Corporate Law Summary PDF

**CORPORATE LAW SUMMARY** **MODULE 1** **CHAPTER 1 -- WHAT IS A COMPANY?** Company law is a branch of private law that rule the organizations and activities of the companies. In the UK \>\> 'company' In the US \>\> 'corporation' or 'corporate form' Its aim is to reduce the organizational costs of companies, and protects the companies from the 'principal-agent problems'). Company \>\> a legal entity established by one or more persons under the law separated by its founders and its members (shareholders) and governors (board of directors), with capital divided into shares (azioni). Shares \>\> quota di proprietà di una società The company is dotate of legal personality (it can be sued, sue, enter into contracts, bear their own assets and rights). It needs representatives to act on their behalf. A company is governed not only by company law but also by its corporate charter (Article of Association or AoA) which is the fundamental contract that governs the company. **Three kinds of RULES:** There are some rules, the mandatory corporate rules that cannot be changed by the corporate charter or any other actor. Default rules, instead, can be deviated by the Charter. These rules apply only when the charter does not specify otherwise. Soft laws (not legally binding) \>\> they can also influence court decisions. Ex, Corporate governance codes intended for stock-exchange - listed company (societa quotate in borsa che hanno quindi azioni che vengono scambiate pubblicamente sulle borse valori). They contain the best practices about the internal structure of the company that are not legally binding. stock-exchange - listed company \>\> società che emettono azioni che possono essere vendute e comprate da investitori sul mercato azionario. GORPORATE GOVERNANCE \>\> Internal system by which companies are directed and controlled. The company must disclose if they're complying with these practices or need to explain why they deviate from them \>\> COMPLY-OR-EXPLAIN PRINCIPLE (Key feature of European Corporate governance under the European Directives). (If they do not explain their non-compliance, they could get sanctions). **Jurisdicition**: most company law rules are determined at the national level of jurisdicition or even lower. - THE UNITED STATES Federal Government and state governments. Companies are governed by the laws of the states (DGCL), the federal government and the Stock exchange. Federal government \>\> handle federal and interstate lawsuits State Courts \>\> handle everything else, including corporate law cases. Most of the largest companies are governed by Delware Law. All companies use the abbreviations Inc. or Corp. - THE EUROPEAN UNION European Member States, such as Germany or Netherlands, have national statutory company laws but are also subject to European Law. TWO of the most important European Treaties is the TFEU and TEU. Three main sources of European Law\> - Regulations: binding legislative acts (regulations related to securities market) - Directives: binding on the outcomes to reach (MS must transpose the rules into their national law. They only apply after transposition into national law. - Recommendations: do not need to be transposed into national law to bind individuals (companies), Art. 288 TFEU specifies that regulations are directly applicable in European Member State. Within the EU each European Jurisdiction has its own legal form. Also, conflicting doctrines among MS complicate regulatory competition. 1. Doctrine of incorporation: the applicable company law is that of the jurisdiction in which the legal person is incorporated, regardless of its 'real seat', which is the main centre of business affairs, while the seat of incorporation is the place where the company is legally established. \>\> the doctrine allows companies to set up a legal entity in any European Member State regardless of whether they do business. 2. Real seat doctrine: it determines the applicable company law by the location f the company's reals seat, allowing companies to incorporate only a jurisdiction where they also conduct their main business activities. The European Union (EU) legislation and the rulings of the European Court of Justice (ECJ) have reshaped the landscape of European company law, fostering greater freedom in the choice of jurisdiction for companies. This shift is rooted in Article 49 of the Treaty on the Functioning of the European Union (TFEU), which guarantees the freedom of establishment as one of the EU\'s four fundamental freedoms. This freedom allows citizens and companies from member states to establish and operate freely in any other member state under the same conditions as the nationals of the host country. **The European Company (Societas Europaea - SE)** To further facilitate the single market, the European Company (Regulation EC No. 2157/2001) was introduced, providing a corporate structure valid across all member states. This company type is governed by European regulations, offering a uniform framework. However, its use remains limited, with popularity in countries like the Czech Republic. **Brexit Impacts** After Brexit (January 1, 2021), the United Kingdom is no longer subject to EU law. Consequently, EU legislation on European companies, such as the Societas Europaea, no longer applies in the UK. Existing European companies were automatically converted into \"UK Societas\" and can be restructured into public limited companies (Plc) under UK law. **MODULE 2** **CHAPTER 2: The main characteristics of companies** Corporation \>\> United States Company \>\> EU and UK It involves variuous actors: Shareholders (members or owners) , directors, employees, creditors, primary and secondary stakeholders. **5 PRINCIPAL CHARACTERISTICS:** 1. **Legal personality** 2. **Limited liability** 3. **Transferability of shares** 4. **Centralized management under a board structure** 5. **Investor ownership** Shareholder \>\> they own shares in the company which receives in return for their investments. They enjoy limited liability, cause they're no personally liable for the company's debts. In small companies: part of the management or board. They are paid after the creditors and receive any remaining income that the company makes. Creditors \>\> they provide companies capital to finance their operations and expantions in exchange for interest payments and repayments of the principal (the face value of the loan) after a certain period (maturity date). They got paid first. Directors \>\> sit on the board, bind the company without incurring in personal liability. Strakeholder \>\> parties with an interest in the company who can affect or be affected by it. (including employees and consumers) Two categories: Formal or contractual relationship with the company (primary) Without relationship (secondary) [CHARACTERISTICS OF THE COMPANY: ] 1. **LEGAL PERSONALITY:** It implies that the company is a legal person and is distinct from the corporate actors. The company needs representatives though. The company has its own assets called 'separate patrimony in law'. 2. **LIMITED LIABILITY** It protects shareholders. They are liable for the amount they have invested. Creditors can only make claims against the company's assets \>\> Owner shielding Advantages: It stimulates the creation of a risky business Shareholders do not have to monitor every step of the business Limited liability enables portfolio diversification Principle of 'piercing the corporate veil', according to which the courts sustain that shareholders should be held liable for the company's debts. (not accepted) **Salomon v Salomon case** is important under UK company law: company is separate legal entity and that shareholders are not liable for the company's debts. The impacts of limited liability on creditors: - Shareholder -- creditor agency problem: Creditors possess fixed claims on the firm's assets and income, while shareholders hold residual claims. Also, shareholders have a greater control over company decision and are incentivized to embrace higher risks for potentially greater returns. Several opportunistic behaviours towards the creditors: \- asset diversion or dilution, where shareholders may withdraw assets for personal benefit, depleting the asset pool available to creditors. \- debt dilution, where increasing corporate borrowing dilutes the claims of existing creditors. \- asset substitution, where shareholders swap low-risk assets for higher-risk, increasing the risk to creditors. \- debt overhang, when existing high debt levels discourage shareholders from funding new viable projects because the primary benefits would accrue to the creditors, resulting in underinvestment in projects that could be profitable. Debt overhang\>\> is a situation where high levels of debt discourage shareholders from funding new investments, even if they are potentially profitable, because the benefits of such investments primarily go to creditors rather than to the shareholders. 3. **TRANSFERABILITY OF SHARES:** Company has a perpetual life. It increases the liquidity of shareholders investments. The creditworthiness of the company does not change with the change of owners. Public companies usually have freely transferable shares, often publicly listed on a stock exchange for trading. Financial Markets: marketplaces for the issuance and trading of capital and other financial instruments and assets. The primary markets are where companies issue their shares to the public for the first time The secondary market is where investors trade already issued shares. Listed companies are subject to ad hoc and ongoing disclosure requirements and other rules from securities laws, company law, Listing Rules and other (soft) law instruments. Private companies are usually not traded on a stock exchange. They also do not have to disclose as much financial information as public companies and are not subject to the same level of public scrutiny. Asset specificity \>\> once a seller makes specific investments for a particular transaction, the buyer can credibly threaten to stop buying from the seller. 4. **CENTRALIZED MANAGEMENT UNDER A BOARD STRUCTURE.** The principal authority over the company's affairs is delegated by law to a body called the corporate board. It has an autonomous role to act in the company's interests. BOARDS' STRUCTURES: - One-tier board, all directors are part of the same board (non-executive directors oversee the executive directors beviour). Shareholders can elect both executive and non-executive directors. - 2- tier board, the supervisory directors separated from the managements board members. Shareholders elect the supervisory directors who elect the management board members. **Other business form** Companies are the only one type of business A sole proprietorship: the simplest form of business (they must obtain the necessary icenses and permits). It does not have a separate legal personality and neither limited liability. A partnership: involves morethan one person, identifies as partners. **GP \_ general partnership, the easiest one: agreement between partners; alla partners have unlimited liability.