Corporations, Module II: Policy, Lesson 1: Federalism

CORPORATIONS
MODULE II: POLICY
LESSON 1: FEDERALISM
Professor Seth C. Oranburg
Duquesne University School of Law
Spring 2020

Concepts in This Lesson
■US Corporate law history
■Internal Affairs Doctrine
■Federal (non) Abstention
■Race to the Bottom/Top
© 2020 Seth C. Oranburg

At the end of this lesson, you
should be able to:
■ Remember and identify which corporate actions
constitute internal affairs
■ Describe the internal affairs doctrine (IAD)
■ Apply the IAD to McDermott
■ Analyze the impact of corporate long-arm statutes
(e.g., CA 2115) of the IAD (see L-P, VVP)
■ Evaluate whether the IAD is good for corporate
stockholders, stakeholders, and society

The Fundamental Question:
What Is a Corporation?
■Private Property?
■Social Institution?
■Human Collective?

Corporations: A Brief History
■ Joint stock companies (UK)
– State concession or complex contracts
■ Colonial chartering
■ State chartering
■ Corporate personhood
■ New Jersey (1888) and Delaware (1899)
enabling statutes

Bubble
Act of
1720
“An Act to
Restrain the
Extravagant
and
Unwarranted
Practice of
Raising Money
by Voluntary
Subscriptions
for Carrying on
Projects
Dangerous to
the Trade and
Subjects of this
Kingdom”
On a single day, one thousand persons subscribed to shares
in the South Sea Company “for carrying on an undertaking of
great importance, but nobody to know what it is.”

The Delaware General
Corporation Act of 1899
“Delaware began the twentieth
century with a general incorporation
law that was as modern as any
existing at that time.” S. Samuel
Arsht, A History of Delaware
Corporation Law, 1 DEL. J. CORP. L.
1, 7-8 (1976)

The Modern Corporation
■Artificial or Natural Entity?
■Aggregate Theory
–Shareholder or Director
Primacy?

Horizontal Federalism in
Corporate Law
■States compete to offer the
“best” corporate laws
■This competition is possible
because of the “internal affairs
doctrine,” a doctrine of state
abstention

Internal Affairs Doctrine
■A corporation’s internal
affairs are governed by the
law of the state in which it is
incorporated
■What are “internal affairs?”

Internal Affairs:
■Voting of shareholders
■Fiduciary duties of directors
■Procedures for corporate action
■Other issues regarding the
relationship between the corporation,
its officers, directors, and
shareholders

Why do we have the internal
affairs doctrine?
■Uniformity
■Predictability
■Private choice

What is a “foreign corporation?
■A corporation that does
business in a state in which it
is not incorporated

McDermott
Inc.
What law governs a corporate reorganization?

Public
shareholders
McDermott
Delaware
McDermott
International
BEFORE
McDermott
Delaware
McDermott
International
100%
Remaining
Public Shs
8%
New public
shareholders
92%
AFTER
10%90%100%
Exchange
(1:1 + $0.35)
So what if sub
owns parent shares?
Credit: Palmiter & Partnoy

Reasoning in McDermott
“[Courts and
legislatures] have
consistently applied
the law of the state of
incorporation to the
entire gamut of
internal corporate
affairs. In many cases,
this is a wise,
practical, and
equitable choice.”
“[A]pplication of the
internal affairs
doctrine is not merely
a principle of conflicts
law. It is also one of
serious constitutional
proportions—under
due process, the
commerce clause and
the full faith and credit
clause.”

Bonus Question: What
Delaware law prohibited a
majority-owned sub from
voting?
(c) Shares of its own capital stock belonging to the
corporation or to another corporation, if a majority of the
shares entitled to vote in the election of directors of such
other corporation is held, directly or indirectly, by the
corporation, shall neither be entitled to vote nor be
counted for quorum purposes. Nothing in this section
shall be construed as limiting the right of any corporation
to vote stock, including but not limited to its own stock,
held by it in a fiduciary capacity. DGCL § 160 (c)
Corporation's powers respecting ownership, voting, etc.,
of its own stock; rights of stock called for redemption.

Holding in McDermott
■The trial court erred in refusing
to apply the law of Panama to
the internal affairs of McDermott
■Internal affairs doctrine means
the law of the state of
incorporation applies

Attempted State Regulation of
Pseudo-Foreign Corporations
■Corporations incorporated
outside the state are foreign
corporations
■What happens when the
majority of corporate business
is done with a foreign state?

