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Business Law The Firm

Part 1.A Company law = Micro-micro economics

Modern business frim own assets, enter contracts and incur liabilities that are legally separate from those of their
owners and managers
Study modern business firm, investigate:
Key features, how it is financed and governed

General statements, what is a firm?

Organisational form, through which suppliers of various inputs can come together
and coordinate their activities to achieve certain objectives
Business activities, designed to make profits
Some may aim to promote charitable and other objectives

Some organisational forms:

Companies, USA: Corporation, Italy: Societ, France: Societe, Germany:
Aktiengesellschaft, Gesellschaft mit beschrnkter Haftung
Cooperatives, Italy: cooperative, Germany: Genossenschaft
Associations, trusts, other forms of non-profit organisations Focus on business

Part 1.B Law and the rise of the Firm

Law and economics
Organisation is framed by the law, as an institutional device making things possible
No law, no modern business firm
1: Property law
Private property system, gives individuals the exclusive right to use their property as they wish
Dominion over own assets, gives owners full account of all benefits and the costs of usage
Process of weighting costs and benefits produces efficient outcomes
2: Contract law
Essence of free market economy ability of private parties to enter into voluntary agreement that govern
the economic exchange between
Contract law sets the rules for exchanging individual claims to entitlements and determines extents to
which society is able to benefit from trades
Default rules applies only in case of absence of agreement by relevant parties to be governed by a
different rule
Unless the parties have differently agreed, Rule A applies or Rule A applies, if the parties have not chosen
a different rule.
Mandatory rules are seldom limit freedom of contract and freedom of trade
3: Tort law
Relationships between people for whom transactions cost are rather high
Economic essence use of liability to internalise externalities created by high transaction costs
One of many instruments to internalise externalities
Back to Law and Firms
Law is an institutional device to organise societies and human activities
In western countries the law governing trade, business activities and organisational forms is very similar
Reasons: Trade, imitation and influence (Genoese were imitated by the Dutch, trading with the British etc.)
Essence of contract law: agreements are binding, with few exceptions
Parties can enter binding agreements, exchange goods and services and coordinate activities
Note: Economists tend to overestimate the differences between common law and continental law Firms
and Law
Are firms a matter of contract law?

Coase, The Nature of the Firm 1937

Why are there organisations of the type represented by firms?
Why is each firm of certain size?

Coase, 1937: The Firm vs the market

Firms originate when allocative measures are carried out at lower total production,
contract and administrative costs within the firm than by means of purchase and
sales on the market
A firm expands to the point where an additional allocative measure costs more
internally than in would through a contract on the market
if transaction costs were zero, no firm would arise, allocations would take place
through simple contracts between individuals on the market

Coase, The Nature of the Firm, 1937: The firm as a set of incomplete contracts
Two types of contracts One stipulates the parties total obligations or reverse
rights, the other is left incomplete by not specifying all obligations thus allowing a
free margin for unilateral decisions by pone of the parties
Open contract can be exemplified by employment contracts, usually leaving room for
directions and orders
Firms are characterised by latitude for decision created by a particular cluster of such
open contracts
Related to the rest of the world by other fully specified contracts, regarding
purchases of inputs, sales of production and loans under prescribed terms

Transaction costs
Under the standard assumption of zero transactions costs, externalities
would vanish, because it would be less costly for the parties to bargain an
efficient result
There would never be an occasion for vertical integration, contracts would
cost less to complete
Pushing the need for positive transactions costs, arise three problems
1. Positive transaction costs are everywhere, rationalisations were easy and
TC got a bad name focus on basics
2. Not sufficient to show largeness of transactions costs, you had to highlight
the differences across alternative modes, markets and hierarchies
3. Analytical framework needed from which predictions can be derived and
empirical tests concluded
Market: Spot contracts Complex contractual setting
Some form of joint organisation, e.g. consortium, joint venture Firm

Entrepreneur Managers Clients

Organisation: Goods,
Manager Manager Equipments, Lenders
Employees etc.
Common contribution of cash
Employee Employee Employee or goods/services Shareholders

Companies are a nexus of contracts, between managers and owners, among owners,
managers and employees etc.

Law and the rise of the firm

Are founders/shareholders liable towards business creditors?
Are firm assets protected from the founders/ shareholders personal creditors?
Limited liability and entity shielding are the two features of the modern business firm that depend on the
Basic attribute of a firm that could not feasibly be established by contractual means alone
Modern business firm institutional invention, created by business needs, offering limited liability and
entity shielding
What kind of law is company law?
Organisational law, important forms of property law
Defines types of property interests that can be created and made binding against third parties
Provides default and mandatory rules aimed at protecting shareholders and third parties common
purpose of making the firm possible

Separate Legal Personality

The company is a legal person entirely separate from its shareholders, directors,
creditors etc., facilitating other key features of a company such as limited liability
and transferable shares
Company law mediates relations through the company

Part 1.C The Partnership

You start a business with two friends, being good photographers and excellent mountaineers
Offer new touristic experience to rich people who like photography
Drive them through the dolomites, lead them to the most picturesque places where to take iconic
pictures, explain them how to take photos and provide necessary equipment
Customers will pay lump sum in advance, everything will be arranged for them
Memorable Dolomites, will be promoted on the internet
Discussion, imagine that:
Competitor sues you, because you use a similar trademark
You cannot repay the photo equipment bank loan,
Trip to Sardinia with the Girlfriend, can the 4W car bought for the firm be used?
The Partnership
Organisational forms for small profit businesses (shops and businesses)
Contract law with very limited organisational features given by the law and mainly
concerning partners liability towards the creditors entity shielding

The Contract
Partnership is a relation between partners carrying on a common business aiming to
Can be created orally, often an agreement is drawn up called Articles of Partnership,
Partnership Agreement or Partnership Deed
Contains rights and obligations of each partner, agreement can be changed either
unanimously or with the prescribed majority at any time
General rule: Partners are jointly and severally liable for the full value of any
partnership debts
Wrongful acts or omissions, such as torts of any partners acting in the the ordinary
course of the business with the authority of the other partners gives rise to joint and
several liability
Contract regulates e.g. following issues:
Who manages the partnership?
What is each partners contribution to it? (cash, work, credits, material goods)?
How are profits and losses shared? (What is the profit sharing ratio?)
Can partners use the partnerships assets?
What happens if a partner wants to sell his participation to the partnership?
Can partners be excluded? Under what conditions?
What happens if a partner dies? Can heirs take his place?

Limitation of liability and registration

Contract can limit the liability of some partners towards the partnerships creditors,
who have to know that limitation, therefore the partnership must posses some
recognisable features
Features are part of the organisational framework
Limitation of liability The Italian S.A.S.
Under Italian law partners must adopt the form of the societa in accomandata semplice in order to limit
the liability
Company is to be registered as such in the Registro delle imprese
Then the partners responsibility differs as
general partners (accomandatari) can be personally liable for all the partnerships debt
limited partners (accomandati) are only liable up to the amount they initially invest in the business
Societa in nome colletivo e s.a.s.
If they run a commercial business and have not adopted the s.a.s. form, their partnership is a societa in
nome colletivo and they are jointly and severally liable
The company registration as s.n.c. offers a minor form of owner shielding
the creditors of the partnership must first seize the partnerships assets and only if they cannot be paid in
full, can they seize the partners assets
Entity shielding vs. limitation of liability
Entity shielding is the protection of the entitys assets from the aggression of the
partners creditors
Distinguish between two classes and issues
Owner shielding and limited liability of partners: The partnerships creditors and
whether they can seize the partners assets
Entity shielding: The partners creditors and whether they can seize the
partnerships assets

Prerequisite for limiting liability (through appropriate organisational form, s.a.s.) and
getting some form of entity shielding
In some countries (England) partnerships have no separate legal existence of their
own, the firm is not a legal entity, e.g. when suing the partnership, the partners are
In other countries registered partnerships have some form of separate legal
existence (Italy is a case in point- autonomia soggetiva)

Part 1.D The Company short history and core characteristics of company law

The modern company: language

Italy: societ per azioni, societ a responsabilit limitata
UK: public company, private company
US: public corporation, private corporation
France: socitanonyme, socitresponsabilitlimite
Germany: Aktiengesellschaft, Gesellschaft mit beschrnkter Haftung

From Rome to Renaissance

Ancient Rome: Romans were not great sea-traders
Private financing of trade enterprises was important, but there was nothing
comparable to the modern (public or private) company and its key features
Medieval and Renaissance Italy: medieval Italy arrived at a regime whereby
partnership creditors enjoyed a claim to partnership assets that was prior to the
claim of the partners personal creditors (weak entity shielding);
Development in insolvency (US: bankruptcy) law favoured this process;
Bookkeeping and math had a very important role as well
Commenda: device for maritime trade
Societa in accomandita: enjoyed limited liability so long as they refrained from
lending their name to the firm and from participating in its management
The invention: from Genoa
Genoa, starting in the fourteenth century, sold shares in state-backed monopolies
engaged in a variety of trade ventures, including the conquest of some
Mediterranean islands
These Genoese enterprises were managed to operate under a rule whereby every
owner had to consent to any sale of a firms shares - an arrangement that is not
feasible for big firms can you tell why?

