International Business and Contracts Law exam questions

Contracts and Companies

Contracts

Question

Explain the concept of Contracts

Answer

A contract is a voluntary, deliberate, legally binding and enforceable agreement among two or more people.

• Voluntary: both parties want the benefits and the costs correlated with the contract
• Legally binding: the contract needs to be recognized by the legal order
• Enforceable: it has a legal coverage in case of one of the parties doesn't perform its obligation

Question

What are the main characteristics of the contract?

Answer

A contract needs at least one legal system for recognizing it as a contract. Different jurisdictions have different laws about contracts, so they look at the same thing but with their own perspective.

Effects:

• Binding force of a contract: among its parties it has the same binding force provided by law if the contract if properly formed and signed. If one of the parties breaches one of the terms it's as. It is breaching the law.
• Privity of contract principle: does not allow obligations for third parties if they are not involved directly in the contract.

Structural elements:

• Parties: they are two or more, both natural person (human being) or non-natural person (legal person à fictious entity) can enter a contract. Some jurisdictions also provide for unilateral contracts (as an example donation in Italy).
  Parties must have the legal capacity to enter the contract. For legal capacity we intend to have the legal age (18+ in Italy) and not be under the influence of drugs or alcohol.
  The principle of freedom of contract says that parties must be free to enter the contract and parties are also free to determine the object of the contract. It's against the law and the contract is invalid if:

  • One party make relevant and reasonably mistake
  • One party is under influence of a threat
  • One party wants to fraud the other

• Meeting of minds: when the offer matches the acceptance. It's considered matched when all terms and conditions are agreed by all parties.
  If the contract is signed, but parties are far from each other, it is required to find the jurisdiction of the contract:

  • Letterbox rule (like in UK): when the person who receives the offer mail the acceptance the contract is started (more trust among parties and more efficiency of postal services)
  • Actual acceptance's receipt (like in Italy): the person that places the offer needs to receive the acceptance in the business domicile the contract is started (less trust among parties and less efficiency of postal services)

• Object: every contract must be characterized by an economic value even if one or more parties does not have an economic significance. The object must be explicitly determined in the contract, must be legal and has to be intended in two ways:

  • Content, i.e the obligation among parties, for instance party A must deliver wood to party B and party B need to pay Party A for that
  • Purpose, i.e the type of contract, for instance a purchase and sale agreement or a performance and service one

• Consideration: the reason why the parties sign the contract. For every contract there must be a bargained for exchange, which means that every part of the contract has some benefits from signing that contract but also some costs associated, the costs can be monetary or non-monetary (usually property title).
  There must not be a "gross disproportion" between the benefits and the sacrifices for all the parties, especially for B2C contract because the law tent to protect consumers (paternalistic attitude). Example: in a purchase and sale agreement, the seller gives up the property title for money and the buyer pays some amount in exchange for the property right of the good.

• Formalities: how the terms are written. They can be:

  • Written: here we can have addition formalities
    • Notarized for authenticate (for example for create a company)
    • Registered with public authorities in public register for the existence to third parties
  • Oral: parties actually contract with each other, and they discuss term and condition about the contract but they don't want to write down those terms and conditions (under this setting is much more difficult prove things, because "verba volant, scripta manent")
  • De facto: doctrine elaborate by judges find a partnership where a partnership was never entered into by the parties. Just assuming that because those parties behave in a way that it looks like partners and third parties relying in that nonexistent partnership
  • Digital formation of a contract, without notary or government who certify the formation of a company

Question

What happens in case of breach of contract?

Answer

The consequence of not fulfilling the contract obligations, that if a party doesn't follow the terms and conditions of a signed contract there is a breach of contract. It implies that a party can ask for:

• Specific performance: asking the judge that the other party perform what that the contract provided for, sometimes this is not possible, for instance if a lawyer doesn't want to defend you there is no way to obligate him
• Damages: it covers all the expenses in order to get those expenses (layer fee), but also for the missing profit
• Both the above

Question

What are the main types of contracts?

Answer

• Commutative or exchange contracts: one party undertakes to do or pays something in exchange for delivery of goods or perform a service
• Multilateral contracts: there are more than two parties, such as life insurance contract with an insurance company, many customers and third parties partners
• Associatory contracts: all the parties take the same position, as they share the same interet, such as shareholders in a company or associations
• Multi-party contracts: even if only party establish the company by a unilateral act, the contract is "open" to subsequent adhesions by an indefinite number of people that can be both human or legal persons
• Consumer contract: the legal system takes away some freedom of contract because all the terms and condition are settled up by the company because consumer are viewed as weaker party of the relationship
• Commercial or business contract: there is more freedom of contract than in a consumer contract because it's assumed that the bargaining power of the two businesses are more or less the same, given on the company size. EU wrote down regulations to protect SME from large corporations as if it was a consumer contract
• Discrete contract: relation exists between the parties apart from the simple exchange of goods
• Long-term contract: effects are based on a relationship of trust between the parties
• Relational: cooperative contract with usually involving some degree of asset specificity and often exposed to ex-ante and/or ex-post opportunism

Question

What does the Williamson matrix suggest?

