Corporate Federalism Fundamentals: Understanding Corporate Law and Policy

1. Chapter 3 Corporate Federalism Gustav Klimt, Portrait of Adele Bloch-Bauer (1907)

2. Module II – Corporations and Policy Chapter 3Corporate Federalism Bar exam Corporate practice US corporate law history State legislative chartering General incorporation Internal affairs doctrine Regulation of foreign corporations Choice of law rules Pseudo-foreign corporations Federal abstention “Race of laxity” Delaware wins race Race to bottom or top? Law profession Citizen of world Chapter 3 Corporate Federalism

3. Fundamentals Introduction to firm Corporate basics Corporations and policy Corporate federalism Corporate social responsibility Corporate political action Corporate form Organizational choices Incorporation Locating corporate authority Corporate finance Numeracy for corporate lawyers Capital structure Corporate externalities Piercing corporate veil Corporate environmental liability Corporate criminal liability Corporate governance Shareholder voting Shareholder information rights Public shareholder activism Fiduciary duties Shareholder litigation Board decision making Board oversight Director conflicts Executive compensation Corporate groups Stock trading Securities markets Securities fraud class actions Insider trading Corporate deals Sale of control Antitakeover devices Deal protection Close corporations Planning Oppression • Fundamentals • Introduction to firm • Corporate basics • Corporations and policy • Corporate federalism • Corporate social responsibility • Corporate political action • Corporate form • Organizational choices • Incorporation • Locating corporate authority • Corporate finance • Numeracy for corporate lawyers • Capital structure • Corporate externalities • Piercing corporate veil • Corporate environmental liability • Corporate criminal liability • Corporate governance • Shareholder voting • Shareholder information rights • Public shareholder activism • 7. Fiduciary duties • Shareholder litigation • Board decision making • Board oversight • Director conflicts • Executive compensation • Corporate groups • 10. Close corporations • Planning • Oppression Chapter 3 Corporate Federalism

4. Federal securities laws (1933, 1934) Dartmouth College case (1819) State legislative special chartering General incorporation statutes Sherman Antitrust Act (1890) Takeover wave (1980s) Delaware GCL (1899) D-F (2010) SOX (2002) 1800 1850 1900 1950 2000 US corporate law timeline Chapter 3 Corporate Federalism

5. Corporation: private property or social institution? • “A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law. Being the mere creature of law, it possesses only those properties which the charter of its creation confers upon it, either expressly, or as incidental to its very existence.” • “But …. It is no more a state instrument, than a natural person exercising the same powers would be.” Dartmouth College v. Woodward (US 1819) Justice John Marshall Chapter 3 Corporate Federalism

6. 3. State corporate statutes can be amended (and thus change corporate rights) because of: General police powers of states Reservation of rights – see MBCA § 1.02 Constitutional power of state to amend contracts 4. Early corporate statutes distrusted corporate power -- placing limits on corporate purposes, activities, and capitalization. True or false? 1. Corporations are: “Artificial beings” created by and modifiable by the legislature “Contracts” that cannot be unilaterally amended by the legislature 2. US corporations could only be formed by special legislative enactment, until the early 1900s when Delaware enacted a “general corporation law.” True or false? Pop quiz(corporate law history) Chapter 3 Corporate Federalism

7. 5. New Jersey passed the first “liberal” corporate law that -- Allowed corporations to own stock in other corporations (permitting holding companies) Allowed shareholders to bring derivative suits Allowed shareholders to do away with BODs 6. New Jersey lost its “lead” to Delaware when NJ Governor Woodrow Wilson re-regulated NJ corporations. True or false? 7. The takeover wave of the 1980s was a response to the “conglomeration” of the 1960s. True or false? 8. Hedge funds (private investment pools) have have pressured PHC managers to generate high short-term returns for shareholders. Hedge funds rely on - Institutional investors (mutual funds and pension funds) to vote for their proposals Derivative suits to compel management action. Answers: 1- AB / 2-F / 3-B / 4-T / 5-A / 6-T / 7-T / 8-AB Chapter 3 Corporate Federalism

8. Horizontal corporate federalism Regulation of “foreign corporations” Internal affairs doctrine Chapter 3 Corporate Federalism

9. Foreign corporations Suppose a corporation in the business of selling doughnuts – • Is incorporated in Delaware • Is headquartered in North Carolina • Locates its retail outlets in California • Gets its capital from investors in Florida Suppose the corporation– • Sells bad doughnuts in California – what law applies? • Prevents shareholders from voting in Florida – now what law? MBCA Chapter 15 Chapter 3 Corporate Federalism