** Partners liable for the firm's debts and obligations. No need of a written contract in most jurisdictions In France an entrepreneur can start a sole partnership 'individual businessperson'. He's liable for creditors for debts incurred during professional activities but only to the extent of their professional assets. Two or more businesspeople\>\> company or société in France. **Limited partnership (LP) \>\> At** least one partner has unlimited liability and other partners has limited liability. LLP\>\> limited liability partnership is commonly used for law firms and professional services firms. The LLP has legal personality. In this case limited partners can contribute capital but cannot lose more than their invested capital and they are not involved in management activities. **MODULE 3** **CHAPTER 3 -- FORMATION OF THE COMPANY** When you start a company the first step to take is to choose the name of the company which needs to be unique. You will need to file the Articles of Association (the corporate charter) that outline the company's structure and regulations. A common distinction is made between a private and a publicly traded company, or similarly, between a closed and an open company. Private companies are generally not allowed to offer shares to everyone, and often the number of shareholders in a private company is limited. Incorporating a company in Germany - Establish a structure: private or a public company? Private company (GmbH) Public company (AG), e AG is required to have a minimum capital of EUR50,000 - register your company with the German Commercial Register. This involves applying, which includes information such as the company's name, registered office, and Articles of Association. The intervention of a notary is required. - The third step is to obtain a value-added tax (VAT) number. - you will need to open a bank account for your company - As a final (continuous) step, you as a founder will need to comply with various legal requirements, including preparing and filing the annual accounts and maintaining tax administration Founders \>\> anyone, whether a natural or legal person, can be a founder (sometimes also called promoter) of a company. French law mandates that a limited liability company must be established by at least two founders. Founders wishing to establish a company must demonstrate their intention by signing a document containing the Articles of Association or a notarial deed with the Articles of Association (France, Germany, and the Netherlands.) e United States or New Zealand, it is sufficient to register the company (by the founders or a lawyer on their behalf) without requiring a notarial deed. The Articles of Association the founders must prepare a document containing the essential information of the company. Known as the Articles of Association in many jurisdictions, this document may also be called the (corporate) charter, articles of incorporation, or certificate of incorporation. The Articles of Association outline the rules and regulations for the company's governance and operations. In the United States, it is common for the board of directors to adopt by-laws (establishing important organizational, legal and administrative aspects) when establishing a company. In other jurisdictions, these issues are often addressed in the Articles of Association. Shareholders can amend the Articles of Association, but by-laws are usually determined by the corporate board. Usually in the Article of Association, the law lists essential items that must be included and additional items that founders may consider. - According to Section 101 of the Delaware General Corporation Law (DGCL) the charter must provide in: 1. the name of the company, (2) the address, (3) the nature of the business or purpose to be conducted, (4) the total number of shares of stock the company can issue, (5) the name and address of the incorporator(s) (which are commonly lawyers), and (6) if the powers of the latter ends upon the filing of the certificate, the names and addresses of the first directors. Other matters that the charter can provide are: (7) provisions of the management of the business or conduct of affairs, (8) pre-emptive rights, (9) provisions eliminating or limiting the personal liability of the director to the corporation for a breach of a fiduciary duty, etc. - German law adds: (5) the number of the members of the board (or rules how this number will be determined), and (6) how the company will make its official announcements. German law requires explicit details about the company's share capital. Delaware law offers flexibility to include various additional topics in the Articles of Association. - According to Dutch law, the Articles of Association can be brief, requiring only the company's name, the nature of the business, the purpose of the company, its address, the amount of capital, and the number and type of shares. - A company must not be registered under this Act by a name if, in the opinion of the Secretary of State--- (a) it use by the company would constitute an offence, or (b)it is offensive. - Additionally, a company name generally cannot be identical or too similar to an existing company name or other business name. **Corporate purpose** The corporate purpose (or goal, or object) can be a required part of the Articles of Association. A company's purpose typically includes a statement of its intent or mission, outlining its overall goals. The corporate purpose serves as a guiding principle for the decision-making and actions of the company.. The corporate purpose is also crucial for shareholders who acquire shares in the company, as it informs them about the company's activities and management's expected conduct. Ultra vires doctrine \>\> This legal doctrine states that a company is only authorized to undertake activities specifically outlined in its Articles of Association. Under this doctrine, any action taken by a company that is not authorized by its Articles of Association is considered ultra vires and invalid. Many jurisdictions around the world have adopted adapted versions of the ultra vires doctrine or abolished it. Some jurisdictions now rely on other principles, such as the principle of corporate capacity, which allows a company to conduct, under specific conditions, any lawful business, thus protecting third parties with whom the company engage. Not all jurisdictions require a company to have an object laid down in the Articles of Association. According to UK Companies Act 2006, the company's objects are unrestricted unless the articles specifically restrict those objects. **Registration** For the incorporation of the company, the aforementioned documents must be registered. In Delaware, the Division of Corporations of the Department of State handles the registration, while in the United Kingdom, the Companies House is responsible. In France, the National Institute of Industrial Property (INPI). In Germany (district court). It is common practice that the company comes into existence with its registration, which asses the company a registration number. **Disclosure** Upon registration, the company becomes a (legal) person, able to act, acquire rights, and enter into obligations. Company acts, as well as accounting rules and securities laws, oblige companies to disclose information about their existence, representatives, and operations. Jurisdictions must ensure that the following company information is made public: the deed of incorporation, the persons authorized to represent the company, the amount of capital, the accounting documents for each financial year, the dissolution of the company, the declaration of invalidity, and the termination of the liquidation. **Financing the company** Companies can only develop their activities if they are properly financed. Every public limited company limited by shares must have an issued capital of at least 25,000 euros. Financial administration is required: As companies must pay taxes and regularly inform corporate incumbents of the financial situation of the company, they must establish a financial administration that carefully tracks all the operations and performance of the company. The company, once duly incorporated, can assume the obligations arising from acts performed by the parties for the company 'in formation'. If the company does not assume these 18 obligations, the persons who acted are jointly and severally liable, unless otherwise agreed. **Nullity of the company and consequences** Any breach of procedural requirements can have major consequences, including, in the most serious cases, the nullity of the company, meaning that the company is declared non-existent. When third parties interact with the company, they should be protected against the negative consequences of the company being sanctioned for breaching establishment requirements. Therefore, nullity, which would result not only in the disappearance of the company but also in the invalidation of transactions. nullity of the company has an effect ex nunc, and not ex tunc as if the affected act never took place. **MODULE 4** **Chapter 5 -- THE CORPORATE BOARD** The fourth characteristic is a centralized or delegated management under a board structure, known as the corporate board, since a company cannot perform its own actions; it requires individuals to represent and act on its behalf. **BOARD STRCUTURE** 1. **One -- tier board structure** The common model was the single board of directors. It remains the dominant board model in many jurisdictions, including the United States and the UK. In a one-tier board system, both management and oversight responsibilities are vested in the board of directors, which holds comprehensive powers. In most jurisdictions, a one-tier board consists of several directors. Under the FCC \> "The board of directors determines the orientations of the company's activities and oversees their implementation \[...\] it deals with any question concerning the smooth running of the company and settles the concerning matters\--. The UK \> 'a director is simply a person appointed to act as one of a board, with power to bind the company when acting as a board, but having otherwise no power to bind them' Netherland \> the Board of Directors represents the corporation unless the law provides otherwise. Each director may also individually represent the corporation. The articles of incorporation may, however, provide that only one or more of the directors may represent the corporation. Directors, who have management responsibilities, are also called executive directors in this one-tier board structure. The CEO is the most important executive director, acting as the main contact person for the corporate board. The CEO manages the major strategic decisions and, together with a team of executive officers (and sometimes other executive directors), develops and executes corporate policies. Non-executive directors \>\> Directors not involved in the day-to-day management activities of the company but engaged in the monitoring role on the board of directors. Also, the non-executive directors are appointed by the shareholders. 2. **Two-tier board mode** Germany introduced this model. Netherlands also adopted this kind of model. The roles and functions of the board are divided into a management board and a supervisory board: a member of the supervisory board cannot be a member of the management board, and vice versa. The supervisory board's principal role is to oversee the management of the company and to appoint the directors of the corporation. The supervisory board members in two-tier board structures have a role comparable to non-executive directors. The management board represents the company both in and out of court; while non-executive directors sit on the same board as executive directors in a one-tier board (hence the term \"one-tier board\"), supervisory board members are in a separate board from management board members in the two-tier board structure. Also, the supervisory board is generally appointed by the shareholders. **Other board structure** In Italy, the default model consists of a board of directors and a board of statutory auditors (collegio sindacale). This model resembles a two-tier board model, the role and responsibilities of the collegio sindacale differ from those of a typical supervisory board. Both boards are elected by the shareholders. Alternatively, shareholders may opt for a two-tier model, consisting of a management board and a supervisory board (consiglio di sorveglianza), or a one-tier board (consiglio di amministrazione) with executive and independent non-executive directors. **One-tier or a two-tier board?