Answer

The Williamson matrix can aid deciding if it is better to pursue a long term contract or buying from the market directly:

• Market governance: buy from the market
• Trilateral governance: "third party assistance" is used for resolving disputes or evaluating performance
• Bilateral governance (relational contracting): long term relational contract between two independent firms, does not import any unification/merge between the two independent firms
• Unified governance: companies who produce, there are more incentives from a cost point of view to merging together. It depends on the specificity of the investment

Question

What are the main features of Long Term Contracts?

Answer

Also known as relational contracts, they are corporate contracts are tools that aim to defeat the uncertainty may help prevent or readdressing a given position of the party during an extended time horizon. The most common features are:

• Guarantees, collateral, enforced if the other part don't respect the clauses of the contracts
• "Dealing in good faith" terms, general clauses used to curb the opportunism of other party
• Renegotiation clauses, used to explicitely set the conditions for new negotiations
• Hardship clauses a way to terminate the contract if something happens, unless the other part agrees to a renegotiation

It is required to match the governance with the appropriate type of contract in order to lower transaction costs as possible.

Question

Explain the concept of Smart contracts

Answer

Smart contracts can be defined as computer programs that regulates and automates the relationship between two or more parties. Features of smart contracts:

• Self-enforcement: parties negotiate conditions but after that it's very difficult to renegotiate
• Designed to cooperate with digital and real world contracts
• Need data to work
• Use token such as digital vouchers
• Democratic because they are immutable and incorruptible
• No need for intermediaries, for instance when collecting data to calculate insurance premiums
• Can expose one part to privacy issues if one part can monitor the other

Under common law jurisdictions like the US, judges tailored solutions for every aspect of different cases as they require more flexibility.

Example of smart contracts employment:

• Sharing economy
  • B&B
  • Shared office space o Car sharing
• Small amount of transaction contracts
• Easy contracts (not M&A)
• Insurances
  • Medical
  • Automotive
• Regularly contracts
  • Supply of goods

Companies

Question

What are the five common characteristics of a company?

Answer

Companies have "common" characteristics because there is a convergency trend among all jurisdictions, as these are always present in the corporate law of every country and are useful for investors in order to start a relation with the management. They are

1. Legal personality
2. Delegated or centralized management
3. Investors' ownership
4. Limited liability
5. Transferability of the shares

Free transferability needs to be intended as default rule (for example here in Italy), but it can be changed. In Germany the default one for private company is the opposite

These are useful because all over the world are used, so through standardization we can achieve a cheaper and an easy way to define company (they lower transaction costs). By counterpart, it's true that lower transaction costs, but they rise agency costs.

Question

Who manages the investment in a company?

Answer

The board of directors manages and supervises the business. It often delegates its power to officers. Directors are subjected to fiduciary duties. The evolution of firms tents to this setting of division of powers based on the professionalism of managers.

Question

What is the return on the investment in a company?

Answer

With investors' ownership every investor who invests in a company has the right to dividends. Also, under the golden rule the power is proportionally distributed among investors. There are some basic guidelines for claiming company resources:

• Creditors are first in line to receive the cash based on their contract signed with the firm
• Equity investors are only expected the residual claim, if there is any left
• If the business dissolves, creditors' claim have priority and shareholders are residual claimants

Question

How can people exit their investment in a company?

Answer

If there is the free transferability of shares and there is an active market it's easy to sell stocks. However, the corporation has no obligation to reacquire the shares, so the investor has to find a buyer on the market where its stocks are traded.

Companies can be:

• Public held: traded in the public market
• Private/close: need to be sold through private agreement
• Limited liability company: there are quotas and not shares, those type of firm can never go public
• Partnership

Question

What are investors' responsibilities to others?

Answer

If the investors of a corporation are given limited liability, only the corporation is liable for its own obligations. Shareholders cannot be asked to repay the debt of the company, so they only risk their investment.
On the other hand, directors and officers are not liable for corporate obligations if they acted respecting their fiduciary duties .

In small businesses such as private companies or limited liability companies it's possible that in order to obtain financial resources shareholders may be asked by potential creditors to use personal assets as collateral guarantees for reducing insolvency losses or granting a lower interest rate.

Question

When does the investment in a company begin and end?

Answer

When a corporation is formed, it has an independent perpetual existence. It is distinct from:

• Who gives the capital initially (shareholders) à they come and go, but business remain
• Who manage the business (directors and officers)

Legal personality tells the investors if and when the company close, but also the transferability of the shares can be intended as an ending of the investment.

Agency Theory

Question

Why are managers risk-averse?

Answer

As business organizations grow, managers tend to become risk-averse, as they would like to protect their position maximizing their chance of success by selecting easy tasks; this however does no longer result in the maximization of the shareholders' interests.

