Dissection of Commentaries and Cases in Business Organisation

Introduction to Business Organisation

The study of business organization law applies in one form or another to all businesses. Every business spends its first moments contemplating its new identity, its preferred structure, its purpose and its aspirations, and its very survival hangs in the balance.
The subject of business organizations, as a division in legal study, is the product of the enactment of the Limited Liability Company Act ("LLC Act") of 1991 and the amendments to the General Corporation Law ("CL"), which, together, ushered in the era of entities. Corporate organization had been the law in Delaware since 1899. For centuries prior, business organizations had taken the form of partnerships. Since then, business entities have had a remarkable impact on the way commerce is conducted in the United States . There are now hundreds of thousands of business entities in Delaware; indeed, the State is now host to more than one million legal entities.
Governing the rights and obligations of these entities are the company agreements that bind their members. Each agreement is the product of a choice of law and litigation provision chosen by the parties. By default, for Delaware entities, the laws of the State apply, but members will always have some ability to contract around the predictable elements of the State’s statutes.
How has the LLC Act changed the legal landscape for businesses? The new body of common law will in due time provide predictability for the community of businesspeople, advisors and decision makers whose contracts and relationships govern what the world at large will, eventually and inevitably, become.

Significant Commentaries in Business Organisation

The evolution of Delaware case law, whilst critically important and in many ways the most helpful aspect of our jurisprudence, is not the only aspect of our jurisprudence. The real world of business organization law also needs to be explained, and that has been done so, for many years, via commentaries, which I have previously referred to as "scholarship", on many occasions in my practice, by practicing lawyers and judges, and many law professors, both full-time and adjunct, including full-time and retired/law school emeritus judges, including especially Myron Steele, Chancellor Champion, Leo Strine, Seitz, Steele, Berger, Jacobs, Hartnett, Jacobs, Noble, Hartnett, Slights and Baltimore. Notable professor commentaries have included those from the more recent era of law professors such as Larry Hamermesh (also a lawyer), Wilmington native Robert Thompson, as well as the venerable R. Franklin Balotti and Jesse Fried, along with useful contributions from others like Dale Oesterle and William Carleton in "Foreign Compulsory Process". For recent commentary on the LLC statute, Delaware professors include the new Dean at Widener, Jay Elsenbaumer, faculty members at the Delaware law schools including Elad Roisman, Ann Marie Trace (whose name will take some getting used to), Greg Bell, and others from Villanova and other locales. Many influential law review articles have influenced the evolution of cases over the years as well.
While the "stack-list" of volumes of "Corp & LLC Annual Review" has heretofore served as the bible for all of those written explanations of what the law of Delaware is, the state of the art, is represented by two extremely wide-ranging and detailed chapters on business organizations in The Delaware Law Review, 68 Del. L. Rev. 1 (2017); 64 DLR 1 (2012), and the most recent edition in 70 Del. L. Rev. 1 (2019). Although the editors have not firmly committed to the concept of periodicity, readers can be thankful for the fact that the contributors to these extensive surveys of the state of the law have agreed to undertake the substantial effort required, and to provide the reader with a welcome relief from the burdens of hunting down older, still very valuable commentaries, by collecting them in one convenient place.
As discussed in prior posts, among the more famous "annual reviews" of previous years were the "Annual Review of Delaware Corporate Law", then known as "Annotated Corporate Law" written by Frank Balotti and Jessica Cosden, published in 1984 in 7 Del.Law. 42 (1983). The Annual Review was published in 8 Del.Law 61 (1984); 9 Del.Law 87 (1985); 10 Del.Law 259 (1986); and 11 Del.Law 305 (1987). Some aspects of those terrific reviews were carried forward, via one of the co-authors to the "Directors Desk". The Annual(s) were later renamed as the "((Directory)" and then scrapped for an "Annotated Corporate Statute" which combined the statute with a substantial amount of explanatory text. That was also scrapped about 10 years ago, in favor of the summary of the cases and statutes that became the preferred choice for practitioners, with commentary from the judges and the practitioners at the Chancery Court.
Chief Justice Leo Strine, who has since retired from the bench, wrote the compendium of commentary on books on corporate governance by Delaware judges and practitioners himself in a book entitled "Making Corporate Law: From Clerks to Professors to Pundits to Politicians", published by the University of Chicago Press. It was reviewed on the Delaware Corporate Law Blog here, among other places. In recent years, the Chancery Court has provided readers with new perspectives on corporate law including the cumulative advantage of formal judicial opinions announced in the wake of appraisal trials, in addition to some scholarly debates in opinions about board decisions under the Caremark standard and the pernicious impact of forum shopping for litigation in states that are not Delaware via corporate charters designed to create legal entitlements that are more favorable to the positions of the plaintiffs challenging corporate governance decisions.
Rightly or wrongly, the above-mentioned Daniel Carney, of Wilmington, not only worked on the Texas Pie statutes, and is available for consultation, but is also a heavily relied upon author, with John Reed Stark, of the DGClarity blog, and the New York Law Journal, among other venues, of a very detailed treatise on "The Delaware Law of Obligations". Dean Erwin Chermyinsky, emeritus of Hastings, has repeatedly, and correctly, pointed out that commentaries in the form of treatises are heard from far more frequently than those in the form of cases, especially given how frequently thoughtful law professors especially law professors tend to be heard from in the latest litigation on issues concerning business entities in Delaware courts.

