Business Organizations - LAW 459/Unit 1

UNIT 1 (WEEK 1): INTRODUCING BUSINESS ORGANIZATIONS & THEIR REAL WORLD CONTEXTS

ALT:

photo of Bombardier BD-700-1A11 Global 5000 business jet

Source of image: http://commons.wikimedia.org/wiki/File:Bombardier_BD-700-1A11_Global_5000,_Jet_Aviation_Business_Jets_JP6462270.jpg

UNIT OVERVIEW: Corporate law exists not only within legal and juridical contexts, but also within political and social ones. Prof. Joel Bakan’s seminal film “The Corporation” explores those nexus points. As part of this Unit you should also begin familiarizing yourself with the course materials and syllabus generally.

UNIT OUTCOMES: You will have the opportunity to reflect on the reality that corporate law, beyond being a legal subject has profound impacts on our society, and implicates important ethical and economic issues. You should be able to name three such impacts. You should have obtained a glimpse of the dichotomies of corporate law. On one level a technical and detail oriented vehicle of commerce, and on another an ethical conundrum because of its requirement of profit and the fiction of “corporate personhood”.

UNIT TOPICS:

TOPIC 1: A BASIC METHODOLOGY FOR APPROACHING THE COURSE

Spend some time introducing yourself to some of the underlying ideas of the course. First read through the Course Syllabus and familiarize yourself with the course. Then go through this unit and finish all its activities.

Starting with elementary Stuff – ask yourself what, for a lawyer, is a company?

It is an organizational form recognized by the law, to coordinate and regulate the activities of those who provide the various inputs necessary to carry on a business designed to earn profits.

It is the most successful form of organization for doing this – at end of the course you should be able to explain in some detail why that is.

Whose activities are being coordinated and regulated? Company law suggests three groups:

Shareholders, Directors (and to some extent senior managers who are not directors), and What is being regulated are the relations between these groups (e.g., shareholders as against directors; creditors as against shareholders), and also the relations within each group (e.g., majority/minority shareholders, secured/unsecured creditors).

The Law also has some interest in how one becomes a member of a group and in how one leaves.

You may well ask what of others whose activities must be coordinated for a business to succeed: employees, suppliers, and customers, at the very least.

In general company law not interested in them, though other areas of law are.

In short as you go through the remainder of this Unit (and in fact the remainder of this course), a good starting point is to continuously ask and re-ask yourself three basic questions:

What does company law concern itself with? What not? Why (in either case)? A helpful reference in this regard may be the following “Bloomberg Businessweek” article: “Time Warner: 25 Years of Acquisitions, Sales, and Spinoffs” (and especially the chart it contains) at: http://www.businessweek.com/articles/2014-07-24/time-warner-25-years-of-acquisitions-sales-and-spinoffs

Discussion Activity: Please introduce yourself on the course discussion forum called “Introduction” and talk about who you are and how the course can be relevant to your goals and interests.

Watch, Think, Blog Activity: Watch the movie “The Corporation” at your leisure. Note that the film is available for purchase or rent through iTunes and YouTube. There is also a DVD version. As well, an official shareware version of the film is available at: http://youtu.be/s6zQO7JytzQ

Blog Activity Unit 1:

Considering some of the issues you have identified and please blog your impressions of the film “The Corporation” in less than three pages under the heading “The Corporation”. Feel free to incorporate any of the “reflective questions” enumerated below into your posted page of impressions. However you approach your blog, in particular please address in some way whether you see it as mostly inevitable that corporations will be have badly. If so, why? If not, why not?

Please also read at least two other blogs from your peers and add comments.

For the blog activities, you need to create your own blog account.

If you are a UBC Blog user, click on the activity title and then reply to the posting. You will then be asked to login with your CWL. Once you enter your CWL, you will be in the activity. Click Reply to start your posting.

If you are a non-UBC Blog User (haven’t used UBC blogs before), you need to sign up to be a UBC Blog user first. In order to register, click on the activity title (or go to http://blogs.ubc.ca) and you will be prompted with a screen to sign up to be a UBC Blog user. You will need to fill out the form with username etc. (Please note that your user name cannot be changed) and then choose to sign up as a user. You will then have to fill out your profile. Once this is complete and you have signed up for a UBC Blogs user account return to your course. Click on the activity title, enter your CWL and click Reply.

For more information about how to get an account go to http://wiki.ubc.ca/UBC_Blogs_FAQ or

http://elearning.ubc.ca/toolkit/blogs/

Movie_poster_the_corporation

Figure 1: The Corporation

ALT: Poster for the film “The Corporation” showing the outline of a businessman with an angel’s halo above his head and a devil’s tail.