Question

Explain the concept of Bounded Rationality,

Answer

Contracts by nature are incomplete in the sense that they can't forecast all contingencies arising from the relationship between parties.

Bounded rationality is one of the characteristics that make contracts incomplete. It is the limited ability of humans to process information.

According to Williamson market performs poorly compared to internal production because the market relies on formal contracts, but, firms rely on relational contracts. And, with relational contracts we should have less opportunistic behavior, but the problem with bounded rationality never ends.

Question

What are agency costs and how many types are there?

Answer

Agency costs are the cost of relying on someone else to perform a task and comprehend three types of costs:

• Monitoring cost charged by principal: the principal cannot perfectly and costlessly monitor the action of the agent. If the agent is submitting himself to the monitor by the principal, this practice reduces monitoring costs. An example can be an employee that accepted to be supervised by its supervisor using a camera
• Bonding cost charged by agent: the agent cannot perfectly and costlessly reassure the principal about his skill and trustworthiness
• Residual loss charge by booth: the interests of principal and agent will always diverge to some extent

The sum of all three are called agency costs by Jansen and Meckling.

Holdup problem

Question

Explain the concept of Holdup Problem.

Answer

An holdup problem happens when two factors occur in a relationship:

• Asset specificity
• Opportunism

Example: in a franchising contract the franchisor typically asks the other party of the contract to make some investment that are some specific in the McDonald's business (equipment). After that investment the franchisor can threat the franchisee with higher prices.

Fiduciary Duties

Question

What are the managers' responsibilities to other?

Answer

Every director and officer can be viewed as an agent, and shareholders are principal.
Directors are tied with shareholders to protect fiduciary duties:

• Duty of care
• Duty to act in good faith
• Duty of loyalty

Agents can also be liable to third parties for damages

Question

Explain the concept of Fiduciary Duties.

Answer

Fiduciary duties are the highest standard of care, and include

• Duty of care
• Duty of acting in good faith and fair dealing
• Duty of loyalty

Duty of care is a legal obligation that is imposed on an individual, requiring adherence to a standard of reasonable care while performing any acts that could foreseeably harm others. The agent needs to act with:

• Care (e.g. making sure that the good delivered is as promised)
• Skill and experience (e.g. using previous studies or field experience)
• Prudence of like persons in a like position

An eventual plaintiff needs to prove the breach of duty of care, in doing this the agent will be more prudent in acting for third parties. So there is a tradeoff for the law in putting too much pressure. Example: a doctor always acts prudently if he knows that he can be punished.

Duty of acting in good faith and fair dealing are a general presumption that the parties to a contract will deal with each other honestly, fairly, and in good faith, so as to not destroy the right of the other party or parties to receive the benefits of the contract. They are placed between the duty of loyalty and duty of care.

Duty of loyalty represents a single obligation that directors and officers of any corporation owe the corporation. Typical behavior to explain it are:

• Self-dealing (a person is on both sides of the transaction)
• Person is in competition with the companyàserving two masters at the same time
• Overprotect company's control from hostile takeover (which will then change the board of directors)
• Duty regarding sensitive information and materials such as industrial trading

Question

Explain the concept of Business Judgement Rule

Answer

BJR is a set of rule created to protect managers acting on good behalf and are informed on a good basis. The BJR only protects the duty of care, but not the duty of loyalty.

With BJR directs the judges cannot examine the substantive merits of business decisions that are not contaminated by conflicts of interests or by gross negligence.

The BJR protects directors and top managers from liability of decision, the assumption is that sometimes they are simply unlucky. It has been implemented in two ways to be protected by shareholders and third parties:

• Conservative jurisdictions: managers are safe if they act with diligence and without conflict of interests
• Majority of jurisdiction: they are safe if they are informed before acting. "Courts do not measure, weight or qualify directors' judgment. We do not even decide if they are reasonable in this context. Due care I the decision-making context is process due care only. Irrationality is the outer limit of the BJR"

Corporate Governance

Delegated management

Question

Explain the concept of Delegated Management

Answer

Delegated management is one of the five common legal characteristics of a company. It is strictly related to the agency problem, and so related to agency costs.

When delegating a management role, an agency problem always arise due to the agency relationship.

Delegation is useful for:

• Size or scope of the activity
• Sophisticated level of operations
• Lack of specific skills or know-how
• Complicated decision-making process

Question

Explain the concept of Corporate Governance.

Answer

Corporate governance can include all rules that influence the governing bodies of the corporation including, for example, rules concerning the financial structure of the corporation or shareholders' agreement.

Question

Describe the various Corporate Governance models.