To Amsterdam and London

The trade opportunities that opened during the sixteenth century to European
nations with ocean access required organizational forms capable of amalgamating
capital pools of unprecedented scale
Portugal and Spain responded by organizing and funding intercontinental trade
through the state, whereas the Dutch and the English followed the Genoese example
of combining private investment with state-granted monopoly privileges

Guilds of traders, operating through commenda-like arrangements, were issued
charters that included exclusive privileges to trade.
These chartered companies divided the cargo among the investors at the end of each
voyage, but this was inefficient.
In 1623, the Dutch East India Company was granted perpetual existence:
shareholders lost their power to withdraw at will but were compensated with a new
right to sell their shares without the consent of other owners.
Chartered companies
The English East India Company (EIC), founded in 1600
The Dutch East India Company (VOC), founded in 1602
They pioneered features which later became textbook characteristics of modern companies: legal
personhood, a permanent capital, limited liability for shareholders, tradable shares, separation of ownership
and management

UK developments incorporation through a simple registration process

UK: the parliament created a charter shortage
The rise of the so-called unincorporated meaning unchartered joint stock
company, a business form improvised to mimic the chartered company
The shortage ended with the general incorporation act of 1844: for the first time in
history it was possible to incorporate through a simple registration process

The US trajectory
After the Revolution, when the authority of the English monarch and Parliament
were no longer recognized, state legislatures took over the task of issuing charters,
and did so with greater frequency and for more different types of organizations than
had the King or Parliament.
Nonetheless, it was still costly to organize a business as a chartered corporation
rather than as a partnership or unchartered joint-stock company (individual special
acts by the governor or state legislature were required)

M. M. Blair, "Corporate Personhood and the Corporate Persona" (2013) U. Ill. L. Rev. 785, at

The invention proliferates worldwide

France: the socit anonime is created by the Napoleon Code in 1807 and then goes
with Napoleon around Europe
Socit anonime tells a lot. Please discuss for Italy, Germany, Japan etc

The modern registration process

See Bainbridge, Corporation Law, 3rd ed., 13-17 (in the course webfolder)
A simple process
Articles of incorporation + bylaws (US)
UK: set up a private company (in the course webfolder)
What about Italy? See articles 2328-2329-2330 c.c. for s.p.a. and 2462-2463-bis for s.r.l. What about Germany or
Austria or Switzerland?
The Second European Directive (on formation of public companies and capital)

Part 2 Corporate personality

The benefits of separate entity status

Separate entity status provides: continuity by assuring a clear line of succession in
the holding of property and the carrying out of contracts
An identifiable persona that business people could contract with, and that could hold
important intangible assets
A mechanism for partitioning assets and committing them to a particular enterprise
while protecting not only those assets from creditors or heirs of the corporations
participants (entity shielding) but also investors in the corporation from creditors of
the corporation (limited liability)
Separating and identifying assets and liabilities ordinary partnerships assets and
liabilities of the business run by the partnership are held by the partners jointly; the
non-partnership assets and liabilities by the individual partners
Examples of corporate personality (personhood)
Registered Associations (associazioni riconosciute)
Certain public bodies (persone giuridiche pubbliche)

Asset partitioning entity shielding

The shareholder creditor can seize his debtors shares, not the companys assets. **
Corporation statutes generally require that a majority or supermajority of
shareholders vote to authorize dissolution. Thus, only a creditor seizing shares
constituting a majority also possesses the power to force a corporate liquidation.
The shareholder (and his creditors) can sell the shares, she cannot ask for the pay out
of the share of the firms net assets
Thus, corporate creditors are protected from attempts by a shareholder or his
personal creditors to liquidate those assets

The doctrine of reflective loss

The doctrine of reflective loss is another facet of the same issue
What [a shareholder] cannot do is to recover damages merely because the company
in which he is interested has suffered damage. He cannot recover a sum equal to the
diminution in the market value of his shares, or equal to the likely diminution in
dividend, because such a "loss" is merely a reflection of the loss suffered by the
company. The shareholder does not suffer any personal loss. His only "loss" is
through the company, in the diminution in the value of the net assets of the
company, in which he has (say) a 3 per cent. shareholding.

The doctrine of reflective loss (2)

The plaintiff's shares are merely a right of participation in the company on the
terms of the articles of association. The shares themselves, his right of participation,
are not directly affected by the wrongdoing. The plaintiff still holds all the shares as
his own absolutely unencumbered property. The deceit practised upon the plaintiff
does not affect the shares; it merely enables the defendant to rob the company.
Prudential Assurance Co. Ltd. v. Newman Industries Ltd. (2) [1982] 1 Ch. 222h and
The interest of the creditors of the company would be damaged if a shareholder
could get a reflective loss
We will return on this when talking about derivative suits

How does a company act and know? Research this

The company, being an artificial person, is only able to act and know if humans attribute
to it, therefore it has to be known whose actions or knowledge and in which situations shall
be treated as the companys, to be known when the situation can be answered with these
1. Has the company entered into a transaction, e.g. contract?
2. Whether the company has committed a wrong, either civil or criminal?
Contracting: primary rules of attribution
Secondary rule of attribution: agency and authority
The doctrine of usual authority
The effects of restrictions in the company articles of association

The European First Directive

on coordination of safeguards which, for the protection of the interests of members and third parties,
are required by Member States of companies within the meaning of the second paragraph of Article 48 of
the Treaty, with a view to making such safeguards equivalent

Art. 2394 Italian Civil Code: Il potere di rappresentanza attribuito agli amministratori dallo statuto o
dalla deliberazione di nomina generale. Le limitazioni ai poteri degli amministratori che risultano dallo
statuto o da una decisione degli organi competenti non sono opponibili ai terzi, anche se pubblicate, salvo
che si provi che questi abbiano intenzionalmente agito a danno della societ.
US Examples Alphabet, bylaws 2015

US Examples Apple, bylaws 2015

Tortious Liability
Vicarious liability and tort
Primary rules of attribution
Tortious liability of individual actors
Negligent misstatements
Decisions not to perform a contract
The UK leading case: Williams v. Natural Life Health Food (see the course webfolder)
The doctrine of the company as a separate entity in action

Criminal Liability
The UK experience
The US one
The Italian experience: Legge 231/2001
If you want to know more see Torraca "Corporate Liabilities as a Consequence of Criminal Offences in Italy: Legislative
Decree No. 231/2001." US-China L. Rev. 12 (2015): 616 (in the course webfolder, optional reading).

Part 3 Limited Liability and Creditor Protection

Conceptions of limited liability
1. Distinction of corporate and non-corporate assets
2. Provision of limited liability
Limited liability claims of the company's business creditors cannot be
asserted against the assets of the shareholder, but against the companys assets
protecting those connected to the company e.g. managers who will be shielded
against the claims of the creditors in case of insolvency (unless they have
engaged in fraudulent and wrongful trading)
The creditors of the shareholders cannot assert their claims against the
assets of the company, because of the separate legal personality (The shares
may be pledged to the creditors, without impairing the companys assets)

Costs of limited liability: Shareholders Opportunism

Shareholders can engage in asset diversion by making distributions to themselves
in the form of dividend payments, share buy-backs and excessive remunerations.
Shareholders can engage in claim dilution
Shareholders can transfer wealth from fixed claimants to themselves by pursuing
investment projects that are riskier than the creditors had contemplated when
they extended credit
Should creditors be protected by opportunism created by limited liability?

L. Enriques and J. R. Macey, "Creditors versus capital formation: The case against the European legal capital rules"
(2000) 86 Cornell L. Rev. 1165, at1169-70.
Asset partitioning limited liability
Art. 2325 Italian Civil Code: Nella societ per azioni per le obbligazioni sociali
risponde soltanto la societ con il suo patrimonio.