Important Cases in Business Organisation

The modern law of business organization grew out of classic agency law. A, B, and C each owned a third of Ajax Corporation. A hated C. A refused to allow C to participate in the management of the company. C spent all his time giving information to A on how to run the company, which A ignored. C sued to have A have an agent of the company listen to C’s good advice. The court refused. A v. B, 500 A.2d 188 (Del. Ch. 1985). A would have been an inefficient agent for B, who had him, C, as principal.
A wanted to avenge himself on C. He caused the corporation to refuse to permit C to attend shareholder meetings. C forced entry into the meetings through a restraining order. He won the case, which was well-documented in a recent compilation of decisions that supported the principle of shareholder access to corporate records. A v. B, 700 A.2d 953 (Del. Ch. 1997). He lost his standing to sue by doing something not permitted by the corporation agreement. He did not make a proper demand on the corporation for relief. A v. B, 699 A.2d 929 (Del. 1997).
C filed a stockholder derivative action claiming A entered into a transaction on behalf of the company that was unfair to the corporation. A filed a pre-answer motion claiming that the complaint could not state a cause of action if the person for whom he acted was not adversely affected by the act or omission complained of, thus defining the business judgment rule. Under the rule, the court is not to interfere with A’s prudent exercise of discretion in making business decisions as long as there is no bad faith or settled intent to injure C. A v. B, 709 A.2d 764 (Del. 1998). A had the burden of convincing the court that his actions were not independently confirmable from the circumstances and were made in good faith, without wrongful purpose.

The Comparison of Legal Devices: Corporation and Partnership

There are all kinds of legal structures with which to operate a business. As indicated on the following chart most of these types are available in all states. One of the most important and common considerations for selecting a form of entity is the exposure that an entrepreneur has to liabilities from its business. In general the more limited the liability the entity form affords the entrepreneur for the debts and liabilities of the business the more complex and costly the form of entity generally is. In other words the forms of entity that offer the least liability protection for entrepreneurs are usually simpler and less expensive than those forms that afford maximum liability protection. Whether the form of entity actually carries through on the promise of limited liability, however, is another question. A general principle is that limited liability entities can be pierced by creditors when certain requirements are met. The structure of the entity may also affect the personal liability of shareholders. For instance, just as the tort liability of a director can be imputed to a corporation, the tort liability of a partner can be imputed to a partnership. Moreover, under conventional legal principles, a director cannot be held vicariously liable on an agency theory merely because she is a director of a corporation. In contrast, however, the vicarious liability of a partner will ordinarily be imputed to all partners regardless of the degree of their participation in the activities of the partnership. This means that in some cases a plaintiff can sue a partner who is not at fault for the tortious conduct of another partner; in such a case the liability of the non-faulty partner would be vicarious, not direct. Corporate shareholders are not subject to any such imputation of liability under the same circumstances, although a shareholder who controls the affairs of the corporation may be subjected to liability where he owes a fiduciary duty to the creditor of the corporation. Generally, however, the corporate shareholder is not obligated to pay the debt of the corporation.

