule for class topic & pre-class assignment: http://www.law.illinois.edu/aviram/BA_out.htm

• There are three class types:– Lectures (L)

• Before class you read an assigned case(s) from the course materials packet• In class I lecture & may call on people or ask for volunteers for some questions• Used mostly for theoretical material

– Application (A)• Before class you listen to a video of my lecture (on YouTube – the link is on the class schedule)• Cases/notes in the materials packet are optional for application classes• In class you work in groups with people next to you on problems that exercise the material

covered in the lecture– Review (R)

• No pre-class assignment; in class you work in groups with people next to you on complex problems/cases involving multiple issues

• Material for the exam also includes the legislation that’s in the course packet (for both L & A classes) and my lecture notes, but you don’t need to prep for that prior to class (just know it for the exam)

© Amitai Aviram. All rights reserved. 9Introduction to BAClasses

http://www.law.illinois.edu/aviram/BA_out.htm

http://www.law.illinois.edu/aviram/BA_out.htm

• Here, have my lecture notes…– All of my lecture notes are available online (on PowerPoint slides)– They are likely to change just before a lecture (as I prep)– I recommend you read them after each class, to clarify what you didn’t

understand in class & augment your notes (my notes are part of material for the exam)

• Accessing materials– Course schedule, lecture notes, past exams, course outline & syllabus are all

posted and regularly updated here: http://www.law.illinois.edu/aviram/• Talking to me outside of class

– Please e-mail prior to meeting with me• Suggest when you would like to meet (not limited to office hours)• Describe what issues you want to talk about

– E-mail: [email protected]; Room 326

© Amitai Aviram. All rights reserved. 10Introduction to BAResources

• Take-home exam– Exam will be e-mailed to you at 10am at your choice among these days:

– Course deadline: Friday, Dec. 4, 5pm– You must e-mail my administrative assistant by the course deadline, with your

choice among these three dates; if you didn’t e-mail your choice by the deadline, you will receive the exam on the first day it takes place

– My administrative assistant is Clyde Gabriel ([email protected])• Time limit

– Exam responses must be e-mailed to my administrative assistant by 10am on the day following the day it was e-mailed to you (even if it’s a weekend)

• Exam structure: issue spotter (traditional essay-type law school exam question)– Word limit: 1,000 words– More info on the exam in the exam prep session (last class of semester)– Past exams (with model answer) available at: http://www.law.illinois.edu/aviram/Exams.htm

• Course deadline is also the deadline for answering student questions (both face-to-face & by e-mail)

Thursday, Dec. 10 Friday, Dec. 11 Monday, Dec. 14

© Amitai Aviram. All rights reserved. 11Introduction to BAExam

http://www.law.illinois.edu/aviram/Exams.htm



• Instead of taking the exam, you may submit a project– Case study (plus teaching notes) for one of the sections of the course

• Case (typically 7-12 pages, plus exhibits): this is the part students read• Teaching notes: explains to the prof teaching goals, suggested solution, extensions

(other issues that can be addressed by extending the case), how the case developed in reality

• Information on creating a case study is available on my website at: http://www.law.illinois.edu/aviram/Aviram-Writing_case_studies.pdf

– Teaching module picks a topic studied in the course (typically, one sub-section; e.g., 2b – principal’s liability in torts) & creates alternative or supplemental materials to teach the same topic• Module can include new cases, practical application of the material, etc.• Product you submit should include:

– PowerPoint slides used to teach the material– Teaching notes that provide information professor needs to know to use slides in class, plus a

statement explaining why you structured the module the way you did & what you believe are the strengths of the module compared to the material as it was taught in the course

• Product you submit may include other aids, such as relevant video clips, scanned images, excel spreadsheets etc.

• Module should provide enough content to teach a 75-minute class (~20 slides)

© Amitai Aviram. All rights reserved. 12Introduction to BAProject in lieu of exam

http://www.law.illinois.edu/aviram/Aviram-Writing_case_studies.pdf

• Deadline– Project is due by the course deadline (see “Exam” slide for the deadline)– E-mail project to my administrative assistant as 1 or more attached files

• Anonymity– Projects are graded anonymously (like exams) so the only identifying marks on

them should be the 4-digit exam ID number– To maintain anonymity, you can’t tell me your specific project, consult with me

about your project or have me look at drafts of your work• But you may ask me general questions that don’t identify your project

– Due to anonymity, projects don’t qualify for ULWR• Finality of choice between exam & project

– A student who submitted a project can’t withdraw it & can’t take the exam– A student who didn’t submit a project by the deadline must take the exam on

one of the days it is administered• Attendance & participation

– Must comply with class attendance/participation standard throughout the entire semester, whether you take the exam or submit a project

© Amitai Aviram. All rights reserved. 13Introduction to BAProject in lieu of exam

Introduction to BASupplemental reading (only if you’re interested)• Regarding agency & partnerships

• Comments in Restatement (Third) of Agency (e.g., on Westlaw: REST 3d AGEN §1.01)• Bainbridge, Agency, Partnerships & LLCs (Foundation Press, 2004)

• Regarding corporations• Bainbridge, Corporate Law (2nd Ed., 2009)

• For business & business law immersion• The Wall Street Journal, Sections C (Money & Investing) & B (Business & Tech.)• The Business Lawyer, American Bar Association Business Law Section• Harvard Law School Forum on Corporate Governance & Financial Regulation (

http://blogs.law.harvard.edu/corpgov/)• Business Law Today, American Bar Association Business Law Section• The Deal Professor Blog (http://dealbook.nytimes.com/category/deal-professor/)


http://blogs.law.harvard.edu/corpgov/

http://blogs.law.harvard.edu/corpgov/

http://dealbook.nytimes.com/category/deal-professor/


a. Introduction to BAb. Firms

1. Types of firms• Legal & economic types of firms• How firms are created

2. Constitutional documents3. Control in the firm

c. Actors


• “Real” firms (allow multiple beneficiaries to conduct business jointly)– Public firm (many Bs)

• Delegated control (firm controlled by a board that is elected by Bs)• Restrictive dissolution (difficult for dissenting B to dissolve the firm)• Liberal alienability (easy to sell B’s interest to third parties)• Contractual rigidity (most rules are mandatory)

– Private firm (few Bs)• Direct control by Bs• Liberal dissolution (easy for dissenting B to dissolve firm)• Restricted alienability (difficult to sell B’s interest to third parties)• Contractual flexibility (parties can opt out of most rules)

• Quasi-firms– Passive firm (single B or multiple Bs)

• Firm owns assets but doesn’t operate a business; firm structure used to benefit from some legal features (e.g., preferable tax treatment; limited liability, etc.)

