Lecture 1, Introduction to law
Public law: relationship between the state and its citizens
Private/civil law: rights and duties of individuals towards each other (Business law is for 90% private law)
There is not just one business law, but there are multiple. Main jurisdictions:
- UK (common law)
- US (common law)
- Continental European countries (civil law)
Civil law: the very detailed written laws (e.g. Dutch civil code) is the primary source of law,
afterwards we have the ‘case law’ → the judges adhere to the law
Common law: the case law comes before the written law, judgement from the judges is primary to
written law → the judges interpret the law
Case law: verdicts, judgement by judges. Decision made prior by other judges form the information
on which other legal decision are made.
Business Forms
Corporations Partnerships Sole proprietorship
Private corporations (closely-held General partnership Sole proprietorship
Limited partnership
Public corporation (open) Limited liability partnership
Limited liability limited
partnership
The course focuses on corporations, because corporations are way more regulated than
partnerships.
Corporations (Companies with Share Capital)
Shareholders are always referred to as the owners of the
firm
Introduction to the jurisdictions: US
- Federal government
- State governments
Courts: Federal courts on federal subject matters or interstate suits
States: everything else, including corporate law
Companies are free to incorporate in any state regardless of whether they are doing business there
or have any contact with this state. Most corporations are incorporated under the law of the state
Delaware! Why Delaware? According to the literature Delaware has a reputation to be friendly
towards corporations:
- There is a political consensus to keep the Delaware Corporation law modern and up-to-date
o Example: virtual shareholders’ meeting
o Low administrative burden
- Experienced judges (not just corporate law, but also corporate finance judges)
- Tax policy
1
,Introduction to the jurisdictions: Europe
Member States have national statutory company law but are also subject to European law. The EU
uses 3 law instruments:
- Regulations: a binding legislative act. It must be applied in its entirety across the EU
o It has a direct effect on all the member states
- Directives: set out a goal that all EU countries must achieve. However, it is up to the
member states to devise their own laws on how to reach these goals.
o Minimum and maximum harmonization
o Directives only have an effect once they are implemented into the national law,
countries can choose to specifically include some laws and not include others.
- Recommendations: not binding. A recommendation allows the institutions to make their
views known and to suggest a line of action without imposing any legal obligation on those
to whom it is addressed
There is less regulatory competition (like the competition with Delaware) in Europe than in the US.
Why?
- Reputational aspects: Particularly, the Dutch people are very familiar with the BV, and
therefore, in some situations rather do business with this type of company compared to the
relatively less known SARL (France) or GMBH (Germany). You can see this (thus, that every
country has its own corporate form) as an extra reason that regulatory competition in
Europe is less present than in the US (all are inc. or corp).
However, the main reason is of course that in the US you always can incorporate in any state
no matter where your business activities take place:
- Two conflicting doctrines in Europe:
o Doctrine of incorporation
▪ Company laws applicable to the legal entity are those of the jurisdiction in
which the legal entity has been incorporated, irrespective of the ‘real seat’.
So the legal basis of the company and the main center of activities do not
have to be in the same country.
o Doctrine of real seat
▪ The place where the company is effectively managed or operated is the
country from the laws are applied. Hence, a company cannot simply adopt
the legal structure of a French company, or a French company cannot simply
move its business elsewhere!
Soft Law Requirements
We have mandatory law and soft law
Soft law refers to Corporate governance codes. Soft law includes principles and best practices. As a
company you should comply with these best principles if not, you mandatorily have to explain why
you deviate from these principles
- The US generally doesn’t have a corporate governance code
The Five Characteristics of Corporations
Basic legal characteristics (Contractual Efficiencies):
1. Legal personality
2. Limited Liability
3. Transferability of shares
4. Delegated management under a board structure
5. Investor ownership
2
,1. Legal Personality: implies that the corporation is a legal person. It enables the corporation to
operate as a single contracting party with a perpetual life that is distinct from corporate actors such
as board members and shareholders. In order to enter contracts or use its entitlements of
ownership such as using or selling the assets, the corporation needs representatives to act on its
behalf. The corporation is the legal owner of the corporate assets, which are separated from the
assets of the shareholders. As a result, the creditors of the shareholders cannot claim the firm’s
assets. This separated pool of assets that belongs to the corporation and is distinct from the
shareholders is often denoted as a separate patrimony in law. An important function of this separate
patrimony is entity shielding.