10. Internal affairs doctrine … Operation of doctrine Constitutional dimensions Chapter 3 Corporate Federalism

11. McDermott Inc. v. Lewis(Del. 1987) Panama City, Panama Chapter 3 Corporate Federalism

12. AFTER BEFORE Public shareholders New public shareholders 100% 90% 10% Exchange (1:1 + $0.35) McDermott Delaware McDermott International RemainingPublic Shs 100% 8% 92% McDermott International McDermott Delaware So what if subowns parent shares? Chapter 3 Corporate Federalism

13. “…. [courts and legislatures] 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.” “ … 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.” McDermott Inc. v. Lewis(Del. 1987) Delaware Supreme Court Chapter 3 Corporate Federalism

14. Constitutional dimensions …(what is pseudo-foreign corporation?) Compare (and distinguish): Wilson (Cal. App. 1982) Vantage Venture Partners (Del. 2005) Chapter 3 Corporate Federalism

15. Vantagepoint Venture Ps v. Examen Inc (Del. 2005) Wilson v. Louisiana-Pacific Resources Inc (Cal. App. 1982) • A pseudo-foreign corporation • incorporated in Delaware • most of its assets, payroll, sales and shareholders in California • Shareholder voting • California requires separate class voting • Delaware “single class” voting A pseudo-foreign corporation • incorporated in Utah • most of its assets, payroll, sales and shareholders in California Shareholder voting • California requires cumulative voting • Utah has straight (plurality) voting. Distinguish Chapter 3 Corporate Federalism

16. “If California's statute were replicated in all states, no conflict would result. We conclude that the potential for conflict is, on this record, speculative and without substance.” “We conclude that to the extent that the cumulative voting requirement imposed by section 2115 upon pseudo-foreign corporations is shown to have any effect upon interstate commerce, the effect is incidental, and minimal in relation to the purpose which that requirement is designed to achieve.” Wilson v. Louisiana-Pacific Resources Inc(Cal. App. 1982) Private Choice Chapter 3 Corporate Federalism

17. “The internal affairs doctrine is not … only a conflicts of law principle.” “In CTS, the Supreme Court concluded that ‘so long as each State regulates voting rights only in the corporations it has created, each corporation will be subject to the law of only one State.’ Accordingly, we hold Delaware's well-established choice of law rules and the federal constitution mandated that Examen's internal affairs … be adjudicated exclusively in accordance with the law of its state of incorporation, Delaware.” Vantagepoint Venture Partners v. Examen Inc(Del. 2005) Justice Randy Holland Chapter 3 Corporate Federalism

18. Vertical corporate federalism State antitakeover statutes Role of Delaware Race to the top / bottom Chapter 3 Corporate Federalism

19. Anti-takeover statutes 1st generation 2nd generation 3rd generation • Response / hostile TO • State securities law • “fairness” review • Example: Illinois • Mgmt lobby • Domestic corporations • Voting rights (control shs) • Example: Indiana Edgar v. MITE (US 1982) CTS v. Dynamics (US 1987) Chapter 3 Corporate Federalism

20. “The markets that facilitate… ownership of corporations are essential for providing capital…. The beneficial free market system depends at its core upon the fact that a corporation… is organized under, and governed by, the law of a single jurisdiction [its State of incorporation].” “It is thus an accepted part of the business landscape in this country for States to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” CTS v. Dynamics(U.S. 1987) Justice Lewis Powell Chapter 3 Corporate Federalism

21. Anti-takeover statutes 1st generation 2nd generation 3rd generation Amanda (7th Cir 1989) • Response / hostile TO • State securities law • “fairness” review • Example: Illinois • Mgmt lobby • Domestic corporations • Voting rights )control shs) • Example: Indiana • Mgmt (w/ SH input) • Incorporation-based • Merger moratorium • Example: Wisc, Del Edgar v. MITE (US 1982) CTS v. Dynamics (US 1987) Chapter 3 Corporate Federalism

22. “If our views of the wisdom of state law mattered, Wisconsin’s takeover statute would not survive.… Wisconsin’s law makes a potential buyer less willing buy, but this is equally true of [many] other rules of corporate law.” “To say that states have the power to enact [inefficient anti-takeover laws] is not to say that investors should kiss their wallets goodbye. States compete to offer corporate codes attractive to firms.” Amanda Acquisition v. Universal Foods(7th Cir. 1989) Judge Frank Easterbrook Chapter 3 Corporate Federalism

23. “Incorporation-based private ordering” • What is the “race of laxity”? • Why has Delaware won it? • Is this good or bad? Chapter 3 Corporate Federalism

24. Delaware bar Delaware legislature Delaware judiciary Chapter 3 Corporate Federalism

25. Ralph Winter’s “race to top” Mark Roe’s “vertical corporate federalism” William Cary’s “race to bottom” Chapter 3 Corporate Federalism

26. Using the E&E Chapter 3 Corporate Federalism

27. Using the E&E Chapter 3 Corporate Federalism

28. Using the E&E Chapter 3 Corporate Federalism

29. The end Chapter 3 Corporate Federalism