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LLM Law Outlines Corporation Outlines

Limited Liability And The Rights Of Creditors Outline

Updated Limited Liability And The Rights Of Creditors Notes

Corporation Outlines

Corporation

Approximately 210 pages

Corporation with Kahan Autumn 2018...

The following is a more accessible plain text extract of the PDF sample above, taken from our Corporation Outlines. Due to the challenges of extracting text from PDFs, it will have odd formatting:

A. Limited Liability

  • Shareholders enjoy limited liability

  • In effect shifted some of the risk of business failure to debtholders

  • More debt means higher expected returns to shareholders; and to the extent that debtholders expect risk to be shifted, higher interest rate as well

  • Limited liability also alters control over corporate assets

    • Shareholders with limited lability can more easily abandon responsibility for the obligations of the firm that goes bankrupt

    • Limited liability implies that creditors (rather than shareholders) will control the business over a broader range of circumstances in which it performs poorly

Example

  • ABC manufactures carpet cleaning fluids, A is the CEO and own 75% of its stock, 25% owed by Tamara (A’s cousin). 7 years ago, T moved to Indonesia and doesn’t involve in management of ABC, but receives dividend every 3 months.

  • Company liquidated, valued at $4M + A and T both have personal assets of $3M each.

    • But ABC borrowed $5M from FC Bank due to poor business + $2M litigation debt owe to R + $50k owe to A + $500k due wages owe to employees.

  • Should A be able to recover a portion of the salary owed to her by ABC? Whether T deserves her dividend.

    • She worked for her wage, but wage decided by directors (herself) whether she deserve such amount?

    • Promote industry by permitting ABC to steal resources from others

    • What if it was intentionally paid immediately before company liquidate?

      • Intentionally to avoid paying creditors

  • Should the bank be paid?

    • Bank assumes/agree to the risk, as it is a sophisticated creditor who got into the deal, knowing the legal rule, don’t have a ‘no recourse’ clause in the contract

  • Should Rich be paid?

    • For suppliers to prevent non-payment, can protect themselves (e.g. to ask for guarantee, payment upfront, retention of title, no recourse). If they did not they assume the risk. But Rich didn’t assumed he risk that there would be an accident and ABC would not have money to compensate him

    • If A was negligent/ at fault personally/ could’ve done more Rich still sued her due to corporate veil

      • But cause of action: product liability (need not show negligent) only co. liable for its products

      • Corporate veil prohibits Rich to sue A, ABC is a separate entity – as we want to promote corporate activities

  • How is risk on bank and Rich different?

    • Risk is negative

    • For shareholders: amount owe to supplier is known no uncertainty = no risk

    • Shareholders don’t know amount owe to Rich yet uncertainty = risk

      • But ABC could have buy liability insurance ABC only need to pay insurance cost (cost of doing business)

      • Rich can also take out insurance

    • So who should get insurance? Whom should we impose burden on?

      • ABC in better position to control risk should impose burden on ABC

      • Rich can only buy comprehensive insurance (health, disability, against accidents) – whether insurance popular in the society

  • Would answer be different if ABC were publically held corporation?

  • How would you express the legal principal that should govern shareholder liability for corporate debts?

    • Separate legal entity shareholders should not be liable personally for corporate debt encourage corporate activities

    • But a business that yields enough profit is business we want to encourage + people should want to invest without limited liabilities.

    • Usually need limited liability because they are not profitable don’t need businesses that is not profitable

  • What kind of incentives would be created by such principles? Are these incentives desirable?

    • If company does well, A and T would benefit; if things go bad, R shouldn’t be responsible for it

    • Imposing cost creates incentive for A to exercise care

Commentator: Frank Easterbrook & Daniel Fischel

  • Publicly held co. is the most popular form of business

  • Facilitates division of labour, managerial skills and provision of capital may be separated

  • Holder of a diversified portfolio of investment is more willing to bear the risk that a small fraction of his investment will not pan out

  • Separation of investment and management comes with cost: agency problem

    • managers who do not obtain the full benefits of their own performance do not have the best incentives to work efficiently

    • costs generated by agency relations are outweighed by the gains from separation and specialization of function

  • Limited liability reduces

    1. the costs of this separation and specialization; and

      • investors' potential losses are "limited" to the amount of their investment as opposed to their entire wealth, they spend less to protect their positions

      • limited liability decreases the need to monitor

      • many investors will have diversified holdings, who would have neither the expertise nor the incentive to monitor the actions of specialized agents

      • The price investors are willing to pay for shares will reflect the risk that the manager’s acts may cause them loss

        • Mangers therefore find ways to offer assurances to investors without the need for direct monitoring

    2. the cost of monitoring other shareholders

      • Without limited liability, shareholders have incentive to engage costly monitor of other shareholders to ensure other shareholders are wealthy.

      • The greater the wealth of other shareholders, the lower the probability that any one shareholder's assets will be needed to pay a judgment

      • limited liability makes other shareholders irrelevant and thus avoid these costs

Commentator: Henry Hansmann & Reinier Kraakman

  • Limited liability in tort create incentives for excessive risk-taking by permitting corporations to avoid the full costs of their activities

    • incentives: price of securing efficient capital financing for corporations

  • Some propose to limit such limit liability for some classes of tort claims/ type of corporations to control its worst abuses but all these proposals retains limited shareholders liability as the general rule

  • Limited lability: a firm owns a wholly-owned subsidiary undertakes investment create risk of tort liability exceeding...

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