** For larger corporations, particularly listed ones, we see that most corporate boards exhibit some characteristics of a two-tier board. This results in some separation between governance (or control) and management (or direction) of the corporation. The one-tier board structure is often considered to foster a closer relationship between the executive and non-executive directors and better information flow between them. **The appointment and composition of the (supervisory) board** In a one-tier board, it is common for shareholders to elect the board members. (DGCL) offers companies the choice between organizing a staggered or non-staggered board. In a staggered board, the directors are divided into up to three classes, and every two or three years, each class steps down and can stand for re-election at the general meeting. In a non-staggered board, each annual general meeting typically (re)elects all the board members. In the United Kingdom, it is common practice for the general meeting to elect the directors. In French as well. In a two-tier board structure, the procedure for composing the directors is generally more defined. In Germany, the members of the (management board) are elected by the (supervisory board). For directors of a large, listed UK company, it is common to stand for re-election every year. Belgian or French public limited liability company can be up to six years. Generally, the company decides the size of the (supervisory) board of directors. **Independent directors** \>\> are non-executive directors or supervisory board members who fulfil certain independence requirements. In the United States, the majority of its listed companies' directors are independent. The corporate board has the authority to identify non-executive directors who are independent in the annual report and to provide circumstances or conditions that may affect a director's independence. Independence requirements in the UK corporate governance code: - has been an employee of the company - a material business relationship - has close family ties with any of the company's advisers, has served on the board for more than nine years. **Board committes** There are various committees: - The audit committee is primarily responsible for overseeing the financial reporting process, the audit process, the company's system of internal controls, and compliance with laws and regulations - The committee members shall have competence relevant to the sector in which the audited entity is operating - The chairman of the audit committee shall be appointed by its members or by the supervisory body of the audited entity, and shall be independent of the audited entity - The remuneration committee is responsible for making proposals regarding the directors' remuneration and the corporation's remuneration policy. - The nomination committee is tasked with identifying and selecting suitable board candidates. It also needs to ensure a balance of skills, expertise, and diversity within the corporate board. **Diversity** Many regulators and legislators have not only addressed the issue of independence but have also introduced specific rules for gender diversity on the boards of stock exchange-listed companies. European countries, including Norway, France, Belgium, the Netherlands and Germany: these countries' rules require that between 30 percent and 40 percent of the board be composed of directors of the opposite gender. Managing the company: In summary, the board of directors plays a crucial role in setting the strategic direction of the company, ensuring legal compliance, managing risks, and overseeing top management to protect shareholders\' interests. Their duties are shaped by both statutory laws and regulatory codes, as well as case law. **Executing specific legal duties** In addition to managing the company, company law prescribes other duties that directors or the company must execute. Since the company is a legal entity, these duties must be performed by its representatives. First, in many jurisdictions, it is required for the board of directors to annually call the general meeting of shareholders and set the meeting agenda. Second, the board of directors must present the annual financial statements and an annual management report to the general meeting of shareholders. a remuneration report with information on directors' payments and the remuneration policy. In many jurisdictions, directors are prohibited from engaging in certain activities or businesses. **Representation** The representation of a corporation by directors is safeguarded by corporate law, contract law, and/or the law of agency. The law of agency involves a principal authorizing an agent to act on their behalf. When an agent makes an agreement with a third party, the agent has no personal rights or liabilities in the agreement. Generally, the power of directors to represent the corporation is without limitations. The powers given to directors to enter transactions on behalf of the corporation are deemed free of any limitations in the Articles of Association. These representation rights rules of the board of directors provide comfort to third parties when dealing with the board of a company. However, jurisdictions can limit the protection of third parties in several ways: \- First, when the board of directors is acting outside the objects of the company, and third parties knew or could not be unaware that the act is outside the company's object, a jurisdiction can consider the act non-binding for the company. \- Second, when a jurisdiction legally allows the Articles of Association to stipulate that only one or more specific persons can validly represent the company. \- Third, when the board exceeds its powers that the law confers to another organ, the company is not bound. **General rule[:]** [when a director or the board of directors enters into a transaction or a contract on behalf of the company, the director or board does not become a party to that contract; only the company does.] **Executive remuneration** The compensation of these board members can be used to create desirable incentives aimed at the long-term value creation of the company. Many corporate laws start from the premise that a director does not have a right to be remunerated for their services unless the Articles of Association or the shareholders provide for compensation. In many jurisdictions, a CEO's compensation package comprises four main parts: fixed remuneration, a short-term bonus, a long-term incentive plan, and additional perks. **Stock option** \>\> They are incentive tools usually granted to the top management and board members of a company or to employees. Such plans grant the employee the right to purchase (or allocate, in the case of previously issued shares) or subscribe to (in the case of newly issued shares) securities representing the company\'s capital. Executive compensation as an incentive contract, also called performance-based compensation, can help to decrease agency costs by aligning incentives \>\> Jurisdictions have introduced mandatory remuneration disclosure rules for the executive directors. The European Union made it mandatory for publicly traded companies to disclose an annual remuneration report containing detailed information about the pay packages of directors; These compensation packages often include various components to ensure this alignment, including for instance variable pay. **MODULE 5** **Chapter 6: the duties of the corporate board** Many jurisdictions provide standards and open norms through company law on how directors should direct the company. Shareholders want directors and officers to take risks to create value and drive innovation, and therefore rigid rules should not impede directors' willingness to make business decisions. Directors are considered fiduciaries or agents and must act in the best interest of the company. **Director's duties and the company's interests:** Directors' duties are now codified in many jurisdictions. In the UK Companies Act of 2006 general duties are based on common law rules. Similarly, in many civil law jurisdictions, directors are viewed as fiduciaries who are responsible for directing the company by complying with their duties: the duty of care and the duty of loyalty. In the United States, both these duties are considered fiduciary duties. This term in the UK only concerns the duty of loyalty. There are two approaches to regulating director's conduct: standards and rules. In almost all jurisdictions, directors\' duties are owed to the company. However, the interpretation of "the company" varies. In more shareholder-oriented jurisdictions, such as the US, the company's interest is the aggregate interest of the common shareholders. In jurisdictions with a more stakeholder-oriented approach, the company's interest encompasses the welfare of other stakeholders, including employees and creditors. (Germany and nl). United Kingdom adopts the so-called enlightened shareholder model which allows directors to consider interests beyond those of the shareholders. **The duty of care:** Board members must execute their tasks as mandated by the law, the Articles of Association, and other contractual arrangements. Directors need to act in accordance with standards of care and perform their tasks properly and in an informed manner. *The UK:* In the United Kingdom directors have the duty to exercise reasonable skill, care, and diligence. There is an objective and a subjective test: - Objective: Section 174(2)(a) mandates that a director exercise the care, skill, and diligence that would be expected from a reasonably diligent person with the general knowledge, skill, and experience expected of someone performing the director's functions in relation to the company. (implies that anyone accepting a directorship should be adequately qualified). - Subjective: requires a director to exercise the care, skill, and diligence that would be exercised by a reasonably diligent person with the director's actual knowledge, skill, and experience. This duty of care applies to both executive and non-executive. *Delaware:* Delaware's General Corporation Law (DGCL) does not specify the duty of care. Delaware case law distinguishes between the standards of conduct and the standards of review. The standards of conduct define proper director behaviour, while the standards of review are the tests applied in court. (Disney case). A derivative suit action is taken when the company itself is unwilling to pursue legal action. From the Disney case it was ruled that: directors of a Delaware corporation use that amount of care which ordinarily careful and prudent men would use in similar circumstances, and consider all material information reasonably available. Only a "sustained or systematic failure of the board to exercise oversight will establish the lack of good faith. *The MBCA:* MBCA outlines the standards of care. Here too there is distinction between the standards of conduct and the standards of review. The standard of conduct for directors: each member of the board of directors, shall act: in good faith, and in a manner the director reasonably believes to be in the best interests of the corporation. The director must discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances. MBCA also includes concepts of the duty of loyalty: term "reasonably believes" encompasses both subjective and objective requirements. *Germany:* These duties are codified in the AktG § 93 (1), which states that management board members must exercise the care of a diligent and conscientious manager and act based on adequate information when making business decisions. *Other jurisdictions:* Not all jurisdictions make explicitly reference the duty of care, but all jurisdictions impose on directors the responsibility to act with care, skill, and diligence. Dutch law proper performance of assigned tasks ensure that the company's interests are protected. Belgian Code states that directors are liable for errors and for tortious acts that are manifestly beyond what normal, prudent, and careful directors in the same circumstances could reasonably disagree upon. French law requires directors to consider corporate interests, including social and environmental stakes in good faith in order to promote the objects of the company for the benefit of its members as a whole. Standards of care thus allow directors to manage the company as they see fit, as long as they exercise their role with due care and avoid making plainly irrational decisions. In addition, the duty of loyalty generally requires directors to act in good faith and in the best interests of the company and its shareholders. **Duty of loyalty:** Directors also have a duty of loyalty, as fiduciaries they must subordinate their own interests to those of the company. Company law stipulates that board members must perform their decision-making and oversight functions in accordance with their duty of loyalty, understood as acting in good faith and in the best interests