International Business And Contract Law PDF

Leonardo Puricelli’s Note International business and contract law 01 - Introduction Firms can decide where to locate activities by picking the best jurisdiction for them, called Legal arbitrage. "Legal arbitrage" refers to the practice of taking advantage of differences in laws or regulations betwe...

Leonardo Puricelli’s Note International business and contract law 01 - Introduction Firms can decide where to locate activities by picking the best jurisdiction for them, called Legal arbitrage. "Legal arbitrage" refers to the practice of taking advantage of differences in laws or regulations between jurisdictions to gain a competitive advantage or exploit profit opportunities. This can involve various strategies such as tax planning, regulatory arbitrage, or exploiting differences in legal systems. Recently the concept of “Law as a Product” emerged. It refers to treating legal services or expertise as a commodity that can be packaged, marketed, and sold to clients like other products or services. This perspective represents a departure from the traditional view of law as a profession governed by ethical standards and obligations to clients, and instead, it adopts a more business-oriented approach to the practice of law. One important consequence of the standardization of the legal system and globalization is the Race to the Bottom: legal service providers seek to cut costs and maximize efficiency through standardization, and there's pressure to offer increasingly discounted rates or low-cost solutions to attract clients. Once a country makes an advantageous rule, the others tend to follow it. This can lead to downward pressure on fees, reduced profitability, and an erosion of professional standards as practitioners prioritize volume and speed over client outcomes. This phenomenon concerns both the internal (corporate governance and internal rules) and external dimensions of the company. The higher the differences within different countries' legal systems, the more loopholes from which you can extract advantages for the business. The standardization of rules affects both rules concerning the Inside (Corporate Governance) and corporate law rules (rules imposed by the legal system and adopted by investors. There is a slow convergence of corporate laws. 3 main legal rules: 1) formation of a company (Freedom of establishment, incorporation process, and its legal and economic effects) 2) equity financing 3) corporate governance (shareholders’ rights, management) Economic Institution of Capitalism 1. Contracts: The simple “Lego” element to operate in the market. They establish a business relationship. Contracts are legally enforceable agreements between two or more parties that specify the terms and conditions of a transaction or exchange. They are foundational to capitalist economies as they enable individuals and businesses to engage in mutually beneficial exchanges with confidence. They allocate Power, Rights, and Obligations. The Interests of the parties are in contrast and through the contract they find a common denominator. For a definition, no contract is complete (life goes beyond the contract agreement), and there may be opportunistic behaviors. 1 Leonardo Puricelli’s Note 2. Firm: organization alternative to the market. The art. 2082 of the Italian Civil Code defines the role of the Entrepreneur. Still, it also helps in understanding the concept of the firm: "Entrepreneur is the one who exercises, on a professional basis, an economic activity organized to produce or exchange goods or services." This definition outlines that an entrepreneur is someone who engages in 1) economic activities (at least they need to break even), 2) steadily meaning as a primary occupation or business endeavor, and that these activities are 3) organized with the purpose of 4) producing or exchanging goods or services. This definition is fundamental in establishing the legal status and responsibilities of individuals or entities involved in business activities within the Italian legal framework. Under EU law, the term "undertaking" is used to define a firm or business entity, distinguishing it from definitions used in other countries. An undertaking refers to any entity engaged in economic activities within the EU market, regardless of legal form or ownership structure. This definition is particularly important in areas like competition law, where it determines the scope of regulatory obligations and enforcement actions. EU laws look more at the dynamics of the firm phenomenon. 3. Company: “Nexus of contracts” (quasi-contractor relationship) provides a theoretical framework for understanding the complex and multifaceted nature of corporate relationships and governance. It highlights the contractual basis of corporate organization and decision-making, emphasizing the role of contracts in shaping the behavior of individuals and entities within the corporate context. Organization is the key to economizing costs of production/distribution 2 interlaced meanings: 1) it organizes how the business activity is carried out in the market 2) it provides for internal organization (rules to operate) 5 Common legal features 1. Legal personality is a defining feature, conferring upon an organization the status of a legal person. This designation establishes a framework of rules that governs the entity's conduct and interactions within the legal system. 2. The concept of centralized/decentralized management is rooted in the very old principle of division of labor and defined roles. Within this structure, managers and directors play central roles, as authority is delegated from capital providers, such as shareholders, to those entrusted with day-to-day management responsibilities. 3. Investor ownership adheres to the proportional rule, where a higher investment grants greater control. Equity, while having a higher risk (you basically participated in Business Risk), offers the potential for greater returns. In the event of bankruptcy, debt takes precedence over equity, emphasizing the priority of debt holders. Loans often involve collateral, a matter intricately connected to insolvency law. Debt usually has fixed rules for interest and return time. 4. Free transferability of shares is a crucial aspect, though not all shares are traded on securities markets. Authorization from relevant parties is required for selling partnership shares, sometimes involving veto power. Although not a default scenario, a startup may choose to remain closely held initially and later transition to going public. [Limited liability companies may deviate from the standard model, potentially lacking aspects of centralized management and free share transferability.] 2 Leonardo Puricelli’s Note 5. Limited liability of companies’ stakeholders is a distinctive privilege, setting aside the conventional rule. Shareholders' liability is restricted to the capital they contribute, providing a safeguard against personal financial exposure beyond their investment. Shareholders have only a limited governance role, they have the right to vote to: 1) elect/remove directors 2) approve fundamental corp. changes (ex. merge, liquidation) 3) initiate some org. rules reforms The return on the investment: there is a hierarchy in the case of business dissolution: creditors' claims have priority, and shareholders are treated just as “residual claimants”. The shareholders can realize the value of their investment by selling to other investors interested in acquiring their financial rights. Corporate insiders are usually not personally liable to outsiders on corporate obligations. These characteristics although have some transaction costs associated with organization in businesses and at the same time they also generate tensions and the Trader option that lead to the agency problems that corporate law must address. C.E.M.s (Control Enhancing Mechanisms) Depending on the legal system of the countries: in EU law is called “Status”. One Important case is the multiple decision Shares: it refers to a class of shares that grants their holders more voting rights per share than the holders of common shares. They may have many rules attached, such as the fact that to obtain voting power, you have to hold the share for a fixed amount of time. The FCA case underscores the significance of financial instruments and the strategic legal maneuvers employed by companies. In 2014, FCA relocated its headquarters from Italy to the Netherlands, capitalizing on the benefits offered by the multiple voting share system. The Italian government subsequently revised its legislation to accommodate this corporate structure, but the changes came too late for FCA. Type of Business Organization In Europe 1) Partnerships (Unlimited Business Partnership - General Partnership - Limited Business Partnership) 2) Companies ( Public Limited Liability (Publicly held company - Closely-Held company) - Private companies (Closely-Held Companies - Limited liability Companies)) In the USA 1) Incorporated Business Associations (C or S corporations, can be both listed or not) 2) Unincorporated Business Associations (General Partnership - Limited Partnership - Limited liability Partnership - Limited liability limited Partnership) 3) Limited liability companies (Member-Managed - Manager-managed) 3 Leonardo Puricelli’s Note In the US we will use Public/publicly-held corporations or close/closely-held corporations. In the UK, the terminology "public" and "private" companies carries a different connotation. It revolves around the transferability of shares, with the presumption that shares can be transferred (public means that is ready go public but not necessarily listed yet). Additionally, certain forms of companies allow for deviation from one of five core characteristics, such as eliminating the board in favor of direct management by shareholders. Moreover, in the UK I legal framework, a "public" company may not necessarily be listed, indicating its readiness to go public. The sources of company law 1) at law: both mandatory provisions (cannot depart from their prescriptions) and default/residual provisions: can be waived by contractual arrangements, the default norms are intended as solutions proposed by the enabling statute. 2) at contract: fill the gaps left open by the law (even if they can’t regulate everything) - complementary to law. The law cannot fully regulate every aspect of human relationships. They can establish a code of conduct (They can establish a code of conduct). Article of Incorporation and By-law - The Organisational Quasi-Contracts Special types of contracts enable an organization to organize from a legal point of view to carry out the market product and services. A legal person can survive for more than a human life and they can change over time (merging, dividing, changing legal form). Complex dynamics and situation. 2 Different contracts: 1) Article of association/incorporation: the foundational act of a firm/company. The thing that starts the organization and creates the legal person. 2) “By-laws”(Statuto) are the organizational contracts: that contain fundamental info (board of directors formation and other important stuff). General legal rules. 