Answer

There are three main types of corporate models:

• One-tier system: there is a single organ called board of directors and it's responsible for managing the company and entrusted with full authority to manage the company.
  Committees are frequent, which are groups of members that deal with a specific matter and with some responsibility. The composition of the board of directors needs to include both, executive and independent directors. External members support to provide an objective approach and to monitor executives
• Two-tier system: there are three mandatory organs such as general shareholder meeting, supervisory board, non-executives and management board and executives. The difference between the one-tier is that the two-tier has a slow decision process but the outcome of the decisions are less contestable
• Latin model: the general shareholders meeting has to appoint both, the management board and the internal audit committee, also called the board of statutory auditors. The management board has to manage the business. The internal audit committee has to monitor the managers' activities, it stays normally for three years and it elects the external auditor. It is composed primarily of non-executive directors and at least one needs to have a financial/accounting background. The external independent auditors are normally selected by the board of statutory auditors and formally appointed by the general shareholders meeting

Question

What are the main differences between indipendent and non-executive directors?

Answer

Directors can be classified according to their role and their relationships with the company.

Role:

• Executive: employee of the company (example: CEO, CFO, COO, etc.). They are not necessary but, usually, they are sitting on the board of directors
• Non-executive: if they are not involved in the day-to-day management and they do not have a specific power to represent the company vis-à-vis third parties. If a director is non-executive not necessarily is also independent

Relationships:

• Independent: they cannot be executives and they supervise the executive in the board of directors. They need to have an autonomous judge. They do not maintain, directly or indirectly or on behalf of third parties, nor have recently maintained any business relationships with the issuer or persons linked to the issuer, of such a significance as to influence their autonomous judgement
• Non-independent: they have some degree of conflict of interests with the company, for instance they are spouses or contractors

Investors Ownership

Question

Explain the concept of Investor Ownership.

Answer

Any unspecified use of a resource (capital, labor) belongs to the owner to that resource. Owning a right on a resource means that one can control that resource.

Examples: if one invest some equity in a business project, the use of that equity is for the person that has invested in that project. Any return of the invested equity not dedicated to somebody else belongs to the investor; if a person buys machineries can do whatever he wants with it, if he rents it, he is limited by the contract's condition or mandatory rules by the law, because he doesn't have the residual claim.

The power of shareholders, also known as investors' ownership, consist of:

• Electing and remove directors
• Approving fundamental corporate changes (mergers, acquisitions, conversions, divisions, dissolutions)

All of these rights can be executed:

• Directly, in partnership, partners are entitled to manage the company
• Indirectly, in public held company shareholders are not entitled to manage the company

Question

What are the relationship between shareholders? How can they vote?

Answer

According to Jensen and Meckling, when shareholders are scattered out, all of them own a small fraction of the entire enterprise value. They have the same objectives and goals, but their economic incentives are so low that they don't want to put effort in monitoring the agent (in this case the management of the firm) and for them is difficult to find a coherent decision to give to managers.

So managers are free to do what they want inside the contract signed with the shareholders due to the lack of monitoring.

Shareholders can vote directly or indirectly, it depends if there is a separation between ownership and management. With direct voting they are also the managers and they can drive business decisions, if they are only shareholders they vote indirectly by appointing managers.

Question

What is a shareholders' agreement?

Answer

Under Italian law, companies can be incorporated by unilateral act or by agreement, but a public deed (atto pubblico) is required.

The shareholders may - at the same time or later – conclude a shareholders' agreement (patto parasociale) that is outside the deed of incorporation and the bylaws, Art. 2341-bis Codice Civile.

Such an agreement is just optional; it is not required for the formation of a company.

Examples: appointment of representatives to the boards, the restrictions on share transfers, the exercise of voting rights, the pre-emption rights on share transfers, the minority shareholders‘ protection.

Companies, depending on their status (public, private or resorting to capital market) will follow different sets of rules regarding this topic:

• Listed public companies: application of Art. 122 ss. Legislative Decree 58/1998 (consolidated law on finance).
• Closely held public companies: application of Art. 2341-bis Codice Civile (introduced by company law reform 2003).
• Public companies that resort to capital markets: application of Art. 2341-ter Codice Civile (introduced by company law reform 2003).

Question

Explain the concept of Cumulative Voting System.

Answer

The cumulative is a voting system thought for minority shareholders: multiple lists are presented and list owners (majority or minority) decide how to allocate votes on its candidates.

In Italy, list voting system is very similar to cumulative voting system:

• Each shareholders entitled to vote at the ordinary shareholders' meeting, shall have the right to submit a list
• Each list must not contain more than the number of directors up for election
• Any shareholder entitled to vote may vote only a single list
• Each shareholders can cast a number of votes proportionally to the number of shares held

Unlike cumulative voting, in list voting, the total number of votes obtained by each list is then divided by the progressive number assigned to each candidate. If list A has three candidates and obtains 12 votes,

• candidate 1 obtains 12 votes
• candidate 2 obtains 6 votes
• candidate 3 obtains 4 votes

In both systems candidates obtaining the highest scores (regardless of their original list) are eventually elected as member of the board.