Entity shielding consists of the priority rule and liquidation protection.
- Priority rule entails that the creditors of the corporation have a first claim on the assets of
the corporation. The assets are automatically available for the enforcement of contractual
obligations of the corporation by its creditors.
o Fixed claimants: Creditors (that have a priority claim)
o Residual claimants: shareholders (receive all residual proceeds after the fixed
claimants are paid)
- Liquidation protection includes that the shareholders – as the owners of the corporation – or
the shareholders’ creditors cannot withdraw their share of the corporation’s assets at will.
The assets are thus protected against liquidation by a shareholder or the shareholder’s
creditor.
- Shareholders: owners of the shares not the assets (entity shielding; liquidation protection
and the priority rule)
o Entity shielding= the company has its own assets and are owned by the company
and not by the shareholders (also called liquidation protection). So shareholders
cannot withdraw the assets of a company at will. The company is a legal person and
owns the assets itself
▪ Creditors have the first claim directly on the asset,
2. Limited Liability
Owner shielding: Creditors of the corporation are limited to making claims against the corporation’s
assets and have no claims against those assets that are owned by the shareholders.
- Whereas legal personality protects the corporation’s assets against claims from shareholders and the
shareholders’ creditors, limited liability provides protection to shareholders as the corporate owners
Limited liability is a right that belongs to the shareholders rather than the company itself.
Advantages of limited liability:
- It stimulate entrepreneurship and R&D
- Fosters investment
- Enables portfolio diversification (imagine being liable for a full portfolio of companies)
Asset Partitioning
A= Entity shielding (liquidation protection);
B= Entity shielding (liquidation protection);
C= Owner shielding;
D= Entity shielding (priority rule, a priority claim on the
assets)
3
, This example shows the different incentives of shareholders and creditors:
Two projects: A: B:
90% chance to gain 1000 90% chance to gain 0
10% chance to gain 1500 10% chance to gain 5000
Every project costs 1000,- but you can only choose one of these projects and you loan the
1000,- from a bank.
- Which project does the bank want you to choose? Project A because then they are
guaranteed to get their money back
- What do your shareholders want? They want B, they won’t get anything from the first 1000,-
since this goes to the bank. So they only focus on the amounts above 1000,- which is more in
project B
Tort victims: another type of creditor, namely “involuntary creditors” such as former employees
suffering from asbestos, industrial accidents etc.
- They cannot write down their terms ex ante, because they don’t voluntary choose this. You
can either agree or not
CASE example
Salomon v Salomon & Co Ltd. (1897, UK)
- Aaron Salomon: manufacturer of leather boots
o Sole proprietorship, but he wanted his business to be corporate
- He sold his business to a new corporation he formed;
o Seven ‘members’ (shareholders): 20,007 shares
▪ At that time you needed 7 shareholders/members to set up a corporation
o £10,000 secured debt instrument
▪ If you have a bankruptcy this 10.000 will be payed to you first before the
debts are claimed
- Correctly incorporated
However, the business failed. No sufficient assets left to pay all creditors… the creditors were angry
because the company was the same as it was before. It was still just Aaron Salomon, so they believed
they should be able to claim Aaron’s personal assets. However, due to the ‘corporate’ status of the
company this was not allowed by the court. So the creditors were left with nothing
- “[…] The company is at law a different person altogether from the subscribers to the
memorandum; and, though it may be that after incorporation the business is precisely the
same as it was before, and the same persons are managers, and the same hands receive the
profits, the company is not in law the agent of the subscribers or trustee for them. Nor are
the subscribers as members liable, in any shape or form, except to the extent and in the
manner provided by the Act. […]”
Veil Piercing: uplifting the limited liability, so the shareholders become fully liable
- Largely based on case law
- Mostly exceptions, except in Brazil: unlimited shareholder liability to compensate workers,
consumers and the environment.