4 Leonardo Puricelli’s Note They cannot be qualified as contracts (quasi-contracts), companies are state-created entities although they bear some contractual features. They will almost inevitably bear both 1) private ordering (freedom of contract) 2) public ordering (Grant of legal personality that becomes an incorporated firm - a set of mandatory org. and operating legal rules to which it needs to adapt) Economists have come to view the firm as a Nexus of contracts among participants in the organization (a concept born in 1970 in the US). Network of relationships, a further level of complexity. Multiple contracts between all the stakeholders should aim for the company's success. Prof. Butler declared that the Contractual theory of The Corporation is in contrast to the legal concept of The Corporation as an entity created by the state. Each contract in the nexus of contracts warrants the same legal and constitutional protection as other legally enforceable contracts This theory is also called contractarian theory: Companies while maintaining their formal hierarchical position within the legal system (mandatory legal rules), could be intended as a set of default contract clauses common offered to the market by the legal system of incorporation. Some scholars say that contracts are used as a modular tool to connect the economic interests of many parties (entity theory), someone others stand for the contractual theory. The debate around the nature of the modern Corporation has found a middle-ground solution: both contractual law and company/corporate law are part of the state law and they are both enacted to regulate firms. The legal system retains and exercises the sovereign authority both to recognize the business and to regulate its ability to operate in the market as a person. Company law has been increasingly crafted as a set of default contract clauses that enable the formation and organization of the governance rules of the company. The law enables a person to form a company under some prescriptions that can be Mandatory (very few) or Default rules (you can change them based on your needs). You can change the model you choose within some set boundaries. This is true to some extent, the system of the company is a matter of public interest, and the legislator needs to take account of it. It involves the protection of third parties (like creditors mostly and minority shareholders). Legal personality and limited liability are privileges that you can acquire only by law. You can choose among different types of companies (legal animal). The agency problem Agency law underwent a transformative shift in 1997 with the introduction of Cause's article, redefining the entire framework of company relationships. At its core, agency entails a consensual and contractual connection, established when a principal authorizes another party (the agent) to act on their behalf and operate under their general control. This principal-agent relationship, often seen as the fundamental structure of business organizations, embodies a consensual bond between agents (such as shareholders) and principals (like managers). Trust is a cornerstone in this dynamic, as the principal grants 5 Leonardo Puricelli’s Note authority to the agent with the expectation that actions will be taken in the best interest of the principal. In essence, the agency relationship is a pivotal component in the intricate web of business associations, marked by a consensual understanding between agents and principals, emphasizing trust and the pursuit of the principal's best interests. The agent is granted the power to affect the principles of legal relations with third parties within the scope of the agency’s agreement. There is a dual approach: 1) Legal 2) Economic The employer-employee relationship is a principal thing of the agent relationship. Division of labor, delegate the work. Delegation tool is the agency. it imposes an increasing specialization of roles. Business Organisations are meant: - Business organizations (BOs) aim to endure over a significant period, potentially outliving their founders or partners. - BOs operate based on a set of organizational rules, which are a blend of legal requirements and contractual agreements. These rules are designed to address ongoing and future decisions, allowing flexibility in dealing with various situations. - The principal-agent relationship, fundamental in basic business structures, continues to be significant in more complex forms of BOs. The Legal Approach 4 main problems: 1) Formation and termination of an agency relationship 2) The scope of the agent’s power to act/transact on behalf of the principal 3) Principal’s relationship to 3rd parties with whom the agent did or may have acted/transacted 4) What are the duties owed by the agent to the principal and vice versa? An agent is granted the power to affect the principal's legal relations with third parties within the scope of the agency's agreed-on appointment. They can legitimately act beyond the scope of the authority granted by the P, only in some limited and selected circumstances; It is irrelevant whether the parties did expressly characterize their relationship as principal-agent: sometimes, this relationship arises if the circumstances of the case and/or equity considerations suggest that there should have been an agency between the parties, or if a third party reasonably and in good faith relied on the mere (but reasonably convincing) "appearance" of an agency relationship between an apparent agent and an apparent principal. Tort's law rules may also step in (besides contract law rules): "respondeat superior" doctrine: the "principal" may be held responsible for her agent's actions if those actions can 6 Leonardo Puricelli’s Note be considered, in the light of the circumstances, "reasonably within the scope" of the agency relationship About the scope of their authority agent may be: special agents (authority limited to a single act or transaction) or general agents (authority contemplates a series of acts or transactions of a given type scope value) The agency model is one possible explanation of the complexity of the modern company model. In addition, We should be aware that any agency relationship hides agency costs for both the principal and the agent, especially considering the option of both parties being utility maximizers. That might lead to agent opportunism: self-interest with guile (moral hazard). It makes transaction and agency costs rise. Formation, termination, and scope of an agency relationship Express appointment vs implied appointment vs Agency “ex lege”. Details of the relationship. a) Ex-lege agency powers: established directly by the law, it allows the negotiation of the details (ex. director of a company, local manager). In the contract, it is not necessary to specify that a person when employed as manager becomes an agent of the company and can act on behalf of it. The 2 Interests they are protecting are: 1) protect the company I 2) protect the 3rd parties, they might not know the internal organization of the company. The company can limit or expand (to a certain extent) the power of managers. b) Express Authority depends on what the principals empowered delegated the Agents to do on an express basis. Authority on: 1) A specific transaction 2) Specific types of transactions 3) General authority (you can deal with everything in the business) c) Implied Authority comes with express authority. It is the agent's additional power to do whatever is necessary for the execution of the express authority in the proper manner. Within business law, it sometimes overlaps with authority ex-lege. The general rule is that the agent can never exceed the limits of the principal’s authority. Agency ex. Insurance company. In business law, implied authority sometimes overlaps with notion of authority ex lege. Problem with the scope of the Agent authority: who is going to sign the contract to hire a person in the organization? A mix of law and contract. Intuitive limit. The express authority granted by the principle and implied authority. Need to put in place additional transactions or actions granted by implied authority contained in the scope of authority. If you want to exclude or limit implied authority you should put it in writing. The problem with the Scope of the Agent's authority: the general rule is that the agent’s authority can never exceed the limits (that is the scope, the “perimeter”) of their principal’s authority. By the same rule, the principal should not be bound to third parties if the agent did act, in the principal’s name, but outside the scope of (a) express authority granted by the principal + (b) implied authority, unless either: 7 Leonardo Puricelli’s Note 1) the principal authorizes a specific action 2) the authorization was granted by the Principal (even impliedly) after the binding act was carried out 3) the 3rd party reasonably understands by the principal’s behavior that the agent was indeed granted by the principal the necessary authority to carry out any specific transaction If the market thinks that your agent has the right to do a certain transaction when it is not true it is a problem (apparent authority). Apparent relates to fairness. The apparent authority principle in law refers to a situation where a person or entity (such as a company or organization) gives the appearance of having the authority to act on behalf of another person or entity, even if they do not have actual authority. In legal terms, apparent authority arises when a principal (such as a company) creates a reasonable belief in a third party (such as a customer or another party) that an agent (such as an employee) has the authority to act on behalf of the principal. ChatGPT It is also a matter of good faith, reasonableness can be judged by the circumstances. Difference between implied and apparent authority: slippery concepts, may overlap. The first is an addition to express authority (and can be limited), apparent authority does not go with express one but it goes with the circumstances. It is led to believe in the good faith of the third party. The agent should always act on behalf of the principal. Trust is not a legal thing (whether you have it or not), you need some legal bounds to ensure the conduct of the agent. They might have some conflicting interests with the principal ones, they might act not in the best interest of the company. Under Agency law, the principal-agent relationship creates mutual duties: duty of loyalty (Agents cannot compete directly with their principal) and duty of care are the fiduciary duties (always due to the agent to the principal). Agent Relationships usually generate long-term and cooperative commitments that are difficult to regulate completely. It Generates agency costs. The agent may have (or have access to) more information than the principal concerning the transaction. ex. When I invest in security I am investing in a/multiple company/ies. There is an asymmetry of information: One party has more info and the other. One of the problems with delegating the power is when the agent knows more than the principal there are some costs to face (“chi fa da se fa per tre”=gives the measure of agency costs). I know that if I delegate I am going to pay the price of it (both the agency cost, opportunity cost, conflict of interests, and knowledge). Agency as a contractual relationship (important questions): - Is the agency relationship better characterized by the discrete contracting model or the long-term relational contracting model? - Are either or both parties subject to information asymmetry affecting bounded rationality and/or risk? - Does one or both parties face opportunistic behavior from the other? - Can property rights, as defined by Hart, be allocated between principals and agents? - What is the essence of this relationship, and on what foundational non-legal feature does it primarily rely on?" 8 Leonardo Puricelli’s Note The economic approach The "agency relationship" serves as a modular model for understanding business relationships within legal boundaries. This model is a powerful tool for analyzing costs associated with incorporating and managing firms, aiding the "Law & Economics" perspective in minimizing transaction and agency costs, thereby optimizing economic efficiency in business structures. Scholars use this model to re-qualify the relationship between shareholders and the firm’s top management. The agency is a cooperative type of contractual relationship rather than an “arm’s length”/adversarial relationship: the nature, identity, and behavior of the parties are very important. According to the Theory of the firm: Managerial Behaviour, Agency Costs and Ownership Structure” (1976): If both parties to the [agency] relationship are utility maximizers, there is good reason to believe that the agent will not always act in the best interests of the principal. Opportunism: self-interest with guile (furbizia) - a moral hazard. They are knowingly taking advantage of somebody else's deficiency. It is the main concern in any agency relationship because it causes transaction and agent costs to rise. We should be aware of Legal constraints and economic limits: 1) Monitoring costs: expenditures incurred by principals in monitoring agents’ actions. Oslo a matter of time I spend monitoring; 2) Bonding costs: expenditures incurred by agents to reassure principals, They may result in a reduction in monitoring costs. 