California § 2115
■California’s
corporate long-arm
statute
■“Pseudo-foreign
corporations”
■“Quasi-California
corporations”

Louisiana-
Pacific

Issue of L-P: Which state’s
corp. gov. laws apply?
■California requires cumulative
voting by shareholders for
directors
■Utah permits straight voting
■Can California trump the
internal affairs doctrine?

Facts of L-P
■π claimed entitlement to
cumulative voting – what’s that?
■∆ incorporated in Utah but
>50% employees,
shareholders, operations in
California

Holding: Yes, California law
may apply
■ California may impose its law requiring
cumulative voting by shareholders upon a
corporation which is domiciled elsewhere, but
whose contacts with California, as measured by
various criteria, are greater than those with any
other jurisdiction.
■ California had a “greater interest” and therefore
its voting provisions were applicable under the
Constitution

How does the US Constitution
impact this holding?
■ Due Process
– Corporate stakeholders require
adequate notice of whose law applies
■ Commerce clause
– State mutual non-interference
■ Full faith and credit clause
– Enforceability and certainty

Due Process and
Equal Protection
■Notice given

Commerce Clause
(U.S. Const., art. I, § 8, cl. 3),
■Effect upon interstate commerce
was minimal in relation to its
purpose of preventing pseudo-
foreign corporations from
circumventing the social policies of
California

Full Faith and Credit Clause
(U.S. Const., art. IV, § 1)
■California had a significant
aggregation of contacts with the Utah
corporation,
■State interests created by those
contacts were substantial, and
■Utah law permitted cumulative voting.

The “California Approach”
■Wilson v. Louisiana-Pacific
Resources, Inc., 138 Cal. App. 3d
216, 187 Cal. Rptr. 852 (1982) is
the minority approach
■Most courts, especially Delaware,
apply the internal appairs doctrine

Vantagepoint
Venture
Partners
Delaware
incorporation
California
activity

Issue in VVP
■Which state’s law applies to
shareholder voting rights
when a firm does substantial
business in California but is
incorporated elsewhere?

The Conflict of Corporate Law
■California requires separate
class voting
■Delaware has single class
voting

Rule: Internal Affairs Doctrine
■The internal affairs of a
corporation shall be governed
by the corporate law of its
state of incorporation

Brief Facts of VVP
■π is a quasi-California corp.
■∆, a SH of π, claimed π is
required by California law to
have class voting for merger
approval
■π sued for declaratory judgment

Arguments
■π claimed that VVP not entitled a
class vote of Series A Preferred
Stock for a merger because the
internal affairs doctrine applies
■∆ claimed VVP is entitled to a
Series A vote because of CA 2115

Holding in VVP
■ Delaware law applies
– Internal Affairs Doctrine
■ Only one state should have the authority
to regulate a corporation's internal affairs:
the state of incorporation
– Certainty and predictability
– Protects justified expectations of the
parties with interests in the corporation

Reasoning from VVP
■ “The internal affairs doctrine is not … only a conflicts of
law principle.”
■ “In CTS, the Supreme Court concluded that ‘so long
as each State regulates voting rights only in the
corporations it has created, each corporation will be
subject to the law of only one State.’ Accordingly, we
hold Delaware's well -established choice of law rules
and the federal constitution mandated that Examen's
internal affairs … be adjudicated exclusively in
accordance with the law of its state of incorporation,
Delaware.”

Due Process Argument
■Corporate actors have the
right to know what law will
apply
■Internal affairs doctrine
provides certainty

Commerce Clause Argument
■States have no interest in
regulating the internal affairs
of a foreign corporation
■Did California have a
legitimate interest in
regulating VVP?

Reconciling the Cases
■Are you surprised that a California
court would impose California law
on a Utah corporation?
■Or that a Delaware court would not
impose California law on a
Delaware corporation?

Vertical Federalism
■The Internal Affairs Doctrine is one
of state abstention from the
internal affairs of foreign
corporations
■The federal government also
abstains from much interference in
state corporate law, but not all…

Class Discussion:
Race to the Top or Bottom?
■The Human Element
■A Broader Application
■In Higher Education
■Impact on Society

Conclusions:
■ Remember and identify which corporate actions
constitute internal affairs
■ Describe the internal affairs doctrine (IAD)
■ Apply the IAD to McDermott
■ Analyze the impact of corporate long-arm statutes
(e.g., CA 2115) of the IAD (see L-P, VVP)
■ Evaluate whether the IAD is good for corporate
stockholders, stakeholders, and society

Corporations, Module II: Policy, Lesson 1: Federalism

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