Source of image: http://en.wikipedia.org/wiki/The_Corporation_(film)

Reflective Questions: ThINKING ABOUT THE issues raised by “The Corporation” IN THE CONTEXT OF THIS COURSE

Think about how companies as a form originated. Is it what you expected? How much do we really know about the purposes of companies? In many areas of law, origins and history play a vital role in defining the scope and details of all the emergent law in that area (e.g. criminal, constitutional, equity) – do you feel the same applies to business organizations? Do we “anthropomorphize” corporations? Why do you think we do? What purpose does being a “person” serve for corporations? Why not animals? What about robots? Is it fair to suggest that if the corporation is a person then it is in fact a psychopath? Is Hannah Arendt’s notion of the banality of evil worth considering in this context? Are corporations inevitably psychopathic? “Bad apple” or Sructural problem? Consider the Sanford Prison experiments and the systemic not personal nature of evil – See Philip Zimbardo’s “The Lucifer Effect” http://www.lucifereffect.com Is greater regulation the answer? Are there other alternatives? What do you see as the role of lawyers in the creation of the corporation (implication that the personhood of slaves was the legal mechanism lawyers took advantage of to popularize the corporate form)? Do our responsibilities relate to our role in creating the legal fictions that are the corporate form? What are our responsibilities as lawyers given the above? Why shouldn’t corporations do “good” even if it does not benefit them? After all natural persons do that all the time.

TOPIC 2: CORPORATE LAW – SOME INTRODUCTORY NOTES

WHAT IS COMPANY LAW ABOUT? A company is the most successful among a variety of organizational forms – including, for example, partnerships –recognized by law to coordinate the activities required to carry on a business designed to earn profits. The persons whose activities are necessary to this end are shareholders, directors and senior managers who are not directors, creditors, employees, suppliers, and customers (i.e. users of the company’s products or services). III. In general company law is not interested in the activities of employees, suppliers, and customers. It focuses on shareholders, directors and, to some extent, creditors.

The questions as to why company law is concerned with shareholders, directors and creditors, but for the most part uninterested in employees, suppliers, and customers are, therefore, important questions. As to those groups with whom company law is concerned, it focuses on: how one becomes a member of one of these groups; how one ceases to be a member; regulating the relations between them (e.g., shareholders as against directors; creditors as against shareholders) and regulating the relationships within the groups, for example, between majority and minority shareholders and between secured and unsecured creditors. SHAREHOLDERS Become a shareholder by acquiring shares[1] either from the company itself in exchange for cash, property or services; or an existing shareholder - generally, but not invariably, for cash. Cease to be a shareholder by disposing of shares to another investor. The ease with which this may be done is, from the perspective of company law, principally a function of the existence of a public market for the shares – if there is such a market, exit may be easy; if there is no market, exit could be difficult. rarely to the company itself, and then only subject to restrictions and limitations designed to protect creditors and/or other shareholders,. III. Rights acquired by shareholders not, generally speaking, defined by law. Contained in a contract between the investor and the company. The content of the contract is generally not limited in any way.[2] Telus Corporation, for example, has created and sold First Preferred, Second Preferred and Common shares, each with different rights. Teck Cominco has Class A common shares without par value, Class B subordinate voting

shares and preferred shares. Bombardier has Class A (Multiple Voting) Shares, Class B (Subordinate Voting) Shares, Series 2 Cumulative Redeemable Preferred Shares, Series 3 Cumulative Redeemable Preferred Shares and Series 4 Cumulative Redeemable Preferred Shares.

The “Common” share is the most basic form of share. Generally, there are no entitlements to financial gain even though the courts have (as you will see) found that financial gain must be the motive underlying the corporate enterprise. While shareholders may expect, or hope for, dividends or capital gains arising out of an increase in market price there is not generally an enforceable right to any of this. To compensate for this shareholder will generally (but not invariably) have the right to vote, i.e. theoretically at least to exercise control over corporate affairs. In contrast to the “Common” share are “Special” shares, e.g. preferred, which are generally accorded defined financial entitlements which can be of various kinds, e.g. assured dividends at defined rate, liquidation rights (otherwise than through sale to another investor) and financial priorities of one sort or another. Generally, in recognition of the financial entitlements associated with “Special” shares, there will be no right to control through votes.

DIRECTORS Typically manage, or arrange for management, - generally a “board”. If shareholders numerous, generally little overlap between authority of shareholders and of directors. Efficiency requires that decision-making be in hands of a small group. III. If few shareholders distinction between them and directors, although formally required, may be quite trivial and artificial.