3) Residual loss: typically borne by the principals, almost inevitable in any transaction; cannot be eliminated, it may be only reduced. (The opportunity costs concept is important here) Conflicts linked with opportunistic behaviors 1) Situations of conflicts between shareholders, as a group, and directors of the “public company” (delegated management). The last should act in the interest of the first. 2) Situations of conflicts among shareholders (majority vs. minority shareholders, especially in “closely-held companies” and within the group of companies). Minority cannot usually control or make decisions 3) Situations of conflicts between shareholders and other stakeholders (like creditors and communities) The basic notion is that dispersed "owners" (shareholders) of the modem corporation do not have a sufficient economic incentive to effectively control corporate management (directors and officers) and, consequently, that managers - knowing it- often act in their own interests rather than in the stockholders' interests => conflict of interests; The origin of the main «Agency problem» The fundamental book: The Modern Corporation and Private Property by Adolf A. Berle and Gardiner C. Means, in 1932. The corps become so big that there is a divorce between 9 Leonardo Puricelli’s Note ownership (shareholders) and control (management and directors). Owners may own a fraction of the company by owning a share (which may represent a fragment of the firm). By not having clear ownership (dispersed owner), managers may feel free to do basically whatever they want. The higher the piece you own, the more control you have and you want to exercise over the firm’s management. The costs that I faced to create the benefits by monitoring the managers are going to benefit people who did not spend anything. A rational shareholder would not do it if it were the only one to do something (Free Riding). Free Riding problem = collective action problem: there is not enough coordination among shareholders (they do not care maybe or they do not know each other). Berle & Means' theory elucidates that the corporate system emerges when the transition occurs from a private or closely-held corporation to a fundamentally distinct entity known as the quasi-public corporation, which in contemporary terms refers to a publicly held corporation or company. This is characterized by a significant division between ownership and control facilitated by the proliferation of owners. The separation may exist in varying degrees: 1) Majority shareholders vs. minority shareholders: the party that is ultimately responsible for running the corporation owns a majority of the voting stock while the remainder is widely diffused, control and part ownership are in their hands. The more concentrated the company capital is, the lower the free-riding problem. Sometimes, minority shareholders have no company directors and no information on what is happening. The majority Shareholders may also be directors. 2) ownership is so widely scattered that working control can be maintained with but a minority interest. In such a case the greater bulk of ownership is virtually without [i.e. deprived of corresponding right of] control. 3) Separation of ownership and control becomes almost complete when not even a substantial minority interest exists (very fragmented company). In a situation like the last one, it may occur the Rational apathy phenomenon (also called the collective action problem): each group’s member lacks sufficient economic incentives to invest time and skills to monitor effectively what the company’s management is doing. Shareholders own too few shares to have the convenience of monitoring; managers ( knowing that asymmetry of information with their “principals)” would protect them from shareholders’ effective monitoring, and are tempted to manage the company’s assets “opportunistically” (in their interests), rather than in the stockholders’ exclusive interests. 10 Leonardo Puricelli’s Note Managerial Capitalism The Company contract Nowadays even if only a person can create a company, also a company can create a company. Companies are usually originated (created) by specific kinds of contracts: 1) Multi-party: even if only one party establishes the company by a unilateral act, the “contractual” nature makes the company “open” to subsequent “adhesion(s)” to the company venture by an undefined-nite number of persons 2) Associatory contracts: each party takes the same position as the other parties vis-à-vis a «joint purpose» of the contract. That’s a cooperative type of contract, all the parties may have economic reasons to cooperate and may work according to procedural mechanisms provided by the contract 3) Long-term: characterized by “bounded rationality”; exposed to the uncertainty of future events; exposed to opportunism ex-post 4) Relational: cooperative (identity of parties is relevant), usually involving some degree of the asset (capital and/or labor) specificity (“idiosyncratic” type of investment) and often exposed to ex-ante and/or ex-post opportunism. The identity of the party is important, the selection of contract parties is essential! Idiosyncratic investment refers to unique investment decisions based on personal criteria rather than following conventional market trends. The contract is intended to regulate the processes that may come in the execution of the company. The longer the term the more incomplete the contract will be (you have to deal with it). I can create some rules to regulate the director's duration or anything else. Legal instruments for the company’s contract are a set of terms, conditions, and/or clauses that shall provide the right to the governance of the multiple groups of parties involved in the organization. Those tools are: 1) Legal rules, including mandatory rules (fiduciary duties) 2) Highly standardized (“plain vanilla”) contractual rules in publicly-held companies 11 Leonardo Puricelli’s Note 3) Specific contractual rules, “tailored” to the circumstances and the members’ specific needs 2 ways to define a company 1) A firm, organizing factors of production, actively conducts trade or business in the market. A company serves as a mechanism to structure firms, emphasizing organization and its primary function of engaging in market activities. It acts as a market agent, operating within the marketplace, yet maintaining a broad scope. 2) It is a distinct legal entity, featuring the government with certain collective rights and responsibilities. It is an "artificial being" ("persona ficta") that (usually) is created by the State, that affords the privilege of the LL to its members (shareholders, quota-holders). It has the same ability to do business as a real person, legally binding the assets committed to the company to its liabilities. It has its own "reputation" and "name" and to some extent, they may become political actors (by endorsing politicians) Legal Personality and choice of corporate law In the globalized economy, incorporated business firms, or companies, are created under specific national Company Laws but often conduct their business across multiple states. These legal entities, governed by their respective national laws, cannot exist without nationality and purpose. Therefore, determining the appropriate jurisdiction for incorporation involves considering international private law (also called conflict of laws rules), which addresses private relationships, residency, citizenship, family, and contract matters. Each jurisdiction contains unique rules that establish the relevant connection between a given situation or set of facts and the applicable law. Additionally, in certain cases, judges in one country may choose to apply the laws of another jurisdiction if they deem it more suitable, adding complexity to the legal landscape. "Conflicts of laws" can emerge when the legal framework of the jurisdiction where a company conducts its business operations, or where significant and prolonged interactions with the company occur, questions the corporate status or the corporate law regulations established in a different jurisdiction where the company was initially incorporated. Freedom of incorporation Business freedom, also referred to as freedom of enterprise in Western nations, entails the ability to operate a business without the necessity of a license in most cases, with certain exceptions. This principle holds significant importance and is frequently enshrined and safeguarded in various legal documents such as national constitutions, such as Article 41 of the Italian Constitution, as well as Article 16 of the EU Charter of Fundamental Rights, and the "Commerce Clause" within the US Constitution, which US courts have interpreted as entailing freedom of incorporation. Furthermore, business freedom is intricately linked with individual liberty, as individuals have the autonomy to establish companies independently. Within the European Union, it is termed as freedom of establishment and is a pivotal aspect of the internal market, enabling EU citizens to establish businesses in other member 12 Leonardo Puricelli’s Note states under unified regulations, treating the EU market as a cohesive entity with uniform rules. When deciding where to establish a business, adherence to the regulations of the host country is essential. In the EU, this may involve navigating non-material disparities among member states' legislations, such as variations in minimum capital requirements for company formation. Similar considerations apply to dealings with countries outside the EU. Additionally, specific sectors, such as banking, casinos, and insurance, may require licensing for operation, necessitating compliance with additional regulatory frameworks. For instance, establishing a bank entails following distinct protocols, wherein forming a company is obligatory, and a partnership structure may not suffice. When all significant company elements are consolidated within a single jurisdiction, conflicts of law are generally minimized, although exceptions may arise. However, complications may arise if these elements are dispersed across multiple countries, leading to challenges in law application. Conflicts of law are inherent in legal systems and are typically addressed through international private law rules, with each state having its legislation in this regard. These rules serve to resolve conflicts among the differing laws of various countries, a matter of significant interest for multinational enterprises (MNEs) operating in multiple jurisdictions. Simplifying matters for companies, the application of company law is primarily determined by the jurisdiction where the company is incorporated, following the Incorporation Theory. In scenarios such as the death of a citizen in a foreign country, the heirs have the discretion to choose where to initiate legal proceedings. Subsequently, the judge may assess whether the case falls within the jurisdiction of the chosen country and determine which jurisdictional laws apply, offering three options: 1)the court has no jurisdiction over the case, 2)application of the country's jurisdiction where the case is lodged, 3)or the jurisdiction of another country. Heirs may strategically select the jurisdiction for economic reasons, a practice known as forum shopping. In Italian international law, nationality serves as the connecting link. Italian international company law exhibits more stability, with judges typically applying Italian