of the company. *The UK:\ *In the UK, this duty is encapsulated within the fiduciary duties of directors. There are six codified fiduciary duties: 1. Duty to act within powers; 2. Duty to promote the success of the company; 3. Duty to exercise independent judgment; 4. Duty to avoid conflict of interests; 5. Duty not to accept benefits from third parties; 6. A duty to declare an interest in any proposed transaction or arrangement with the company: a director must disclose any direct or indirect interest he has in a proposed transaction. In addition to the six fiduciary duties, specific rules to safeguard against conflicts of interest. *Other jurisdictions:* Other jurisdictions do not codify the duty of loyalty as explicitly. Under Delaware case law, directors must act with an honest belief that their actions are in the best interests of the company. In German law, there is no general duty of loyalty. However, conflicts of interest must be addressed. Similarly, in France, there are broadly defined provisions addressing various topics. *Self-dealing and related party transactions:* A director may have a direct or indirect personal interest in a transaction as self-dealing, creating a potential conflict of interest and opportunistic behaviour. International Accounting Standards provide a formal definition: a related party is any party that has the potential to control or significantly influence the company. A company in which the director is involved can also constitute a related party indirectly. Other related parties include, for instance, large shareholders. Related party transactions can be addressed by the law in various ways. Firstly, they need to be disclosed in the financial statement. But there are several other provisions: shareholders may also have approval rights; full ex ante disclosure and involvement of independent Directors are the ones used in the EU. Delaware does the same. Transactions between the company and directors are protected from equitable relief if the material facts are disclosed and the transaction is either approved or is considered 'fair' to the company. A second category of conflict of interest situations involves corporate opportunities. A director may compete with the company by operating or owning a competing business or by taking direct advantage of business opportunities. *The UK:* Related party transactions are defined and regulated quite extensively, corporate opportunities are more difficult to regulate. Factual questions are established through case law. Duty to avoid conflicts of interest, this duty "applies in particular to the exploitation of any property, information, or opportunity. *Delaware:* Delaware has a wealth of case law addressing corporate opportunities, the doctrine is Guth v Loft from 1939. Guth's appropriation of the Pepsi-Cola opportunity to himself placed him in a competitive position with Loft thereby rendering his personal interests incompatible with the superior interests of his corporation. Guth, as its President, had no right to appropriate the opportunity to himself. In Broz v Cellular doctrine to prohibit a director from pursuing a corporate opportunity for their own account: a director or officer may take a corporate opportunity if: (1) the opportunity is presented to the director or officer in his individual and not his corporate capacity; (2) the opportunity is not essential to the corporation; (3) the corporation holds no interest or expectancy in the opportunity; and (4) the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity. *Germany:* Section 88, management board members, without ex ante approval of the supervisory board, are prohibited from: engaging in any trade, entering into transactions within the company's line of business and being a member of the management board, a manager, or a general partner in another commercial enterprise. The supervisory board assesses the transaction's quality when the management board is conflicted. - No similar rules exist for supervisory board members, who often sit on other companies' boards. **Court review:** Generally, courts will refrain from second-guessing their business decisions. Business decisions are inherently risky and unique, running a business involves generating uncertain future cash flows. If directors were held liable for unfavorable outcomes after making decisions, they might avoid starting such projects. Moreover, if directors faced court reviews of their decisions, judges would find it challenging to evaluate complex and contextual business decisions after the fact. Judges, like anyone, are susceptible to hindsight bias, a cognitive bias making people believe an event was more predictable after it occurred. (hindsight bias = ex post is different than ex ante). Hence, to avoid ex post evaluations company law generally avoids assessing business decisions. This "hands-off approach" is known as the business judgment rule. When a director is found in breach with its duties, she will be liable towards the company and third parties. *Delaware:* Delaware case law standard of review is the business judgment rule, which emphasizes that courts will not review business decisions if "in making a business decision the directors of a corporation acted on an informed basis, and in the honest belief that the action taken was in the best interests of the company. The Business Judgment Rule (BJR) in Delaware includes a presumption that applies when there is no evidence of fraud, illegality, or conflict of interest. There is a high burden of proof. *The MBCA:* MBCA outlines the standards of review and codifies the business judgment rule. This Section indicates that a director is not liable unless the plaintiff can prove that the director acted in bad faith, not in the best interest of the company, or not on an informed basis. *The UK:* The United Kingdom does not have a codified business judgment rule. UK directors can exercise their business judgment. As directors owe their duties to the company, it is the company that can hold them liable for any breach. For solvent companies, the board of directors decides whether to commence proceedings against a director, which occurs relatively rarely. Alternatively, a member of the company can initiate a derivative claim on behalf of the company in cases of a director's negligence. There are two steps for this process: first, the court must grant permission; second the case is investigated. If successful, any damages recovered are paid to the company. *Germany:* The standard differs significantly from the presumption of good faith in Delaware. Here, directors "shall not be deemed to have violated the aforementioned duty if, at the time of taking the business decision, they had good reason to assume that they were acting on the basis of adequate information. *Aktiengesetz* stipulates that directors bear the burden of proof, contrasting with the US. **MODULE 6** **CHAPTER 4 - FINANCING THE COMPANY** The formation of share capital is a prerequisite for incorporating a public limited company in many jurisdictions. **Financial accounting** In companies and other economic organizations, activities, assets, liabilities, revenue, expenses, and cash flow need to be recorded and reported. Creditors and other stakeholders require knowledge of the corporation's financial state to be willing to provide capital. The three fundamental components of financial statements are the balance sheet, the income statement, and the cash flow statement. 1. 2. **The balance sheet** the balance sheet presents the assets, liabilities, and shareholders' equity, providing information about the corporation's size and structure. It's a snapshot of the corporation's assets and liabilities at a specific moment in time **Assets** are everything a corporation owns, whereas **liabilities** are everything a corporation owes. **Liabilities represent the company's obligations to creditors**. The difference between assets and liabilities is shareholders' equity, which represents the residual claim of the shareholders The balance sheet must always balance, meaning assets are always equal to liabilities plus equity: **Assets = Liabilities + Equity** **Equity = Assets -- Liabilities** First, the assets are divided into current and non-current assets. - Current assets \>\> are either cash (or cash equivalents) or assets that could be converted into cash within one year (an accounting principle). Other current assets \>\> to denote all other items that could be converted into cash within one year. - Non-current assets, on the other hand, are held for more than one year (an accounting principle) and are divided into tangible and intangible assets. - Tangible assets have a physical form, such as land, property, or machinery. - Intangible assets do not have a physical form and include intellectual property rights. The liabilities shown on the right side of the balance sheet are divided into current and non-current liabilities. Non-current liabilities include all liabilities exceeding one year, such as long-term borrowings (also called long-term debt) and leases for the use of 4 assets (also called capital leases) **The shareholders' equity:** **Share capital** = number of issued shares \* par value of the shares - **The par value is** the minimum amount of consideration that needs to be paid when buying the company's shares**.** - **The share premium** is the amount paid for the corporation's shares above the par value **Reserves** are the final part of shareholders' equity and can include **retained earnings\>\>** which consist of net income or net profit that is not distributed to shareholders (e.g., via dividends) but retained in the company for future investments or payments. Shareholders have a residual claim on the corporation's earnings, while creditors have a fixed claim with priority over the equity claim Whatever remains after creditors are paid goes to the shareholders. **Liquidity \>\> refers to the company's ability to convert assets into cash, while solvency concerns its ability to meet long-term liabilities as a going concern** **Working capital \>\>** refers to current assets minus current liabilities, focusing on the corporation's ability to pay its current obligations. **Capital assets** \>\> are long-term assets financed by long-term capital, either non-current liabilities or shareholders' equity. Leverage indicates the extent to which the corporation is debt-financed. **2. The income statement** The income statement provides information about the revenue a corporation generates, and the costs incurred in generating that revenue. It tracks business activities and shows the profit or loss for a particular accounting period. t tracks business activities over a particular accounting period, usually the financial year (also called the fiscal year). **All expenses are subtracted from revenue, and whatever remains is net profit (also denoted as net income or earnings).