Rationales for limited liability

Encouragement of public investment raise capital for major projects
Facilitation of public markets in shares argument falls away if it is not listed
Partitioning of assets entity shielding, two classes of assets are held by two
different legal persons, no competition from business and personal creditors,
reduced monitoring costs

Costs of limited liability

Costs are evident when those who benefit from the limited liability also control the
management of the company, might use their powers in an opportunistic fashion
benefitting themselves as shareholders
Creditor self help:
o Limited liability as a default rule coupled with freedom of contract, best policy?
Often used to opt out of limited liability rule in particular transactions, in small
companies the bank may contract out limited liability by reinstating the its right to
assert its claims against personal assets of the shareholder, should the companys
assets be insufficient
o Contracting around limited liability through covenants
Means of protection against debtors of uncertain financial status
Main contribution law makes to creditor self help is in relation to disclosure of
information (annual financial statements etc.)
Floating charge, permits companies to give securities over classes of asset which
otherwise would be difficult to pledge, enables lenders to attach a significant
additional sanction to restrictions a company may have accepted in the loan
contract, it brings the charge-holder into the governance of the company
o Contracting for governance rights
Through the flexibility of the companys constitution the creditor is enabled to
secure representation within the governance organs of the company, (nominate a
director to the board) BUT the shareholders can remove a director by ordinary
majority at any time furthermore the nominee director owes duties to the
company and not to the nominator, but the nominee director can prove a useful
channel of information to the nominator
o Company law helps creditor self help through mandatory information (mainly
concerning financial statements)
Is self-help sufficient? Are more mandatory rules necessary?
It creates opportunistic behaviour on part of the of secured against unsecured
creditors, a proportion of the assets realized must be set aside for the unsecured
creditors and not paid to the floating charge holder, floating charges may be
renders invalid when created shortly before insolvency, furthermore the floating
charge holders may use contractually specified events to to replace the existing
board even though they would have been able to trade out its difficulties
The European answer is that self-help is not sufficient, because weak creditors or
small creditors cannot use it

European Legal capital rules

Legal capital? wealth available for or capable of use in the production of
further wealth, value of the consideration which the shareholders have provided
to the company in exchange for their shares, this reveals its creditor protection
function. Company becomes insolvent, the shreholders have no claim to the return
of their contributions until the creditors claims habe been satisfied
Shareholders last
Two forms of minimal capital requirement, one referred to as capital maintenance
Minimum capital Putting a minimal amount away only to be used to meet the
claims of the creditors, turning capital into a fund for their protection. BUT capital
is not an inexpensive commodity, raising a significant amount of capital and not
being able to deploy to profit earning end would make the corporate form a very
unattractive form for business, therefore it is notmandatory
Second policy would require a company to have received in exchange for its
shares a certain minimum value (minimum capital) before commencing business,
but not to be put aside
BUT!! High figures would create an illusion of security and low figures create
barriers and restrict competiton
Third policy, capital maintenance: Leaving it free to companies to raise what
capital they want, both prior to commencing business and subsequently, but then
to use to use the value of the capital raised as a mechanism to regulate the
freedom of the companys controllers to move assets out of the company, raised
capital is used as a bar for the value of assets which the company can distribute to
its shareholders
Article 6 Capital EU Directive
Does it work? Discuss

European legal capital rules: contribution

Price of share issuance: Article 8
Time of payment: Article 9
Shareholders may not be released from the obligation to pay: Article 14
Admitted contribution: Article 7
The intricate regime of contribution in-kind:
The general rule: experts report (Article 10)
The exceptions: Article 10(4) and Articles 11, 12, 13
The anti-elusive rule of Article 13
European Legal capital rules: capital maintenance and serious loss
Capital maintenance rules preventing capital invasion: Articles 17 and 18
Serious loss as a red flag: Article 19
Share buy backs
The company cannot subscript its own shares: Article 20
The limits to share buy backs: Articles 21, 22, 23, 24
Treasury shares. Voting rights and own shares
Redeemable shares: Article 43
Financial assistance: Article 25
Limits to subscriptions, acquisitions and holdings by controlled companies: Article
The capital reduction regime: Articles 34 ff
Buy back can be funded in two ways that do not offend capital maintenance, they may
be funded out of the proceeds of a fresh issue of shares, in which case the consideration
received for the new shares simply replaces the repurchased shares in the companys
legal capital (relatively uncommon in reality)
Company with unwanted assets may fund buybacks without a new share issue, out of
distributable profits, once the shares have been bought back the value of consideration
which the company then holds in exchange for its shares will have been reduced, i.e. its
legal capital
Therefore the freedom of the company will be increased because under the dividend
rules, the amount of margin which the company must hold above an exact balance of
assets and liabilities, will be less applied to private companys

The US way
In the US the Europe-style rules on capital protection were abolished a long time
ago, on the assumption that:
The Legal Capital Doctrine Does Not Protect Creditors: minimum capital is trivial
and not sensible to business specificities
The capital maintenance rules are ineffective and very costly for the company
Legal capital rules limit opportunistic behaviour on the part of the companies by
restricting the boards freedom to make distributions of assets to the shareholders.
However, the the controllers of a company may reduce the value of the companys net
assets not only by shifting assets out of the companys corporate box

Controls on opportunism not linked to legal capital rules: director duties

Insolvency (US: bankruptcy) is the key moment for creditors
Shareholders incentives on the edge of insolvency
Directors liability: wrongful and fraudulent trading
Systemic inability to pays debts triggers a duty to start an insolvency procedure
under the control of courts

Controls on opportunism not linked to legal capital rules: voidable preferences

The law of voidable preferences (US: fraudulent conveyance)
The insolvency liquidator (Italy: curatore fallimentare) needs to show that:
the person or company was insolvent at the time the payment was made
the person or company then went into insolvency within a specified time
thereafter (vulnerability period);
the payment had the effect of putting the creditor in a better position than
other unsecured creditors
[in some jurisdictions, it might be necessary to show that the insolvent firm
intended to grant a preference]

Controls on opportunism not linked to legal capital rules: piercing the corporate veil?
Should court pierce the corporate veil in order to protect creditors from abuses such as
Common law (confused) doctrines
Civil law (confused) doctrines
In any jurisdiction, piercing the veil is extremely rare
In Italy, it is basically unknown
Recent studies in the US show that the doctrine is applied to cases different from
undercapitalization or similar

Cornell Law Review, 2014, 99

Controls on opportunism not linked to legal capital rules: controls over intra-group
Company groups: what is their purpose?
How do they work in practice?
See slides 108 109

Big modern firms are organized in groups

Each company is a separate entity
There are cash pooling agreements, Intercompany loans, Intercompany guarantees
A group is a nexus of contractual and managerial relationships
Legal risk
Asset diversions from one company to the other, through intercompany
Effect: assets are diverted from one class of creditors (and shareholders) to the
other Examples of diversion
How to protect creditors? Should courts veil pierce in these situations?
Different approaches Continental Europe UK US

Part 5 Shares

Shares incorporate the right to the distribution of profits and the right to the
liquidation value of the company, the right to vote in the shareholding meeting and other
rights, such as the right to ask for inspections, internal investigations, the call of
shareholders meetings, etc.
Compare to debt instruments: debt instruments incorporate the right to repayment
and interest
Equity to debt continuum: quasi equity and hybrids
1. Profits distributed to shareholders = dividends
2. Liquidation = with the shares you can receive your % of the liquidation value
(diritti patrimoniali delle azioni)
3. Voting rights in the shareholder meeting
4. Right to ask for investigations
5. Right to call for a shareholder meeting
Debt instrument (Equity) = bond, a certificate incorporating a participation to a loan
Shares = right to distribute profits if they are profits = shareholder
Debt instrument = right to a payment + an interest = debt holder
Key distinction = you should repay debts in any case, while distribute dividends only if
there are profits

Shares, certificates, dematerialisation

Shares can be represented by paper certificates to minimalize costs share are now
dematerialized digitalized, electronic book keeping by the company or financial
intermediaries substitutes the physical certificate