Delaware Corporate Law

Question

Explain the concept of Nimble Dividend

Answer

The term "nimble dividends" refers to dividends that are paid out of the current earnings of the corporation notwithstanding the fact that the corporation otherwise would not be entitled to pay the dividend.
Nimble dividends is a dividend paid out of a corporation's current earnings when there is a deficit in the account from which dividends may be paid.
Nimble dividends are permitted in some states, while not in others.

Question

Explain the concept of Par Value and Accountable Par

Answer

A par value for a stock is its per-share value assigned by the company that issues it and is often set at a very low amount such as one cent.

since companies were required by state law to set a par value on their stock, they choose the smallest possible value, often one cent. This penny price is because the par value of a share of stock constitutes a binding two-way contract between the company and the shareholder.

If shareholders pay less than the par value for a share of stock and the issuing company later becomes unable to meet its financial obligations, its creditors can sue shareholders for the difference between the purchase price and the par value to recoup the unpaid debt. If the market price of the stock falls below the par value, the company may be liable to shareholders for the difference.

There is a choice of two basic types of no par value share: the "true" version permitted in the US and Canada and the "accountable par" model, permitted in Belgium and Luxembourg.

The "true" no par value share according to the American model has no par value and no share capital. The solution for voting rights, profit-sharing and the liquidation quota for the remaining assets is reduced to "one share-one vote" and the profit-sharing and the liquidation quota correspond to the number of shares. Under this model, the share capital is not reflected in the balance sheet. By implication, there is no direct correlate between shares and capital - as a result, both quantities can be changed independently of one another.

In the case of the "accountable par" value share, the share capital remain a balance sheet item, but the par values of the individual shares are repealed. By consequence, an arithmetical or "fictive" par value can still be assigned to the share by determining the amount of the individual share with respect to the entire share capital.

Unlike a stock, a bond has a real par value. The bond is worth its par value at maturity.

Eexample, if company XYZ issues 1,000 shares of stock with a par value of $50, then the minimum amount of equity that should be generated by the sale of those shares is $50,000. Since the market value of the stock has virtually nothing to do with par value, investors may buy the stock on the open market for considerably less than $50. If all 1,000 shares are purchased below par, say for $30, the company will generate only $30,000 in equity. If the business goes under and cannot meet its financial obligations, shareholders could be held liable for the $20-per-share difference between par and the purchase price.

Corporate Social Responsibility

Question

Explain the concept of Corporate Social Responsibility.

Answer

Corporate social responsibility is a self-regulating business model that helps a company be socially accountable to itself, its stakeholders, and the public. By practicing corporate social responsibility companies can be conscious of the kind of impact they are having on all aspects of society, including economic, social, and environmental.

Mostly for the benefit they obtain, shareholders have a long-term view and managers have a short-term view, so the law provides to disclose a lot of financial information for listed companies to increase the monitoring of agents. If those monitoring tools came from the law the costs for the principal are the same because the investors do not need to negotiate with the board of directors.

Legal personality

Freedom of incorporation

Question

Explain the concept of Legal Personality.

Answer

Legal personality is the right to held juridical relationships acquired after its incorporaration. Companies are created and recognized by State Law and they are based on contracts (articles of incorporation and by-laws).

So we have to deal with two types of rules:

• Jurisdiction: law under the country where the company is formed
• Parties: through the article of incorporation and the by-laws

When a corporation is formed, it has an independent perpetual existence. It is distinct from:

• Who gives the capital initially (shareholders)  they come and go, but business remains
• Who manage the business (directors and officers)

Question

Why is minimum capital required when founding a company?

Answer

In the European view, the minimum capital requirement protects creditors and gives incentives to be less afraid in financial markets.

On the other hand, US and UK view the goal that they want to achieve is efficiency, so with less capital required markets will be more efficient, because more firms occur due to fewer requirements.

The suggested minimum capital requirement from the European commission is 25k€, but the effective amount may vary depending on the State. For instance in Italy it is:

• 50k€ for SPA
• 10k€ for SRL
• 1€ for simplified SRL

In UK and Delaware, you only need to pay feed for the establishment.

Question

What are the advantages and disadvantages of the online formation of companies?

Answer

Pros:

• Less expensive
• Statutes, bylaws and other legal texts can be draft electronically. The formation shall be very efficient and fast and shall not take longer than 10 days
• The automatic procedures allow anyone, from anywhere, with the legal capacity to access the data

Cons:

• Online procedures could encourage fraudulently actions
• Only physical people can do it
• There will be no need to meet face-to-face with a notary or any other institution for the registration, so there is the need to set up a secure authentication system (such as eIDAS)

Question

What are the three steps of incorporation?

Answer

1. Drafting the instrument of the constitution: is the document that when is signed and notarized becomes filed within a public register it created the legal person. It tells to third parties:
   • Article of incorporation
   • The objective of the company c. Initial capital
   • Name of directors
2. Public checks
3. Registration on a public register ("Registro delle imprese" in Italy)

Question

What are the legal effects of incorporation?