** **Interest expense \>\>** directly linked to the division between fixed and residual claimants: fixed claimants receive interest as financial compensation for providing capital to the company. As mentioned earlier, these fixed claimants are paid before shareholders. While the interest expense is linked to creditors (fixed claimants), the net income or profit at the bottom of the income statement is linked to shareholders (residual claimants). The net income can either be distributed to shareholders or retained within the company as retained earnings in many jurisdictions, the general meeting of shareholders approves the dividend distribution. The interest expense is included before income tax, meaning that the more interest a company pays, the lower its tax expenses. In other words, when a company has liabilities, it receives a reduction on its tax payment. This is called the interest tax shield, considered a benefit of debt financing. **3.The cash flow statement** The cash flow statement, this statement reflects the amount of cash a company generates over a specific period (usually the financial year). One of its important function is to adjust the net income. per riflettere le spese che non comportano un\'uscita effettiva di denaro, come **l\'ammortamento** e la **depreciation** (depreciamento). La **depreciation** si riferisce alla riduzione del valore degli asset materiali (come edifici, macchinari, ecc.) nel tempo. L\'**amortization**, invece, riguarda l\'ammortamento degli asset immateriali (come brevetti o diritti d\'autore). Sebbene questi costi riducano il reddito netto in bilancio, non rappresentano una vera uscita di denaro. It makes important adjustments for cash that has not yet been received (accounts receivable) or still needs to be paid (accounts payable). knowing the cash balance is crucial to avoid a liquidity crisis. La liquidità è il denaro disponibile per far fronte a obblighi finanziari immediati, come il pagamento di stipendi, fornitori, interessi su debiti, ecc. Se un\'azienda ha redditi netti elevati ma non abbastanza liquidità. **Financial accounting standards** Financial accounting must conform to certain standards, such as the International Financial Reporting Standards (IFRS). These codified standards improve the transparency, reliability, and comparability of financial statements for external users. In Europe, IFRS is required for listed companies United States, the Generally Accepted Accounting Principles (GAAP) **The share capital** When a company is incorporated, shares are issued for the first time to the initial shareholders, such as the company's founders. In many jurisdictions, shares have a par value or nominal value. The par value is the fixed or minimum amount that each shareholder must eventually pay, as stated in the Articles of Association Together, these elements are referred to as the share capital: **Share capital = par value \* number of issued shares** The main idea behind share capital is to provide creditors with a degree of assurance. Despite being capital providers, creditors and shareholders have different interests, often leading to a conflict of interest. Shareholders typically prefer riskier strategies that promise higher returns, while creditors prefer strategies that ensure the repayment of their principal. Although shareholders are not personally liable for the company's losses and debts, they are required to pay their contributions up to the committed amount for their shares. Another function of share capital is to ensure equal treatment of shareholders and protect them against the issue of 'watered stock' \>\> The term \"watered stock\" refers to shares that have been issued for a value higher than their actual market value or a value greater than what has been invested in the company One solution to watered stock is to require that shares cannot be sold for less than the par value. When a company\'s value decreases and its share price drops below the par value, the market price of the shares becomes lower than the par value (the nominal value assigned to each share). If a company continues to issue new shares at the par value (which is higher than the current market price), potential buyers will not want to purchase shares at a price above the market price because they can acquire shares at a cheaper rate in the open market. In many legal systems, shareholders may be liable to pay the company for the difference between the amount they paid for their shares and the par value. In Europe and prohibited issuing shares at a price below par. **The accountable par** \>\> the share capital contributed upon issue **divided by** the number of shares. The par value of shares can be understood as an abstract accounting concept that has no relation to the market price of a company's shares after incorporation. In some jurisdictions, including many US states, shares without par value can be issued. This creates a gap between the par value of the shares (if any) and the price the company wants to receive for newly issued shares. This gap is called the additional paid-in capital (APIC), which is the premium on top of the par value that shareholders must pay for the shares. **Other capital notions** 1. Authorised capital: This capital is \'authorised\' in the AoA and shareholder approval needed to increase this amount. 2. Issued capital: The issued capital is part of the authorised capital that is issued to investors. 3. Subscribed capital: The subscribed capital is often equal to the issued capital but can be lower if the public applies for less shares (or higher, in case of oversubscription). 4. Outstanding capital and Treasury shares: Issued capital that is **outstanding** by the investors or bought back by the company and held in **treasury.** 5. Paid up -- capital: The amount of money received from shareholders for the shares is called the paidup capital. **The consideration** The paid-up capital indicates that shareholders do not always pay the full share price immediately. The price at which shares are issued to investors is also called the consideration The following rules apply to the consideration: First, shares cannot be issued for less than the par value. The consideration may be formed only of assets capable of economic assessment. In case shares are issued for cash, the shareholder needs to pay at least 25 percent of the par value of the shares (Article 48(1) for the initial capital The share premium (APIC), in contrast, needs to be fully paid (Article 69). Shares can also be issued for in-kind contributions: to safeguard that the value of these in-kind contributions (contribuzione in natura) is equal to the consideration, they need to be assessed by an independent expert and the report of this expert needs to be published'. In contrast to European rules on the formation of a corporation's share capital, which ensure that shareholders pay their committed contributions and that in-kind payments have the promised value, in US states, including Delaware and those following the MBCA, do not impose such substantial requirements on a company's share capital and shareholder contributions. **Capital increases** A capital increase is a common way for companies to fund new business activities. This must be approved in Europe by the shareholders. However, in Germany, since the share capital needs to be stated in the Articles of Association. European law also requires that shareholders have pre-emptive or pre-emption rights when the share capital is increased. **Pre-emptive rights** provide many advantages for shareholders, serving as a minority shareholder protection mechanism by allowing shareholders to maintain their proportional stake. requires that shareholders have a minimum period of fourteen days to exercise their pre-emptive rights. During the fourteen-day period in which shareholders can exercise these rights, however, stock market prices can fluctuate significantly In contrast to Europe, in Delaware, the corporate board has the authority to increase the share capital without shareholder approval, if the authorized capital stated in the corporate charter (Articles of Association) is sufficiently large. shareholders do not have pre-emption rights in Delaware unless expressly granted in the charter. **Capital distributions and creditor protection** companies can retain cash flow and invest in new business projects or accumulate it in their cash reserves. Another option is to pay out cash flow to shareholders. Dividends are paid to shareholders on a specific date Dividends are usually paid in cash but can also be paid by issuing extra shares to shareholders, known as a stock dividend (azioni aggiuntive). When a company buys back shares from shareholders, it distributes cash to them in return for their shares (treasury shares which can be resold in the future). Capital maintenance rules are in place to balance the interests of creditors and shareholders. Creditors prefer the company to retain cash balances to ensure they get their money back, while shareholders have strong interests in capital distributions from the company. The European framework imposes mandatory requirements on distributions. Distributions are prohibited if they reduce the company\'s net assets below required capital or reserves, or exceed the available profits. Shareholders must return distributions made in violation of these rules if they knew or should have known about the irregularity. In contrast, many U.S. states, including Delaware, give corporate boards full control over distributions, allowing dividends to be paid from surplus or net profits, including profits from previous years. The capital impairment test ensures that distributions do not impair the company's capital. In case of unlawful distribution: Directors involved in authorizing such unlawful distributions are personally liable to the company, and in case of insolvency, possibly also to the creditors. **The minimum capital requirement and creditor protection** share capital rule in Europe: the minimum capital requirement, while US states do not have a minimum capital requirement. The primary rationale for the minimum capital rule in Europe is to maintain capital and protect creditors: a certain amount, the minimum share capital, cannot be transferred to shareholders. The minimum capital rule aims to reduce the risk of creditors. **Sources of finance** Companies can finance their activities internally and externally. Internal financing involves using **retained earnings \>\>** net income from previous periods that has not been distributed to shareholders and is recorded as part of shareholders' equity on the balance sheet. external financing \>\> can be divided into debt and equity financing. **Debt financing** involves borrowing a fixed amount of money from a lender, which must usually be repaid on a fixed date **Equity financing** involves selling shares to investors, who then become shareholders. In this case there's no obligation to repay. Share classes the distinction between par value and non-par value shares, there are different share types to consider. These share classes generally need to be included in the Articles of Association and to change share rights require majority shareholder approval - The vanilla or normal shares that carry one vote per share are also called common shares or ordinary shares. - preferred shares or preference shares that typically carry special capital rights. Preferred shares, particularly convertible preferred shares, are often used by venture capitalists (VCs) in start-up financing. **Leverage effect** The capital structure of a company typically consists of debt and equity. Leverage indicates the level of debt financing within a company. The idea is that a company's total cash flow from a particular project remains the same regardless of how it is financed. markets are not perfect. stating that debt (or leverage) increases the risk of the company's equity. Specifically, the more debt a company has, the higher its bankruptcy risk.. If a company cannot repay its loans, it becomes insolvent, and creditors can force it into bankruptcy. debt increases the risk of equity (risk for the shareholders). Assets -- liabilities = Equity The debt also led to significant benefit: - including the interest tax shield that positively impacts firm value [A mix between debt and equity is generally optimal. ] Also, debt can reduce conflicts between insiders and outsiders by improving **transparency** and increasing **external monitoring**, thereby lowering agency costs and encouraging more responsible corporate behavior. [The **leverage effect** of debt] can increase the **return on equity (ROE)** in favorable conditions, leading to high returns for shareholders. However, it also raises the **risk** of equity. This effect is commonly used in **Leveraged Buyouts (LBOs)**, where a company acquires another using significant debt financing. **Chapter 9: Reporting and risk management** Corporate board's decisions impact shareholder groups connected to the company; for this reason, to keep all parties informed and aware of the company's course of affairs, reporting systems have been developed. There has been a shift towards unified international reporting standards such as IFRS. To address challenges of misreporting, external controls and stringent control standards have been implemented. **Types of reporting:** - *Financial reporting:* Originally, the disclosure of a company's financial information was a private matter: capital providers requested. However, companies grew in size and private standard setters began developing