Listed shares
Shares can be listed on secondary markets (stock exchanges) or other types of
electronic trading systems, listed shares are dematerialised and
Shares can be not listed, but buying and selling those shares is more difficult
Public companies usually have listed shares public companies = listed companies
Private companies are not listed
Non listed shares
Shares can be sold and purchased, but there is no secondary market
In non listed companies (private companies) the sale of shares can be limited or
conditioned, through right of first refusal, co-sale and tag along rights, drag along rights
These are contractual terms between shareholders which can be included in the
Articles of Association
1. ROFR, Tag along rights
If one shareholder wishes to sell shares that are subject to a right of first refusal
(ROFR), it must first offer them to other shareholders
If a shareholder wishes to dispose of shares that are the subject of a co-sale or
tag along right, the other shareholders can insist that the potential purchaser
agrees to purchase an equivalent percentage of their shares, at the same price
and under the same terms and conditions Used as an instrument to avoid the
possibility that the third party enters and to have a controlling shareholder
2. DAR, Drag along right
Drag-along right (DAR) assures that if the majority shareholder sells their stake,
minority holders are forced to join the deal (same price and terms)
A drag-along right gives the investing shareholder the right to force the other
investor(s) to exit, should the investing shareholder exit, again, usually on the
same price and terms
It is possible to buy shares with a controlling premium price (low/high depending on
the jurisdiction)

Share classes
Companies can issue, in accordance with their articles of incorporation, single class
shares or what the Americans call dual class stocks
In a dual class structure, different classes of shares enjoy distinct voting rights, dividend
rights or rights of any other type
In UK listed companies dual share structures are unusual (Davis 222-224)

Common shares, preferred shares, super voting shares

Common and Preference shares
Preferred shares are prioritized in dividend payments and in the event of a company's
liquidation or insolvency
Multiple voting (super voting) shares are used in many jurisdictions
Fiat S.p.A. was merged into a new holding company, Fiat Chrysler Automobiles N.V.,
which is incorporated in the Netherlands, in order to be able to issue super voting shares

Loyalty shares
Are allowed in Italy for listed companies as well, they favour controlling shareholders
reaction to FCAs reincorporation in the Netherlands
For instance, Campari in Italy adopts a loyalty share structure:
() 2. Ogni azione d diritto a un voto. 3. In deroga a quanto previsto dal comma precedente,
ciascuna azione d diritto a voto doppio ove siano soddisfatte entrambe le seguenti condizioni: a) il
diritto di voto sia spettato al medesimo soggetto in forza di un diritto reale legittimante (piena propriet
con diritto di voto, nuda propriet con diritto di voto o usufrutto con diritto di voto) per un periodo
continuativo di almeno ventiquattro mesi; b) la ricorrenza del presupposto sub a) sia attestata
dalliscrizione continuativa, per un periodo di almeno ventiquattro mesi, nellelenco speciale di cui al
presente articolo.

Redeemable shares, Convertible shares

Redeemable shares can be (or must be) purchased back by the company, i.e. the
company (or the owner) have an option to buy back (to sell) the shares.
Convertible shares can be converted in a different class of shares
Note that you can combine in various different ways a share and an option right
option rights are key instrument in business law/finance/accounting

No par value shares

In many jurisdictions (e.g. Italy) companies can issue no par value shares
Without nominal value, companies are able to, e.g. Issue shares without increasing
share capital - subscription price can be booked in free reserves
Increase share capital without issuing shares; no need for general meeting resolutions
Create new shares and hold them in treasury for future issuances (enables delivery vs.

The company can issue quasi-equity and other hybrids
Hybrids and other capital securities refer to a wide range of capital markets
instruments with precise definitions varying by sector and jurisdiction
Have characteristics of debt and equity instruments they are somewhere in the equity
to debt continuum, very common in debt restructuring transactions

Chapter 5 - Managing the company

Public companies vs private companies or companies with a controlling shareholder

1. Big companies with a large and fluctuating body of shareholders (prevailing in the
US and UK), usually listed companies
Diversified shareholders, invest in many companies and rely more on managers
2. Companies of any size a with a controlling shareholder or a small group of stable
shareholders (e.g. Family controlled companies)
usually in Europe, strong incentive by the controlling shareholder to control and
monitor, appoint and be in charge
Different corporate governance approach!!
The division of power between the board of directors and the shareholders in the UK
Management by shareholders would be inefficient, why? Discuss
lack of commitment (in daily running of the company)
slow decision making
good investor good manager
The board of directors (appointed and removed by shareholders) manages the
company. What does this mean in practice?
appoint one or more executive director who manages the daily affairs in the
company, CEO in the US or managing director in the UK
The board is responsible for the management of the companys business
BOD monitors the executive directors
Decisions that need shareholder approval:
1. UK Company Act does not regulate the board
2. UK Company Act regulates all companies without distinctions between
private and public companies
3. Division of power is located in the companys own constitution, articles of

The division of power between the board of directors and the shareholders in
Continental Europe
Continental Europes company acts generally regulate separately private
companies SrL and public companies SpA
The division of powers is located in the companys own constitution but also in the
See article 2380-bis Italian Civil Code, concerning s.p.a.
ARTICOLO N.2380 bis Italian Civil Code
Amministrazione della societ.
[I]. La gestione dell'impresa spetta esclusivamente agli amministratori, i quali compiono le operazioni
necessarie per l'attuazione dell'oggetto sociale.
Company run by the directors
[II]. L'amministrazione della societ pu essere affidata anche a non soci.
[III]. Quando l'amministrazione affidata a pi persone, queste costituiscono il consiglio di
[IV]. Se lo statuto non stabilisce il numero degli amministratori, ma ne indica solamente un numero
massimo e minimo, la determinazione spetta all'assemblea.
[V]. Il consiglio di amministrazione sceglie tra i suoi componenti il presidente, se questi non nominato

The standard division of powers in Europe

Shareholders control the division of power, the boards power depend on the articles
Provides flexibility to adapt division to the companys needs (regarding size and
Shareholders and the BOD cannot interfere with each other as long as they exercise
their respective powers conferred to them by the Art. Of Ass. Art. can be altered by
The board of directors (BOD) manages the company
Shareholder can hold back competences
In almost in any jurisdiction the shareholders can give directions to the board with
an established majority
Article 2364 Italian Civil Code: the shareholder meeting
delibera sugli altri oggetti attribuiti dalla legge alla competenza dell'assemblea,
nonch sulle autorizzazioni eventualmente richieste dallo statuto per il
compimento di atti degli amministratori, ferma in ogni caso la responsabilit di
questi per gli atti compiuti
The board of directors (BOD) manages the company, but many managerial decisions
require the amendment of the terms of the articles of association
The shareholders set the terms of the articles and can amend the terms of the
articles In some US state laws, the board can amend the articles
1. The BOD proposes a merger the merger requires an amendment to the articles
articles need to be changed, contract governing the company
2. The BOD proposes an acquisition and the cash needed is raised through an equity
issuance the capital raise requires an amendment to the articles director calls
in shareholder meeting
This on-going dialogue between the board and the shareholders is often
underestimated in books
In the US and UK raising capital does not need approval by shareholders, because
they have strong financial markets, a bad decision by the managers would be
followed by a reaction of the market. (In Europe however many families controlled
companies concerned about dilution, in a situation where you have a controlling
shareholder, approval by him is almost often needed. They would vote against a
merger if it diminishes their control over the company. In the US no concern about
dilution because not many companies with controlling shareholder. (Approval
often only informal)
The board of directors (BOD) manages the company, but what if shareholders wish to
intervene because they think the board is taking a wrong direction on a certain matter?
In public companies there are strong differences among jurisdictions on this issue
MODEL PROVISIONS often only for public companies
subject to the articles, the directors are responsible for the management of the
companys business, for which purpose they exercise all the powers of the company
Model default rule hold certain matters (competences) back partly or fully and
clarify power of the shareholders to give directions to the board
The members may, by special resolution, direct the directors to take, or refrain
from taking a special action
In companies with a controlling shareholder this is a no-brainer
why? they simply remove the managers in a shareholder meeting
Centralized management and principal/agent costs
The shareholders need to monitor the managers, because they managers might
shirk, embezzle, pursue managerial imperialism, divert assets, etc.
If cost of monitoring exceeded the benefits of the centralized management the
hole institution would need to be called into question
Principal/agent relationship: it differs for economist and for lawyers, SEE DAVIS
page 111
Lawyers Agents = Directors, Principals authorise Agents to act in their name and
alter legal position
When in shareholder meetings minority shareholders = Principals, majority
shareholders = Agents
Economists view is helpful because is focused on situations of factual dependency
There are different legal strategies available IN DAVIS, BUT NOT IMPORTANT

Disclosure of information, auditing

Essential to any legal strategy addressing the principal/agent problem: the
principal needs to be informed about what the agent does
Mandatory annual accounting and financial reporting by directors to shareholders
(mandatory public filing is disliked bc. of competition and public authorities)
designed to provide some context in which the financial statements are better
understood and their implications for the future analysed
to guarantee reliable information EX ANTE verification by a third party, the
auditors, guarantee a true and fair financial statement and revise other central
concerns of the shareholders
How to monitor the monitors (the auditors)?
Auditors reputation is not enough, bribed by managers inducing auditors to
reduce their audit rigor by buying non audit services from them

How to monitor the monitors?