4
Public law: relationship between the state and its citizens
Private/civil law: rights and duties of individuals towards each other (Business law is for 90% private law)
There is not just one business law, but there are multiple. Main jurisdictions:
- UK (common law)
- US (common law)
- Continental European countries (civil law)
Civil law: the very detailed written laws (e.g. Dutch civil code) is the primary source of law,
afterwards we have the ‘case law’ → the judges adhere to the law
Common law: the case law comes before the written law, judgement from the judges is primary to
written law → the judges interpret the law
Case law: verdicts, judgement by judges. Decision made prior by other judges form the information
on which other legal decision are made.
Business Forms
Corporations Partnerships Sole proprietorship
Private corporations (closely-held General partnership Sole proprietorship
Limited partnership
Public corporation (open) Limited liability partnership
Limited liability limited
partnership
The course focuses on corporations, because corporations are way more regulated than
partnerships.
Corporations (Companies with Share Capital)
Shareholders are always referred to as the owners of the
firm
Introduction to the jurisdictions: US
- Federal government
- State governments
Courts: Federal courts on federal subject matters or interstate suits
States: everything else, including corporate law
Companies are free to incorporate in any state regardless of whether they are doing business there
or have any contact with this state. Most corporations are incorporated under the law of the state
Delaware! Why Delaware? According to the literature Delaware has a reputation to be friendly
towards corporations:
- There is a political consensus to keep the Delaware Corporation law modern and up-to-date
o Example: virtual shareholders’ meeting
o Low administrative burden
- Experienced judges (not just corporate law, but also corporate finance judges)
- Tax policy
1
,Introduction to the jurisdictions: Europe
Member States have national statutory company law but are also subject to European law. The EU
uses 3 law instruments:
- Regulations: a binding legislative act. It must be applied in its entirety across the EU
o It has a direct effect on all the member states
- Directives: set out a goal that all EU countries must achieve. However, it is up to the
member states to devise their own laws on how to reach these goals.
o Minimum and maximum harmonization
o Directives only have an effect once they are implemented into the national law,
countries can choose to specifically include some laws and not include others.
- Recommendations: not binding. A recommendation allows the institutions to make their
views known and to suggest a line of action without imposing any legal obligation on those
to whom it is addressed
There is less regulatory competition (like the competition with Delaware) in Europe than in the US.
Why?
- Reputational aspects: Particularly, the Dutch people are very familiar with the BV, and
therefore, in some situations rather do business with this type of company compared to the
relatively less known SARL (France) or GMBH (Germany). You can see this (thus, that every
country has its own corporate form) as an extra reason that regulatory competition in
Europe is less present than in the US (all are inc. or corp).
However, the main reason is of course that in the US you always can incorporate in any state
no matter where your business activities take place:
- Two conflicting doctrines in Europe:
o Doctrine of incorporation
▪ Company laws applicable to the legal entity are those of the jurisdiction in
which the legal entity has been incorporated, irrespective of the ‘real seat’.
So the legal basis of the company and the main center of activities do not
have to be in the same country.
o Doctrine of real seat
▪ The place where the company is effectively managed or operated is the
country from the laws are applied. Hence, a company cannot simply adopt
the legal structure of a French company, or a French company cannot simply
move its business elsewhere!
Soft Law Requirements
We have mandatory law and soft law
Soft law refers to Corporate governance codes. Soft law includes principles and best practices. As a
company you should comply with these best principles if not, you mandatorily have to explain why
you deviate from these principles
- The US generally doesn’t have a corporate governance code
The Five Characteristics of Corporations
Basic legal characteristics (Contractual Efficiencies):
1. Legal personality
2. Limited Liability
3. Transferability of shares
4. Delegated management under a board structure
5. Investor ownership
2
,1. Legal Personality: implies that the corporation is a legal person. It enables the corporation to
operate as a single contracting party with a perpetual life that is distinct from corporate actors such
as board members and shareholders. In order to enter contracts or use its entitlements of
ownership such as using or selling the assets, the corporation needs representatives to act on its
behalf. The corporation is the legal owner of the corporate assets, which are separated from the
assets of the shareholders. As a result, the creditors of the shareholders cannot claim the firm’s
assets. This separated pool of assets that belongs to the corporation and is distinct from the
shareholders is often denoted as a separate patrimony in law. An important function of this separate
patrimony is entity shielding.