generally accepted accounting principles. With the internationalization of the economy, international accounting standard bodies emerged. Many jurisdictions began incorporating these: 160 jurisdictions using IFRS but US uses FASB. IFRS standards are closely connected to company law-related issues. - *Management reporting:* The board of directors must also provide a narrative report that contains specific information about the company's business position, among other things. The company must also provide both "financial and non-financial key performance indicators relevant to environmental and employee matters." Furthermore, the management report must give indications of: future development; activities in the field of research; acquisitions of own shares; the existence branches of the undertaking; and, in relation to the undertaking's use of financial instruments, assessment of its assets, liabilities, financial position, and profit or loss: the undertaking0s financial risk management objectives and policies and the undertaking's exposure to price risk, credit risk, liquidity risk and cash flow risk. The United States provide material information relevant to an assessment of the financial condition that must focus specifically on material events and uncertainties; the company must also add qualitative and quantitative information about market risks. - *Governance and remuneration reporting:* In the 1990s new rules at the level of the board of directors have been developed. European Union requires stock exchange-listed companies to include a corporate governance statement in their annual report and issue and maintain a corporate governance code. The US reporting rules also include the code of ethics, which is a set of written standards designed to deter wrongdoing. In many other jurisdictions not mandatorily required. The developments in corporate governance also brought the issue of director and executive officer remuneration to the forefront. This led to new requirements for structuring these packages. It is not uncommon to find lengthy and detailed reports on remuneration practices. The United States require clear, concise, and understandable disclosure of all plan and non-plan compensation awarded to, earned by, or paid to the named executive officers. - *Sustainability reporting:* An increasing number of jurisdictions require companies to inform shareholders and other stakeholders about the effects of their business on sustainability. The Corporate Sustainability Reporting Directive (CSRD) encourages companies to adopt sustainable practices. In Europe, detail on the social and environmental impact of their activities, as well as sustainability risks and opportunities that affect the company\'s financial health are required. This reciprocity, which considers the effects both of and on the company, is known as 'double materiality' since it encompasses two perspectives of materiality: financial materiality (which focusses on how sustainability issues affect the financial value of a company), and impact materiality (which assesses the impact of a company's operations and behaviour on the environment and society). In addition, the CSRD emphasizes 'sustainable corporate governance' board report with additional information. The reporting obligation extends beyond the company's own activities to include value chain, business relationship and supply chain. To guide sustainability reporting within the European Union, the European Sustainability Reporting Standards (ESRS). In addition to the European Union, other regions are also implementing: California introduced laws that focus on environmental but not social dimension, adopting a more limited approach. **External control:** When you receive financial information, it is crucial to verify its reliability. This is the role of external audits. Today, most countries require the external control of a company's accounting records. An audit is an impartial examination and evaluation of a company's accounting records by a statutory auditor. An auditor, who is an independent professional trained and qualified to perform such assessments, typically, comes from an audit firm. Conducting audits may be expensive. *Scope:* Given the significant cost, debate about whether all companies should be audited. In the European Union, Member States shall ensure that the financial statements of public-interest entities are audited by statutory auditors approved by member states. US requires that the board of directors shall cause all accounts to be audited. *The external auditor:* The external auditor must be well-qualified and act independently, must be registered as an auditor with a competent authority. In the US, AICPA is responsible for licensing certified accountants. In Europe, auditors must have a university-level education or equivalent and pass an examination. Europe guarantees that the auditor independence is not affected through many restrictions on the relationships between the audited entity and the auditor. In the US a similar approach is used. In Europe, the general meeting of shareholders has the final say over the election of the external auditor. The audit committee then makes a recommendation. In the United States, the audit committee is directly responsible for the appointment, compensation, and oversight for the purpose of preparing or issuing an audit report. It is common that the appointment is ratified by the general meeting of shareholders. *The audit report:* The statutory audit pertains to the financial statements. A true and fair view of the financial position means that the financial statements accurately reflect the company's current situation, identifying materiality is crucial and depends on the professional judgment of the auditor performing the audit. Auditing standards are used during the audit process. An unqualified opinion is issued if the financial statements give a true and fair view and comply with statutory requirements. An adverse opinion is issued if the financial statements contain material misstatements. A qualified opinion is provided when, except for the effects of the matter to which the qualification relates, the financial statements present a true and fair view. A disclaimer of opinion is issued when the auditor is confronted with an insufficient scope. EU audits are the most comprehensive. **Internal control and risk management:** Internal controls are procedures established by a company to effectively manage and monitor its operations. External controls assess the adequacy and effectiveness of these internal measures. *Regulatory and case law developments in the US:* The US duty of care requires directors to ensure an adequate information and reporting system is in place. A director's obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system exists. Liability follows from the conscious disregard of the board's duties. The MBCA outlines the scope of the board's oversight responsibilities, including its duty of care: business and affairs of the corporation shall be managed by or under the direction, and subject to the oversight, of the board of directors. 'The scope of the board's oversight responsibility will vary depending on the nature of the corporation and its business. For public companies the responsibilities include oversight of: performance, assessment of major risk, performance and compensation of executive officers, policies to foster the corporation's compliance with law and ethical conduct, assessment of the effectiveness of the corporation's internal controls, plans for the succession of the chief executive and ensuring the corporation has information and reporting systems in place.' The board's oversight responsibility encompasses the corporation's compliance with the requirement to keep corporate records and to provide financial statements to shareholders. *Regulatory and case law developments in Europe:* EU requires reports to include "a description of the principal risks and uncertainties that \[they\] face" and an indication of important events that have occurred during the first six months of the financial year, and their impact. Listed companies must also provide "a description of the main features of the company's internal control and risk management". The Directive also requires public-interest entities to establish an audit committee to monitor the effectiveness of the company's internal control. European Member States had introduced similar legislative and regulatory requirements related to internal control and risk management. *The internal control system COSO:* In many jurisdictions, companies must establish an internal control. However, regulatory requirements often remain vague, leading private initiatives to assist companies. One of the best-known frameworks is COSO, which defines internal control as 'a process designed to provide reasonable assurance regarding the achievement of objectives in the effectiveness an efficiency if operations, reliability of financial reporting and compliance with applicable laws and regulations. COSO I is an internal control system consists of five essential components: control environment (the set of standards, processes, and structures that provide the basis for carrying out internal control across the organization), risk assessment, control activities (actions established by policies and procedures to help ensure that management directives to mitigate risks to achieving objectives are carried out), information and communication, monitoring activities. IN 2024 COSO II enhanced internal control with effective risk management. **MODULE 7** **Chapter 7: Shareholders and Shareholder Meetings** Shareholders, with their shares, receive a bundle of rights. Typically, the founders become the first member(s) as well as the first directors. For some companies share capital is of great financial significance. In these cases, later 'capital rounds' are frequently used to finance the company's growing activities. All these shareholders can transfer their shares, which may even result in daily changes in the ownership. In return for their capital contributions, shareholders receive shares that provide various benefits: participation rights, granting them influence over how the company's affairs are conducted; also shareholders receive what remains after all other parties have been satisfied. It logically follows that shareholders should have significant decision-making rights in the company. However, there are arguments for a more nuanced approach because of problems such as the problem practical inefficiencies. Additionally, shareholders are unfamiliar with its activities. Shareholders exercise their influence collectively in the general meeting of shareholders, but their powers are limited. **General meeting:** General meetings are venues where shareholders exercise many of their rights. They are governed by procedural rules. - ***Annual General Meetings (AGM):*** Companies are legally required to organize shareholder meetings regularly annually after the end of each financial year. The responsibility of calling them falls on the board of directors in one-tiers systems an on the management board in the two tier one. Corporate laws provide procedures for when the general meeting is not called; in these cases, the competent court can order the directors to convene the meeting or sanction them. The organization of an annual general meeting is not mandatory in some countries. - ***Extraordinary General meetings (EGM):*** These are used for specific shareholder decisions. Some countries grant the right to call a general meeting of shareholders to parties other than the board or allow companies to empower other parties with this right. French law also grants this right to the liquidator, a court-appointed agent. In many jurisdictions, shareholders who meet certain conditions can call a general meeting. It is common for the board of directors to be responsible for calling the general meeting and handling the administrative issues related to organizing the meeting. ***Requirements for general meetings:*** It is necessary that all members are appropriately informed about the meeting. The notice must be provided in time to allow shareholders to prepare for the meeting, be easily