– Proprietorship (a single B)• Operates a business but does not have multiple owners

Types of firmsEconomic types of firms


• Limited liability company (“LLC”)– Two defaults for governance: member-managed (similar to partnership)

or manager-managed (similar to corporation)• Business trust (based on the common law concept of a trust)• Proprietorship (aka Sole Proprietorship)

– An individual operating a business directly (without using an artificial entity); sometimes uses a business name (“doing business as” or dba)

Types of firmsLegal types of firms


PartnershipGeneral partnership (“GP” or “partnership”)Limited liability partnership (“LLP”)Limited partnership (“LP”)Limited liability limited partnership (“LLLP”)[Joint venture][Joint stock company]

Corporation• Public corporation• Close corporation• Benefit corporation

Types of firmsThe corporation

• By default, the corporation is optimized to be a public firm– Delegated control– Liberal alienability/restricted dissolution– Contractual rigidity

• Applicable law– Corporations are governed by state statutory law

• Less uniformity between states than in agency or partnership law• Public corporations are also subject to federal securities laws

– ABA created a Model Business Corporation Act (“MBCA”)• Serves as uniform law on which some states base their corporate law

– Majority of publicly-traded companies incorporated in Delaware• Delaware General Corporation Law (“DGCL”) is dominant for public corps

• Variants of the corporation– Public corporation (or publicly-traded corporation): corp that issued shares to

the public or that has shares traded on a stock exchange; this is usually defined by Federal securities laws, not state corporate law


Types of firmsClose corporations

• Some jurisdictions have special rules for close corporations, which are optimized to be a private firm

• Delaware– DGCL §342 allows a corporation to elect close corporation status, if:

• Charter provides that it is a close corporation• Charter provides that it may have no more than 30 SH• Corporation didn’t issue stock in a public offering• Stock is subject to one/more transfer restrictions specified in §202

– DGCL rules unique to close corporations• Direct control: charter may allow corp to be managed by SHs rather than

directors (DGCL §351)• Contractual flexibility: SH agreement between SHs who hold a majority of the

outstanding voting stock binds the parties even if it interferes with the board’s discretion (DGCL §350). Within this scope, directors are relieved from FD and FD is imposed instead on the SHs party to the agreement

• Liberal dissolution: Charter may give SHs a right to dissolve the corporation, at will or at the occurrence of a certain event (DGCL §355)

• Common-law close corporations– In some states (e.g., Mass.) case-law applies different rules if corp is closely-held– Direct control: FD analysis is more sensitive to risk of oppression of minority SHs

(i.e., more focus on FD to minority SHs that on FD to the firm)– Liberal dissolution: Courts are less reluctant to order judicial dissolution if

relationship between SHs is dysfunctional


Types of firmsBenefit corporations

• Most jurisdictions require that the purpose of corporate acts is to maximize shareholders’ financial interests

• Some states (e.g., CA, DE, NY) allow creation of & conversion into a public benefit corporation (PBC) or a flexible purpose corporation (FPC)– PBCs need to state in charter they have the purpose of creating a public benefit

• Directors of a benefit corporation may prefer non-SH interests:– “The board of directors shall manage or direct the business and affairs of the

public benefit corporation in a manner that balances the pecuniary interests of the stockholders, the best interests of those materially affected by the corporation's conduct, and the specific public benefit or public benefits identified in its certificate of incorporation” [DGCL §365(a)]

– A director “will be deemed to satisfy [her] fiduciary duties to stockholders and the corporation if [her] decision is both informed and disinterested and not such that no person of ordinary, sound judgment would approve” [DGCL §365(b)]

• What are drawbacks of PBCs/FPCs?


Types of firmsThe partnership

• By default, GP is optimized to be a private firm– Governed in most states by the Uniform partnership act (1997) (“RUPA”)– A few states still use the Uniform partnership act (1914) (“UPA”)

• Other variations of partnerships– Limited liability partnership (“LLP”): same as GP except partners have limited

liability (governed by RUPA)– Limited partnership (“LP”)

• Two classes of partners: general & limited• General partners have control rights & unlimited liability• Limited partners have limited liability & very limited control rights• Governed by Uniform Limited Partnership Act (“ULPA”)

– Limited liability limited partnership (“LLLP”): same as LP except that all partners have limited liability (governed by ULPA)

• Mostly obsolete variations of partnerships– Joint venture– Joint stock company


Types of firmsHow firms are created

• Spontaneous creation (GP)– Firm is created when Bs act in certain ways, even if they formally don’t act to

(or even want to) create a firm– Similar to agency (which is created when P&A satisfy R3A §1.01 test)

• Creation by filing (corporation, LLC, LP, LLLP)– Firm is created when Secretary of State confirms that an entrepreneur (B or

someone who will recruit Bs) filed certain documents• Creation by conversion (firm of one type become another type)

– Conversion through election (firm converts by voting to do so)• GP can convert into LLP or LP; LP can convert into GP

– Conversion through merger (firm converts by merging into another firm of a different legal type)• Requires statutory authorization (typically, conversion is authorized between

corporation/LP/LLLP/LLC & between GP/LP)


Types of firmsCreating a GP

• Definition of a GP– RUPA §§101(6), 202(a): “an association of two or more persons to carry on as

co-owners a business for profit”– ‘Co-owners’ means:

• Shared control of the business; and• Shared profits of the business.

– Spontaneous creation: doing business as co-owners results in creation of partnership by operation of law

• Fenwick [NJ 1945]– Fenwick owns a beauty shop; Chesire works as a receptionist– Chesire demands raise; Fenwick counters with offer to make her a partner, with

a right to 20% of the profits (in addition to her salary). They sign an agreement.– Why does the Unemployment Compensation Commission dispute the

existence of a partnership?• Fenwick claims he and Chesire are partners. What’s his best argument?


• Fenwick court’s analysis– Intention of parties: No change in business’ operation (no intent to share control)– Right to share in profits: Chesire gets 20%– Obligation to share in losses: Chesire not obligated– Ownership and control of property and business: Fenwick retains– Community of power in administration: Chesire not involved– Conduct of the parties toward 3rd parties: Filed partnership tax returns, but

didn’t hold themselves out as partners to suppliers & Fenwick licensed their trade name personally

– Rights of parties on dissolution: Chesire’s dissolution is similar to quitting a job• How much shared control is enough?

– According to Day v. Sidley & Austin (1975), Sidley & Austin was managed in the following way:• Executive Committee decides on all matters, except for participation, admission

& severance of partners• The latter require the approval of partners holding a majority of partnership

interests (not majority of partners)– This minimal shared control was seen as sufficient; S&A is a partnership

Types of firmsCreating a GP


Types of firmsCreating a GP: exercise

• Key reason for Fenwick court’s ruling was that the agreement gave Chesire no management rights. Structure an agreement that gives her formal management rights but allow Fenwick to ‘run the show’

• Fenwick court noted Chesire didn’t share in losses. Mitigate this factor while being sensitive to increasing Chesire’s risk


Types of firmsCreating a corporation

• Incorporator chooses the state of incorporation• Incorporator drafts charter• Incorporator files charter with the relevant state’s Secretary of State

– The person filing the charter is the incorporator (DGCL §107); an incorporator is an autonomous fiduciary (owes a fiduciary duty to the corp)

– Once state certifies the filing, corporation has been created (DGCL §106)• Organizational meeting of incorporator/initial board

– Names directors & adopt bylaws (DGCL §108)• Board appoints officers• Board issues shares to SHs


• Corporation is created only when Secretary of State acknowledges that the charter was filed