corporate law as if the company were incorporated in Italy. This contrasts with the UK system, where the incorporation country holds greater significance. Nonetheless, despite the presence of rules, there is often maneuvering within legal frameworks, highlighting the nuanced nature of legal application. In Common Law countries, the Incorporation Theory is typically adopted, focusing on the internal affairs of the created company. In the real seat doctrine, which is typically followed in Civil Law countries, emphasis is placed on the location where the company is managed, often where the Board of Directors usually convenes. Regarding the external affairs of a corporation, it is treated as a legal entity, similar to a natural person (for instance, if a person is poisoned in California, Californian laws would apply). However, for internal affairs issues of a corporation, two contrasting approaches exist: 13 Leonardo Puricelli’s Note 1) Real seat doctrine: This doctrine focuses on the actual location where the company is managed or controlled, often where its central administration or management is situated or where the purpose/ business is mainly carried out. 2) Incorporation doctrine: In contrast, the incorporation doctrine directs attention to the jurisdiction where the company is formally incorporated, following the legal framework of that jurisdiction for internal governance matters. True for Common law jurisdiction (UK, US, Canada…) Internal Affairs Doctrine generally concerns the relationships among: - shareholders and the corporation; - shareholders and directors (and top management), including breach of fiduciary duties; - minority shareholders vs. majority shareholders issues; - shareholders' rights and voting issues are also included; There are two main ways to decide which rules apply to the members of a firm (shareholders, directors, officers) and how the club operates: Incorporation State: This is like the state where the firm got its charter. Even if the company never meets there, those laws generally apply unless... Principal Place of Business: This is like the state where the firm holds most of its meetings I and activities. Some courts might consider these laws instead, especially if the connection to the incorporation state is weak. In rare cases, a third option comes into play: State with Significant Contacts: If a corporation has a lot of business in a particular state (even if it's not the incorporation or main business state), that state's laws might also be relevant in certain situations. McDermott Inc v Lewis New corporate Structure: 92% of shares held by McDermott 8% of remaining public shares. The last one did not want to be a shareholder in the new company (https://www.youtube.com/watch?v=AfH8F4CzWAE). Assuming one class share (one vote each), there is a scatter ownership. There is a collective action problem. Who is voting to elect the directors of Mcdermott Delaware? McDermott International Directors did that because they exercised the power of the shares that McDermott International (Panama, not a US state) had. The problem here is quite evident, they only had 10% of the shares but the rest (90%) is owned by people who did not care about the company (public investors). The managers re-perpetuate their jobs by reconfirming their positions all the time. There was an overlap between the two companies at the board level. Ex. of Self-perpetuation of Management (opportunistic behavior), that’s NOT illegal. According to many US laws and directives, the votes of a subsidiary in the decision of the parent company during the board meeting should not be considered at all (either to make decisions nor be counted for the quorum purpose) Important questions - Is it legal to own partner company shares for a subsidiary company? YES - Is it legal to exercise the power of vote related to the shares? Here comes the complication. which company law do you look at in this case? Panama or Delaware? 14 Leonardo Puricelli’s Note In this case, Panama because we are concerned about the international shareholders (Possible Exam Question). Panama law was okay with self-perpetuation of management, but Delaware was not. Following Delaware law, shares of a corporation's capital stock, or those of another corporation in which it holds a majority voting interest, cannot be entitled to vote or counted for quorum purposes. This rule underscores the principle that voting rights issues are primarily within the purview of the jurisdiction where the company is incorporated. Delaware Supreme Court had consistently applied the law of the state of incorporation to the entire gamut of international affairs. They had to apply Panama law (apply incorporation theory) [In Italy, these tricks are not allowed] Examen Inc. v Vantagepoint Venture Partners Examen, Inc., a Delaware corporation, filed a case in Delaware's Court of Chancery to decide if Delaware or California law should govern a stockholder vote for a pending merger. VantagePoint Venture Partners, owning 83% of Examen's preferred shares, argued for California law. The issue revolved around how to count shareholder votes when different classes of shares were involved in a merger with another company. In this case, Examen, Inc.'s shareholders were asked by the company's directors whether they approved the merger with Reed Elsevier, Inc., a Massachusetts-based company. The contentious issue revolved around how shareholder votes should be calculated for the merger resolution: - If governed by Delaware Corporation law, all shareholders would vote as a single class, letting the merger happen. - If under California Company law, preferred shares would vote separately, giving VantagePoint Venture Partners (owning 83% of Examen's preferred shares) a potential veto on the merger. This issue, concerning voting rights, was deemed an "internal affairs" matter. According to Delaware's conflict of laws principles, the law of the state of incorporation applies. As Examen, Inc. was a Delaware corporation, Delaware Corporation law would govern, likely resulting in VantagePoint Venture Partners losing the case. However, California's conflict of laws rules are different: - The default rule, akin to Delaware, is the "incorporation theory." - Yet, if a company has significant ties to California, under Section 2115 of the California Code, California law prevails, regardless of where the company was formed. Therefore, whether California law would supersede Delaware law depended on the level of Examen, Inc.'s connection to California. In sum, the two sets of legal rules (DE and CA) could not be applied simultaneously, because (a) they are mutually exclusive as to the substantive results each rule would lead to (voting class by class or single voting), and (b) CA law expressly states that it would apply “to the Exclusion” of any other (foreign) law (note: DE law is "foreign" concerning CA law). In the precedent case CTS, the Supreme Court determined that as long as each state governs voting rights solely within the corporations it has established, each corporation will be bound by the laws of only one state. Therefore, we affirm that Delaware's longstanding 15 Leonardo Puricelli’s Note choice of law principles, coupled with the requirements of the federal constitution, dictate that Examen's internal affairs must be exclusively adjudicated following the laws of its state of incorporation, Delaware. Further specification on the case In the case of Examen Inc. v. VantagePoint regarding a merger matter, several legal complexities arise, particularly concerning the computation of votes and the application of corporate law from different jurisdictions. The issue of voting computation becomes intricate due to the presence of dual classes of shares: common shares and preferred shares with differing allocations of voting rights. The defendant, holding 83% of Examen's preferred shares, argued for the application of California law, which provided different rules for counting preferred shares' votes. This divergence could lead to different outcomes regarding the approval or rejection of the merger. The determination of whether the litigation falls under internal affairs or external matters of the company is crucial. The court must ascertain which company affairs are primarily at stake. In this case, with a Delaware judge presiding, the substantive law applicable would typically be that of the state of incorporation, which is Delaware. However, the court must consider connecting links to other jurisdictions, such as 1) state of incorporation, 2) state of central management, and 3) state where most of the trade of business is carried out, and apply conflict of law rules accordingly. In the context of Californian company law, the existence of two sets of voting shares (preferred and common) empowers shareholders to potentially veto the merger. Given that the majority of shareholders were Californian and most business operations occurred in California, the case was brought to court. Pseudo-foreign corporations If Californian jurisdiction were applied, Section 2115 of the California Code stipulates that California law would prevail, even if the company was incorporated in another state. Ultimately, since Examen Inc. is incorporated in Delaware, the court applied Delaware law, as it governs internal affairs. Had Californian jurisdiction been applied, the outcome could have differed due to differing voting rules, highlighting the significance of jurisdictional considerations in complex legal matters involving mergers and corporate governance across multiple jurisdictions. Despite the incorporation theory some states (including California) chose, by statutory provisions, to impose their own corporate law rules to the internal affairs of those business associations that could be qualified as «pseudo-foreign corporations»: that is, corporations incorporated outside the forum state (CA), and therefore “foreign”, but conducting most of their business (payroll factor, property factor, sales factor) and having most of their shareholders within the forum state. According to California Code, Corporations Code - CORP § 2115 A foreign corporation is subject to certain requirements if: 1. The average of its property, payroll, and sales factors in the jurisdiction is more than 50% during its latest full income year. 2. More than half of its outstanding voting securities are held by persons with addresses in the jurisdiction. 3. The property, payroll, and sales factors are those used in computing the portion of its income allocated to the jurisdiction in its franchise tax return. 16 Leonardo Puricelli’s Note Certain chapters and sections of the law apply exclusively to foreign corporations, excluding the law of the jurisdiction in which the corporation is incorporated. These include topics such as annual board elections, director removal, filling director vacancies, directors' standard of due care, indemnification of directors and officers, limitation on corporate distributions, annual shareholders' meetings, cumulative voting rights, limitation on asset sales or mergers, dissenters' rights, and shareholders' right of inspection. Exceptions exist for corporations listed on specific stock exchanges or whose voting shares are owned entirely by corporations not subject to these requirements. Delaware attractiveness Delaware is known to be highly attractive to American companies for several reasons: 1) Favorable corporate laws: Delaware has flexible and advanced corporate laws that offer companies a wide range of options to structure and manage their businesses. These laws provide a high degree of protection to shareholders and corporate executives and allow greater flexibility in managing business operations and decisions. 2) Specialized commercial courts: Delaware has a court called the Court of Chancery, which specializes in commercial and corporate disputes. This court is known for its expertise in resolving disputes quickly and efficiently, providing a predictable and stable judicial environment for businesses. 