Shareholders appoint the auditor and can remove them
Legal rules on auditor independence
Rules on non audit services
You cannot offer audit and non audit services to one company
European law deals with auditing
of 17 May 2006 on statutory audits of annual accounts and consolidated accounts
If I sell my shares, how can anybody else be sure the books are not cooked, value is the
right one (especially when Im controlling shareholder?) Due diligence review,
however, not possible/practical with diversified shareholders therefore: law asks
company to make public any price sensitive information on a day by day basis, in order
for the market to arrange transactions daily on the basis of reliable information about the
company. Managers dont like to give this information (bc. competitors)
Quoted companies: transparency directive (TRD) and Market Abuse Directive (MAD)
The TRD covers:
Annual financial reports
Half yearly financial reports
(Information about major holdings by shareholders)
MAD concerns, inter alia, the duty to inform the market about any new price-
sensitive information concerning traded financial instruments

Shareholder involvement in decision making, Davies p. 122

Main corporate decisions which the UK act subjects to shareholder approval
Initiation and veto rights for shareholders will generate bargaining between
shareholders and directors
Act regulates central managements mandatory inputs, when
infrequent decisions (general run of the management decisions remain
high degree of conflict of interest between shareholders and directors
Decisions shareholders are obliged to make by the legislature display the converse
of the features which argue in favour for a central management as a normal rule
Let us discuss them, because they tell us on what shareholders have a voice (apart
from appointing directors and distributing dividends)
UK main corporate decisions approve yearly financial reporting, alteration to
companys constitution, decisions to dissolve the company, repurchasing shares,
raising capital, appointing/removing auditors, merger and divisions, transactions
involving conflict of interest
shareholders decision making at potential cost of depriving them of the benefits of
centralized management
Recap: what do shareholders decide?
approve yearly financial reporting, appoint/remove directors (most important
right, therefore you want to be controlling shareholder), decisions about
amendment to companys constitution, decisions to dissolve (wind up) the

Appointment rights
Appoint and remove directors typical pattern: director either elected or
approved at their first AGM, annually or every three years subject of re-election,
articles make it difficult for the shareholders to propose a new director, other
shareholders have a veto right
It is on the companys constitution to decide how directors are to be elected and
what is the voting procedure, absence of mandatory rule requiring appointment or
periodic reappointment by shareholders may simply operate as to facilitate the
entrenchment of incumbent management
E.g. 51 % vs 49 % shareholders ->51% appoints all directors unless otherwise
specified in constitution (other system one vote per share or voto di lista,
coalitions by minority shareholders)
Why does the shareholder disapprove of the constitution giving the right to
appoint the directors to creditors? They wont distribute dividends thus repaying
the loans etc., will keep the company safe, take business decisions that will only
repay the loans, wont take risks and take opportunities (limited liability ->
shareholders want to be risky)
Shareholders can at any time remove directors without having to assign a reason
for doing so, applies also to the director appointed by the third party though
company may suffer from undesirable consequences like obligation of paying back
the loan immediately
Dismissed director hat the right to compensation or damage payable to him in
respect of the termination of his appointment as director or of any appointment
terminating with that as director
The dismissed director has a right to claim damages if he was not breaching the
service contract, e.g. pay the time left in the contract

Provision of information to shareholders

In public companys shareholders have no right to inspect the companys records,
because they could be a competitor (note: in the US shareholders have certain
inspection rights)
Unless the directors or the shareholders by ordinary resolution have have
conferred such a right
In Italy shareholders have no inspection rights in s.p.a., they have inspection
rights in s.r.l.
They have the right to receive answers (concerning the agenda topics) at
shareholder meetings
In public companies, before shareholder meetings they have the right to receive a
circular (report) on the proposed resolution setting out the reasons for the favour
of the adoption of the resolution resolution will be invalid if the information is
More important source of collective information under the act is is periodic and
episodic reporting which the board is obliged to make to the market and the
shareholders if it is a listed company

Convening meetings
Great differences between jurisdictions
Usually shareholders having a certain percentage of the voting rights can requisite
a special shareholder meeting e.g. 5% or more of the companys voting rights
Quite often these special meetings concern directors removal discussed
When no AGM in the near future, request a special meeting Directors usually
do not want to call this meeting, knowing it concerns a (their) removal obliged
by the law, otherwise the court would be calling the meeting

Exit or Voice?
The collective action problem in widely held companies
huge amount of work if you do not have a lot of shares, so when faced with
problems you tend to prefer to sell your shares instead of trying to make your
voice heard, e.g. in Company with a large body of shareholders, each with small
Instructions (SH to DIR) requires a special resolution 2/3 majority
Removals requires ordinary resolution of simple majority
When wishing to instruct, shareholders often formulate their resolution as a
conditional removal one
Shareholder = Institutional investors pension funds, mutual funds etc. are a
simple solution for this problem
Their (moderate) activism participate in shareholder meetings etc. are more
active in working more with managers and directors
Institutional shareholders activism and Governments
Legislation in all countries tries to make inst. Inv. Use their voice rather than
using exit strategy
Voice not only means exercise of the removal rights but all the decision rights as
well, especially their oversight powers
Governments solution to the coordination problems of shareholders in listed UK
companies is to pressurize the institutional shareholders to take the lead

Affiliation Right
Unsatisfied shareholders can sell their shares and choose exit
In listed companies shares must be freely tradable
From the companys point of view free transferability is provided by the
doctrine of separate corporate personality, the shares in the company can be
transferred without any impact on the ownership of the business assets which
remains vested in the company
For the shareholders it is legally much less secure
In non listed companies the articles can contain limits to the tradability, e.g. by
requiring boards consent to transfers or by giving a pre-emption right to other
In not listed companies exit strategy is not an option usually (difficult to find buyer,
limits etc.)
However, the exit right can be of no great value only of value to the highly
prescient shareholder who can predict the unlawful or unwise conduct of the
board before it occurs and before the rest of the market realizes what happened!!
because the sale will simply crystallize the loss even for listed companies
therefore exit may not be a (good) option

Takeover bids
Unsatisfied shareholders can sell their shares at a price above the market price in a
takeover bid
Major advantages of the takeover offer:
under a legal regime which facilitates takeover bids, the threat of it will be a
constant pressure, on the boards of all companies quoted on public markets, to
keep the interests of the shareholders centre-staged shareholder value
takeover threat requires no input of resources
if the board does not respond to the pressure and the shareholders interest are
neglected, the shareholders can exit the company at a premium to market price
What is a takeover bid? (in Italian: offerta pubblica di acquisto, OPA; in the US,
tender offer)
the bidder is willing to pay more than the market price, because once he has
obtained control of the company he can and will replace the board with his own
new nominees

The European Directive covering takeover bids

takeover bids
Article 2 Definitions
1. For the purposes of this Directive:
(a) takeover bid or bid shall mean a public offer (other than by the offeree company itself)
made to the holders of the securities of a company to acquire all or some of those securities, whether
mandatory or voluntary, which follows or has as its objective the acquisition of control of the offered
company in accordance with national law
E.g. poorly run company, bad decision making, selling shares, price plummeting,
person sees problems, wants to make profits out of it take control of the company,
replacing the bad managers and directors, propose a merger launch a public offer to
all shareholders usually above the market price market for corporate control,
especially in the US, not so much in continental Europe, because of controlling
shareholders Best Exit strategy, sell company at a profit