• Exception – “defective corporation”: sometimes courts recognize a corporation even without Secretary of State’s certification of the charter being filed– De facto corporation– Corporation by estoppel

Types of firmsCreating a corporation: defective corporations




1. What is a firm?2. Types of firms3. Constitutional documents

• What are constitutional documents?• Contents of constitutional documents• Changing the constitutional documents• Some basic concepts about capital

4. Control in the firmc. Actors


Constitutional documentsTypes of constitutional documents

• A firm’s constitutional documents regulate the firm’s internal governance (between the firm, SHs & management)– Required: firm-specific info (e.g., name of firm, address, # of shares)– Optional: opting out & replacing default rules

• Two common models– A single document

• Private document: partnership agreement (in general partnerships)• Public document: memorandum of association (some non-US corporations)

– Two documents; one public (usually more difficult to change & less detailed), the other private (easier to change & more detailed)• In US corporations

– Charter – Articles of Incorporation (MBCA) / Certificate of Incorporation (DGCL) – public; must contain certain info, may contain more

– Bylaws – private; easier to amend; can’t contradict charter• In LLCs: articles of organization / operating agreement• In LLPs: statement of qualification / partnership agreement


Country• Laws of physics• Constitution• Laws/regulations• Presidential directive• Decisions of gov’t employees

Constitutional documentsHierarchy of legal sources in a corporation


Corporation• Applicable federal/state laws• Charter• Bylaws• Board’s resolutions• Decisions of officers

Country• Laws of physics• Constitution• Laws/regulations• Presidential directive• Decisions of gov’t employees

Constitutional documentsHierarchy of legal sources in a corporation


Constitutional documentsCharter: mandatory terms [DGCL §102(a)]

• Firm’s name• Address of firm’s registered office and name of its registered agent• Nature of the business to be conducted (“any lawful act or activity”)• Name/address of incorporators and initial directors• Specify if firm is not a stock corporation (in which case, conditions of

membership must either be specified, or refer to bylaws)• “A statement of the designations and the powers, preferences and

rights, and the qualifications, limitations or restrictions [on firm’s stock]”• Number of authorized shares & share par value


Constitutional documentsCharter: optional terms [DGCL §102(b)]

• “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 […]”

• “Any provision which is required or permitted […] to be stated in the bylaws may instead be stated in the certificate of incorporation […]”

• SH preemptive rights• Supermajority requirements for SH or board votes• Opting out of limited liability or perpetual existence• Limits on directors’ fiduciary duty


Constitutional documentsBylaws [DGCL §109(b)]

• “The bylaws may contain any provision, not inconsistent with law or with the [charter], relating to the business of the corporation, the conduct of its affairs, and its rights and powers or the rights and powers of its stockholders, directors, officers or employees.”


Constitutional documentsCreation & amendment

• Creation of constitutional documents– Charter [DGCL §101(a)]: incorporator– Bylaws [DGCL §109]

• Until stock is issued – Board• After stock is issued – SHs, but charter may also authorize board to amend bylaws

• Amendment of constitutional documents– Charter [DGCL §242(b)]• First, board must adopt the proposed amendment• Then, SHs approve the proposed amendment (in some circumstances, SHs vote

in separate groups [DGCL §242(b)(2)])– Bylaws [DGCL §109]• SHs always allowed to amend• Board not allowed to amend by default, but charter may authorize board to

amend bylaws


Constitutional documentsAssumptions for exam

• On the exam, assume that the corporations mentioned in the fact pattern have the following terms in their constitutional documents, unless the fact pattern states otherwise

• Charter– Corp. is a stock corporation, has limited liability & perpetual existence– Corp. may conduct any lawful act or activity– Director FD is limited to the maximum degree allowed under §102(b)(7)– Board may amend bylaws

• Bylaws– Chairperson of board is authorized to call a board meeting– Board is authorized to call both annual & special SH meetings


Constitutional documentsCapital: financial terminology

• To finance operations, firms receive money from investors in return for claims on its assets & future profits

• Capital can mean either side of this transaction– Firm’s money (and other productive resources)– Investors’ claims on firm’s assets & future profits

• Capital is categorized as debt or equity, depending on nature of claim– Debt: Claim to a predetermined stream of money, unrelated to the firm’s

performance (e.g., bonds, loans). Owner of claim is a creditor.– Equity: Claim to remainder of firm’s assets after paying all other claims

• Units of equity capital are called: shares (in MBCA) or stock (in DGCL) in a corporation; “(partner’s) interest” in GP/LLP; “distributional interest” in LLC; “units” in some firms

• Owner of claim is called a “shareholder” (“SH”) or “stockholder” in a corporation; “partner” in a partnership; “member” in an LLC; “beneficiary” in a business trust

• In this course we will refer to equity owners as SHs & equity capital as shares, regardless of the type of firm

– Some types of capital are hybrids with characteristics of both debt & equity (e.g., convertible bonds)


Constitutional documentsCapital: how do SHs profit?

• Equity: Claim to remainder of firm’s assets after paying all other claims– But firm is done paying all other claims only when it is dissolved (rare)

• Most SHs receive money from investing in shares in one of 2 ways:– Dividends (distributions): payments authorized by the board, from firm to SHs

• Board is never obligated to pay dividends• Some shares (called preferred shares) have right to get certain amount per year in

dividends; if board doesn’t pay them in a given year, the amount accumulates to the next year, and until they are paid, no other SH can get a dividend

– Capital gains: selling the shares to someone else for more than the price you bought the shares (but why is buyer willing to pay more? Presumably because she believes the firm would be able to pay higher dividends in the future)


Constitutional documentsCapital: Constraints on issuing shares

• The board has the right to issue new shares (DGCL §161)– This runs the risk of SHs losing value and control of the firm, if the board issues

new shares at cheap price to new SHs• Two protections against this risk:

– Authorized shares: the maximum number of shares that can be issues (stated in the charter & can only be changed by joint board & SH action)• Outstanding shares: shares that have been issued to SHs (& not repurchased by firm)• Example: firm’s charter states firm has 1,000 authorized shares• Board issues 600 shares to SHs for $1/share (firm receives $600). Firm has 1,000

authorized shares; 600 outstanding shares.• Now board issues another 400 shares to SHs for $2/share (firm receives $800). Firm

has 1,000 authorized shares; 1,000 outstanding shares• Board cannot issue new shares without amending the charter

– Par value: the minimum price board may sell a share for• Example: Charter states firm’s common shares have a par value of $1. Board may issue shares

(up to the authorized number) for $1 or more, but not for less.• Par value only restricts firm’s selling price. SH may sell the share to another SH for less than $1• Par value is an optional protection, and doesn’t offer much protection.