accessible, and contain sufficient information. Notice periods typically range between 10 and 42 days; for EGMs, this may be reduced. Notice periods can also vary according to the type of meeting or the identity of the party calling for the meeting. The notice should inform shareholders of the agenda items. A shareholder may properly and prudently leave matters in which he takes no personal interest to the decision of the majority; in that case, he is content to be bound. Companies often provide a booklet with all the relevant information for shareholders to prepare for the meeting, sometimes explicitly stressing its importance. Further, the notice will inform shareholders how they can participate shift toward new (electronic) meeting modes. Modern communication technologies have shifted way of inviting shareholders, and companies now use various channels. Before the meeting takes place, the company needs to identify who can participate and vote. As trading of shares takes place almost 24/7, the record date acts as a cut-off point for participation; shareholders must be registered as shareholders by this date to attend and vote. Empty voting occurs when shareholders can vote but do not hold the Shares. Activist shareholders, including hedge funds, may borrow shares before the record date and return them immediately after. In addition to the invited shareholders, other parties can or must attend the general meeting. - Another requirement is **[the quorum]**, which is a specific number or percentage of shareholders that must be present vary widely across jurisdictions. Quorum requirements can create administrative burdens - The next requirement is **[the majority]:** the general meeting of shareholders is a decision-making body responsible for approving or disapproving agenda items. These decisions are taken in various ways. The most common rule is the simple majority rule, where abstentions are not considered (50% +1). In the United Kingdom, another system is presented as the default: a show of hands; each shareholder being counted only once unless they also act as a proxy. Especially for director elections, different regimes exist. In the United States, there is the plurality voting, where the director must obtain more votes for their election than any other candidate. In some jurisdictions, election is only valid if the director is voted for by both the majority of participating shareholders and the majority of non-controlling shareholders. In many jurisdictions, a simple majority is required for most resolutions, but a qualified majority is required for some special resolutions (two-thirds and 75 percent of the votes). The [ways of participating] to AGM: shareholders can physically attend meetings and vote; however, this is often suboptimal. A shareholder with a diversified portfolio would need to attend many meetings. To reduce these costs and encourage shareholder attendance, shareholders can designate a proxy holder to vote on their behalf, which can be a natural person or a legal entity. In addition, many jurisdictions allow for electronic components in shareholder participation. **[Proxy voting:] '**legal and economic' shareholders in a company no longer hold physical paper. Instead a book-entry system managed by a Central Securities Depository. In the US there is a system called share immobilization, where certificates are held by Depository Trust Company (DTC) are recorded. Financial intermediaries, hold accounts with the parent company of DTC. DTCC is the legal owner of the shares in the United States, so shareholders need to use these financial intermediaries to vote their shares and receive information. shareholders are considered beneficial owners who receive economic benefits and vote, while DTCC is the legal owner. Similar proxy voting models exist in other jurisdictions (UK). Germany and the Netherlands, a co-ownership model is used. In this model, beneficial owners are also the legal owners. **Agenda items:** Notice of the meeting must include the meeting agenda. The agenda provides insight into the division of powers, and it identifies the items on which shareholders can express their opinions. These items are spread throughout the companies act, while in others, like Germany, the voting items are centralized. Although shareholders can vote their shares in all jurisdictions, the types of decisions they can make may differ significantly across jurisdictions. Generally, decisions related to daily business and corporate affairs are made by the corporate management; the second type of decisions: those considered fundamental to the company and thus requiring shareholder approval. Each jurisdiction defines which agenda items shareholders can discuss and vote on, and in which meeting; some items are common across most jurisdictions. ***Annual report, accounts and dividends:*** United Kingdom, the voting on the accounts proves that they have been laid before the meeting, whereas in France and Belgium, the vote serves as an approval, in the Netherlands, as an adoption. In the US accounts are not voting items. *Discharging the directors:* In some countries, the approval of the accounts is accompanied by the general meeting's decision to discharge the directors. Not in the UK nor France. ***Director appointments and removals:*** In virtually all jurisdictions, shareholders can appoint (management) directors. Shareholders only appoint the corporate board members (or the supervisory board members), a form of approval or ratification: the board itself usually nominates its own candidates. In the two-tier board model, the supervisory board usually appoints the management board members. In Germany, shareholders can appoint shareholder representatives on the supervisory board. (in this jurisdiction employees can also appoint their representative.) In other jurisdictions, we also find some form of employee co-determination. In the Netherlands companies with an employee council, have the right to nominate one-third of the supervisory board. Shareholders have the right to approve, but not necessarily the right to nominate since this may not be optimal. However, boards have special nomination committees to select good candidates. In some jurisdictions, shareholders do have nomination rights. (Italy). In many jurisdictions, shareholders can remove board members without cause, at any time, and with a simple majority decision. Some jurisdictions impose further restrictions. (Germany, South Korea). The right of dismissal is not frequently used. More often, directors resign or do not stand for re-election. The term of election is important, it differs in jurisdictions. *Election of the auditor:* Many jurisdictions shareholders reappoint the auditor annually, in some other jurisdictions there are longer terms. *Capital decisions:* Some jurisdictions require corporate boards to obtain shareholder approval before they can issue new shares or, for instance, cancel pre-emptive rights because these transactions can dilute their stake. For share issuances, this may involve required approval for an amendment to the Articles of Association. Another method is to grant shareholders specific approval rights related to share issuances. In Delaware, the authorized share capital can only be increased through an amendment of the corporate charter but issuing shares within the authorized capital limits is within the corporate board's discretionary powers. In EU, shareholder approval rights; shareholders may provide approval for share issuances or delegate this decision to the corporate board for a maximum period of five years. Shareholders in Europe have pre-emptive rights, unless the company receives shareholder approval to waive these rights, which requires qualified majority vote of at least two-thirds. Delaware, do not have pre-emptive rights unless provided in the corporate charter. Other capital decisions that require shareholder approval in several jurisdictions include share repurchases (or buy-backs) and the cancellation of shares. *Fundamental changes:* In all jurisdictions, shareholders have approval rights concerning fundamental changes that tend to reallocate control in the company or change its nature. Transactions can fundamentally change the nature of the company: shareholders generally have the right to approve a transaction if it involves 'all or substantially all' of the corporate assets. This is no clear cut in Delaware. In the Gimbel case, *Gimbel v Signal Companies,* the chancellor said: If the sale is of assets quantitatively vital to the operation of the corporation and is out of the ordinary and substantially affects, then it is beyond the power of the Board of Directors. In *Katz v Bregman* court concluded that the proposed sale constituted a sale of substantially all. In contrast to Delaware law, the Model Act provides a clear-cut quantitative threshold for transactions falling below 25 percent in quantitative terms. The Holzmüller case, in Germany, the court determined that because this transaction involved the company's core operations and the most valuable part of the company, it changed the corporate structure, necessitating shareholder approval. The lack of approval resulted only in internal liability. Like the Katz ruling in Delaware, the Holzmüller doctrine raised important questions. Dutch Article 2:107a DCC concerns the codified shareholder approval including: (i) the transfer of the entire or substantially the entire enterprise (ii) long-term cooperation and (iii) taking a participation in the capital of another company with a value of at least one-third. In France, substantial transactions fall within the discretionary powers of the corporate board. A final category of fundamental changes is amendments to the Articles of Association. ***Related party transactions:*** Related-party transactions are those between a company and its insiders, which may create opportunities for opportunistic behaviour. Shareholder approval mechanism is used to constrain opportunistic behaviour. ***Say on Pay:*** A shareholders' Say on Pay is a mechanism designed to strengthen the governance role of executive remuneration. Many jurisdictions have introduced a Say on Pay vote to restrain executive compensation. When exercising Say on Pay, shareholders have the right to approve the executive remuneration. This can be ex-ante and ex-post. Shareholders can have a binding vote, which has legal consequences, or a non-binding or advisory vote. **Shareholder proposal and proxy fights:** The shareholder rights discussed in the previous paragraphs often involve ratification rights. However, in addition shareholders may also bring forward their own proposals. In Europe, to do this the maximum threshold is 5 percent of the share capital. (can be lowered by member states). In Germany, any shareholder has the right to file a counter-motion to a proposal of the management board. Delaware does not offer many initiation rights to shareholders but it allows shareholders to make shareholder proposals, which the corporate board must distribute; these are known as proxy statements. If shareholders cannot use the company's proxy statements, because of the difficulty and costs shareholders may request distribution of their proxy if they have held USD 2000 or 1%. Not all shareholder proposals may be added; there are 13 grounds of exclusions in the Rule 14a-8. Nomination of board candidates are generally considered a hostile act as well as proposal that deals with a matter relating to ordinary business. The evaluation of whether such a proposal raises a significant policy issue is company-specific according to the SEC. SEC explained that a shareholder proposal might be considered micromanaging if it is too prescriptive. When considering the United States shareholder proposal right in relation to board elections, we must address the term 'proxy access', which refers to the shareholder's right to include their own nominees in the company's proxy materials. Shareholders can still file shareholder proposals seeking proxy access at the company level. Although these proposals are non-binding proxy access has increasingly been adopted. This trend has been particularly driven by coordinated actions of institutional investors. Institutional investors