Cases in business law

Cases in business law

Lesson 1 (16/09)

Prof. Andrea Sacco Ginevri

Lessons on Monday (18:30-20:00; theoretical lesson) and Friday (15:30-17:00; practical cases from 3 to 6 pages that will be presented). The materials are on the syllabus. Attendance is mandatory.

Midterm: 28 October, not mandatory but strictly recommended!! 3 open questions about the first part of the semester.

The final exam is oral about the second part of the semester and it is only ONE question.

Books:

• AA. VV., The Anatomy of Corporate Law. A Comparative and Functional Approach, Oxford University Press, 3rd Edition, 2017
• AA. VV., Commentaries and Cases on Italian Business Law, directed by A.Sacco Ginevri

Exam Dates: 19 December, 7 February

The Financial Market does not care about country, only efficiency. Starts in C and ends in F. There are two ways to go from F to C, that are upside or downside:

• Indirect circuit: from F to C
• Direct circuit: from C to F

Big F: means Families (because they have their resources, that in juridical terms is called "Savings", art. 47 of Constitution: Republic of Italy shall protect public savings).

Big C: Corporation can expand business through people’s savings (investors are lenders), can increase employment, can grow economic and social welfare.

Financial Market Goals: Good allocation of resources from lenders to borrowers and reduction of transitional costs. The first goal of the financial market is to create more competition; the second goal is to reduce transitional costs. "I" means insurance companies that receive money from us, which will go to the corporation. Financial market protects your money and attracts/incentivizes families.

Indirect way (you don’t decide where your savings go):

• B: Bank, who collects savings from F and lends to C
• T: Insurance companies (attract our money more intermediation → profit)

Direct way (you decide where your money goes):

• D (dealers) and B (brokers) you ask them to invest in a particular corporation, they ask you for a percentage

We need to incentivize families to invest their money into corporations.

Difference between debt and equity: Companies have to decide how to allocate money and have these two opportunities.

Alpha Corporation

A company can be financed by debt (lenders) and equity (new shareholders). From a legal point of view, debts are obligations to give money back plus interest (less risky), while equity takes 100% risk of the company. Shareholders are people who invest in a corporation by buying shares or debt; they take the risk of the company. Shareholders take profit (quota) or incur a loss. At the end of the year, the financial register profits or losses.

Reasons for equity and debt:

• Equity: meaning losing your control (main reason why most companies don’t like to issue new equity) but it is less easy to go bankrupt (because equity means "I pay just in case of profits").
• Debt: Easier to go bankrupt (to repay debts, more obligations to be respected) but it’s easier to get debtholders. It’s a way to maintain full control.

Lesson 2 (20/09)

Savings come from the right (family) and go to the left (company). There are 2 ways (just seen). B/TC FB/D.

• 1st way the traditional way: the upper part. Indirect circuit because family does not know exactly where their money goes.
• 2nd way direct way.

Conflict of interest issue:

• 1st class between financial intermediaries (in the middle of the figure, banks, brokers) and their clients. It is called an external conflict.

Family needs, in any financial market regulation, a financial intermediary to invest their money because finance is a sophisticated game, and so legislators do not want people to act alone but want someone to help investors save their money.

Simple principle: In case of a conflict between financial intermediaries and its clients, the interest of the clients win/prevail. So, if there are two different interests in conflict, the rules say that the interest of the family prevails.

Example: Banks are involved in IPO process (Initial Public Offering). When a company goes public (listed) there is a law that company has to give a mandate to one or more banks. Such banks are paid by the company to allocate the shares to the public, but they are paid more to take the risk of the transaction: if they do not find investors, they buy/purchase the shares that are not sold in the market. When banks pay shares that are not allocated, they have a lot of shares to sell to the market. This is a conflict of interest between a financial intermediary and clients.

(Contract is a legal way to find a balance/a meeting point to two conflicting interests. So, it’s a way to resolve a conflict between two parts.)

So, if you look at the relationship between financial intermediaries and their clients, from a contractual perspective, we don’t understand why there is a conflict. The rule of contract can’t explain the conflict of interest.

