Chapter 3



Chapter 3 Corporate Federalism

Class Outline

(updated 23 Aug 06)

Chapter 3 Corporate Federalism

A. A Brief History of Corporate Law Federalism

1. Early antecedents

2. Early development of U.S. corporate law

o evolution of corporate attributes

o Trustees of Dartmouth College v. Woodward

3. The modern corporation

o Managerialism before 1980 ("rusty girders ... wind")

o 1980s takeovers

▪ emergence of shareholder primacy

▪ leveraged buyout

o 1990s mergers and restructurings

▪ stock options

o 2005 Hedge fund activism

o state / federal regulatory interaction

B. The Internal Affairs Doctrine

1. Background on the Internal Affairs Doctrine

o Choice of law rule: law of the state of incorporation governs “internal affairs”

o Judicial nature of rule

o Internal affairs v. external affairs

▪ internal affairs: shareholder / management relations

▪ external affairs: labor, tax, contracts, torts, property

o exceptions: pseudo-foreign corporations

2. Lessons from California and three generations of antitakeover statutes

o “first generation” state antitakeover laws

▪ Edgar v. MITE Corp.

o “second generation” state antitakeover laws

▪ CTS Corp v. Dynamics Corp of America

o “third generation” state antitakeover laws

▪ Amanda Acquisition Corp. v. Universal Foods Corp.

3. The Internal Affairs Doctrine Revisited

o VantagePoint Venture Partners 1996 v. Examen, INC.

C. The State Charter Competition Debate

• choice of state of incorporation

o practical factors

o state competition

▪ "race to the bottom"

▪ "race to the top"

o preeminence of Delaware –why?

Class Notes

Chapter 3 Corporate Federalism

|A. A Brief History of Corporate Law Federalism |

|Justice John Marshall [in Trustees of Dartmouth College v. Woodward |Judge Easterbrook (in Amanda Acquisition) |

|(US 1819)] | |

| |To say that states have the power to enact laws whose costs exceed |

|A corporation is an artificial being, existing only in contemplation|their benefits is not to say that investors should kiss their |

|of law.  Being the mere creature of law, it possesses only those |wallets goodbye.  States compete to offer corporate rules attractive|

|properties which the charter of its creation confers upon it, either|to firms.   Laws that in the short run injure investors and protect |

|expressly, or as incidental to its very existence. |managers will in the longer run make the state less attractive to |

| |firms that need to raise new capital.  ... States regulating the |

|[pic] |affairs of domestic corporations cannot in the long run injure |

| |anyone but themselves. |

| |[pic] |

|B. The Internal Affairs Doctrine |

|What is a foreign corporation? |MBCA § 15.01 AUTHORITY TO TRANSACT BUSINESS REQUIRED |

| |  |

|Can a corporation in the business of selling hamburgers be |(a) A foreign corporation may not transact business in this state |

|incorporated in Delaware, locate its retail outlets in California, and|until it obtains a certificate of authority from the secretary of |

|have its headquarters in North Carolina. How can it operate (with full|state. |

|corporate attributes to own property, enter contracts, sue and be |(b) The following activities, among others, do not constitute |

|sued, provide limited liability for investors) in each of these |transacting business within the meaning of subsection (a): |

|states. What is a "foreign corporation"?   See MBCA ch. 15.   |(1) maintaining, defending, or settling any proceeding; |

| |(6) soliciting or obtaining orders, whether by mail or through |

|Could California decide it does not want a hamburger chain selling in |employees or agents or otherwise, if the orders require acceptance|

|its state? Is a corporation a "person" under the US Constitution's |outside this state before they become contracts; |

|privileges and immunities clause? Is a corporation a person under the |(9) owning, without more, real or personal property; |

|14th Amendment's due process and equal protection clauses? Is a |(10) conducting an isolated transaction that is completed within |

|corporation a person with respect to the protection of the dormant |30 days and that is not one in the course of repeated transactions|