Answer

When shareholders incorporate and when a contract is transformed into a legal person there is the need for 4 sets of rules in order to make work the legal personality in the market.

Only the law can provide for the segregation of affirmative assets, i.e. moving property from shareholders to the company; after that, a private agreement can slightly modify it. The first two rules below are a consequence of the segregation of assets.

1. Rule of priority: the personal creditors of shareholders have no recourse against the money of the company because of legal personality of the company completely separates from the shareholders. But, the creditors of the company have priority over the assets that have been segregated
2. Liquidation protection rule: shareholders of a company can't just go away whenever they want, unless the company has been created for an unlimited duration. Each shareholder is entitled to a pro quota share of the company and that money is necessary in order to keep the business going (otherwise they jeopardize every business future plan). They can sell their shares if they want to quit the company (free transferability of shares) or ask the company to liquidate a quota of their net assets at the present value
3. Attribution rule: the power of a person to act on behalf of the company. Usually, that power is concentrated in the board of directors, also often there is a double signature rule, it says that there will be at least two people who sign the contract (it's a way to make sure that no one is taking advantage of its power)
4. Standing right: it the right to sue and to be sued in court like a person

Freedom of Establishment

Question

Explain the concept of Freedom of Establishment.

Answer

The European Freedom of establishment prohibits restriction of freedom of establishment in national states, it's useful to not discriminate and to increase competition against jurisdiction.

Under article 49 of the TFEU there are two types of freedom of establishment, the first is intended as the prohibition of any type of restriction from the sovereign state and the second one refers to any branch, agency or subsidiary, but then the company is also under the jurisdiction of the host country.

Non-EU companies cannot enjoy the freedom of establishment. For enjoying the freedom of establishment the company needs to have at least one connecting factor with a EU jurisdiction:

• Register office: place where was founded
• Control administration: headquarter where it's managed
• Principal place of business: where the business is carried out

Question

Explain the concept of Internal Affairs Doctrine.

Answer

Generally speaking there are two choice of law principles that can be adopted in order to identify applicable corporate law rules to a court case:

• Freedom of incorporation principle (adopted in common law countries): the internal affairs are governed by the rules of the state in which the corporation is incorporated even if the corporation does no business in that state. In order to incorporate is generally sufficient to file the governing documents of the corporation (charters and by-laws) with the Secretary of State or other similar office, and to pay a small fee.
• Real seat approach (adopted in civil law countries): a corporation is subject to the rules of the state with which it has the strongest physical connection (real seat). The real seat is defined in different ways according to the jurisdiction (e.g. where corporate bodies meet).

Limited liability

Question

What is Limited Liability?

Answer

Limited liability is a legal status where a person's financial liability is limited to a fixed sum. It ensures the risk incurred by any member of a company or a corporation or other firm's organization be limited to be "equity interest" contributed to the business venture by each member, as corporate creditors have recourse only against the assets of the company and not the personal patrimony of the shareholders or managers.

It is important to stress that limited liability is a privilege of the members of the company, as the company itself is unlimited liable to third parties. Sometimes when trying to obtain a loan shareholders have to give something as collateral, only, in that case, banks or money providers can obtain personal assets.

Limited liability does not always come with legal personality (California until 1931 did not allow limited liability to shareholders).

The main advantages of LL are

• Incentivize investments
• Stimulate diversification among investors
• Reduce monitoring costs (managers and shareholders)
• Provide uniform share valuation
• Allow for IPO of companies

Its main disadvantages are

• Discouragement of credit extension
• Insider opportunism
• Externalization of risks borne by corporate creditors, including involuntary creditors
• Can incentive irresponsibility from shareholders

Creditor protection

Question

Explain the concept of Equitable Subordination.

Answer

Equitable subordination involves shareholders becoming creditors. They may become so legitimately or to improve selfishly their debt paid off priority.

Equitable subordination describe when a judge converts the credit (the first debt to be paid off) of the creditor-shareholder as equity (the last debt to be paid off) when there is this transformation has been abused.

The Court can make a clear distinction between "equitable subordination" and "recharacterization" of a claim: recharacterization cases turn on whether a debt actually exists, not on whether the claim should be equitably subordinated.

There are three key points in order to evaluate if equitable subordination should be applied in the US:

• The claimant must have engaged in some type of inequitable conduct
• The misconduct must have resulted in injury to the creditors or conferred an unfair advantage on the claimant
• Equitable subordination must not be inconsistent with the provisions of the bankruptcy act

The doctrine was born in the US, but it now exist also in other countries.

Trusts

Definitions

Question

Explain the concept of Trust.

Answer

A trust is a principal-agent relationship where the principal, called settlor, does not receive benefits from the trust, unlike the third party called beneficiary.

Question

What are the main differences between fixed and discretionary trusts?

Answer

Fixed trust: the trustee doesn't have to choose if they want the assets or not.

Example: 300 shares in Alpha limited company on trust for my two children in equal shares (150 shares each one).