3) Favorable taxation: Delaware offers a tax-friendly regime for companies. It does not tax profits generated outside the state, making Delaware an attractive choice for companies with operations in multiple states or internationally. 4) Privacy and confidentiality: Delaware offers a high level of privacy and confidentiality for companies registered in its jurisdiction. For example, there is no requirement for public disclosure of shareholders of Delaware-registered companies, which can be advantageous for companies wishing to keep certain business or financial information confidential. 5) Legal and professional infrastructure: Delaware has a well-developed legal and professional infrastructure, with a wide range of legal, accounting, and consulting services available to businesses. This facilitates the process of incorporating and managing companies in Delaware. 6) Delaware cannot change anything against the companies because its economy is strongly reliant on Franchising taxes. [from ChatGPT] [The following text in green is a repetition of the thing I wrote up here, I don’t know why I have covered the same topic twice but I will keep both explanations to be sure I did not miss anything] Common law countries: decision based by jury, good for civil matters, not very good and precise for corporate law matters. Examen Inc v. Vantagepoint (matter of marger) Marger can be hostile or not, negotiation starts between the management of the 2 companies. The top management needs to submit the project for the merger to the shareholders in order to be voted on. How do we compute the votes in this case? In this case, we have the dual class of shares: - common shares 17 Leonardo Puricelli’s Note - preferred shares (the different ways you can allocate voting rights) The defendant owned 83% of Examen’s “preferred shares”, and argued instead that California (company) the law should control the issue (because they provided different rules on how you should count preferred shares vote). By changing that you would obtain 2 different outcomes (yes or no to Marger). 1) Does the matter of the litigation fall at the internal affairs of the company or externally? In this case, we need to understand which company affairs are the main ones 2) where the court is adjudicating the case. (Delaware judge in this case) 3) What substantive law should be applied? (if a court of incorporation of the comp. whose “internal affairs” are at stake coincide, then the court will usually apply the state’s own “substantive” law You need a link with the parties and the subject matter you are dealing with. (a certain court can decide to apply the corp. law of another country if it best suits the case, that is also true for Italian one, art 25 that deals with company, 3 connecting links (guarda su moodle)) The common law countries also use the real seat doctrine 1) to look at the place of incorporation 2) 2 real seet link (Central management or main place of business) Basically real seat doctrine (it looks at the facts, it is better preferable sometimes) Judges are biased because they do not like to apply the laws of other countries (because they are not trained to do so). Even states that are applying incorporation theory Connecting links, apply the substantial jurisdiction of: - incorporation theory - where is located the central management - HQ where most of the decisions are takenConflict of law rules (US) private international rules law (worldwide) Californian company law provides for 2 sets of voting shares: - preferred - common with that shareholders could have vetoed the marge. Since the majority of the shareholders were Californian and the majority of business was carried out the case was brought up in court. In Delaware, they would have voted together and there wouldn’t be the veto to block the merger. That definitely an Internal Affair problem. The rules that had been applied were the Delaware one because Examin Inc. is a Delaware firm incorporated there. If Californiana jurisdiction would have been applied, under the circumstances and, according to Section 2115 of the California Code, California (company) law shall prevail, even if the company was formed under the law of another State. “Pseudo-foreign” corporations: 18 Leonardo Puricelli’s Note Despite the internal affairs doctrine, which calls for the application of the law of the state of incorporation (“lexincorporationis”) a few states (including California) have chosen, by statutory provisions, to impose their own corporate law rules to the internal affairs of those business associations that could be qualified as «pseudo-foreign corporations»: that is, corporations incorporated outside the forumstate (CA), and therefore “foreign”, but conducting most of their business (things to look at: payroll factor, property factor, sales factor) and having most of their shareholders within the forum state; this “connecting link” clearly refutes the “incorporation theory”, whereby the “internal affairs” of a corporation should always be regulated by the laws of the incorporation state. California Code, Corporations Code - CORP § 2115 (a) A foreign corporation […] is subject to the requirements of subdivision (b) […] if: 1) The average of the property factor, the payroll factor, and the sales factor […] with respect to it is more than 50 percent during its latest full income year and 2) more than one-half of its outstanding voting securities (Class of common share here) are held of record by persons having addresses in this state appearing on the books of the corporation on the record date for the latest meeting of shareholders held during its latest full income year or, if no meeting was held during that year, on the last day of the latest full income year. The property factor, payroll factor, and sales factor shall be those used in computing the portion of its income allocable to this state in its franchise tax return or, with respect to corporations the allocation of whose income is governed by special formulas or that are not required to file separate or any tax returns, which would have been so used if they were governed by this three-factor formula. If that is true, Californian Corp. law will be applied to your case. (b) Except as provided in subdivision (c), the following chapters and sections of this division shall apply to a foreign corporation as defined in subdivision (a) (to the exclusion of the law of the jurisdiction in which it is incorporated): [long list of topics, including annual board election, removal of directors, filling of director vacancies, directors’ standard of due care, indemnification of directors and officers, limitation on corporate distributions of cash or property, annual shareholders’ meeting, shareholders’ right to cumulative voting, limitation on the sale of assets or mergers dissenters’ rights, right of inspection]; (c) This section does not apply to any corporation (1) with outstanding securities listed on the New York Stock Exchange, the NYSE Amex, the NASDAQ Global Market, or the NASDAQ Capital Market, or (2) if all of its voting shares (other than directors' qualifying shares) are owned directly or indirectly by a corporation or corporations not subject to this section. EU Company Law: Digital Incorporation In the past, The big bang of the company was the day of the registration of the company, the notary took care of the substance, the content of the articles, and the by-laws, to see if they were compliant with the law. The notary sends then the documents to the register, which just checks the formality (it does not check the content.) Establishing companies (such as limited liability companies) or partnerships in many EU member states has always been expensive and complicated. Therefore the business community in the EU has been asking for legal tools to establish companies online. The 19 Leonardo Puricelli’s Note advantage of online establishments consists in the fact that there is no need to meet face-to-face with a notary or any other institution (such as a court) competent on the member-state level for registration. On the other hand, there are risks regarding the identification of the involved players and thus the risk of abuse. Since 2017, within the Company Law Package (CLP) the European Union legislation has been focussing on a digital process in order to form companies. The CLP does not affect only digitalization; another directive deals with cross-border conversions, mergers, and divisions. The directive we are going to concentrate on is The Directive 2019/1151/EU of 20 June 2019 amending Directive 2017/1132/EU as regards the use of digital tools and processes in company law. It is intended to facilitate a full online registration and incorporation of companies and contains a 2 year implementation period. Therefore, today no physical presence of the involved persons with any authority and/or notary is required. The way people interact is changing with technology, nowadays many contracts are concluded online. The formation of an Entity is defined by the national laws of each country. What the EU contributed to the role of digital technology in the incorporation of firms. The complexity and costliness of establishing companies, like limited liability companies or partnerships, across multiple EU member states have prompted calls from the business community for legal mechanisms facilitating online establishment, eliminating the necessity for in-person interaction with notaries or jurisdictional bodies at the member state level for registration purposes. On the other hand, there are risks regarding the identification of the involved players and thus the risk of abuse. One of the driving forces of the digitalization is the freedom of establishment (and of branches) [There is a new reform that is being discussed these days but we are not going to cover it] Digital process separate 3 aspects: 1) set up a company (you still need many documents) 2) submission of documents for the pre-existing companies (no matter how they were set up) 3) setting up of branches 1)set up a company Directive 2019/1151/EU of 20 June 2019 amending Directive 2017/1132/EU as regards the use of digital tools and processes in the company law: it has the aim of facilitating the use of digital technology in the company law. The EU regulation needs to be implemented first in the national law. The deadline for it was in Agust 2021 (extended to August 2022) so now the online formation of companies has been available in all member states. Under the provisions of Directive 2019/1151/EU, amending Directive 2017/1132/EU, the drafting of statutes, bylaws, and other legal texts required by national company law can now be conducted electronically. This amendment ensures that the establishment of companies is highly efficient and rapid. Moreover, by Directive 2019/1151/EU, the formation process is mandated to be completed within a timeframe not exceeding 10 days, further streamlining 20 Leonardo Puricelli’s Note the process. The necessity of this speed can be explained by the urgency of some situations like the intellectual property of new technology that needs to be patented. l Advantages and disadvantages of Physical Presence before a notary 1) Proof of identity via ID or Passport, 2) Reduction of set-up costs Now, it is possible to create (e.g. a limited liability company completely online, therefore without the requirement of any face-to-face- meetings). The Types of Companies that are affected by this directive are listed (some can be opt-out by the national legislator). With the upcoming revision of Directive 2017/1132/EU, the EU legislation will continue to expand the use of digital tools in the field of company law. [Since the implementation in Italy, the società a responsablità limitata (Art. 2462 Codice Civile) and the società a responsablità limitata semplificata (Art. 2463-bis Codice Civile) can now be created online.] It is essential to prove who you are when you register a company with your name. In the EU we have the e-IDAS (electronic identification and trust services for electronic