are entities (institutions) that pool money to purchase shares (banks, insurance companies, etc.). Usually, two types of institutional investors are distinguished: asset owners and asset managers. Asset owners are institutions that actually own their investment assets. Asset managers are tasked with managing investment portfolios on behalf of the asset owners and they earn fees. Since January 2022, additional amendments to Rule 14a-8 have made it more difficult for shareholders to add their proposals certain level of support to be eligible for resubmission. **Voice and exit:** Voice and exit are alternative options for shareholders dissatisfied with corporate management. \"Exit\" refers to selling shares in the market, "voice" represents the political solution, refers to the use of the control rights. In practice, large shareholders and institutional investors often have the opportunity to voice their concerns and negotiate decisions during private engagements and roadshows. Voice is an important tool for institutional investors, especially when conducted 'behind the scenes'. Although the shareholder meeting is the primary decision-making body, this behind-the scenes voice may sometimes impede its role. Since shareholder voice has the potential to improve corporate management, it is often encouraged by regulatory initiatives. However, largely depends on the incentives and types of shareholders present in the company, as well as the demarcation of powers. Voice can also be more expensive than exit, especially for small shareholders while exit strategy is feasible for small shareholders since selling a small number of shares is unlikely to affect the stock price. The outcome of the vote will be the same regardless of whether a small individual shareholder exercises their voice. The free-rider problem: in (partly) widely dispersed ownership structures, shareholder monitoring is considered a public good. Public good enhances the welfare of all. Due to the non-excludable nature other shareholders can (partly) free-ride no individual shareholder would be willing to incur the (full) costs of voice and they would rather exit the corporation. Despite these we see that small shareholders do attend shareholder meetings and use their voice. **Shareholders and ESG:** Shareholders and particularly institutional investors are under pressure to leverage their significant influence on Environmental, Social, and Governance (ESG) issues. Principles for Responsible Investment (PRI) in 2006 provided a set of six principles that encourage investment practices which incorporate ESG considerations. The main idea is that shareholders may be able to drive environmentally friendly corporate behaviours. Many institutional investors make their commitment to corporate sustainability public. Some critics are sceptical about the sustainability commitments of major institutional investors. Growing concerns about misleading investor practices have led regulators to focus on rules for disclosing investment strategies. Some experts are sceptical about the effectiveness of these disclosure requirements and argue that these rules don't necessarily make investors change their behaviours. **MODULE 8** **Chapter 8: Concentrated ownership and minority shareholders** Many companies, including some of the largest public companies, have concentrated ownership structures. 'Ownership concentration' refers to a situation where a substantial portion of the shares is held by one or a few shareholders who can control the company. Shareholders can differ significantly: there are large shareholders, also known as majority/controlling shareholders and small shareholders. There is therefore also another agency problem: between majority or controlling shareholders and minority or small shareholders. **The ownership structures and control:** Berle and Means described the modern corporation and introduced the concept of the separation of ownership and control. The term 'separation of ownership and control' refers to the situation where a large number of small shareholders own the public company but do not control it. In such companies, the corporate board and managers have actual control and make all the decisions. Many companies have more concentrated ownership structures. These may be owned by families, or small private companies; here the agency problem is between majority shareholders or other corporate controllers and minority shareholders. (second agency problem in corporate law). The 2023 OECD Corporate Governance Factbook illustrate significant differences in ownership concentration across jurisdictions for large companies. In some jurisdictions, even the top three shareholders can hold a significant portion of a company's equity. United States and Australia show a more distributed ownership structure. In countries with high ownership concentration, majority shareholders can exert substantial influence over corporate decisions, sidelining minority shareholders. This can lead to issues of minority shareholders. The second agency problem is where majority shareholders play a key role. In the Law & Finance literature, a threshold of 20 percent of the votes is often used to define a controlling shareholder. In EU it is 30% and, in this book, we treat it as the 50%. However, it is important to remember that control and voting power are not necessarily equivalent: the voting power of a specific shareholder is not solely determined by their own stake but also depends on the company's entire ownership structure: the Banzhaf Index, a well-known voting power index from cooperative game theory, measures a legislator's power by the number of different situations in which they can determine the outcome. ***Controlling and enhancing mechanisms:*** The simplest way to exercise control is to hold a majority stake, however, that the ability to control also depends on the ownership structure in the company. Moreover, there are also corporate mechanisms enabling controlling shareholders to exercise control with only a minority stake. Controlling Minority Structures (CMSs) or Control Enhancing Mechanisms (CEMs) use two types of structures: - A [pyramid structure] involves a controlling minority shareholder having a controlling interest in a holding company, which, in turn, has a controlling interest in an operating company. - Many jurisdictions allow [multiple share classes], which lead to high and low voting shares. High-voting shares are also considered a controlling minority mechanism and exist in several jurisdictions. A dual-class share structure does not involve the creation of multiple companies and therefore provides an easy way to separate control from cash flow rights. Some European member state allow the issuance of such shares, which grant shareholders additional voting rights if they hold the shares for a minimum period. (An example are the loyalty shares in France). Non-voting shares are another example of an alternative voting system. Many big tech companies that went public in recent years have controlling shareholders who are the founders and retain shares with superior voting rights. **Private benefits of control (PBC).** In the minority-majority relationship, the presence of controlling shareholders leads to agency costs. These controlling shareholders can enjoy \"private benefits of control\" (PBC), which are defined as profit resulting from exercising control, at the expense of shareholders who lack control. An alternative view proposes that PBCs are a necessary cost to drive efficient oversight and good business performance. It can even be argued that controlling shareholders extract PBCs as a reward for their illiquid and company-specific investments. *Idiosyncratic vision:* Goshen and Hamdani presented a complementary view of ownership structure, with two views: not all controlling shareholders are opportunists and control allows entrepreneurs to pursue business strategies that they believe will produce above-market returns. The entrepreneur values control because it protects her against the possibility of subsequent midstream investor doubt. Outside investors may doubt the entrepreneur's assets, because of the information asymmetries. Goshen and Hamdani suggest that the idiosyncratic view in concentrated ownership structures is best pursued when control and cash flow rights are aligned. With one-share-one-vote, opportunistic behaviour is limited. While the idiosyncratic view may be plausible lawmakers in many jurisdictions protect minority shareholders. **Minority shareholder protection rules:** Rules not only protect minority shareholders but also other corporate stakeholders. Some corporate mechanisms are specifically developed to address the relationship between majority and minority through tools such as classes of shares and special voting rules. ***MoM rules:*** There is a unique voting rule known as the Majority of Minority (MoM) rule. This rule excludes related parties from voting on resolutions in which they have an interest. In the United Kingdom, external shareholders vote separately on the election of independent directors in companies with a controlling shareholder. Another common application of MoM voting rules is in related party transactions, where the interested corporate insider is often excluded from the approval process. The general meeting of shareholders must then approve the agreement, with the involved shareholder excluded. In contrast, Delaware law does not generally require this. However, it has significantly increased the voluntary adoption of MoM. As said in the MacAndrews & Forbes case: 'a special committee alone ensures only that there is a bargaining agent who can negotiate price and address the collective action problem facing stockholders, but it does not provide stockholders any chance to protect themselves. A majority-of-the-minority vote provides stockholders a chance to vote.' In other words, both protection mechanisms together ensure minority shareholder protection. Following this ruling, the use of MoM voting rules increased substantially in Delaware. ***Cumulative voting:*** Another special voting regime, mainly used for director elections, is cumulative voting, which allows minority shareholders to cast all their votes for one or more directors. Cumulative voting is allowed in the United States, although its actual use has declined. It is popular in some East Asian jurisdictions and is used in certain European countries. While cumulative voting clearly benefits minority shareholder it also has some disadvantages such as complicates changes of control. ***Qualified majorities:*** There are qualified majority requirements or supermajorities. These make it easier for minority shareholders to block decisions. However, disproportionate power to minority. ***Classes of shares:*** In many jurisdictions, company law allows companies to create classes of shares with special rights that can take different forms, such as the right to appoint one or more members to the board of directors, provide candidates for the board, or the right to a certain level of dividends each year. These share classes can both enhance and impede minority shareholder rights. ***Finding the right balance:*** Minority shareholder protection mechanisms are widely used. However, they increase costs for companies. **MODULE 9** **Chapter 11: mergers, acquisitions and other major transactions** Corporations possess many of the rights and responsibilities akin to those of individuals. There are numerous motivations for companies to engage in such transactions. 'M&A transactions' can be categorized based on several criteria. Understanding these distinctions is crucial transactions are facilitated by the operation of law. It is essential to understand key aspects. First, in M&A transactions, two main parties involved: the buyer and the seller. The company being acquired is known as the target. These transactions, are a significant aspect of what is termed the market for corporate control; these activities have therefore considerable importance and need shareholder approval. The nature of these transactions opens avenues for opportunistic behaviour, laws in many jurisdictions provide protections for mi

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