UNDERSTANDING CORPORATE LAW

UNDERSTANDINGCORPORATE LAW

LexisNexis Law School PublishingAdvisory BoardPaul CaronProfessor of LawPepperdine University School of LawHerzog Summer Visiting Professor in TaxationUniversity of San Diego School of LawOlympia DuhartAssociate Professor of LawNova Southeastern University, Shepard Broad Law SchoolSamuel EstreicherDwight D. Opperman Professor of LawDirector, Center for Labor and Employment LawNYU School of LawSteve FriedlandProfessor of LawElon University School of LawJoan HeminwayCollege of Law Distinguished Professor of LawUniversity of Tennessee College of LawEdward ImwinkelriedEdward L. Barrett, Jr. Professor of LawUC Davis School of LawPaul MarcusHaynes Professor of LawWilliam and Mary Law SchoolJohn SpranklingDistinguished Professor of LawMcGeorge School of LawMelissa WereshDirector of Legal Writing and Professor of LawDrake University Law School

UNDERSTANDINGCORPORATE LAWFOURTH EDITIONArthur R. PintoProfessor of Law & Co-Director of theCenter for the Study of International Business LawBrooklyn Law SchoolDouglas M. BransonW. Edward Sell Chair in Business LawUniversity of Pittsburgh School of Law

Library of Congress Cataloging-in-Publication DataPinto, Arthur R.Understanding corporate law / Arthur R. Pinto, Professor of Law & Co-Director of the Center for theStudy of International Business Law, Brooklyn Law School; Douglas M. Branson, W. Edward Sell Chair inBusiness Law, University of Pittsburgh School of Law. -- Fourth edition.p. cm.Includes index.ISBN 978-0-7698-6512-6 (softbound)1. Corporation law -- United States. I. Branson, Douglas M. II. Title.KF1414.P56 2013346.73'066--dc232013025875ISBN: 978-0-7698-6512-6eBook ISBN: 978-0-3271-8984-8This publication is designed to provide authoritative information in regard to the subject matter covered. It is soldwith the understanding that the publisher is not engaged in rendering legal, accounting, or other professionalservices. If legal advice or other expert assistance is required, the services of a competent professional shouldbe sought.LexisNexis and the Knowledge Burst logo are registered trademarks of Reed Elsevier Properties Inc., used underlicense. Matthew Bender and the Matthew Bender Flame Design are registered trademarks of Matthew BenderProperties Inc.Copyright 2013 Matthew Bender & Company, Inc., a member of LexisNexis. All Rights Reserved.No copyright is claimed by LexisNexis or Matthew Bender & Company, Inc., in the text of statutes, regulations,and excerpts from court opinions quoted within this work. Permission to copy material may be licensed for a feefrom the Copyright Clearance Center, 222 Rosewood Drive, Danvers, Mass. 01923, telephone (978) 750-8400.NOTE TO USERSTo ensure that you are using the latest materials available in this area, please besure to periodically check the LexisNexis Law School web site for downloadableupdates and supplements at www.lexisnexis.com/lawschool.Editorial Offices121 Chanlon Rd., New Providence, NJ 07974 (908) 464-6800201 Mission St., San Francisco, CA 94105-1831 (415) 908-3200www.lexisnexis.com(2013–Pub.284)

PREFACEUnderstanding Corporate Law is intended to assist law students and lawyers with abasic understanding of the law of corporations as taught in most corporations courses.Significant business, economic and policy issues are highlighted in connection with athorough analysis of the important cases and both state and federal statutory provisionsused in the study of corporations. It includes the major theoretical approaches used incurrent corporate law literature. In each chapter, the authors identify important policiesand discuss the relationship of the law as it has developed to those policies. Statutoryissues are covered under both the General Corporation Law of the State of Delaware andthe Business Corporation Act. In addition, significant sections from the Principles ofCorporate Governance of the American Law Institute are covered. The corporate scandalsof 2001 and 2002, the enactment of the federal Sarbanes-Oxley (2002), Dodd-Frank(2010), and JOBs (2012) Acts, and the financial crisis of 2008 are also covered. Chapter11 now incorporates significant new material on limited liability companies (LLCs). Thisbook is designed to be used with all of the major corporate law casebooks.We also have written this volume so that non-lawyers who desire to progress beyond arudimentary knowledge of corporate law may do so by reading this book.Although the book was a collaborative effort, Professor Pinto wrote Chapters 1, 4, 5, 6,8, 9, 10 and 12. Professor Branson wrote Chapters 2, 3, 7, 11, 13 and 14.Professor Pinto would like to acknowledge the helpful suggestions on the chapters hewrote from his colleague Professor Brackman Reiser. In addition, he would like to thankBraden Hasnay, Brooklyn Law School Class of 2014, for his editorial assistance. Hewould like to also acknowledge Stephen J. Bohlen for his constant support.Professor Branson dedicates this book to Elizabeth, Clare and Annie.The book is dedicated to our students past and present who have inspired this project.Arthur R. PintoDouglas M. Bransoniii

