Corporations
September 13 Class

Problem 5.1

This problem illustrates the sorts of differing interests that multiple clients can have in the corporate context. The financial positions of different shareholders are likely to be different, and that is likely to make their interests in the structure of a corporation different, which in turn often makes it difficult to represent them all.

State of Incorporation

Most corporation initially incorporate in the state in which they do business. When corporations become larger, they often reincorporate in Delaware, perhaps to gain the benefit of the experience in corporate matters of Delaware's judges. The reason also may be, however, that Delaware's corporate law gives directors and officers considerable freedom. Some argue that this freedom allows directors and officers to take advantage of shareholders; other argue that if Delaware law were unfavorable to shareholders, reincorporation in Delaware would lower stock prices, so that directors and officers would not do it. (This is the Cary-Winter debate.) This is an empirical question, and the answer is not known.

Could shareholders prevent a reincorporation if they did not want it?

Yates v. Bridge Trading Co.

Most of the issues in this case are only peripherally related to corporate law; the case is assigned simply to illustrate the importance of the state of incorporation. The internal affairs doctrine is a corporations doctrine, however. It is a choice of law doctrine that applies the law of the state of incorporation to issues relating to the internal governance of a corporation.

Corporation by Estoppel, De Facto Corporation, and M.B.C.A. § 2.04

In general, persons who purport to act on behalf of a corporation when that corporation does not in fact exist can be liable individually for obligations they incur. Liability can be imposed both on shareholders (who are treated as partners, due to the lack of incorporation) and on individuals who participate in organizing (or attempting to organize the enterprise), through the doctrine of "promoter liability." The harshness of this result can be avoided, however, through two other doctrines: corporation by estoppel and the de facto corporation doctrine. Corporation by estoppel operates to deny recovery to creditors who thought they were dealing with a corporation and who would receive a windfalll if they were to recover from a promoter. The de facto corporation doctrine applies to protect those who in good faith tried to incorporate, had the legal right to do so, and acted as a corporation. As the casebook points out, M.B.C.A. § 2.04 takes a somewhat different approach, instead protecting those without knowledge that incorporation has not occurred. The M.B.C.A. has not been adopted in all states, however, and even where it has, the extent to which § 2.04 will preempt the older doctrines will differ from state to state.

Sivers v. R & F Capital Corp.

The force, if not the wisdom, of M.B.C.A. § 2.04 is shown by this case. The court seems to suggest that the promoter should have done a better job of ensuring that corporation had occurred, but since he did not know that it had not, he is protected by § 2.04. Of course, he might also have been protected under the de facto corporation doctrine, if he were found to have acted in good faith. And the corporation by estoppel doctrine might have barred Sivers from recovery, for the reasons discussed in the first full paragraph on page 106.

Equipto Division v. Yarmouth

The court reverses the lower court's determination of liability because it rejects the lower court's application of agency principles (from which promoter liability is derived). The court concludes that the adoption of M.B.C.A. § 2.04 abolished the corporation by estoppel and de facto corporation doctrines, and that there is no reason why § 2.04 should not apply in the post-dissolution context as well as the pre-incorporation one. Hence, the decision, it says, should turn on the defendant's knowledge of the absence of incorporation. The excerpt given here does not, however, state the court's final decision. What do you suppose it was?

Coopers & Lybrand v. Fox

A promoter can best avoid promoter liability by entering into a contract under which the creditor agrees to look only to the corporation for payment of the debt. Fox claimed that Coopers & Lybrand had made such an agreement, but the court concluded that he had not proved it. It is worth noting that the agreement should reflect explicitly that the corporation does not exist, by providing that the creditor will release the promoter from liability when the corporation comes into existence; in that way, the uncertainty of an agreement providing that the creditor will look only to a then-nonexistent corporation is avoided.

A similar agreement is desirable even in a promotion case like Sivers, though the parties are not likely to enter into such an agreement if they believe that the corporation already exists.