transactions). Therefore, member states have to recognize the electronic identifications of EU citizens, as long as the electronic identification falls within the definitions of Regulation 910/2014/EU. 2) Online submission of documents during the companies’ life-cycle Even more important than online setup, online submission of documents happens quite regularly. The submission of documents (e.g. the update on information regarding the management etc) sometimes can be complicated and often takes too long. The online submission is particularly relevant for companies that are in a cross-border situation as far as their management is concerned. You do not need any III party to act for you with online submission, even if it can be not user-friendly. The submission is in the interest of the stakeholders (usually they provide higher transparency on the company) 3)Online Registration of Branches The scope of Directive 2019/1151/EU, amending Directive 2017/1132/EU, extends to encompassing the online registration of branches belonging to established companies. Facilitating swift and cost-effective registration of branches is crucial for upholding the principles of freedom of establishment, as established by the European Court of Justice in landmark cases like Centros, Überseering, and SEVIC, among others, reflecting the evolving dynamics of the contemporary business landscape. If you operate as a natural person in the EU you can operate as a person over your country board. The registration of branches has always been done with papers The Role of the notaries in various EU Countries is the gatekeeper to honesty and integrity. Before the enactment of Directive 2019/1151/EU amending Directive 2017/1132/EU, notaries and/or courts played a crucial role in preventing fraud by scrutinizing documents for 21 Leonardo Puricelli’s Note authenticity and verifying the identities of founding individuals to safeguard against fraudulent submissions and fake identities. Notaries were often referred to as the "gatekeepers to honesty and integrity." Even in the current landscape, post-implementation of Directive 2019/1151/EU amending Directive 2017/1132/EU, notaries continue to fulfill this role, even if parties may not engage in face-to-face meetings. Several member states have adopted the provision of video conferencing as an alternative to in-person interactions, facilitating identification through video means, as outlined in Recital 22 of Directive 2019/1151/EU. The gatekeeper has a role in the 3 situations related to checking that everything is done correctly. Before the implementation of Directive 2019/1151/EU amending Directive 2017/1132/EU, the expenses associated with establishing companies in the EU totaled approximately €50 million per year. While it is plausible that these costs could be substantially reduced by promoting the adoption of the significantly cheaper online procedure, there exists a concern that if the online process incentivizes criminal activity and if safety measures fail to deter such fraudulent behavior, the economic risks associated with online company formation may outweigh the savings derived from substituting a notary with digital tools. Extensive discussions have revolved around whether a legal entity should enjoy the same advantages of online registration as natural persons. Identifying the ultimate identity of legal entities presents a greater challenge compared to natural persons, heightening the perceived risk associated with online company registration by legal entities. Member’s duties According to Article 13g of Directive 2019/1151/EU, amending Directive 2017/1132/EU, member states are mandated to ensure that the online formation of companies can be conducted entirely through digital means, eliminating the requirement for applicants to appear in person before any notary or authority. Consequently, all member states have established comprehensive regulations for the online establishment of companies, including rules governing the use of templates, as stipulated in Article 13h of Directive 2019/1151/EU. Furthermore, both Italy and other member states have implemented procedures to verify that applicants possess the requisite legal capacity and authority to represent the company, by Article 13g(3a) of Directive 2019/1151/EU. Additionally, these procedures ensure the legality of the company's object, whenever such verification is necessitated by national law, as specified in Article 13g(3d) of Directive 2019/1151/EU. US corporate law (Guest Lecture - Prof Palmiter) The biggest share of revenue is from C corporation and S corporation. The biggest share of the total entity is indeed sole proprietorship. 22 Leonardo Puricelli’s Note The concept of a corporation as a “person” arrived only in the late 1800s. Most of the rules and laws for the corporation come from a single state jurisdiction. Only k Trading are fully regulated by Federal law (Corporate externalities, finance and governance are partially regulated by federal laws as well) Unique Aspects of US Corporation 1) US corporate law is (mainly) state law, not federal law: US corporate law is primarily governed by state laws rather than federal laws. Each state has its own set of corporate legislation that outlines the essential rules governing the formation, operation, and dissolution of corporations. This state-based approach allows for variations in corporate regulations across different states, with each state having the authority to establish its own corporate laws. While federal laws may play a supporting role in certain aspects of corporate governance, the foundation of US corporate law lies in the statutes and regulations enacted at the state level. 2) US corporate law is enabling, not mandatory: US corporate law is characterized by its enabling nature, which grants parties significant flexibility in structuring their corporate relationships. Unlike mandatory systems that prescribe specific rules that must be followed, US corporate law sets forth default provisions that apply in the absence of contrary agreements. This approach allows parties to tailor their corporate governance arrangements to suit their unique circumstances and preferences. The enabling aspect of US corporate law is evident in its emphasis on private ordering and contractual freedom. Parties have the autonomy to negotiate and customize their corporate structures through shareholder agreements, bylaws, and other contractual arrangements. This flexibility enables corporations to adapt their governance mechanisms to align with their business strategies, ownership structures, and risk profiles. In comparison with EU law: the European mandatory provisions for corporations are many, in the US one only 4. 3) Delaware is preeminent: Delaware's preeminence in US corporate law is underscored by its unique position as a leading jurisdiction for corporate governance. With over 50% of the largest US corporations and more than 80% of new public corporations choosing Delaware for their incorporation, the state's prominence is evident. Delaware's legislative framework provides management flexibility, supported by a highly experienced corporate legal community and a robust body of case law that offers certainty to corporate planners. The state legislature's proactive approach to corporate law reform ensures that the Delaware corporation statute remains responsive to evolving business needs. Delaware's Court of Chancery, designed to handle corporate litigation efficiently and expertly, plays a crucial role in upholding shareholder interests and corporate governance standards. The court's specialized focus on corporate law cases, coupled with its experienced judges, contributes to the state's reputation for swift and expert resolution of corporate disputes. Delaware's commitment to transparency and accountability in corporate governance is further reinforced by the practices and norms established within corporate boards, promoting responsible decision-making and shareholder protection. Overall, Delaware's preeminence in US corporate law is a result of its proactive legislative approach, experienced legal community, efficient judicial system, and commitment to upholding corporate governance standards. The state's leadership in statutory reform, coupled with its specialized court system and transparent corporate practices, solidifies its 23 Leonardo Puricelli’s Note position as a preferred jurisdiction for businesses seeking a stable and reliable legal environment for corporate operations. The concept of law as a “product” may lead to a race to the top or the bottom. 4) US corporate statutes are thin on creditor protection: The evolution of US corporate law has seen a gradual erosion of creditor protections, contrasting with historical practices. While early laws enforced minimum capital requirements, reserves, and personal liability for directors, contemporary statutes prioritize shareholder interests over creditor safeguards. Today, corporations can operate with minimal capital, manipulate balance sheets, and prioritize shareholder returns, often at the expense of creditor security. Instead of statutory safeguards, reliance is placed on private contracts and court interventions, such as personal guarantees, contractual stipulations, and the judicial doctrine of "piercing the corporate veil." This doctrine allows creditors to hold shareholders and managers personally liable for corporate debts in cases of abuse or misrepresentation. Despite the absence of ex-ante creditor protections in statutory law, courts provide ex-post relief, ensuring some level of creditor security, as demonstrated in cases such as the piercing of the corporate veil for individual liability (in case of illegal distributions). For instance, in cases such as the piercing of the corporate veil, courts impose personal liability on owners who drain corporate resources, providing a semblance of protection for creditors despite the absence of formal statutory safeguards. 5) Fiduciary duties are the binding cement: in the US corporate law system, emphasizing the central role of directors in corporate governance. Power within corporations resides primarily with the board of directors, rather than shareholders, as highlighted by Delaware judges. The board, in collaboration with corporate officers, holds authority over key corporate decisions such as executive appointments, dividend distributions, mergers, and strategic changes. Shareholders, on the other hand, have limited powers, primarily electing directors and having veto rights over specific fundamental transactions. The legal accountability in corporations stems not from rigid legislative rules but from fiduciary duties enforced by courts. Shareholders possess the right to bring lawsuits to enforce these duties, subject to procedural controls. The business judgment rule, a fundamental principle in US corporate law, protects directors' decisions from unwarranted scrutiny, emphasizing that courts should not interfere with well-meaning business judgments. Directors are held accountable when their actions breach duties such as the duty to be informed, the duty to monitor, or the duty of loyalty. Significant developments in US corporate law over the past 25 years have revolved around court cases interpreting and reformulating corporate fiduciary duties. These cases have shaped the landscape of corporate governance, emphasizing the importance of directors' adherence to fiduciary standards in decision-making processes. The evolution of fiduciary duties reflects the dynamic nature of US corporate law, adapting to new governance and market circumstances to ensure accountability and transparency within corporations. The 2 duties are Duty of Care (A director is called upon to use care, to exercise judgment, the degree of care, the kind of judgment, that one would give in similar situations to the conduct of his affairs), Duty of loyalty (Personal transactions of directors with the corporations... may tend to produce a conflict between self-interest and fiduciary obligation, are when challenged examined with the most scrupulous care.). Furthermore, there are also the Business judgment rules (BJR) which 24 Leonardo Puricelli’s Note protect directors from lawsuits for honest mistakes made in good faith, as long as they follow a proper decision-making process. 