|commerce clause? |of a like nature; |

|  |(11) transacting business in interstate commerce. |

|[pic] |(c) The list of activities in subsection (b) is not exhaustive. |

| |MBCA § 15.03 APPLICATION FOR CERTIFICATE OF AUTHORITY |

| |  |

| |(a) A foreign corporation may apply for a certificate of authority|

| |to transact business in this state by delivering an application to|

| |the secretary of state for filing. The application must set forth:|

| |(1) the name of the foreign corporation or, if its name is |

| |unavailable for use in this state, a corporate name that satisfies|

| |the requirements of section 15.06; |

| |(2) the name of the state or country under whose law it is |

| |incorporated; |

| |(3) its date of incorporation and period of duration; |

| |(4) the street address of its principal office; |

| |(5) the address of its registered office in this state and the |

| |name of its registered agent at that office; and |

| |(6) the names and usual business addresses of its current |

| |directors and officers. |

| |(b) The foreign corporation shall deliver with the completed |

| |application a certificate of existence (or a document of similar |

| |import) duly authenticated by the secretary of state or other |

| |official having custody of corporate records in the state or |

| |country under whose law it is incorporated. |

|What law governs corporations? |Can states change their corporate laws? |

|  |  |

|  What happens if the shareholders of ABC Company are dissatisfied |Given that corporate law is a matter of incorporation-based |

|with the firm's management and sue for breaches of fiduciary duties.  |private choice, can states changes their corporate laws? What if |

|Which law applies if they sue in -- |Delaware decides to change its rules that govern shareholder |

|North Carolina court, where most of the shareholders reside |suits, making it more difficult for shareholders to assert their |

|Georgia court, where the company is headquartered |fiduciary rights?  Can Delaware unilaterally change a private |

|Delaware court, where the company is incorporated |arrangement -that is, the corporate relation between investors and|

|California court, where the CEO has winter home |managers?  |

|  |  |

|Choice of law - look for interests/contacts? What is the internal |See Del GCL § 394 ; NC Bus Corp Act § 55-1-02.  § 55-1-02.  |

|affairs doctrine - why do we have it? |Reservation of power to amend or repeal. Why do the states reserve|

| |the power to amend their corporate statutes - you don't see this |

| |reservation elsewhere in the law! |

|McDermott Inc. v. Lewis (Del 1987) |

| |

|McDermott International recapitalized (that is, changed how it was financed) so that 90% of its voting stock was held by public |

|shareholders and 10% was held by its US subsidiary, McDermott Delaware. |

| |

|This is against the law of Delaware, where McD-Delaware is incorporated, and the law of Louisiana, where McD-Delaware is headquartered |

|and does most of its business. But Panama law, where McD-Int’l is incorporated, allows a company to send voting stock to a sub, even |

|though this gives management the ability to vote stock it never paid fore! |

| |

|A McD-Delaware shareholder sued to stop the reorganization plan that put voting stock of McD-International in the US sub. The defendants|

|argued “internal affairs doctrine”. |

|Questions |Delaware court: |

| | |

|What is the reason for the prohibition against US companies placing |Delaware’s well established conflict of laws principles require that|

|their voting stock in a subsidiary? |the laws of the jurisdiction of incorporation – here the Republic of|

| |Panama – govern this dispute involving McDermott International’s |

|What is the Delaware court attitude? |voting rights. |

| |Under the prevailing conflicts practice, neither courts nor |

| |legislatures have maximized the imposition of local corporate policy|

| |on foreign corporations but have consistently applied the law of the|

| |state of incorporation to the entire gamut of internal corporate |

| |affairs. In many cases, this is a wise, practical, and equitable |

| |choice. |

| | |

| |Given the significance of these considerations, application of the |

| |internal affairs doctrine is not merely a principle of conflicts |

| |law. It is also one of serious constitutional proportions -- under |

| |due process, the commerce clause and the full faith and credit |

| |clause -- so that the law of one state governs the relationships of |

| |a corporation to its stockholders, directors and officers in matters|

| |of internal corporate governance. |

|CTS Corp v. Dynamics Corp of America (US 1987) |

|The Indiana legislature didn't much like that corporate raiders were acquiring control of Indiana businesses.  To stem the tide, the |

|legislature passed a "control share" statute that said that any shareholder of any Indiana corporation that acquired a controlling |

|interest -- by passing a 20% or 33% or 50% threshold -- could not vote its shares unless it received permission from a majority of other |

|shareholders.  How might this prevent coercion in a tender offer?  Why does this may takeovers less likely?  Doesn't this interfere with |

