#11133 - Financial Structure Of The Corporation - Corporations

Financial Structure of the Corporation

1. Corporate Securities

   1. Equity Securities

      1. (1) Common Stock

         • Residual interest in profits/assets of corporation after claims by creditors and preferred stockholders have been satisfied

         • Although common stockholders are last in line with respect to distribution of income and liquidation, they are generally first in line with respect to control

         • Primary beneficiary of fiduciary duties

         • Usually have the exclusive power of electing directors

      2. (2) Preferred Stock

         • Stock is classified as preferred stock when the articles assign to it economic rights senior to those customarily assigned to common stock

         • If no attribute is assigned to a class of stock with respect to its voting rights, right to dividends, or rights to redemption or in liquidation, courts generally will presume that "stock is stock"

           • Most Courts have taken the position that the only protections to which holders of preferred stock are entitled to are those spelled out in the articles/certificate

             • It is all essentially PER CONTRACT

           • Generally, the liquidation preference is behind other creditors but ahead of common stock

         • Preferred stock almost always has dividend rights senior to those of common stock

         • May be voting or non-voting

         • Cumulative: If a dividend is not paid when due, the right to receive that dividend accumulates and all accrued dividend arrearages must be paid before any dividends can be paid on common stock

         • Participating: Receive dividends whenever they are paid on common stock

         • Blank Check Preferred: Rights to dividends, liquidation preferences, redemption rights, voting rights, and conversion rights can be set by the board at the time of issuance

      3. Authorized Stock: Articles/Certificate specifies how many shares of the common/preferred the corporation is authorized to issue

         • Doctrine of Preemptive Rights

           • Traditional Rule: A shareholder had an inherent right to maintain his interest in a corporation by purchasing a proportionate share of any new stock issued for cash

           • Modern Rule: Modern statutes provide corporations with the option of avoiding preemptive rights (almost all corporations do this)

             • MBCA § 6.30(a): "The shareholders of a corporation do not have a preemptive right to acquire the corporation's unissued shares except to the extent that the articles of incorporation provides otherwise."

             • The DGCL does not explicitly address preemptive rights BUT DGCL § 157 authorizes a corporation to issue rights to purchase its stock, which can include preemptive rights

               • Implicitly, this means that there are no preemptive rights by default

         • Before a corporation who has issued all of its authorized shares can issue more stock, it must amend the articles/certificate to authorize more shares DGCL § 242.

         • Step 1: "[T]he board of directors shall adopt a resolution setting forth the amendment proposed . . . ." DGCL § 242(b)(1).

           • But see DGCL § 102(b)(4) (allowing you to set forth a different vote requirement for shareholder approval or for a vote of the board of directors).

         • Step 2: "The holders of the outstanding shares of a class shall be entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation . . . ." DGCL § 242(b)(2).

           • But see DGCL § 102(b)(4) (allowing you to set forth a different vote requirement for shareholder approval or for a vote of the board of directors).

      4. Outstanding Stock: The portion of the authorized stock that has been sold and remains in the hands of the shareholders is the outstanding stock

      5. Authorized But Unissued Stock: Authorized stock but not outstanding stock (a.k.a. Treasury Shares)

         • Board ordinarily has the authority to decide on what terms to issue the authorized but unissued shares

         • BUT where the corporation is issuing shares with more than 20% of voting power outstanding immediately before the transaction AND the consideration is other than cash or cash equivalent, shareholder approval is required. See MBCA § 6.21(f).

      6. Corporate statues require that at least one class of equity securities must have voting rights and the right to receive the net assets of the corporation in the event the corporation is dissolved or liquidated

         • These rights are generally assigned to common stock but can be assigned to preferred stock

   2. Debt Securities

      1. (1) Bonds, (2) Debentures, and (3) Notes

         • Terms are fixed entirely by contract

           • Indenture: Complex contract fixing terms of bonds

           • May include covenants or negative covenants

         • In the event of default, generally an "acceleration" clause

         • Notes and Debentures have shorter maturities than bonds

         • Convertible Debentures: Hybrid securities that closely resemble convertible preferred stock

           • Redeemable or "callable" at a fixed price

         • Debt securities generally do not carry voting rights

           • BUT some corporate statutes allow the issuance of voting debt. See, e.g., DGCL § 221.

         • UNLESS the articles/certificate provides otherwise, the board of directors have the authority to issue debt securities without shareholder approval

   3. Options

      1. The right to buy or sell something in the future (e.g. stock at a fixed price)

      2. Warrants: Another name for Stock Options

      3. Call option: The right to buy shares

      4. Put option: The right to sell shares

      5. Strike or exercise price: The price specified in an option contract

      6. Maturity or expiration date: The date specified in the option contract

   4. Hierarchy re Liquidation Preference

      1. Debt

      2. Preferred Stock

      3. Common Stock

      4. BUT SEE Deep Rock Doctrine - (pg. 214-15)

         • If a corporation had too much debt, a bankruptcy court might treat debt as equity, pushing it further down in the capital structure and making it less likely that the debt holders will receive anything in the process

         • If the investors have deceived the lenders by masking the degree of leverage, courts will be more likely to invoke the Deep Rock Doctrine

   5. Hierarchy re Control

      1. Common Stock

      2. Preferred Stock

      3. Debt

2. Capital Structure

   1. Capital Structure: How a corporation has raised funds using corporate securities

   2. Tax

      1. Because of the propensity to create hybrid securities (that will have characteristics of both equity and debt), the IRS and the courts have created FACTORS to determine whether debt is really debt:

         • (1) the names given to the certificates evidencing the indebtedness

         • (2) the presence or absence of a fixed maturity date

         • (3) the source of payments

         • (4) the right to enforce payments of principal and interest

         • (5) participation in management flowing as a result

         • (6) the status of the contribution in relation to regular corporate creditors

         • (7) the intent of the parties

         • (8) "thin" of adequate capitalization

         • (9) identity of interest between creditor and stockholder

         • (10) source of interest payments

         • (11) the ability of the corporation to obtain loans from outside lenders

         • (12) the extent to which the advance was used to acquire capital assets

         • (13) the failure of the debtor to repay or seek to postpose on the due date

   3. Leverage increases the potential for higher profits BUT ALSO increases risk

   4. Deep Rock Doctrine - (pg. 214-15)

      1. If a corporation had too much debt, a bankruptcy court might treat debt as equity, pushing it further down in the capital structure and making it less likely that the debt holders will receive anything in the process

      2. If the investors have deceived the lenders by masking the degree of leverage, courts will be more likely to invoke the Deep Rock Doctrine

3. Legal Capital

   1. Purpose: To provide a benchmark for the propriety of the declaration of dividends

      1. ALSO serves as the basis for lawyer opinion

   2. General Rule: No distribution may be made to shareholders unless, after the distribution, the corporation has not only enough assets to pay its creditors but also an additional specified amount

      1. Distribution: (1) Declaration of dividend OR (2) Stock...