The Role of Official Bodies

For every role that legislatures, attorneys general, and courts play in developing business organization law, there are regulatory bodies affecting the evolution of legal practices in a business context. Here’s a look at the most notable:
Federal agencies: Sometimes the work of lawmakers is supplemented by their regulatory counterparts. When it comes to areas as diverse as labor, the environment, and company mergers, federal agencies exercise their regulatory authority to mitigate issues associated with legislative shortfalls. This can be an important consideration for businesses, given that the scope of federal regulations has expanded greatly over the past century.
State regulators: The legislative process often falls victim to inertia, but many of the regulations that touch businesses in all industries come from state governments. One example is the Uniform Limited Liability Company Act, which was created by the National Conference of Commissioners on Uniform State Laws before being passed into law by every state but Louisiana . The Act set forth requirements for how LLCs would operate in each state—a uniform requirement greatly simplifying how companies could navigate the administrative burden of organizing across state lines.
Private sector actors: Lawsuit settlements often include so-called "institutional reforms"—changes to the way a company does business in order to achieve a more favorable legal outcome. The consent decrees that usually govern these reforms provide a roadmap for how companies should conduct their operations to comply with the law, and often become the basis for further legal authority once they’re adopted by a court.
Courts: For all the ways that modern courts are able to ease the business of litigating legal issues, they’re also responsible for many decisions that have shaped the way business is conducted. From determining the legality of certain types of contracts to establishing definitions of liability, the global economy can trace its roots back to decisions originally made by judges.

Trends and Developments

The last five to ten years in the business organization law world has been characterized by an expansion of statutory protections for directors and managers of private businesses, particularly limited liability companies (LLCs). This trend has most notably come in the form of the so-called "shield statutes" that protect directors and managers from liability in shareholder derivative lawsuits.
Ohio’s LLC and close corporation laws, for example, both contain "shield statutes" known as "director dissent" and "director ratification" statutes. These statutes serve as a set of rules that help directors of LLCs and closely held corporations stay out of court – or out of an expensive judgment – for decisions they’ve made that might otherwise cause economic losses to the company and its owners.
For example, in the LLC ("director dissent") statute, Ohio Revised Code 1705.57(B) prohibits a manager from:
…[L]iability to a member or manager of the limited liability company for monetary damages for conduct as a manager of the company, except for liability resulting from any of the following:

(1) Intentional infliction of harm on the limited liability company or the members or that resulted in a personal benefit to the manager;
(2) An act or omission not in good faith that constitutes reckless or intentional conduct;
(3) An unlawful distribution under section 1705.38 of the Revised Code;
(4) Intentional infliction of harm on the limited liability company [that] constitutes willful misconduct or reckless conduct [emphasis added].

This statute, and its counterpart in Ohio’s close corporation statute, is designed to protect "managers, directors, and sometimes shareholders, from shareholder derivative suits seeking to recover money damages for corporate mismanagement." Essentially, it takes all of the ability of an affected owner to recover money from directors or managers in a case where they’re liable for a business loss, and gives those directors or managers the ability to reduce their financial responsibility or even get it to zero.
As a practical matter, these statutes remove a variety of issues from consideration in select circumstances – for example, decisions on whether or not to issue dividends or enter into a new business line or market are now made by the directors or managers without concern for the company’s future. In making those decisions, directors and managers are supposed to come to those conclusions in good faith, but there is no simple means of enforcing that good faith standard. In other words, if you’re a director whose self-interested actions cost the business money after a bad decision, you’re getting a free pass (up to the limits of the statute, of course).
It remains to be seen if the free pass will encourage directors and managers in smaller businesses to make decisions they might otherwise avoid out of fear, or even flat out cut costs on their way to a larger company that provides them with the opportunity for self-interest.

Conclusion

The future outlook of business organization law focuses on a few keys points. One, foreign states have sovereign immunity in actions arising out of securities transactions on securities exchanges. Two, as of 2018 the Delaware Court of Chancery has expressed skepticism whether a fiduciary duty is owed to any person by a controlling stockholder who has not undertaken to control the business of the corporation through domination and control over the issuer. Three, controlling stockholder duties are limited to transactions where the controlling stockholder is deriving a direct or indirect benefit disproportionately great compared to other stockholders. Fourth , the Court of Chancery has yet to address enforcement of controlling stockholder duties after MFW. Fifth, optimistic foreign investors may push for debt securities over equity in IPOs. Sixth, we may see an increase in foreign companies avoiding the U.S. securities laws by listing in foreign exchange markets. Seventh, there may be an increase in reverse mergers of U.S. companies into foreign shell companies to avoid the U.S. securities laws. Eighth, there will be a continued flow of capital into U.S. securities markets from foreign issuers.