|the relationship between shareholders and corporate management? |

|  |

|A shareholder of CTS, an Indiana corporation, challenged the Indiana statute under the federal Commerce Clause.  What were the |

|arguments?  How did the Supreme Court respond?   What is the "blueprint" that the Supreme Court outlines for antitakeover statutes? |

|Discrimination - "the Indiana Act is not [a statute that |Does it make any difference that most corporate raiders are not from|

|discriminates against interstate commerce]  It has the same effects |Indiana?  |

|on tender offers whether or not the offeror is a domiciliary or |A corporate takeover pits current management against a team of |

|resident of Indiana" |outside managers.  Isn't the effect of the legislation is to prefer |

| |Indiana managers over outside raiders? |

|Inconsistent regulation - "so long as each state regulates voting |Does this mean that the "internal affairs doctrine" is |

|rights only in he corporations it has created, each corporation will|constitutionally mandated?  |

|be subject to the law of only one state" |Would it be possible for a state to regulate "pseudo-foreign |

| |corporations"?  That is, could California decide to protect its |

| |investors from Delaware corporate law by requiring that California |

| |law corporate apply if most of a company's investors were from |

| |California? |

|Hinder commerce - "The court of appeals failed to appreciate the |What is the "beneficial free market system" that the Court has in |

|significance for commerce clause analysis of the fact that state |mind?  What would be the effect if federal courts were to supervise |

|regulation of corporate governance ... is a product of state law" |the "hindrance" potential of state corporate law?  |

| |Is the Indiana statue valid because it is beneficial to |

| |shareholders?  or because it is merely a product of state law?  Why |

| |should Indiana care about its corporation's shareholders, if many |

| |live outside Indiana? |

|Limit tender offers - "Indiana need not define these commodities |What is to keep Indiana from deciding to give management full |

|[corporate shares] as other states do; it need only provide that |protection against takeovers?  |

|residents and nonresidents have equal access to them. |Could Indiana, for example, repeal its merger provisions?  Or |

| |provide that only incumbent directors or their successors (a dead |

| |hand rule) can agree to any combination with an uninvited bidder? |

|Amanda Acquisition Corp v. Universal Foods (7th Cir. 1989) |

|  |

|The Wisconsin legislature doesn't like takeovers any more than did the Indiana legislature.  Its legislation, similar to that of |

|Delaware's, places a moratorium on the activities of any acquirer of corporate control.  Under the statute a bidder who acquires a |

|controlling interest in a Wisconsin corporation must sit on its investment, and for three years is prohibited from merging or acquiring |

|the assets of the company.  This discourages any bidder who would borrow money to buy a control block, since the target's assets would be|

|unavailable for three years to repay the loans.  As a practical matter the Wisconsin law chills almost all tender offers - its intended |

|effect! |

|Is the statute pro-shareholder or pro-management?  How can the state of Wisconsin impose its will and side with management - what about |

|the corporate contract?  Do the law's costs outweigh its benefits?  Why is it that a state law that is "economic folly" is tolerated |

|under the Commerce Clause, which is supposed to allow for unhindered economic activities in national markets?  What is the nature of |

|judicial review of state corporate law according to CTS? |

|C. The State Charter Competition Debate |

|Market for "incorporations" | |

|  |Why incorporate in North Carolina?  |

|Why incorporate in Delaware?  |North Carolina's legislature follows lead of NC Bar Association, |

|Delaware has highest franchise taxes |Business Law Section |

|Delaware Consittution makes amendments to corporate statute difficult |North Carolina has specialized Business Law Court |

|Delaware has lots of corporate lawyers |See North Carolina's answer. |

|See Delaware's answer. | |

|Debate - "race to bottom" vs. "race to top" | |

|What is the argument by William Cary? What evidence does he marshall that Delaware is | |

|engaged in a systematic dilution of shareholder protections, for the benefit of | |

|corporate managers? | |

|What is the response by Ralph Winter? What evidence does Winter use in arguing that | |

|Delaware cannot engage in a race to the bottom? | |

|How might you determine whether Delaware is engaged in a race to top or bottom? | |

|Incorporation of new IPOs | |

|Re-Incorporation effect on stock prices |Should there be federal intervention? |

|Takeover defenses / executive compensation / parent-subsidiary dealings |(What is Professor Roe's argument?) |

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