Entity shielding consists of the priority rule and liquidation protection.
- Priority rule entails that the creditors of the corporation have a first claim on the assets of
the corporation. The assets are automatically available for the enforcement of contractual
obligations of the corporation by its creditors.
o Fixed claimants: Creditors (that have a priority claim)
o Residual claimants: shareholders (receive all residual proceeds after the fixed
claimants are paid)
- Liquidation protection includes that the shareholders – as the owners of the corporation – or
the shareholders’ creditors cannot withdraw their share of the corporation’s assets at will.
The assets are thus protected against liquidation by a shareholder or the shareholder’s
creditor.
- Shareholders: owners of the shares not the assets (entity shielding; liquidation protection
and the priority rule)
o Entity shielding= the company has its own assets and are owned by the company
and not by the shareholders (also called liquidation protection). So shareholders
cannot withdraw the assets of a company at will. The company is a legal person and
owns the assets itself
▪ Creditors have the first claim directly on the asset,
2. Limited Liability
Owner shielding: Creditors of the corporation are limited to making claims against the corporation’s
assets and have no claims against those assets that are owned by the shareholders.
- Whereas legal personality protects the corporation’s assets against claims from shareholders and the
shareholders’ creditors, limited liability provides protection to shareholders as the corporate owners
Limited liability is a right that belongs to the shareholders rather than the company itself.
Advantages of limited liability:
- It stimulate entrepreneurship and R&D
- Fosters investment
- Enables portfolio diversification (imagine being liable for a full portfolio of companies)
Asset Partitioning
A= Entity shielding (liquidation protection);
B= Entity shielding (liquidation protection);
C= Owner shielding;
D= Entity shielding (priority rule, a priority claim on the
assets)
3
, This example shows the different incentives of shareholders and creditors:
Two projects: A: B:
90% chance to gain 1000 90% chance to gain 0
10% chance to gain 1500 10% chance to gain 5000
Every project costs 1000,- but you can only choose one of these projects and you loan the
1000,- from a bank.
- Which project does the bank want you to choose? Project A because then they are
guaranteed to get their money back
- What do your shareholders want? They want B, they won’t get anything from the first 1000,-
since this goes to the bank. So they only focus on the amounts above 1000,- which is more in
project B
Tort victims: another type of creditor, namely “involuntary creditors” such as former employees
suffering from asbestos, industrial accidents etc.
- They cannot write down their terms ex ante, because they don’t voluntary choose this. You
can either agree or not
CASE example
Salomon v Salomon & Co Ltd. (1897, UK)
- Aaron Salomon: manufacturer of leather boots
o Sole proprietorship, but he wanted his business to be corporate
- He sold his business to a new corporation he formed;
o Seven ‘members’ (shareholders): 20,007 shares
▪ At that time you needed 7 shareholders/members to set up a corporation
o £10,000 secured debt instrument
▪ If you have a bankruptcy this 10.000 will be payed to you first before the
debts are claimed
- Correctly incorporated
However, the business failed. No sufficient assets left to pay all creditors… the creditors were angry
because the company was the same as it was before. It was still just Aaron Salomon, so they believed
they should be able to claim Aaron’s personal assets. However, due to the ‘corporate’ status of the
company this was not allowed by the court. So the creditors were left with nothing
- “[…] The company is at law a different person altogether from the subscribers to the
memorandum; and, though it may be that after incorporation the business is precisely the
same as it was before, and the same persons are managers, and the same hands receive the
profits, the company is not in law the agent of the subscribers or trustee for them. Nor are
the subscribers as members liable, in any shape or form, except to the extent and in the
manner provided by the Act. […]”
Veil Piercing: uplifting the limited liability, so the shareholders become fully liable
- Largely based on case law
- Mostly exceptions, except in Brazil: unlimited shareholder liability to compensate workers,
consumers and the environment.
4