Discretionary trust: the trustee can choose if they want the assets or not. The settlor can set up some principles in order to facilitate the trustee's choice.

Example: 300 shares in Alpha limited company on trust in such shares as my trustees in their absolute discretion may decide.

Roles

Question

What is the role of trustee in Trusts?

Answer

A trusteeis the legal owner of the trust property who holds it and administers it for the benefit of the beneficiaries. The trustees will normally be named in the trust document (it could be a human being or a legal person) and will frequently include the settlor. This will enable the settlor to have a degree of ongoing control over the trust property whilst alive. It is generally unwise for the settlor to be the sole trustee.

Trustees of both fixed and discretionary trusts are sometimes given a number of powers, such as

• power of appointment
• power to employ agents
• power to add beneficiaries
• power to take away beneficiaries
• power to appoint new trustees

Question

What is the relationship between a settlor and a trustee?

Answer

The settlor is the person who creates the trust and transfers money or other assets (such as real estate or factories) to the trustee. The settlor can be more than one person.

The trustee is the legal owner of the trust property that holds it and administers it for the benefit of the beneficiaries. The trustees will normally be named in the trust document (it could be a human being or a legal person) and will frequently include the settlor.
This will enable the settlor to have a degree of ongoing control over the trust property whilst alive. It is generally unwise for the settlor to be the sole trustee.
The settlor can be the beneficiary (as a warranty) and also the trustee (as an example if we have a guy that has 30 years he could set up a trust to pay his children college, if so there is no need of constitution).
But, creditors can attack the trust in order to obtain the credit.

Question

What is the role of debtors in Trusts?

Answer

If you are the trustmaker, also known as the "settlor" or "grantor", it is essential to create an irrevocable trust if you want to protect the assets you place in the trust. Because revocable trusts can be terminated or modified at any time, your creditors will typically be able to reach the assets in an irrevocable trust since you normally, technically retain control over and benefit from them.

However, with irrevocable trusts, you often give up control over its assets and receive no benefit. In essence, legal title is effectively, and permanently, transferred to a third-party, here the trustee. This means that, in many situations, creditors can't collect money from an irrevocable trust to cover your debts as the grantor.

If you are the beneficiary of an irrevocable trust, judgment creditors will not typically be able to take money directly from the trust. However, they usually can access distributions you receive from the trust. When family trusts include a "spendthrift clause," which limits the amount of income the trustee can distribute to a beneficiary, it can help protect assets from creditors as long as they remain in the trust, except in some limited circumstances in some states.

As is often the case when it comes to the law, the answer to this question is "it depends." If you have transferred your assets into a revocable trust, your creditors will typically be able to access those revocable trust assets to satisfy a judgment debt. However, if you have transferred your assets into an irrevocable trust or if you are the beneficiary of a trust, the answer can become a bit more convoluted.

Effects

Question

Describe internal trust in Italy and the economic effects of trusts.

Answer

An internal trust can be viewed as all the parties and assets in the trust are based in Italy.
The economic effects are the same of the agency relationship.

Question

What are the consequences of objects (beneficiaries) being held on trust?

Answer

Beneficiaries are the people for whose benefit the trust has been established.

A beneficiary's precise entitlement will depend upon the terms of the trust: he or she may be entitled to income (e.g. life interest), income and capital (e.g. absolute interest) or income and capital at the discretion of the trustees (e.g. potential interest).

A beneficiary is entitled to have the trust administered in a proper manner by the trustees. Subject to any exclusion clause, if the trustees act improperly and the trust suffers loss, a beneficiary can sue the trustees personally to make up the shortfall.

They have rights to information (financial statement, etc.).

In order to enforce the trust, the beneficiaries need to demonstrate the manifestation of intents of the settlor.

The question is what is the minimum degree of certainty necessary for the trustee and the court to do their respective jobs. Three certainties of a trust:

• Certainty of intention: clear settlor's declaration of intention (a proof)
• Certainty of subject: clear assets within the trust
• Certainty of objects: it must be clear who are the beneficiaries

Court cases

Fiduciary duties

Question

Discuss the Doge vs. Ford case and list some relevant issue.

Answer

Ford had the majority of shares in the Ford Motor Company and Dodge brothers had the minority. Ford was also an executive but Dodge only enjoyed dividends. Dodge sued Ford for two reasons:

• Dividend policy: Ford Motor Company had a lot of retained earnings and didn't want to pay promised dividends
• Construction of a plant: an injunction to forbid the proposal of the construction of the River Rouge plant

At the end Ford was protected by the BJR regarding the second point, while for the first point judges pointed out that a business corporation is organized and carried on primarily for the profit of the stockholders. The power of the directors is to be employed for that end.

The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the non-distribution of profits among stockholders in order to devote them to other purposes.

Question

Explain the Duty of Loyalty and its application in the Salmon vs. Meinhard case.