6) US corporate law is dynamic: characterized by continuous evolution driven by reforms from state and federal legislatures, courts, regulators, and capital markets. Over the past two decades, US corporate law has undergone significant changes, addressing key issues such as the relationship between shareholders and corporate constituencies, merger and takeover regulations, the role of institutional shareholders, and the functions of outside directors. Delaware courts, through the application of state fiduciary law, have played a crucial role in shaping corporate governance practices and setting legal precedents. The regulatory landscape in the US has responded to emerging challenges and market dynamics, with reforms aimed at enhancing transparency, accountability, and shareholder rights. State and federal laws, along with court decisions, have influenced corporate governance practices, shaping the responsibilities and obligations of corporate actors. The regulatory framework in the US reflects a balance between enabling corporate flexibility and ensuring regulatory oversight to protect shareholder interests and promote market efficiency. The US corporate law system has addressed a wide range of issues, including fiduciary duties, executive compensation, corporate monitoring, and internal controls. Fiduciary principles guide board oversight of financial disclosure systems, legal compliance programs, and executive loans, emphasizing the importance of independent directors and ethical decision-making. While fiduciary law provides a foundation for corporate governance, there are areas where regulatory gaps exist, such as institutional shareholder voting, corporate political activities, and charitable giving. The dynamic nature of US corporate law underscores the need for ongoing adaptation to changing business environments and regulatory requirements. By responding to market trends, legal challenges, and stakeholder expectations, US corporate law continues to evolve, shaping corporate practices and governance standards. The interplay between legislative reforms, judicial decisions, and market forces influences the trajectory of US corporate law, highlighting the importance of maintaining a robust and responsive legal framework to support corporate governance best practices and uphold shareholder rights. Limited Liability and corporate externalities (Many critics to modern Capitalism, Pope Francis cite about the exploitation and evil staff ) According to NC Bus Corp Act § 55-6-22. (Liability of shareholders): (a) A purchaser from a corporation of its own shares is not liable to the corporation or its creditors with respect to the shares except to pay the consideration for which the shares were authorized to be issued or specified in the subscription agreement. (b) Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable because of his acts or conduct. It was not always like that, there was an evolution in the history of Limited Liability. The concept of Corporate externalities has been studies by many scholar: - Bob Monks [early corporate governance activist / founder of ISS]: externalitiesa a linked to the reduction of costs (by pushing them on to others). For him the Corporation is an "externalizing machine" (like shark) 25 Leonardo Puricelli’s Note - Milton Friedman [Chicago "school" / Nobel laureate]: He defined an externality as the cost of a transaction between two parties that is paid by a third party without their agreement. It is a Real problem! Limited liability exists to shield shareholders from very high risk and encourage them to pursue a business. Imagine an oil exploration corporation without limited liability: Personal wealth at risk? One of many risks? Monitor management? Monitor other Shs? Valuation of shares? Transfer shares? Piercing the corporate veil is a legal concept that applies to limited liability companies. In normal circumstances, the owners (shareholders) of a corporation have limited liability for the company's debts and obligations. This means that if the company goes bankrupt, creditors can only go after the company's assets, not the personal assets of the shareholders. However, in certain situations, a court can decide to pierce the corporate veil. This means that the court will disregard the separate legal existence of the corporation and hold the shareholders personally liable for the company's actions or debts. There are several reasons why a court might pierce the corporate veil. Some common reasons include: - Fraud: If the corporation is being used to commit fraud, a court may pierce the veil to hold the shareholders accountable. - Alter ego: If the corporation is simply an extension of the shareholder's personal life, with no separate business purpose, a court may pierce the veil. - Undercapitalization: If the corporation is not adequately capitalized (meaning it doesn't have enough financial resources to operate as a separate entity), a court may pierce the veil. - Failure to follow the formalities - Confusion - Misrepresentation Piercing the corporate veil is a legal remedy that is used sparingly by courts. It's most commonly applied to closely held corporations, which are small businesses with a limited number of shareholders. For larger corporations with many shareholders, it's more difficult to justify piercing the veil. Vail-Piercing The paper Veil-Piercing provides a comprehensive analysis of veil-piercing cases, highlighting the crucial role of Fraud in the success of such claims. It notes that claims are more successful when linked to Fraud or supported by specific evidence of fraud or misrepresentation. Veil-piercing claims prevail more in Tort cases than in Contract cases, with a distinction between voluntary and involuntary creditors. Surprisingly, individual shareholders face a higher risk of veil-piercing compared to corporate groups. The text introduces the concepts of the corporate "alter ego" and "instrumentality" in legal proceedings related to veil-piercing. It also criticizes the overuse of metaphors in law, leading to doctrinal confusion. Data presented includes a success rate of about 49% for plaintiffs in veil-piercing cases and a total of 2,925 reported cases of piercing over more than 200 years, predominantly involving close corporations. 26 Leonardo Puricelli’s Note Possible Piercing factors: Domination/control, Undercapitalization, Failure to follow formalities, Confusion, Commingling of assets, Misrepresentation. Corporate Environmental Liability The Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also known as the Superfund statute, imposes liability for cleaning up toxic waste sites on owners and operators of facilities where hazardous chemicals have been dumped. The term "person" in CERCLA includes corporations and other business entities. However, the definitions of "owner" and "operator" are circular, leading to questions regarding liability, especially when companies responsible for pollution have gone bankrupt or been sold. Federal courts initially interpreted "owner" and "operator" expansively, holding parent corporations liable for pollution caused by their subsidiaries. However, the case United States v. Bestfoods addressed whether a parent corporation could be held liable under CERCLA for the actions of its subsidiary. The Supreme Court ruled that a corporate parent could not be held indirectly liable unless the corporate veil could be pierced. However, if the corporate parent actively participated in and controlled the operations of the facility, it could be held directly liable as an "operator." This decision emphasized that "owner" or "operator" liability under CERCLA must adhere to norms of limited liability established in corporate law. It highlights the influence of state corporate law in interpreting federal environmental regulation. The Supreme Court's opinion in United States v. Bestfoods highlights the complex issue of liability under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) for pollution caused by corporate entities. The Court reaffirms the general principle of corporate law that a parent corporation is not typically liable for the actions of its subsidiaries. However, it also acknowledges the principle of piercing the corporate veil when the corporate form is misused for wrongful purposes such as fraud. The Court distinguishes between derivative liability, where a parent corporation is held liable for its subsidiary's actions, and direct liability, where a parent corporation can be held liable for its own actions in operating a facility owned by its subsidiary. Direct liability under CERCLA is not dependent on the parent-subsidiary relationship but is based on the actions of the corporation itself in operating the facility. The Court criticizes the "actual control" test used by some lower courts, arguing that it blurs the distinction between direct and derivative liability. Instead, the focus should be on whether the parent corporation directly operated the facility, regardless of shared personnel or management roles between the parent and subsidiary. The Court emphasizes that actions consistent with the parent corporation's investor status, such as monitoring performance or setting general policies, should not incur direct liability. However, if the parent corporation actively participates in and controls environmental matters related to the facility, it may be held directly liable. In the specific case, the Court finds evidence that the parent corporation, CPC, through its agent Williams, actively participated in and exerted control over environmental matters at the facility. Thus, there is sufficient basis to raise the issue of CPC's direct operation of the facility, although the ultimate conclusion is left open for further consideration. A study showed that the increase in liability protection for parent corporations led to a 10 percent increase in toxic emissions by subsidiaries a result not linked to increased production. Limited liability makes people less responsible. 