Side-lining the board in takeover bids

Transaction occurs between the offeror/bidder and the target shareholders
clear that takeover cannot succeed if a sufficient proportion of the target
shareholders are not prepared to accept the offer minimum veto right over the
The target board might seek to discourage the offers success in order to do
this, they may sell the rights to a third party or launch merger proposal or raise
capital to increase shares, put prized assets out of reach of the new Shareholder
changing situation, discouraging the takeover
This is why the board is side-lined, the boards powers are limited by law, they
cannot take business decisions that would discourage the success of the offer
See Rule 21 of the UK Code on takeover and mergers, prohibiting the board from
any action which may result in any offer or bona fide possible offer being
frustrated or in shareholders being denied an opportunity to decide on its merits
The offer is allocated compulsory and entirely to the shareholder of the target
the Code facilitates an exit right for the shareholders at an attractive price , but
does so mainly by removing the contraints which target management might place
on the offerors entry rights application of the affiliation strategy is
operationalized through a deployment of the decidion rights strategy,
ie requiring a shareholder approval for that class of board decisions which might
have a frustrating impact on the bid
Contra arguments:
1. Offeror might be able to exploit the shareholders collective action problem
which the shareholders might have against the offeror as they have against
their company board structure the offer in such a way that the taret
shareholders have no other way out than accepting the offer
2. Takeovers are driven by the transfer of wealth from stakeholders, such as
employees or creditors to the bidder as the new owner of the company, rather
than by the gains made by addressing the the shareholders agency costs
(Davies, p. 141)

Article 9 of the Takeover Directive

2. During the period referred to in the second subparagraph, the board of the
offeree company shall obtain the prior authorisation of the general meeting of
shareholders given for this purpose before taking any action, other than seeking
alternative bids, which may result in the frustration of the bid and in particular
before issuing any shares which may result in a lasting impediment to the offerors
acquiring control of the offeree company

The boards opinion

Article 9 of the Takeover Directive
5. The board of the offeree company shall draw up and make public a document
setting out its opinion of the bid and the reasons on which it is based, including its
views on the effects of implementation of the bid on all the companys interests
and specifically employment, and on the offerors strategic plans for the offeree
company and their likely repercussions on employment and the locations of the
companys places of business as set out in the offer document in accordance with
Article 6(3)(i). ()
friendly and unfriendly takeover

Three legal strategies for empowering shareholders in companies without a
controlling shareholder
o Decision rights strategy turns on involving the shareholders as a body in
corporate decisions, shifting decision making in the hands of shareholders risks
making corporate decisions making process inefficient
o Appointment rights strategy can be applied by company law, it impact might be
lessend by the inability of highly dispersed shareholder bodies tomake much use of
it due to coordination difficulties; partial re-concentration of shareholding into the
hand of institutional shaerholders has lessend this problem
o Affiliation right strategy Exit right is not as such much protection, shareholders
need to sell a price which reflect the value of the company, it would have, if it were
run properly, threat of a takeover bid is a very powerful corporate governance tool
Strategies to strengthen the hand of the shareholders as a group against the board

Chapter 6 - Directors Duties

Preliminary remarks
Constraints strategy, comes in form of either specifying rules for decision making by
the board or by laying down standards by which the boards decisions can be reviewed by
the courts
Incentives strategy, which consists of either trying to avoid director high-powered
conflicts of interest by excluding them from decision making (trusteeship strategy) or
realigning those high-powered conflicts with the interest of the shareholders
Duties are owed by the directors term includes those properly appointed by the
board and those who act as directors whether regularly appointed to that to the board or
not, including shadow directors i.e. persons in accordance with whose instructions or
directions the directors of the company are accustomed to act
What is equity?
Standards vs rules (discussed by Davies at p. 149)
Standards are easy to formulate but hard to apply (e.g. directors must exercise
due care etc. vs work out on the facts of a particular case what is required by these
precepts) the law making function is shared between the formulator and the
applier, but does the applier have the necessary expertise to work out the best
solution to the issue the standard requires?
The directors may act differently taking less risks ex ante if it unknown how the
court might judge them ex post
Rules, the law-making function lies nearly entirely with the formulator

Directors duties are owed to the company

The duties can be enforced by the company
If the company is no more a going concerns, the duties are enforced by the
insolvency practitioner who acts on behalf of creditors when the company enters a
formal insolvency procedure
There are duties owed to the individual shareholder, but they are much more
The Duty of Care
Directors owe a duty of care to the company, it is a duty of competence
Two views about the appropriate standard:
Subjective or objective standard
Subjective formulation, specified by the reference to what a person with the
directors actual abilities is able to achieve no liability would arise if the director
could not achieve a higher standard the less qualified or or more incompetent
the director, the less the law expects of him
Objective formulated by reference to what a reasonable director in the position
of the actual director could be expected to achieve, irrespective of what the actual
director was capable of achieving the lack of qualification or competence is not
a defence to liability for failing o achieve a reasonable standard
UK trajectory: from subj. to obj. Today Director must exercise a reasonable
skill, care and diligence and that standard is defined by reference to (a) the
general knowledge , skill and experience that may be expected from a person
carrying out the functions carried out by the director in relation to the company
and (b) the general knowledge, skill and experience that the director has
Italian trajectory: from obj. to subj.:
ARTICOLO N.2392 Civil Code Responsabilit verso la societ 1. Gli amministratori devono adempiere
i doveri ad essi imposti dalla legge e dallo statuto con la diligenza richiesta dalla natura dell'incarico e
dalle loro specifiche competenze. Essi sono solidalmente responsabili verso la societ dei danni derivanti
dall'inosservanza di tali doveri, a meno che si tratti di attribuzioni proprie del comitato esecutivo o di
funzioni in concreto attribuite ad uno o pi amministratori.

Avoiding the hindsight bias

The dangers of ex post review of directors decisions on negligence grounds by the
court will unless carefully handled, slow down the decision-making process on
the part of the boards and lead to risk avoidance by the directors
Directors are employed to take risk, the firm is a venture
Shareholders do not want too cautious directors; risk/reward ratio is favourable
In an environment too prone to ex post review, compare decisions to take up
business opportunities that turned out badly vs decisions to turn down
Easier to mount a legal challenge to board decisions to take up business
opportunities, which turn out badly, than to decisions to turn down opportunities,
except in rare cases where the opportunity was virtually riskless

The US business judgement rule (IMPORTANT)

The director fulfils the BJR if she is in good faith and:
1. Is not interested in the subject of the business judgement;
2. Is informed with respect to the subject of the business judgement to the extent the
director or officer reasonably believes to be appropriate under the circumstances:
3. Believes that the business judgement is in the best interest of the corporation
The courts attention is drawn to the procedure rather than the substantive wisdom of
the business decision, rationality test, more important is that there is no conflict of
The director cannot be held liable ex post apart in case of wrongful trading

Delegation and the duty of care (IMPORTANT)

BJR protects only the directors who take decisions, those whose alleged negligence
consist of failure to act, are not protected by it (as it applies only to directors who make
business judgements)
Delegation of tasks
Boards may delegate managerial authority to board or non board managers, but
only on the condition that: They understand the risk involved in the business so
They must keep themselves informed about the true financial position of the
company so as to be able to check whether the delegated powers have been
properly exercised
Have in place monitoring systems (internal control systems)
Respond appropriately to warnings thrown up by those systems (so called red
Duty of care is is not a duty of fiduciary character but it is to be assimilated to
duty of avoiding negligence imposed by the common law

Wrongful trading (IMPORTANT)

Directors are liable when they have negligently (If the decision is fraudulent, this is
a criminal offence) decided to continue to trade when they ought to have realized
that the company had no reasonable prospect of avoiding insolvent liquidation
This is a duty of care towards the companys creditors, in a situation where the
creditors are becoming the residual claimants because equity went underwater
Directors have to protect the companys creditors, 90% of duty of care
Directors may deepen the insolvency if trading is continued, they will have to pay
all the losses from that crucial point onwards, if creditors claim that the losses are
their fault
Reatto di bancarotta
The law prohibits conducting affairs
See Davies, pp. 86 ff.