1. What is a firm?2. Types of firms3. Constitutional documents4. Control in the firm• Control and authority• Rights of a beneficiary under direct control• Dysfunctions of direct control• Rights of a beneficiary under delegated control

c. Actors


Control in the firmControl and authority

• Control in the firm is allocated to actors by giving them authority• Authority (=actual authority): the right to do a certain act on firm’s behalf

– When an actor acts with authority, the act is considered to be the act of the firm, and the actor is not liable to the firm (or its SHs) for undertaking the act

• When an actor acts without authority, either:– The act will not be considered to be the act of the firm (so the firm will not be

liable to third parties for the act) [in this case we say that the actor did not have the power to act for the firm]

or– The act will be considered the act of the firm (so firm is liable to third parties

for the act), but the actor is liable to the firm for acting without authority, and will have to pay for any damages suffered by the firm [in this case we say that the actor had the power but not the right to act for the firm]

• Section 2a addresses the law determining when the firm is liable for an unauthorized act (i.e., when an actor has control powers)

• Section 1c (in discussing authority) & this sub-section discusses control rights


Control in the firmModels of control

Direct control• Management by consensus

(collective decision-making)• Bs jointly control the firm’s other

actors (agents)

• Works well when Bs have:– Low cost to act collectively– Equal access to info/expertise– Similar business interests

Delegated control• Management by authority

(central decision-making body)• Bs select a person/group

(autonomous fiduciary) that can exercise direct control effectively, to control firm’s other actors (agents)

• Needed if Bs have:– High cost to act collectively– Unequal access to info/expertise– Differing business interests


Control in the firmDirect control: Rights of a partner in a GP

• Economic rights– Right to a share of firm’s profits, if they’re distributed: “Each partner is entitled

to an equal share of the partnership profits… [and losses]” [RUPA §401(b)]

– Right to a share of firm’s assets upon dissolution: “Each partner is entitled to a settlement of all partnership accounts upon winding up the partnership business.” [RUPA §807(b)]

– Right to (unilaterally) alienate economic rights: “The only transferable interest of a partner in the partnership is the partner’s share of the profits and losses of the partnership and the partner’s right to receive distributions.” [RUPA §502]


Control in the firmDirect control: Rights of a partner in a GP

• Control rights– No right to alienate control rights: RUPA §401(i)– Right to participate in collective management: “Each partner has equal rights in

the management and conduct of the partnership business.” [RUPA §401(f)]• “A partner is not entitled to renumeration for services performed for the

partnership [except in winding up the partnership].” [RUPA §401(h)] So why bother managing the partnership?

• Actual authority determined by RUPA §401(j).– Ordinary course of business → majority– Outside the ordinary course of business → unanimous

• Amendment to the partnership agreement → unanimous• Example: Ralph, Sarah & Tom are partners in a law firm

– Partnership agreement silent about dividing profits between them– They vote 2-1 to add a section to the agreement that divides profits: 40%

R, 40% S, 20% T. Is the new section valid?– They also vote 2-1 not to accept any employment law cases. Is this valid?

– Right & power to act (unilaterally) on firm’s behalf: Each partner is an agent of the partnership [RUPA §301(1)]


Control in the firmDysfunctions of direct control

a) Inefficiency: – Direct control is efficient when beneficiaries have:

• Low cost to act collectively• Equal access to info/expertise• Similar business interests

– The more Bs a firm has, the greater the cost of acting collectively – Large & changing B group increases likelihood Bs will have different interests– Bs with small stakes in the firm likely to be apathetic, lacking incentive to know

firm’s business & participate in the firm’s management (each B has little power to change things & little to gain from changing things)

• Inefficiency is addressed via:– Governing by delegated control (control on behalf of the beneficiaries, by

someone who can exercise direct control)• Or, as a step in that direction: SH agreements & voting trusts that require

parties to vote in a particular way or based on a predetermined process



b) Deadlock: SHs veto each other– E.g., 50/50 split with neither side having a majority), causing the firm to be

unable to act– When would you have a serious problem of deadlock without a serious

problem of inefficiency?• Deadlock is addressed via:

– Suit for breach of fiduciary duty• Addressed when we discuss litigation solutions

– Dissolution (liquidating the firm) or dissociation (buying out one group of Bs)• Addressed when we discuss exit solutions

– Governing by delegated control• Or, as a step in that direction: SH agreements / voting trusts



c) Oppression: Controller exploits minority SHs (“MSH”)– By tunneling: managing firm in a way that shifts value to controller at MSH’s

expense & pressures MSH to sell shares to controller below their fair value• Employ/joint venture with person affiliated with controller• Buy from/sell to person affiliated with controller• Avoid interfering with profitable opportunities for controller• Make investments with spillovers benefiting controller

• Oppression is addressed via:– Suit for breach of fiduciary duty

• Addressed when we discuss litigation solutions– Dissolution (liquidating the firm) or dissociation (buying out one group of Bs)

• Addressed when we discuss exit solutions– Giving MSHs veto power or exclusive authority on certain issues

• This is a form of a voice solution (approval by the MSHs)• This solution risks MSHs using their rights to extort the majority

– Note that governing by delegated control doesn’t solve oppression


Control in the firmDelegated control: Rights of SHs in a corporation• Economic rights

– Right to a share of firm’s profits, if they’re distributed (i.e., if dividends are declared by the board)

– Right to a share of firm’s residual assets upon dissolution (i.e., if both board & SHs approve dissolution, or if court orders dissolution)

– Right to (unilaterally) alienate economic rights

• Similar to economic rights under direct control


Control in the firmDelegated control: Rights of SHs in a corporation• Control rights

– Right to unilaterally alienate control rights (opposite of GP default rule)– No right or power to act unilaterally on firm’s behalf (opposite of GP rule)– Right to participate in collective management (as a SH meeting), but only for

the following acts (much narrower than the GP default rule):• Electing & removing directors [DGCL 211(b), 141(k); MBCA 8.03(c), 8.08]• Amending charter & bylaws [DGCL 242, 109(a); MBCA 10.03, 10.20]• Approving mergers & major asset sales [DGCL 251,271; MBCA 11.04,12.02]• Approving dissolution of the corporation• Approving corp’s independent auditor

• Why are SH control rights so limited?– When Bs can’t effectively exercise direct control, firm delegates control to an

actor that can effectively exercise direct control: low cost to act collectively, equal access to info/expertise, similar business interests

– This actor can’t be subject to Bs’ control (since Bs can’t effectively exercise collective control), so it is an autonomous fiduciary rather than an agent



a. Introduction to BAb. Firmsc. Actors

1. Types of actors• Agents (controlled fiduciaries): Creating an agency relationship• Agents: Relationships similar to agency (but that aren’t agency)• Agents: Officers• Autonomous fiduciaries• Stewards

2. How collective actors act3. Beneficiary’s duties to an actor4. Authority5. Ratification


ActorsTypes of actors

• All corporate actors act on behalf of the firm• Agents (controlled fiduciaries) act on firm’s behalf & are subject to its control

– Includes officers, who do the day-to-day management• Autonomous fiduciaries act on behalf of firm, are not subject to its

control, but are required to pursue the interests of the firm– Board: ultimate responsibility for managing the firm

• In small firms, board tends to be executive: manages the firm• In larger firms, board tends to be supervisory: oversees agents who manage the firm

– Board committee: part of the board; acts on behalf of the entire board– Incorporator: acts on behalf of the firm before the firm is created– Controller (controlling SH): in general, SHs are not fiduciaries, but shareholders

who control the board owe a fiduciary duty (this will be covered in the M&A course, but not in the BA course)

• Stewards (non-fiduciary actors) act on firm’s behalf but aren’t subject to its control, nor legally required to pursue the firm’s interests– SH meeting


Types of actorsAgents: definition of an agency relationship

Restatement (Third) of Agency (“R3A”), §1.01: An agency relationship is created when A & P manifest assent that A shall act -

1. On P’s behalf2. Subject to P’s control

R3A §1.02: Parties’ labeling & popular usage do not controlR3A §4.03: An agency relationship may be created retroactively by P’s

ratification, if A purported to act as P’s agent

The parties:• Principal (P): person for whom act is to be taken• Agent (A): person who is to act• Third Party (T): person who deals with agent


Types of actorsAgents: creating an agency relationship

A . Gay Jenson Farms v. Cargill [MN, 1981]

• Who are P, A & T in Cargill, according to the plaintiff?• What’s the evidence for an agreement that A shall act

– On P’s behalf?– Subject to P’s control?