TABLE OF CONTENTSChapter 1§ 1.01§ 1.02§ 1.03§ 1.04[A][B]§ 1.05§ 1.06§ 1.07[A][1][2]§ 1.08§ 1.09[A]§ 1.10[A]§ 1.11INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1SOURCES OF CORPORATE LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4HISTORICAL BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5CHOICE OF FORM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6Sole Proprietorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6Partnership vs. Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6LIMITED PARTNERSHIPS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10LIMITED LIABILITY COMPANY . . . . . . . . . . . . . . . . . . . . . . . . . . . 11TAXATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11Double Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Subchapter S Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13Limited Liability Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13INCORPORATION AND ORGANIZATION . . . . . . . . . . . . . . . . . . . . 14CHOICE OF LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15Delaware’s Dominance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16ULTRA VIRES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18Corporate Social Responsibility and Philanthropy . . . . . . . . . . . . . . . . 19SOCIAL BENEFIT ORGANIZATIONS . . . . . . . . . . . . . . . . . . . . . . . . 20Chapter 2§ 2.01§ 2.02[A][B][C][D][E][F]§ 2.03[A][B][C][D][E]INTRODUCTION AND FORMATION . . . . . . . . . . . . . . . . 1PROMOTERS’ LIABILITY AND DEFECTIVEINCORPORATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . .INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .PROMOTERS’ LIABILITY ON PREINCORPORATIONCONTRACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Liability of the Promoter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .The Strict View of Promoters’ Liability . . . . . . . . . . . . . . . . . . . . . . .Reliance on the Intent of the Parties . . . . . . . . . . . . . . . . . . . . . . . . . .Liability of the Newly Formed Corporation or LLC . . . . . . . . . . . . . . .Promoters’ Fiduciary Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .DEFECTIVE INCORPORATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . .The Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .The De Facto Corporation Doctrine and Corporation by Estoppel . . . . .Statutory Abolition of the De Facto Corporation Doctrine . . . . . . . . . . .Does Corporation by Estoppel Survive the Model BusinessCorporation Act? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Model Business Corporation Act Compromise . . . . . . . . . . . . . . . . . .v232324242425262830303032333435

Table of Contents[F]Corporate Death . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35Chapter 3§ 3.01§ 3.02§ 3.03[A][B][C][D][E][1][2][3][4][5][F][G][H]§ 3.04§ 3.05§ 3.06§ 3.07§ 3.08[A][B][C][D][E][F][G]THE CONCEPT OF LIMITED LIABILITY . . . . . . . . . . . . . . . . . . . . .THE LIMITED LIABILITY DEBATE . . . . . . . . . . . . . . . . . . . . . . . . .GROUNDS FOR PIERCING THE CORPORATE VEIL . . . . . . . . . . . . .Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Intermixture of Affairs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Lack of Corporate Formalities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Veil Piercing in Limited Liability Companies (LLCs) . . . . . . . . . . . . .Inadequate Capitalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .What is Capital for These Purposes? . . . . . . . . . . . . . . . . . . . . . . . .When is Capital Adequate? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Is Inadequate Capitalization Alone a Sufficient Ground? . . . . . . . . . .Does a Duty Ever Arise to “Top Off” the Original Capital? . . . . . . . .Evasion of a Contract or Statute or Use of a Corporation Solely toWork a Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Instrumentality Theories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Torts Versus Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .EQUITABLE SUBORDINATION . . . . . . . . . . . . . . . . . . . . . . . . . . . .PIERCING THE CORPORATE VEIL: PROCEDURAL CONTEXTS . . .STATUTORY LIABILITY UNDER ENVIRONMENTAL LAWS . . . . .SUCCESSOR CORPORATION LIABILITY IN PRODUCTSLIABILITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .PIERCING THE CORPORATE VEIL — STRUCTURAL SETTINGS . .Personal Shareholder Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Parent-Subsidiary Settings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Brother-Sister (Sibling) Corporation Settings . . . . . . . . . . . . . . . . . . .Enterprise Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Reverse Piercing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Participation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Chapter 4§ 4.01§ 4.02[A][B][C]§ 4.03PIERCING THE CORPORATE VEIL . . . . . . . . . . . . . . . 37FINANCING THE CORPORATION . . . . . . . . . . . . . . . .INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Common Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Preferred Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .LEVERAGING AND CAPITAL STRUCTURE . . . . . . . . . . . . . . . . . . 36768696971717272737475