There is some flexibility in allocating power and authority as between shareholders and directors.

CREDITORS Relationship between a company and creditors (a comprehensive term covering various relationships, e.g. customer who has pre-paid for goods, employee who is owed salary or the maker of a [long-term] loan, holder of a judgment enforceable against company) is, as with shareholders, primarily contractual. However creditors’ rights can be quite different from shareholders. In principle there is no limit to the variety of rights. But customarily borrowers’ are obliged to repay loans at a fixed future date with the result that their investment is locked for a period rather than, at least in the absence of a public market for shares, is the case for shareholder. Creditors’ normally possess an entitlement to periodic return in form of interest. Contrast this with the shareholders much more uncertain position. III. Lenders’ claims against company rank ahead of claims of shareholders’. Extent of claims determined by contract. Lender may have security for repayment of loan and payment of interest in form of charge against assets; rarely have voting rights, though not impossible. Because of creditor priority, common shareholders often described as “risk” or “equity” shareholders.

Company law regulates shareholder/company relationships quite extensively, presumably because both are creatures of that law. It has a far narrower interest in creditor/company relationships. Why would there be less interest (pardon the pun) in creditor/company relationships? That is because a corporate party, whether creditor or debtor, is not intrinsic to the existence of a debtor/creditor relationship. Many such relationships do not involve companies. So generally they creditor/debtor relationships seem best left to be regulated by general law. This may also possibly explain, partly at least, company law’s relative disinterest in other groups such as employees and customers. Their rights and obligations cannot turn on whether the party with whom they contract is a company and so can safely left to regulation by general commercial and consumer law. This proposition has been generally accepted, though, at least in connection with the position of employees, it is considered controversial. Other legal systems have different approach - German law, e.g. has special rules requiring employee representation on the boards of large companies. VII. But why does company law have anything to say about relations between creditors and corporations?

limited liability – corporate creditor can only proceed against assets of company, separate from those of shareholders and hence creditor cannot ordinarily pursue claims against members.

THE CENTRAL PRINCIPLES OR POLICIES UNDERLYING COMPANY LAW

         Five core characteristics at the heart of company law

the company an entity distinct from all its shareholders. limited liability for shareholders. specialized management, separate from the shareholders. freely transferable shareholder interests shareholder control. Query whether there might be a sixth core characteristic at the heart of company law being that “for profit” is the sole legally permissible motive?

Separate personhood (or, commonly, “separate personality”) Unavoidable, inevitable consequence of incorporation - true of every company, whether large or small. This concept is truly fundamental to the conceptual structure of company law. While personhood facilitates other core features – e.g. limited liability and transferable shares – it sometimes complicates legal analysis - an additional “person” has to be taken into account. Relations between the key groups – directors/managers, shareholders and creditors - not generally directly contractual but mediated through the “company” e.g. directors obligations are owed to company, not individual shareholders; and individual shareholders generally do not have rights against directors – their rights are against “company”. “Company” acts as a sort of ‘focal point’ for all these relationships. Functionally, this eliminates need for individual contracts among multiple parties in interest and the further need to re-do contracts whenever there is a change in personnel. Conferring legal personality sometimes acts as a temptation to treat the company as if it were a natural legal person instead of an artificial one - to attribute ‘interests’ to it which, in the nature of the case, it cannot possibly have. “Interests of the company” shorthand for interests of one or more groups of natural persons who have legal relations with it, e.g. directors owe fiduciary duties to “the company”. Meaning? In our law, typically the natural persons having legal relations with companies are members/shareholders who with some frequency interpret the “interests of the company” through the lens of their own interests. Limited liability Refers to the liability of the company and the fact that creditors’ rights are against company assets only, not against personal assets of the shareholders. “Limited liability company” is a common but misleading expression. The liability of the company is not limited at all – company assets available to full extent to creditors. It is the liability of the shareholders that is limited. Separate personhood facilitates limited liability – it is easy to distinguish business assets (owned by the company) from personal assets (owned by the shareholders/directors). It guarantees limited liability. If a third party has a contract with company as a separate legal person, liability on the contract is confined to the company and its assets - does not extend to natural persons – directors/shareholders - and their assets. Guarantee particularly significant if company “insolvent” – i.e. assets insufficient to meet claims of creditors – shareholders not liable to contribute. Policy reason for limited liability – limited liability encourages investment by those who do not wish to be involved in management. Countervailing consideration - reality suggests (as is pointed out frequently in “The Corporation”) that limited liability may permit, or even encourage, opportunistic behaviour by controllers of company as against its creditors, for example, by disposing of assets which the company was represented as owning when credit extended. This not in interest of shareholders generally: may increase cost of credit – higher interest than if shareholders’ liability not limited. Challenge for company law is not simply to implement limited liability but design a set of rules which achieves the desired benefits of limited liability (encouraging shareholder investment) and at the same time reduces or even eliminates opportunistic behaviour as against creditors. III. Centralized management