Cargill: the court’s reasoningCourt finds control from the combined weight of 9 factors:1. Cargill’s constant recommendations to Warren by telephone2. Cargill’s right of first refusal on Warren’s grain3. Warren’s inability to enter into mortgages, to purchase stock or to pay dividends

without Cargill’s approval4. Cargill’s right of entry onto Warren’s premises for periodic audits5. Cargill’s correspondence & criticism regarding Warren’s finances, officers’ salary

& inventory6. Cargill’s determination that Warren needed “strong paternal guidance”7. Provision of forms to Warren upon which Cargill’s name was imprinted

– FN 7: Warren pays for the grain with drafts (checks) drawn on Cargill8. Financing all of Warren’s purchases of grain & operating expenses9. Cargill’s power to discontinue the financing of Warren’s operations



Cargill: managing risk of becoming a principal• Creditor’s challenge in managing the risk of becoming a principal

– Diverging interests• Creditors want firm to be managed conservatively• Equity holders want to take risks (& they manage the firm…)

– Creditors protect their interests via contractual provisions• Techniques include: covenants & acceleration; convertibility; collateral;

guarantees; insurance• If these techniques are seen as giving creditors control over the debtor and

resulting in the debtor being the creditor’s agent, then creditors become liable for the debtor’s debts

• Can we disclaim the risk in the contract?– Many contracts expressly say that “this agreement does not create an agency

relationship”– R3A §1.02: parties’ labeling & popular usage do not control– So why are such disclaimers so common?



Cargill: explaining the outcome• A reasonable interpretation of R3A §1.01?

– Right of first refusal + financing = on P’s behalf? [Probably not]– Allowing supplier to pay T with P’s checks = on P’s behalf? [Senseless]

• “Gatekeeper liability”: creating an incentive to monitor Warren?– Who is more able to prevent Warren’s risk taking: Cargill or the farmers?– This may be a good policy reason, but it’s not the test in R3A §1.01

• Cargill culpable in making farmers think it was backing Warren?– Cargill caused farmers to believe an agency relationship existed by allowing

Warren to use Cargill’s forms (such as checks)– But why stretch the definition of agency rather than applying estoppel?

• We will discuss estoppel at end of the subsection on P’s liability in contracts


Types of actorsAgents: relationships that aren’t agency

1. Directors (and other autonomous fiduciaries)• A firm is managed by a board of directors (“board”), consisting of one

or more directors• The board acts on behalf of the firm as the firm’s voice, and controls

the firm’s agents• The board isn’t the firm’s agent (nor are the individual directors)

– Board & individual directors aren’t subject to the firm’s control; instead, they control the firm

– When might an individual director be an agent of a firm?



2. Power given as security• Hypo: transferring control in a firm

– C owns Acme Corp. C signs a contract to sell Acme to B for $1B– The deal requires regulatory approval, which will take several months– Until deal closes, C controls Acme. Will C act to maximize Acme’s value?– Solution: in the contract, C gives H (B’s trusted friend) the power to vote C’s

Acme shares (at H’s discretion)• Purpose of the relationship is not to serve C, but to assure B• C is the creator of the power; H is the holder; B is the beneficiary

• Power given as security is a contractual relationship similar to agency (one person (H) is given power to affect legal relationships of another person (C))

• But it is unlike agency in that:– H isn’t subject to C’s control – that would thwart the arrangement’s purpose– H acting on behalf of C? Perhaps, but purpose is to assure B, not serve C

• B’s vulnerability: if C can unilaterally terminate this relationship, he could deprive B of this contractual protection– To be effective, C must not be able to unilaterally terminate the relationship



• R3A §3.13(2): to protect B’s interests, powers given as security are generally immune from termination -– By C’s unilateral revocation– By H’s surrender of the power (unless B approves)– By either C’s or H’s death/loss of capacity

• An agreement appointing H to vote C’s securities is known as a proxy– H is the proxy holder, but sometimes also called “the proxy”– If C can’t cancel the proxy, it is known as an irrevocable proxy– Irrevocable proxies eliminate the exit governance solution, so we want to allow

them only when they are necessary to facilitate a power given as security)• R3A §3.13(1): Irrevocable proxies/powers given as security are

terminated by an event that either -– Discharges/terminates the secured obligation/interest

• E.g., C concludes the sale of Acme to B– Makes the execution of the power illegal or impossible

• E.g., if H’s control of Acme would violate antitrust laws– Constitutes a surrender of the power by B

• E.g., B decides she doesn’t need irrevocable proxy anymore & tells C it’s cancelled


• Officers are a sub-class of a firm’s agents– I.e., all officers are firm’s agents, but not all firm’s agents are officers

• What distinguishes officers from other agents is:– (Actual) authority of the ‘office’ is determined by law, bylaws or board• Allowing an actor to hold the ‘office’ is also a manifestation from the firm to T,

affecting the officer’s apparent authority• Officer may hold multiple offices

– Some laws impose duties/liabilities specifically on officers• E.g., securities laws, environmental laws, service of process

© Amitai Aviram. All rights reserved. 60Types of actorsOfficers

Types of actorsCommon types of officers

• Chief executive officer (CEO)– #1 officer in the hierarchy

• Chairperson of the board– Administers board’s activities– If Chairperson is affiliated with management, firm sometimes also has ‘lead director’

• Chief operating officer (COO)– Responsible for firm’s day-to-day business operations

• Chief financial officer (CFO)– Responsible for accounting & financial operations

• Treasurer– Same as CFO, or subordinate responsible for managing firm’s cashflow

• Secretary– Keeps minutes of board/SH meetings & authenticates corporate records

• President– Head of a business unit (or entire firm, overlapping COO or CEO)


Types of actorsAutonomous fiduciaries: The board of directors• Size [DGCL §141(b) / MBCA §8.03]

– Board consists of 1 or more natural persons– Board size specified in / fixed in accordance with charter or bylaws

• Term in office– By default, directors are elected in each annual meeting (i.e., they serve a term

of 1 year, renewable) [MBCA §8.03(c)]– Exception: charter may create a staggered board, dividing directors into 2 or 3

groups; one group elected each year [DGCL §141(d); MBCA §8.06]• Removal [DGCL §141(k) / MBCA §8.08]