Duty of loyalty
Duty to promote the success of the company, it is a fiduciary duty loyal to
interests of a company
But what is the company? The interest of the company is the interest of the
shareholders only or is the interest of the stakeholders (creditors, employees,
local communities) as well? Promote the success of the company for the
benefit of its members, shareholder-centred statement, but the director is
required to have regard to a number of stakeholder interests, only insofar as
they have an impact on the directors goal of achieving business success for the
benefit of the shareholders
Nevertheless, the director is not required to balance both share and stakeholder
E.g. move the company to another country in order to pay less taxes good for
shareholders but bad for stakeholders
This is an unresolved area of academic, legal and political debate, in any
jurisdiction around the world
EU view more elastic interest of everybody , take into account also the interest
of the people who need the company to run
The UK adopted a tempered shareholder-centred statement of the rule, with
enlightened shareholder value (ESV)
Act in good faith
Section 172 UK Companies Act
172 - Duty to promote the success of the company
(1) A director of a company must act in the way he considers, in good faith, would be most likely to
promote the success of the company for the benefit of its members as a whole, and in doing so have
regard (amongst other matters) to
(a)the likely consequences of any decision in the long term,
(b)the interests of the company's employees,
(c)the need to foster the company's business relationships with suppliers, customers and others,
(d)the impact of the company's operations on the community and the environment, (e)the desirability
of the company maintaining a reputation for high standards of business conduct, and
(f)the need to act fairly as between members of the company
(2) Where or to the extent that the purposes of the company consist of or include purposes other than
the benefit of its members, subsection
(1) has effect as if the reference to promoting the success of the company for the benefit of its members
were to achieving those purposes
(3) The duty imposed by this section has effect subject to any enactment or rule of law requiring
directors, in certain circumstances, to consider or act in the interests of creditors of the company
If strictly forced (it is not) direct would have consider too many aspects and interests,
nearly impossible
Italy, France, Spain, Shareholder oriented
US, interest of company = interest of shareholder, shareholder centric approach

Duty to act within powers

Acting in accordance with the companys constitution and the articles of
association even though directors might think that not acting accordingly would
be promoting the company, they are not free to do it
The Act expresses this in two separate subsections: The directors must (A) act in
accordance with the companys constitution and (B) only exercise powers for the
purpose for which they are conferred
When directors act in breach of the articles, the most litigated issue is whether
their action is binding on the company in favour of third parties
In most cases the directors will be treated as authorized to enter into the
transaction in question, despite the breach of articles in order to protect the
legitimate expectations of third parties dealing with the company through the
Call in a shareholder meeting, if needed, e.g. signing a contract above a certain
value, outside of their jurisdiction, when the company can prove that both parties
are plotting against the company the contract is not valid only exercise powers
for the purpose for which they are conferred
The issue concerns the legitimate expectations of good faith third parties; they are
in good faith if there is no sign of a strange contract and the directors are in their
area of competence
See the part concerning authority
Needless to say, if the action is binding, the directors are liable for the damages
obligation to restore to the company the value of assets paid away in breach of the
constitution or the general law
The company can sue them for the losses when the third parties are not in good
faith and can be proven contract is not binding

Duty to act within powers: acting for an improper purpose

The directors cannot use their powers for an improper purpose
The most significant cases concern defensive actions taken by directors of the
target company in takeover bids e.g. Issue new shares to a friendly investor who
would not accept the offer
The proper purpose doctrine is not well defined they might use pre-bid
measures and defences (Steps taken by the board of a potential target company
before the bid is imminent)
A decision which has a good commercial rationale (e.g. acquisition of another
business) will stand
In Continental Europe we have similar doctrines concerning the abuse of right but
they are not of great relevance in company law with regards to directors
In non public companys the directors might be freer to control the composition of
the shareholder body because those companies were not set up on the basis of a
strict division of powers between shareholders and the board

Self dealing transactions Do not study the details only the key concepts
A director of a company must avoid a situation in which he has, or can have, a
direct or indirect interest that conflicts, or possibly may conflict, with the interests
of the company
The relation between company and subsidiary is not equal to market relations
Person wants to sell a copyright, which is needed by a company
This applies in particular to the exploitation of any property, information or
business opportunity
However, self dealing transactions are not banned. Can you explain why, from a
Law & Economics perspective?
Only if the presence of the director on both sides of the table leads to a deal
which is less favourable to the company than an arms length negotiation would
have produced can the shareholder be said to have suffered harm
Prohibition would impose more costs on the shsareholders
The conflicted director must follow a procedure

Self dealing transactions: procedural requirements

Self-dealing transactions are dealt with by the board, on the basis of full disclosure
of the conflict
However, there is the risk of mutual back-scratching
Accordingly, the constitution or the law in some occasions can ask for self dealing
transactions to be dealt with by the shareholder meeting

Corporate opportunities
The self interest of the director may lead to the exclusion of the company from the
There is a business opportunity and the director develops it through a new entity
fully owned by her, when it could have been developing through the company
Business opportunities/corporate opportunities
There are different possible strategies
oblige the director not to compete against the company
When approached as a director of the company, they have to act in the interest
of the company and not in their self interest
when taking the opportunity for himself, the director is liable for the escaped
Conflict of interest or no profit rule?
Conflict of interest: opportunity must first be offered to the company, where the
exploitation of the opportunity by the director would generate a conflict of interest
between the directors personal interest and his or her duty to the company
No profit rule: Rule against secret profits, director must not make profit arising out
or in the course of his office as director without that profit having been disclosed in
advance and approved by them
Remedies by the company Accounting by the director for the profits made out
out of the personal exploitation, aim to deprive the director of any incentive, to
put the companys interest second, the company can sue for damages

Duty not to accept benefits from third parties

Quite often third parties offer benefits (bribes) to directors for appointing the
third partys nominees to the board and then resigning themselves to commission
paid to the director without any corrupt motive
Directors have a duty not to accept and to exercise independent judgement
This duty is very important in company groups, with regard to the judgement of
subsidiaries directors who have to take decisions that involve the holding or the
controlling shareholder
Nominee directors must exercise independent judgement as well, they are working
for the company and in its interest, even though they were appointed by third
parties for them to gain access to information etc.
Who are nominee directors?
Refers to directors who were appointed by minority shareholders, creditors etc.

Competing directors
Should directors be allowed to compete with their company?
In Continental Europe the general rule is that they are forbidden from competing
unless so authorized by the shareholder meeting
In the UK there is no clear rule but the non competing duty falls within the duty to
promote the companys success

Exculpatory clauses
Can shareholders shape the extension of directors liability to the company
through exculpatory clauses?
Under Delaware law, the limitation of directors personal liability for monetary
damages for breaches of the duty of care is permitted, provided that the clause in
the corporations charter does not eliminate liability
o for any breach of the directors duty of loyalty,
o for acts or omissions not in good faith or which involve intentional misconduct or
a knowing violation of law, and
o for any transaction from which the director derived an improper personal benefit.

Exculpatory clauses
Exculpatory clauses are not allowed in the UK: the provisions on directors liability
are mandatory, they are not default rules that shareholder can alter in the
companys constitution
This approach is generally followed in Continental Europe as well.

However, the company can purchase insurance against the directors liability to
the company, at the companys expense and for the benefit of the director, paying
directly or indirectly through an increased remuneration
This insurance cannot cover intentional wrongdoing, but the presence of insurance
may encourage litigation
This approach is followed in Continental Europe as well
Policy question: Why are companies allowed to protect directors against their own
claims against them? It would not be easier to allow exculpation clauses?
There is no straightforward answer as far as I know: the law is not always fully
rational. Del. law appears more rational.
Shareholder-centric formulation of the duties, with adoption of enlightened
shareholder value means that the shareholders are the primary beneficiaries of
the duties, but the duties are not formulated as to reduce the shareholders
agency costs
Caremark Case Directors Duties
Derivative action The company is suing a director, through a shareholder, when settling the judge has to consent
Allens opinion - framework
Caremark is about the approval of a settlement concerning a derivative action
What is a settlement? Agreement between parties, It Transazione
What is a derivative action?
Why did shareholders sue Caremarks directors?
Which kind of losses had directors caused to the company according to the claim?
The claim
The claim was that the directors allowed a situation which exposed the corporation to enormous legal liability
and that in so doing they violated a duty to be active monitors of corporate performance
Was there any charge of directors self-dealing or conflict of interest?
Was there any charge concerning the duty of loyalty?
Does a violation of criminal law create a breach of fiduciary duties by directors?
Liability of directorial decisions
Judge Allen notes that director liability for a breach of the duty to exercise appropriate attention may arise in
two distinct contexts
Which are those contexts?
1: A board decision that results in a loss because that decision was ill advised or "negligent"
Is this the area concerning the duty of care?
Is the Business Judgement Rule applicable in this context?
Why, according to Allen, compliance with a director's duty of care can never be judicially determined by
reference to the content of the board decision that leads to a corporate loss, apart from consideration of the
good faith or rationality of the process employed?
What is the policy position that supports Allens opinion?
What does it mean second guessing?
Why are judges ill-equipped to second guess directors decisions?
Why is the BJR process oriented?
When a director should be deemed to have satisfied the duty of attention?
Allen writes about moral as well. Can you remember in relation to what he mentions moral issues?
2. Liability for failure to monitor
Why is Allen discussing criminal law and the modern tendency to assure corporate compliance with external
legal requirements?
What are compliance programs?
Allen discusses a 1963 Delaware Supreme Court case concerning the potential liability potential liability of
board members for losses experienced by the corporation as a result of the corporation having violated the
anti-trust laws of the United States. Why? Does he think that the decision is still applicable?
1963 vs 1996
The Delaware Supreme Court in 1963 and in 1996 according to Allen
Why they would not share views about directors liability in oversight cases?
What are the three developments that have changed the law on this issue according to Allen?
How is the law changed according to Allen?
Caremarks directors
Was there a knowing violation for statute?
Was there a failure to monitor?
According to Allen, what kind of failure of the board would establish the necessary conditions to liability?
Is the BJR applicable to oversight cases?
Allen never discusses good faith
What is it in your opinion in this directors liability context?
Chapter 7 - Centralized Management, Setting the Boards Incentives