In companies of any size not surprising that management is not left with the shareholders but entrusted to a small group of managers – reasons flexibility, cost, expertise. Main occupation of individual investors may be entirely unrelated to business. Partly, also, motivation or rather lack of it. Shareholder who is one of, 1,000 shareholders may have no motivation to invest much time in working out the correct answer to a question confronting shareholders, but rather to free-ride on the efforts of the others. If all behave this way, none will prepare properly. The dynamics of small group decision-making, which will govern decisions of the managers, are entirely different. But law does not require a centralized management structure. In general there is considerable freedom to develop appropriate structures and to divide powers between the shareholders and the board in the most convenient fashion, e.g. a company with few shareholders can decide that it does not need a centralized management structure - shareholders may be few enough that they could also be directors/managers. Strangely, company law in Canada says relatively little about the qualifications (and disqualifications) of directors, at least in the case of private companies. The Jim Pattison Group, based in Vancouver, is described on its website as “the second largest private company in Canada”, with sales in 2012 of $7.5 billion and more than 35,000 employees working at almost 500 different locations worldwide and engaged in the automotive, media, packaging, food sales and distribution, magazine distribution, entertainment, export and financial industries. The Group does in fact have a board of directors all of whom seem to have impressive credentials. But this is not required by law. Should this be a matter of concern? Contrast companies traded on public markets, which are subject to increasing regulation of who their directors are and what they do.[3] Shareholder control Traditional company law view - shareholders are ultimate repository of authority. This is reflected in control over the company’s:

constitution; management; and surplus assets. Control over constitution The key (but not the only) constitutional document is in British Columbia called the “articles of association” or “articles” (or, in the case of corporations incorporated federally or in Ontario, the “bylaws”). They deal with the internal governance of a company. Generally, the content of “articles” is not prescribed by law. Instead, because of the primacy accorded to freedom of contract, the law tends to contain default rules only, that is, rules that apply unless the interested parties make a contrary or different agreement. The articles are thus a critical source of the governance rules for the company. In British Columbia the legislation includes a “model” set of articles that apply except to the extent that different provision is made. iii. Articles under control of shareholders. Content, and changes to content, require shareholder approval.

Control over management Intimately related to control of constitution. Company law does not generally prescribe in detail and minutely the way in which power and authority is to be distributed as between shareholders and directors. This is in general left to shareholders to decide but the law also allows shareholders to remove directors from office by following certain special procedures. Control over surplus assets In general, directors may only distribute surplus assets to shareholders, or to satisfy a legal claim against the company, or otherwise to further the company’s business. The shareholders’ primary entitlement to surplus results from the combination of two features of company law: in the case of a company that is a going concern their contracts will define their rights – though common shareholders rarely have a right to participate while the company is a going concern – depends on discretion of directors who are obligated to act “in the best interests of the company”; in the case of a company going out of business, law does not allow a payment to anyone that is not in satisfaction of a legal claim. company to make voluntary severance payments to its employees – no legal claim and no claim based on goodwill Since the payments are not in satisfaction of any legal claim on the company and a company which is ceasing to trade has no need to generate goodwill amongst its workforce, such payments were held to be unlawful at common law. The entitlement of shareholders to a participate in a surplus while the company is a going concern depends In fact, companies tend to be extremely cautious in granting legally enforceable entitlements to dividends to ordinary shareholders. iii. Assets must be used to further business of legal person (i.e. in “company’s best interests”).