– Directors may be removed by SHs for cause– Directors may be removed by SHs without cause, if charter does not say

otherwise (MBCA) or if firm does not have staggered board (DGCL)– Board may not remove a director

• Filling vacancies [DGCL §223 / MBCA §8.10]– SHs or board may fill vacancies on the board

• Meetings– Board of a typical public company meets 8 times a year; compensation & audit

committees typically meet another 6-9 times a year


Types of actorsAutonomous fids: status of individual directors

• The board is a corporate actor; individual directors are not– Individual directors have no authority to act for the corporation, unless

they are granted authority by the board to act as a board committee (which may consist of a single director)

• Neither directors nor the board are the firm’s agents as such– Because they are not subject to SH control

• Directors individually owe FD to the firm– This is derived from their status as directors

• Procedural quirk: you can’t sue the board (or a board committee)– When challenging the act of a collective actor (board, board committee),

plaintiff sues the individual directors, not the board or committee– E.g., when we (figuratively) say “X sued the board”, we really mean that X sued

each of the directors on the board– Why can’t X (literally) sue the board?


Types of actorsAutonomous fiduciaries: board committees

• Appointing committee members [Steigerwald (IL 1956)]– Committee must consist only of directors• Otherwise, Board majority can delegate authority to someone unelected by SHs

– Members must be selected by the board (directors can’t delegate nomination to someone else, such as the CEO)

• Common Board committees– Executive committee: Manages day-to-day operations/decisions– Nominating committee: Picks the directors that board recommends to SHs– Compensation committee: Negotiates/approves officer/director compensation– Audit committee: Oversight of financial reporting & disclosure (sometimes also

oversees regulatory compliance & risk management)– Risk committee: Oversees institution’s risk management practices– Above committees are typical standing (permanent) committees; Board may also

create ad hoc (temporary, single-issue) committees• Ad hoc committees typically used to avoid conflicts of interest (e.g., in deciding

on a lawsuit or transaction in which some directors have conflicts)


Types of actorsStewards

• Stewards (non-fiduciary actors) act on firm’s behalf, but aren’t subject to its control, nor legally required to pursue the firm’s interests– SH meeting: has limited authority in the typical firm, but within that authority

(and subject to any contractual duties they may have agreed to), SHs may act self-interestedly (except when they are controllers, but this will not be addressed in the BA course)

• Why doesn’t a steward owe a fiduciary duty (a legally enforceable duty to pursue the firm’s interests)?– FD strikes down authorized acts that are taken for an impermissible purpose– When permissible purposes are narrowly defined (e.g., maximize SH profit), an

independent party may be able to detect impermissible purposes– But when permissible purposes are broadly defined (e.g., maximize SH profit

and/or maximize benefits to employees from employment and/or maximize benefits to society from firm’s business, etc.), managers can do whatever they want & pick a stakeholder that happens to benefit; so FDs do little to maintain accountability (yet are costly to litigate)

– Yet sometimes we want actors to consider broad and diverse purposes, even if it makes them less accountable (e.g., in government positions)




1. Types of actors2. How collective actors act3. Beneficiary’s duties to an actor4. Authority5. Ratification


How collective actors actConsent & meeting

• Collective corporate actors (e.g., board, board committee, SH meeting) act by approving resolutions, in one of two ways:– Written consent

• Board or board committee may act by written consent if consent is unanimous [DGCL §141(f)]

• SHs may act by written consent if consent is signed by “holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted” [DGCL §228]– Many corporations have a provision in their charter that eliminates SHs’

ability to act by written consent– MBCA default requires unanimity [MBCA §7.04]

– Meeting: three elements to a valid meetinga. Call (authority to call meeting + notice requirements)b. Quorumc. Vote


How collective actors actMeeting: (a) Call

• Authority to call a meeting– Board/committee: Charter, bylaws or board resolution may schedule regular

(e.g., monthly, annually) meetings and may create a procedure for calling special meetings (e.g., chair may call special meeting); Board resolution may call a special meeting (e.g., at end of previous board meeting, or by written consent)

– SH meeting: Annual SH meeting – as stated in bylaws [DGCL §211(b)], and court may order a meeting, if none was called for 13 months [§211(c)]; special SH meeting: board resolution + as stated in bylaws/charter [§211(d)]

• Notice requirements (did the call provide sufficient info & advance notice?)– Board/committee: DGCL has no notice requirements, but abuse may breach FD

• In contrast, MBCA §8.22(b) creates a default 2-day notice of date, time & place of meeting, but not of meeting’s purpose

– SH meeting: notice must be given no less than 10 days or more than 60 days before the meeting; notice must be in writing and specify place, date & time of meeting, means of remote communications [DGCL §222]


How collective actors actMeeting: (b) Quorum

• SH meeting: by default, majority of shares entitled to vote; charter or bylaws can opt out of default, but never less than ⅓ [DGCL §216(1)]– Presence via proxy (appointing an agent to vote on one’s behalf) is allowed

• Board/committee: by default, majority of total # of directors; charter or bylaws may opt out of default, but no less than ⅓ [DGCL §141(b)]– Presence via proxy is not allowed– Presence via teleconference [DGCL §141(i)]: board meetings & board

committee meetings may be held via conference telephone or “other communications equipment by means of which all persons participating in the meeting can hear each other”


How collective actors actMeeting: (c) Vote

• Board/committee: vote of majority of directors present at a meeting (unless charter/bylaws require supermajority) [DGCL §141(b)]

• SH meeting: varies depending on the type of vote– Default standard: majority of shares present [DGCL 216(2)]

• Bylaw amendments• Precatory SH resolutions

– Majority of disinterested shares present• Ratifying breach of FD [DGCL 144(a)(2)]

– Majority of shares entitled to vote• Mergers [DGCL 251(c)]• Sale of all or substantially all of C’s assets [DGCL 271]• Charter amendments [DGCL 242(b)]

– Plurality of shares present• Electing directors [DGCL 216(3)]


B’s duties to AContractual duties

• P’s duties to A are contractual in nature (R3A §§8.13, 8.14(1))• In addition to express terms of the agreement between P & A, P is

liable to A for:– Implied terms (R3A §8.13)– Breach of duty to deal in good faith (R3A §8.15)– Default terms re indemnification (R3A §8.14(2))

• Implied terms– Terms that a reasonable person would infer from the express language of the

agreement


B’s duties to ADuty of good faith & fair dealing

• Duty to deal fairly and in good faith (R3A §8.15)– Protects agreed common purpose & A’s justified expectations

• Common application (1): frustrating A’s justified expectations– P must avoid unreasonable conduct that harms A, when:• Contract lacks specific language governing the issue; and• Conduct frustrates purposes reflected in contract’s express language

– E.g., Prof agrees with RA that he will get an extra $100 if he shows up at prof’s office at 8am. Prof later changes mind, locks office doors so RA can’t enter office at 8am.