27 Leonardo Puricelli’s Note Alternatives to Limited Liability The excerpt discusses the proposition of pro rata shareholder liability for corporate torts, put forth by Harvard law professors Henry Hansmann and Reinier Kraakman in the 1990s. They argued that making shareholders responsible for corporate torts would incentivize more responsible risk management by corporate management and ensure compensation in cases of mass torts. However, their proposal failed to gain traction, largely due to concerns about its potential impact on shareholders and the fundamental principles of the capitalist system, which heavily rely on limited liability. The text then delves into how contemporary corporations, exemplified by entities like Johnson & Johnson and Purdue Pharma, have developed sophisticated strategies to circumvent mass tort liability. These strategies involve leveraging bankruptcy laws to their advantage, devising custom resolution mechanisms, sequestering funds beyond the reach of bankruptcy courts, exploiting statutory loopholes, and fostering divisions among victims to facilitate settlements that may not uniformly address the harm caused. In essence, while the proposal for pro rata shareholder liability fizzled out, the narrative underscores the challenges in holding corporations accountable for their actions, particularly in cases of mass torts. It sheds light on the intricate ways in which modern corporations navigate legal frameworks to evade liability, raising pertinent questions about justice, accountability, and the integrity of the capitalist system. Corporate criminal liability in the United States is a means to internalize externalities created by corporations. This liability primarily operates at the federal level and imposes penalties on corporations when individuals within them commit criminal acts. These penalties typically involve fines payable to the government and agreements with prosecutors for behavioral changes within the corporation. Corporate criminal liability emerged in the early 1900s in response to the growing economic power of corporations and concerns about public health and safety. Enforcement of this liability has evolved over time, with penalties adjusted to reflect corporate culpability. Corporations can mitigate penalties through internal investigations, cooperation with regulators and prosecutors, and settlement of misconduct claims. Deferred prosecution agreements are common, requiring changes in business practices and governance to avoid criminal liability. The seminal case on corporate criminality in the United States is New York Central & Hudson River Railroad Co. v. United States (1909), which arose during the post-Civil War era when federal criminal law expanded due to rapid economic growth. Shareholder ESG Proposals The discussion revolves around the concept of shareholder primacy and the evolving perspectives on corporate purpose in the realm of socially responsible investing. The text highlights a pivotal article by Professor Lynn Stout from the early 2000s, which challenges the notion of shareholder primacy as a misinterpretation of the law and actual corporate practice. Stout argues that corporations can achieve greater value and resilience by viewing the board as a mediator of various stakeholder interests, rather than solely prioritizing investors. This perspective emphasizes the importance of considering employees and other stakeholders on equal footing with shareholders. Furthermore, the document references a case study from Canada where a shift towards a "stakeholder regime" by the country's highest court did not significantly impact corporate litigation patterns, takeover premiums, or equity asset values. This observation suggests that 28 Leonardo Puricelli’s Note the formal recognition of stakeholder interests in corporate decision-making may not always lead to tangible changes in corporate behavior or market perceptions. Overall, these insights challenge traditional views on corporate purpose and underscore the ongoing debate surrounding the role of corporations in balancing financial objectives with broader social and environmental responsibilities in the context of socially responsible investing. (about the slides) The document opens with an insightful overview of ESG investing, highlighting the paradigm shift in corporate decision-making driven by a heightened awareness of environmental and social risks. It underscores how US corporations are increasingly responding to investor pressures, particularly from institutional shareholders, to address sustainability concerns such as carbon emissions, water usage, and supply chain integrity. This shift reflects a broader cultural movement towards responsible business practices and long-term resilience. One of the central themes explored is the role of shareholder activism in promoting ESG principles within companies. The document delves into the process of shareholder proposals, illustrating how shareholders can leverage their ownership rights to advocate for sustainability initiatives and hold management accountable. Through examples of shareholder proposals urging companies to prepare sustainability reports, the document showcases the dialogue between shareholders and management, revealing contrasting perspectives on the value of ESG disclosures. Moreover, the document features insights from industry leaders, including BlackRock CEO Larry Fink, who emphasizes the multifaceted responsibilities of companies in managing their impact on the environment, fostering diversity, and adapting to technological advancements. Fink's call for companies to prioritize community engagement and employee well-being underscores the interconnected nature of ESG considerations with long-term business success. Looking ahead, the document hints at emerging trends in ESG investing, emphasizing the need for companies to articulate clear ESG strategies and engage in proactive dialogue with shareholders throughout the year. It underscores the blurring lines between traditional shareholder concerns and social policy issues, signaling a broader shift towards a more holistic approach to corporate governance that integrates financial performance with environmental and social impacts. In portfolio theory, every company is correlated with each other. Overview of ESG investing: Capitalism has gave us an antidote to suffering, corporation decisions reflect environment and social risk. How ESG shows up in court cases and shareholder voting/engagement. ESG investing 1) 3 Bottom Line - ESG factors are receiving money-manager focus. The drivers are I cultural shifts, out performing returns, long-term resilience. 2) Corporate purpose 3) ESG shareholder proposals. SEC rule, Proper purpose proposal. Who Cares Wins (WCW) was instituted in 2004 with a multinational approach. Complicated situation - ESG is catching up, ESG investments are outperforming. Regenerative agriculture. Shareholders are not really the owners and Directors are not really the agents. Craiglist case: poison pill (In corporate finance, a poison pill is a defensive strategy used by companies to discourage hostile takeovers. The poison pill involves implementing measures that make the target company less desirable or more expensive to acquire.) 29 Leonardo Puricelli’s Note Facebook case: Shareholders sue the directors for violation of fiduciary duties knowing indifferent to how the company - harmed mental health COI as Meta directors preferred themselves over diversified Shareholders. Shareholder proposal (process) 1) Management excludes (if sec is okay with that no vote will happen) 2) Management includes (proxy statement) 3) Management negotiation Shareholders vote on proposal Management can refuse a stupid request by shareholders with a written response. Portfolio theory suggests that every company's performance is interconnected, implying that the fate of one often influences others. Amidst this backdrop, Environmental, Social, and Governance (ESG) investing has emerged as a significant paradigm shift within capitalism. ESG criteria reflect the growing recognition that corporate decisions not only affect financial returns but also environmental and social risks. The integration of ESG factors in investment decisions is becoming increasingly prominent, driven by cultural shifts, the prospect of outperforming returns, and the imperative of long-term resilience. Shareholders once considered mere owners, and directors, typically seen as agents, are now grappling with the complexities of ESG considerations. Initiatives like "Who Cares Wins" (WCW), established in 2004 with a multinational approach, underscore the global momentum behind ESG investing. This trend is further bolstered by the tangible evidence of outperformance in ESG investments and the growing importance of concepts like regenerative agriculture. However, the landscape of corporate governance isn't without its challenges. Instances such as the Craigslist case, where poison pill strategies were deployed to thwart hostile takeovers, or the Facebook case, where shareholders sued directors for neglecting their fiduciary duties by ignoring the adverse impact on mental health, highlight the tension between corporate interests and stakeholder concerns. Moreover, the shareholder proposal process reflects the evolving dynamics of corporate engagement. While management holds the power to exclude proposals that don't align with their vision, shareholders have the opportunity to voice their concerns through proxy statements and voting mechanisms. Nonetheless, management retains the authority to reject proposals deemed impractical or detrimental, underscoring the delicate balance of power in corporate governance. In essence, the integration of ESG considerations into investment strategies and corporate decision-making reflects a broader shift towards more conscientious capitalism. As stakeholders navigate these complexities, the need for transparent, accountable, and socially responsible corporate practices becomes increasingly apparent. [ChatGPT enhanced] Personal Integrity Corporate governance primarily focuses on the assumption that shareholders are the owners of a company, using mechanisms often described as "carrots and sticks" to incentivize desired behaviors. To evaluate whether corporate governance has been effective, one should look at shareholder returns and consider the frequency and impact of scandals 30 Leonardo Puricelli’s Note and market volatility. There seems to be an underlying complexity, often referred to as "dark matter," affecting the outcomes. The problems with corporate governance include the creation of empty or counterproductive incentives and an overabundance of rules, which can result in moral automatons rather than genuinely ethical behavior. Ontological integrity, essentially meaning "keeping one's word," is crucial for a sustainable corporation. This concept is relevant because it ties into mindfulness, the language we use, and our relationship with nature, all of which are foundational for building a truly sustainable and ethical business environment. Modern Corporate Governance Corporate Governance Out of Control: The concept of "best practices" in corporate governance often fails to deliver the expected results. While agency theory, which supports the Shareholder Wealth Maximization (SWM) model, has some empirical backing, it has also shown significant shortcomings. Specific failures of agency theory include the use of stock options, which have sometimes led to accounting fraud. Independent directors often lack industry knowledge, raising questions about their value. Additionally, an overemphasis on compliance can slow down innovation. This situation resembles a Copernican "monster": although we have various elements like hands and feet, the overall body is misaligned and fails to function correctly. Several solution for the fallacies in corporate governance include: - The shift from SWM, which focuses on financial goals, to Corporate Social Responsibility (CSR), which emphasizes non-financial goals. - The application of a new agency theory, which simplifies human nature to mere financial incentives. - The mistaken notion of treating a corporate entity as a person. Limits of Agency Theory Shareholders, particularly passive or institutional investors, often remain disengaged, failing to actively influence corporate governance. Executives struggle with performance-based pay and budgeting, leading to deceptive practices known as the "two lies." Gatekeepers, such as boards and oversight agencies, frequently fail to monitor effectively or intervene too late. Research in corporate governance highlights that board expertise is crucial, as shown by Hau (2012) and Thum (2009). However, independence is not necessarily linked to performance, according to Van Zijl (2012). Additionally, Lorsch (2012) identifies ongoing uncertainty regarding the board's role. To move beyond agency theory, we must recognize that excessive regulation can turn individuals into irresponsible automatons, while new ownership structures still face role confusion and internal motivation is often undermined. Effective corporate governance requires fostering autonomy, mastery, and a sense of purpose beyond oneself. These elements help individuals become "whole" persons, 31 Leonardo Puricelli’s Note guided by virtue and practical wisdom as Aristotle suggested. Incorporating daily practices for improvement, as Benjamin Franklin advocated, and the courage to speak the truth, known as parrhesia by Michel Foucault, are also essential. The habit of prayer, emphasized by Thomas Aquinas, can further contribute to developing a well-rounded and ethical approach to corporate governance. People are much more motivated by recognition and positive reinforcement than they are by short-term rewards Seven Signs of Ine