Our corporate law deeply committed to principle of shareholder control (i.e. the shareholders and their interests are the virtually exclusive objects of legal affection. But the principle is, at least in the minds of some, controversial and has been challenged. They advance a “stakeholder” argument the nub of which is that the economic power of corporations and their impact or influence over the lives and work of citizens, demands a reconsideration of shareholder primacy. This discussion continues – most often in connection with the relationship between corporations and their employees. Transferability of shares Transferability is crucial for two reasons: flexibility and liquidity for investors. governance considerations - the company may function more smoothly if a dissatisfied investor (or one who simply needs cash) is able to leave the company rather than remain as a carping minority. Generally, corporate funds may not be used to provide liquidity to investors. Investment, once made, is “locked in”, i.e. investor loses control over funds contributed. Use of corporate funds to provide liquidity only available, in the absence of contractual entitlement, in limited circumstances narrowly defined to protect interests of other shareholders and of creditors. promotes stability in the resources available to the company. If the funds used to provide liquidity for its investors, there would have to be a higher degree of liquidity of corporate assets to ensure corporate development note: separate legal personhood facilitates liquidity through the market for shares. Disposition of the investor’s interest in the company, (i.e. a share), does not involve a transfer of underlying business assets which are owned by the company and not by the shareholders One can contract for liquidity – redeemable shares – but precisely because they weaken the company’s control over its assets they tend to be rare. Despite importance of market and liquidity, company law does not guarantee: existence of a market; or outside a market, that shares may be transferred freely – consents, restrictions, may apply which reflect valid purposes. SOME GENERAL COMMENTS Only separate personhood is inevitable and unavoidable. The other core features of corporate existence can be avoided through appropriate provisions in a company’s constitution or by contracts with the company or its shareholders. Relationship between core features and corporate size Very small companies most likely not to display the four optional core features. For example: Ms. Smith and Mr. Jones incorporate Smith & Jones (Home Renovations) Ltd, to run a small home renovation business. Each agrees to subscribe for one share for which each pays $1. There are no other shareholders. They control the company. Business financed with funds borrowed from bank which insists on personal guarantees from Smith and Jones. To this extent anyway, they do not have the benefit of limited liability. They appoint themselves the only directors. Indifferent to whether they make decisions as shareholders or as directors. There is complete unity of shareholding, board membership, and management in this company. No centralized management separate from the shareholders. The articles require (a) consent of all existing shareholders to admission of new shareholders and (b) if an existing shareholder wishes to sell his or her shares, they must first be offered to the other existing shareholders. No free transferability of shares. Smith and Jones in total control disposition of surplus funds. Smith and Jones have acquired control not because they have made a major financial investment but because they are the people who will get and do the work that the company is set up to carry on. Contrast, at the other end of the size spectrum, companies such as Telus, Teck, Bell and Rogers, all with shares traded on public markets, each of which has thousands of shareholders, none of whom has given any personal guarantee of the company’s debts or liabilities; the board of each is clearly distinct from both the shareholders and the senior management of the company; and the shares are freely transferable from both the shareholders’ and the company’s point of view. As far as the law is concerned, the shareholders also control the company in the ways defined above – at least in theory. However, by way of contrast with Smith & Jones Ltd, the sheer number of the shareholders raises a serious question whether the difficulties the shareholders will face in coordinating their actions mean that in fact they are incapable of exercising the control the law confers upon them. Nearly all public companies and a substantial number of private companies, display the five core features. III. Interaction among core features

The core features sometimes compete – so a solution that implements one feature may impair attainment of another, e.g. placing broad range of decisions in hands of shareholders would expand their control but at a likely cost of efficiencies derived from centralized management, so more likely to be found in small private rather than large public companies. Consequently, for public companies there is likely to be a search for techniques that provide the benefits of shareholder control without at the same time imposing greater costs by way of loss of the benefits of centralized management. Correlation between corporate size and presence of all five core features not accidental. As companies grow, capital needs of business likely to increase – invite public participation through risk (common) capital; Public shareholders: more likely to invest if they can subsequently dispose of their shares on a market and if they benefit from limited liability unlikely to want or have ability to manage, leading to centralized management;. having provided investment with no legal guarantee of a return, are likely to want the power to remove the management if business unsuccessful.

Unit Wrap Up: At this point, you should have nothing but questions. Plus perhaps two particularly nagging ones along the lines of:

“If corporate law is so bad, why are so many lawyers practicing in and around this area?” & “What exactly are those lawyers doing?” This course will not adequately answer the first question but hopefully facilitate and informed exploration of the second, beginning with some observations about the corporate lifespan. In Unit 2 we begin with the legal version of “immaculate conception” and move forward from there.

[1] Certain aspects of the process of acquiring and disposing of shares are regulated by company law; other aspects by securities law.

[2] Stock exchanges or other public markets may, however, impose certain restrictions as a condition of permitting the shares to be traded through the facilities of the exchange. For example, certain exchanges prohibit or limit the use of shares without voting rights.

[3] This regulation is generally found in the securities laws administered by regulatory bodies such as the stock exchanges and provincial securities commissions and not in company law.