• Common application (2): duty to warn– P breaches duty if P fails to provide A with info about unreasonable risks

involved in the agency, if risk is foreseeable to P & A is unlikely to become aware of risk on his own

– Risks include physical harm, pecuniary loss, and possibly also harm to business reputation & reasonable self-respect• E.g., P sends A to sign up investors for an investment that P knows (but A doesn’t

know) is a Ponzi scheme. When A is implicated in the Ponzi scheme, his business reputation is tarnished and he cannot get another job. P may be liable to A for the harm suffered by A.


B’s duties to ADuty to indemnify

• Indemnifying agents – default rule (R3A §8.14(2))– When the agent makes a payment• within the scope of the agent's actual authority, or• that is beneficial to the principal, unless the agent acts officiously in making the

payment– Officious (“voluntary”) payments are ones in which the agent has a reasonable

opportunity to receive P’s authorization, but makes a payment without seeking authorization

– When the agent suffers a loss that fairly should be borne by the principal in light of their relationship• While this is vague, a duty to indemnify typically arises when A’s loss is:– In connection with the agency relationship; and– Not a result of A's own negligence, illegal acts, or other wrongful conduct


AuthorityWhat is authority?

• Authority is the legal right to act on behalf of another person– An authorized act of A is legally considered to be an act of B– Corporate compliance implication: B is liable to T for a contract or tort created

by an authorized act• This is not the only way B may be liable; we will discuss other ways in Chapter 2

– Corporate governance implication: A is liable to B for acting without authority• This is not the only way A may be liable to B; A may be liable for an authorized

act that violates fiduciary duties (we will discuss this in Chapter 3)

• An actor can have authority in three ways– Grant of authority by law– Grant of authority by agreement (in charter/bylaws/valid SH agreement)– Grant of authority by approval (unilateral behavior of/attributed to B, either

before A’s act (prior consent) or after (ratification))


AuthorityAuthority of the board

• Board’s authority granted by law– DGCL §141(a): “The business and affairs of [a corporation] shall be managed by

or under the direction of a board of directors…”• Board’s authority granted by agreement & approval

– Usually irrelevant because under DGCL §141(a) board already has authority to take almost any act the firm can take

• Board’s power to delegate authority– The board may delegate management authority and tasks to officers or other

agents of the corporation, but may not delegate authority that law, charter or bylaws specifically assign to the board [DGCL §141(a) / MBCA §8.01(b)]• For this reason, directors cannot vote by proxy in a board meeting

– Board may delegate to a board committee authority that was specifically assigned to board, with exceptions (see next slide) [DGCL §141(c) / MBCA §8.25(e)]

– If authority is delegated, board maintains oversight responsibility but may rely in good faith on agent’s/committee’s/expert’s reports [DGCL §141(e) / MBCA §8.30(f)]


AuthorityAuthority of a board committee

• Board committee authority granted by law: not relevant in this course• Board committee authority granted by agreement: check charter/bylaws• Board committee authority granted by approval [DGCL §141(c)]

– The board may designate committees, each consisting of 1 or more directors– Committee may receive, in board resolution or bylaws, any powers or authority

of the board except:• Approving, adopting or recommending to SHs any matter that is subject to SH

approval (other than election/removal of directors)• Adopting, amending or repealing a bylaw

– Different exceptions in MBCA §8.25: approving distributions; filling board vacancies


AuthorityAuthority of the SH meeting

• SH meeting’s authority usually limited to the following:– Exclusive to SHs

• Electing & removing directors• Ratifying selection of corporation’s independent auditor• Precatory (non-binding) SH resolutions

– Jointly with the board• Charter amendments• Mergers / sale of all or substantially all of the firm’s assets• Dissolution of the firm• Ratification of certain unauthorized corporate actions (DGCL §204)

– Either SHs or the board• Bylaw amendments• Ratifying breach of FD


AuthorityAuthority of officers & other agents

• All agents (including officers) have actual authority as determined by agency law

– Manifestations by P that are perceived by A– These manifestation cause A to reasonably believe that A is authorized to act

in a certain way on behalf of P• Officers & actual authority– The manifestation by P that A has a particular office (e.g., she is the CFO)

makes A reasonably believe she has any authority granted to this office by law or by agreement (in the charter or bylaws)

– Like any other agent, officers may also have actual authority derived from other manifestations of the corporation (e.g., delegation of authority from the board)


RatificationGeneral principles

• Approval is behavior by (or attributed to) B, that cures a legal flaw in A’s behavior– If approval takes place after A’s behavior, it is called ratification– If approval takes place before A’s behavior, it is called prior consent

• Rules for prior consent are mostly similar to ratification (I will point out differences)• Revoking approval

– Valid ratification can’t be revoked (i.e., once ratified, act can’t be un-ratified)– Prior consent can’t be revoked after the act takes place; whether it can be

revoked before the act takes place depends on the agency agreement (by default, yes)

• Rights of “fourth parties” (parties other than P, A & T)– Prior consent doesn’t diminish rights of persons not parties to the transaction,

as a general matter of contract law– Ratification doesn’t diminish pre-ratification rights of persons not parties to the

transaction, under R3A § 4.02(2)(c)• E.g., A is P’s financial manager. Without authority, A gives T an option to

purchase P’s Google shares for $50K. P then agrees to sell the shares to S for $40K. When T tells P he wants to exercise the option, P ratifies A’s agreement with T. S can enforce his contract to buy the shares for $40K (but P is also liable to T for damages for breach of contract, because he ratified)


RatificationElements of ratification


1. Appropriate approver• Identity (B or person w/authority to approve & no CoI)• Attributability (A’s behavior is attributable to B)• Capacity

2. Appropriate approval• Unambiguous• Informed• Timely• Appropriate scope

Elements in blue must always be discussed; other elements should be discussed if fact pattern suggests they are an issue

RatificationAppropriate approver (identity)

• Appropriate approvers are:– The beneficiary (person on whose behalf A acted or purported to act)– Person who has authority to approve on behalf of B & doesn’t have CoI with B

regarding the behavior that is approved• Authority to approve: may be assumed if person has authority to conduct on

behalf of the beneficiary the same behavior that is subject to approval (unless specifically prohibited from approving or delegating that behavior)– Example 1: Suppose Amy’s unauthorized purchase of Blackacre was ratified not

by Paul but by Alex (another agent of Paul). Alex is an appropriate approver if Paul authorized him to buy property at $210K (or to ratify such deals)

– Example 2: if Paul authorized Alex to buy property at $210K, but specifically prohibited him from delegating the purchase to others, the authority to approve is not assumed (since if he approved Amy’s act it would amount to a delegation of his authority to Amy)

• No CoI with beneficiary– E.g., In example 1 above, if Alex gets a commission if the sale goes through but

not if it doesn’t, he can’t approve the transaction– Rule means that approver (other than beneficiary) can’t approve his own acts


• When a firm is the beneficiary, appropriate approvers are:– The beneficiary: n/a (firm can’t approve; someone has to approve on its behalf)– A person who has authority to approve on behalf of the beneficiary

• Board– Board can approve behavior of corporate actors (based on its plenary

authority under DGCL §141(a) & on DGCL §144, 204)– As with agency law, board can’t approve its own acts & can’t approve acts

regarding to which board has CoI (e.g., no approval of controlling SH’s behavior)• SH meeting