Trusteeship and non executive directors (The nature of Trusteeship on the board)
Trusteeship strategy as a central element of the reforms in the modern corporate
governance debate
They are based on the insight that the most powerful incentives to self interested
behaviour comes from holding a directorship in conjunction with a full time executive
position in the company as a senior manager and CEO (raising their reward package
and influence the company in away it does not benefit the shareholders but confers
private benefits, e.g. private jets or exercising power publicly)
as long as the company is going well it is very difficult to prove the company could
have been run better from the point of view of the shareholders
Raise of non executive directors, NED After many corporate failures in part
attributable to the CEOs
Independent non executive directors (those not otherwise currently or recently
connected with the company)
They only have a directorship and no managerial positions in the company, part-
time and remunerated by corporate standard, rather modestly
They may be motivated by low-powered reputational incentives to do a good
controlling job and by being more demanded in this role for other companies
! Though it is still being questioned whether low powered reputational incentives
can act as an effective counterweight to self interested executives and are able to
challenge dominant executives
US: NEDs usually constitute the overwhelming majority of members of the board,
making them dependent upon the shareholders and not independent of the
management, the appointment rights strategy being more effective than the
trusteeship strategy
UK: The report of the Cadbury Committee It rejected the proposal for closer
shareholder involvement in the selection of NEDs, not wanting to alienate
management from its proposals
But think of Allens reasoning in Caremark and think how new practices can
influence law nevertheless
How and who is going to vote and appoint directors? Depends on the companys
constitution and the articles of association
1. Simple majority as default rule
2. Voting by proportion
3. Voting by lists, slate election Two groups of shareholders, majority
shareholders propose 4 out of 5, the minority shareholders propose 1
(most common)

The UK Corporate Governance Code

Dual function of the board
Independent NED directors
Who does assess independence?
Board Committees
NED should have access to outside professional advice
To company information
Should be in a position to male adequate commitments of time to the company
The impact of the code in practice

1. Dual function of the board Lead and control the company within a framework of prudent and
effective controls, assessing risks and managing them and setting strategic aims
2. Exceptions are small listed companies
Board should consist of directors with the appropriate balance of skills, experience, independence,
knowledge of the company to enable its discharge its duties and responsibilities (around NEDs)
3. Directors have to be independent in character and judgement, meaning the board has to assess and
disclose whether the director has or had certain types of relationship with the company (e.g.
employment in the past 5 years, material business relationship in the last 3, other form of income or
acting as a representative of a significant shareholder)
4. NEDs both lead and control as well, they should challenge and help develop proposals on strategy,
controlling includes monitoring the performance of the companys executive directors and ensuring
financial controls and systems of risk management are robust and defensive
5. Committees consisting only (or majority) of NEDs for audit, remuneration and nomination, these
matters tend to generate high powered conflicts
6. Formal statement of the matters on which the boards decision is necessary
7. NEDs should have access to appropriate outside professional advice and to internal information
from the company
8. The chair of the board as a counterweight to the CEO, a clear division of responsibilities at the head
of the company between running the board and the executive responsibility for running the
companys business. For both position to be held by one person or a former retiring CEO becoming a
Chair, the board has to consult with the major shareholders in advance and give written reasons in
the next AGM (Chair is responsible for leadership of the board and ensure its effective operation)
9. Senior NED, acting as a crisis manager, proving a conduit between the other NEDs and the chair or
between shareholders and the chair/CEO, and is to lead one meeting a year without executives and
the chair
Importance of trusteeship strategy becomes clear
Not a law, but a code of best practice recommendation Only hard obligation to set out in the
Listing Rules how the company has complied with the provisions and explain areas of non compliance, if
that is done well the company cannot be criticised on non compliance ground
The Italian code
Referred to listed companies exclusively wants to satisfy institutional investors READ ON WEBFOLDER

The code and two-tier boards

Effect of implementation of a trusteeship strategy on the board is distinguishing
between executive and non executive board members
NEDs, participate in board tasks of setting and monitoring execution of business
strategies and the performance of the executive directors and senior non board
Execution and formulation of strategy falls into the hands of the executive
directors, especially the CEO
NEDs vs Executive Directors, Supervisory Board vs Management Board
Antipathy is shown against he two tier boards in the UK, but it is not forbidden
to create a two-tier board

NEDs and Disinterested directors

Interrelationship between independent NEDs and the exclusion of interested
directors from voting on the board resolution to approve the taking of corporate
A director is excluded from voting, if he/she is the director whose proposed breach
of duty is to be approved by another director interested in that opportunity
The excluded can be all type of director (NED, executive, dependent or
independent) as can be the authorizing directors
Interested director meaning he or she has come across an opportunity the
company has a legitimate interest in and wishes to exploit it personally
Not interested meaning he/she are not involved in the proposed exploitation
Decision making is supposedly transferred to sub-groups of director who are said
to uninterested, but it is less clear if they are free of self-interest when the broader
context is examined
they may be profiting from corporate opportunity to be taken by the board
because they might profit from the policy in the future when they are interested

The reward strategy and remuneration

Self-interest is accepted as a powerful motivator and tried to align with the
interest of the shareholders
Strategy with a potential because it does not need a legal framework for its
implementation as the incentives are embodied in a contract between the director
and the company, but
1. Difficulty of identifying an appropriate indicator of the shareholders welfare to
which the directors remuneration can be attached
Share option scheme, rewarding the director with the difference between the
option price and the market price prevailing when the option is exercised, usually
the director subscribes the shares for three years and then sells them, collecting
the reward
! When the share price rises because of an economic boom the value added might
not be attributed to the directors efforts, why then reward them?
! When the market period declines as a hole, the director will have no reward,
even though they have worked especially hard and have taken astute business
Directors reward may be attached to the relative performance of their company
as against appropriate comparator companies, only being rewarded when the
company is doing better than the comparators, regardless of the market situation
Long term incentive plans (ltips), there is a risk that it will generate an incentive
for senior management to maximize and manipulate the figures on which the
incentive plan turns at the particular point in time at which it matures, and it may
be only coincidental if this leads to a maximization of the welfare of the
shareholders over any longer period
2. Conflict of interest, the board still fixes the executives remuneration as a result of
the general grant of authority and their power to delegate their functions to others
on such terms and conditions as they think fit high powered conflict of
interest on the board, even if the particular executive director is often not allowed
to vote his remuneration package, this was exacerbated by relying more on
performance related pay to align the directors interest with those of the
shareholders, though question arises whether it is simply a mechanism of
extracting a higher level of remuneration and other benefits, to be found in the
criteria triggering the reward
Value of performance related pay linking reward to corporate and individual
performance, demanding criteria for determining pay-outs as to ensure the long
term success of the company performance related rewards remain very
New ideas emerging, with the underlying notion to take the setting of the
remuneration packages out of the hands of the board as a hole and into the hands
of NEDs

Remuneration committees
Code requires the companies it covers to establish a remuneration committee
consisting of independent NEDs and usually the chair of the board
Should set the remuneration for the executive directors and the chair and
recommend to the board the remuneration level for senior management below
board level
Code provides guidance on setting of the performance related elements of the
remuneration package, including reclaiming it in case of exceptional misconduct
and misstatement and avoidance of excessive compensation when a director is
removed during his/her term of office ex ante a golden parachute could
induce a director to make risky decisions and take on major role in a company
which needs to be turned around, an alternative would be a higher basic salary
which might be more expensive in the event
Impact of the committees has been muted, often the code seems to associated
with the upward rise of remuneration packages
Main reason for the high remuneration is the following: Many independent
NEDs are executive directors in other companies and are more likely to share a
high compensation culture
Problem with implementation of trusteeship strategy and the difficulty of
finding non executive directors who are both effective and free from executive
directors issues