Answer

The duty of loyalty is one of the fiduciary duties that directors and officers owe to the corporation. To respect that duty directors must not:

• Self-dealing
• Competition with the company
• Overprotect company from a hostile takeover
• Share sensitive information and materials

A famous case where the duty of loyalty has been breached is Salmon vs Meinhard case. Meinhard gave to Salmon for 20 years the leasing of a building and when the lease was about to expire another man called Gerry approached Salmon to negotiate a substantial redevelopment of the property, so Salmon resigned the lease without telling Meinhard.
When Meinhard found out sued Salmon.

The duty of loyalty was breached where the partner appropriated to himself a benefit arising from his status as a partner without allowing his co-partner an opportunity to compete (duty of disclosure).

Investors ownership

Question

Discuss the McDermott Inc. vs. Lewis case focusing on the Internal Affairs Doctrine

Answer

McDermott International is a Panamian corporation, parent of the Delawarean McDermott Inc. company. Despite being a subsidiary, the latter company also owned substantial shares in hte parent company.

In 1987 plaintiff shareholders, Harry Lewis and Nina Altman, of defendant McDermott Inc., sought to enjoin or rescind a reorganization under which McDermott Inc. became a majority owned subsidiary of the Panamanian corporation McDermott International, and owned approximately 10 percent of the parent corporation's common stock. The trial court granted partial summary judgment in favor of plaintiffs, and defendant McDermott Inc. appealed.

The court held that Delaware conflicts law, due process, and the commerce clause mandated application of the internal affairs doctrine, under which Panamanian law governed the issue.

Full faith and credit commands application of the internal affairs doctrine except in the rare circumstance where national policy is outweighed by a significant interest of the forum state in the corporation and its shareholders.

Question

Discuss the Examen Inc. vs. VantagePoint Venture Partners case focusing on the Internal Affairs Doctrine

Answer

VantagePoint Venture Partners (defendant) held 83% of preferred stock and 0% of common stock in Examen Inc., a Delaware corporation with ties to California. In 1996 Examen (plaintiff) entered into a merger agreement with another corporation in Massachusetts, but VantagePoint opposed the merger.

• under Delaware law, the merger would require the approval of Examen's shareholders voting as a single class, and VantagePoint would lack the votes to block the merger
• under California law, the preferred shareholders would be entitled to vote as a separate class; since VantagePoint controlled the preferred shareholder class, it could defeat the merger

A California statute purports to apply California law to foreign corporations if the corporation has sufficient ties to California. However, Examen filed suit in Delaware, seeking a declaratory judgment that Delaware law applied in spite of the Californian statute.

The conflict of laws principle which recognises that only one state should have the authority to regulate a corporation’s internal affairs: the state in which the corporation is incorporated. Since Examen is a Delaware corporation, Delaware law will apply to its internal affairs and all stockholders will be permitted to vote on the proposed merger as a single class.

Legal personality

Question

Discuss the Centros vs. Denmark case focusing on the Freedom of Establishment

Answer

In 1997, the LL UK company Centros decided to register in Denmark, where it was conducting businesses. The Danish authority asked to deposit the minimum amount of share capital (200k DKK), while in UK the minimum was 1£. Centros argued that it had the right to be recognised in Denmark under the provisions of freedom of establishment in the EC Treaty.

The CJEU held that the Danish authorities' refusal to recognise the company was contrary to articles 52, 56 and 58, and that its rules on minimum capital were not justified by the aim of protecting creditors by anticipating the risks of fraudulent bankruptcy due to the insolvency of companies having inadequate initial capitalisation.
National authorities can adopt less restrictive measures, such as enabling creditors to obtain necessary guarantees, or could adopt measures preventing or penalising fraud, if necessary with the cooperation of another Member State.

Question

Discuss the Polbud vs. Poland case focusing on the Freedom of Establishment

Answer

In September 2011, the shareholders of Polbud, a LL company established under Polish law, decided to transfer the company's registered office from Poland to Luxembourg. This operation completed in May 2013, and subsequently, the new company "Consoil Geotechnik" lodged an application with the Polish registry court for its removal from the commercial register. This application was refused to be registered because, as the registry court stated, Polbud failed to provide evidence of the successful execution of a liquidation procedure. Polbud appealed against this decision, arguing that no liquidation was needed because the company continued to exist as a legal person incorporated under Luxembourgish law.

The CJEU stated that:

• the freedom of establishment applies to the transfer of the registered office of a company from one Member State to another even if no real business is intended to be conducted in the latter Member State
• the transfer of a registered office from one Member State to another cannot presume a fraud or justify a measure that adversely affects the exercise of a fundamental freedom guaranteed by the Treaty
• the regulatory power of a Member State (Poland) ends when a company (Polbud) converts itself into a company (Consoil Geotechnik) governed by the law of another Member state (Luxemburg)
• the State of origin is only allowed to provide legislation for the protection of public interests (such as the protection of creditors, minority shareholders and employees) but cannot impose mandatory liquidation

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Authors: Giacomo, Edoardo, Matteo