– SH meeting can cure directors’/officers’ self-dealing by approval (DGCL §144)» Not clear if SH meeting can approve other behavior of corporate actors; even

if it lacks authority to approve, approval may be construed as waiving a SH’s right to sue for the legal flaw that was purportedly approved

– When approving, vote must be specifically designated as a ratification, and SH meeting can only approve acts that don’t require a SH vote to become legally effective [Gantler v. Stephens (Del. 2009)]

RatificationAppropriate approver (identity)


RatificationAppropriate approver (attributability & capacity)• Actor’s behavior is attributable to beneficiary– A must have acted or purported to act on B’s behalf [R3A §4.03]• E.g., if Amy bought Blackacre for someone other than Paul (such as for herself), Paul

can’t ratify– B must exist at the time of the act [R3A §4.04]

• E.g., if Amy bought Blackacre for PaulCo, a corporation that she is about to form (but hasn’t yet formed), PaulCo isn’t bound by the deal (P couldn’t create manifestations of authority) & can’t ratify it (PaulCo didn’t exist when Amy signed deal to buy Blackacre)

• Firm can adopt (rather than ratify) a pre-incorporation act:– Adoption doesn’t relate back to time of contract’s formation– Adoption doesn’t release A from liability

– No public policy reasons to prevent B from approving• Acts with following flaws are void (can’t be ratified):

– Lack of corporation authority (ultra vires): but unanimous SH ratification insulates the board from future SH challenge

– Bad faith actions (illegality & corporate waste); conscious disregard of duty (probably)• Acts with other flaws are voidable (can be ratified): lack of actor authority,

negligence, self-dealing & failure to disclose• Approver must have legal capacity at time of approval [R3A §4.04]


RatificationAppropriate approval (unambiguous)

• R3A §4.01(2) – B approves an act by either:– Express approval: manifesting assent that the act shall affect B’s legal relations

• Express approval must comply with formal procedures (e.g., call/quorum/vote)• There are specific statutory rules for the process of approval of a transaction

flawed by self-dealing or lack of authority (see next slide)– Implied approval: conduct justifying a reasonable assumption that B consents

• E.g., B knowingly accepts the benefits of A’s act, even if B manifests disagreement to accepting the act’s legal consequences

• When B is a firm, implied approval possible by the board, but not by SHs (SH acquiescence is inherently ambiguous)

• Related to ambiguity, R3A §4.02(2)(b) makes ratification ineffective in favor of A if B ratifies to avoid a loss– So, if B ratifies to avoid a loss, B is liable to T, but A may be liable to B– E.g., A is B’s financial manager. A lends B’s money to T without authority. T

becomes insolvent & B files a claim in T’s bankruptcy proceeding. Filing the claim doesn’t release A from liability for exceeding actual authority.

– Not relevant for prior consent (if B gave prior consent, she wasn’t “trapped” into approving by the threat of a loss)


RatificationAppropriate approval (unambiguous)

• Approval procedure when B is a Delaware corporation– Lack of authority: DGCL §204 (approval by board & in some situations also by

SH meeting and/or court) (effective since 2014)– Transactions in which a director/officer has CoI: DGCL §144(a), either:

• Approval by a majority of disinterested directors (even if disinterested directors do not compose a quorum)

• Approval “in good faith by vote of the shareholders” (in Fliegler the court said this requires a vote of the majority of disinterested SH)

– Any other act: no statutory authorization for approval, but approval is possible under the board’s plenary powers (DGCL §141(a))• Follows the normal process for board acts (written consent / call+quorum+vote)

• Hypo– Hypo: Acme’s board consists of A, B, C, D & E. They vote to ratify a contract

between Acme & A’s husband (B, C & D do not have CoI). Only A, B and C show up for the vote. Do they have a quorum? [Note DGCL §141(b), §144 (b)]

– A, B & C all vote in favor of the contract. Was it approved? [Note §141(b), §144(a)(1)]


RatificationAppropriate approval (informed)

• Approval is valid only with “knowledge of [all] material facts involved in the original act” [R3A §§4.06, 8.06(1)(a)(ii)]– Unless B was aware of such lack of knowledge– Probably “all material facts” refers only to those facts A is aware of (since there

are always some uncertainties that neither A nor B know of)– Material facts: Facts that a reasonable person would consider relevant to the

decision whether to approve• Related to this, R3A §4.02(2)(a) says ratification is ineffective in favor

of a person who causes it by misrepresentation or other conduct that would make a contract voidable (duress, undue influence)– E.g., A buys car for B from T without authority. T persuades B to ratify by falsely

telling him car has a new engine. B not bound to T.


RatificationAppropriate approval (timely)

• Ratification ineffective if “circumstances that would cause the ratification to have adverse and inequitable effects on the rights of [T]” occurred [R3A § 4.05]– T withdraws from the transaction

• B hires A to identify houses B might want to purchase. A sees that T is asking for a very low price for his house, so she buys the house from T on B’s behalf with no authority. T learns there was no authority & notifies B he withdraws from the transaction. B then ratifies. Ratification is ineffective.

– Material change of circumstances that makes it inequitable to bind T• E.g., A sells B’s house without authority. B’s house then burns down. B cannot

ratify the sale.– Ratification after rights have crystallized (ratification timed so that T is deprived

of a right or subjected to liability)• E.g., T gives B an option to buy stock, which expires on May 3rd. Without actual

authority, A purports to exercise the option on B’s behalf on May 2nd. B ratifies on May 4th. T is not bound by the ratification.

• Prior consent is always timely


RatificationAppropriate approval (appropriate scope)

• Ratification (but not prior consent) must encompass “the entirety of an act, contract or other single transaction” [R3A §4.07]

• Approval of self-dealing (ratification/prior consent) must address a specific act/transaction or acts/transactions of a specified type that could reasonably be expected to occur in the ordinary course of the agency [R3A §8.06(1)(b)]

• Approval of authority cannot exceed the authority the approver has


RatificationEffect of ratification on future authority

• Ratification without notice to A that the act was unauthorized may result in A having authority in future similar acts– Suppose that Patty told Andy expressly, in front of Tim, that Andy may not hire

Tim. Nonetheless, Andy hires Tim, who fixes the elevator.– Patty pays Tim (maybe feeling it’s unfair to leave Tim uncompensated), without

reprimanding Andy. Did Patty ratify Andy’s act of hiring Tim?– When the elevators break again, Andy hires Tim for another job. This time Patty

objects, claiming she specifically prohibited hiring Tim.– Andy may have authority to hire Tim the second time, because Andy may have

reasonably believed that Patty’s acquiescence in the first hire indicates she was OK with Andy to hiring Tim (i.e., acquiescence changed Andy’s authority)

• Similarly, lack of notice to T that the act was unauthorized may result in apparent authority– I.e., Tim may reasonably believe Andy had authority to hire him, based on the

fact that Patty paid the previous time Andy hired Tim


business associations chapter 1: acting through others prof. amitai aviram [email protected]...

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