So that there is an agent, a representative. Representation: each person acts through an agent.

Two different laws about conflict of interest:

• In case of a contract, two parties are normally in conflict of interest.
• In case of a principal-agent relation, the interest of the agent should be the same as the principle, while the third part is normally in conflict.

In this case, we are in the second scenario. It explains why financial intermediaries always protect the interest of the clients. Because the real counterpart of a transaction is the corporation.

Legally, financial intermediary operates in the name and interest of the client, negotiating the best transaction for the investors.

(Enron crisis: what’s wrong? An accounting firm used to offer their client (public company) ancillary services. You are not independent. Accounting of big firms is mandatory to protect savings. Legislators protect public investment.)

The advantage of a public company is to share the risk and control alone.

2nd class Internal conflict of interest, that happens inside the corporation. In corporations, there are shareholders that, in general terms, are owners of the company (the principal): they invested their money and they shared the property on the company on its business and on its assets. They are the risk takers: they suffer the risk of the business; then there are the directors, who are the top managers of the company. They are the agent (directors that take the business decision, generally speaking, except for extraordinary transactions that are something that could happen sometimes; but normally the CEO and other directors manage the company) but they work for the shareholders.

So anytime you see an agent, you know that he could be in conflict with his principal and that, as a general rule, the agent shall follow, pursue, and achieve the interest of the principal, in case of conflict. That's the basic rule in companies in any business organization.

The real issue is that in public companies it is not easy to select the interests of the shareholders. Why? First, because there are so many shareholders, particularly in Europe, that there are controlling shareholders on one side and minority shareholders on the other side that often are in conflict. And second because the interest of the controlling shareholders could conflict with the interests of the company.

So, in internal conflict of interest, the main conflict is between shareholders and directors because typically shareholders are principal and directors, agents. So directors shall do the interest of the principal; obviously, in real life, they always try to do their personal interest; they want to have very high remuneration, they want to do their personal interest, and sometimes they say "OK, my personal interest is in line with the interest of the company". So, there could be a conflict of interest and there could not be a conflict of interest. But in Italy and everywhere, the rule says that if a director has a conflict of interest with the shareholder, the interests of the shareholder prevail.

In real life, it's not easy to find the interests of the shareholder. In the first issue, because sometimes they can have conflicts of interest among them (typically between the controlling shareholders and minority shareholders). The second issue is "are we sure that interests of shareholders mean interest of the company?". Because many people are starting to say that the interest of the company is something wider than the interest of shareholders because the company is established by business initiative shareholders. So shareholders establish a company. But when a company is established, it deals with several stakeholders (not only with its shareholders but also with clients, employees, creditors, suppliers, counterparties in agreements).

For almost one century everybody told that the interests of the company were the interests of the shareholders, because shareholders are the principal that invest money. While stakeholders were something different that should be protected (when a director decides to take or not a business decision should look only at the interest of the shareholders). Now something changed. Corporations should look not only at the interests of their shareholders but at the interests of the stakeholders. What happened with the last financial crisis of Lehman Brothers? It is called "short term view". It was a very dangerous practice.

Now all the financial regulation shares the mandatory rule that company's financial intermediaries shall pursue the interest of the company in the long-term view (3-5-7 years). So directors cannot do a transaction that is excellent for the next 6 months but can be dangerous for the company in the long-term view because this is not covered by the so-called "business judgment rule" (is a rule that says that in corporations, directors could not be liable/responsible if they take a business decision and things went wrong: it protects directors because it says that a director of a company cannot be liable/responsible if he took a business decision that was reasonable when he took it but then things went wrong for any reason). Example: a soccer team purchases a very good player, paying their fair value of such player and then this player goes broke. So, the director has no responsibility because the decision was reasonable, and he cannot guarantee the final race of their decisions. In real life, if a director takes a decision that is good in the short-term view but is wrong in the long-term view and it's clear that it is wrong from the beginning, these directors go liable and have to repair the damage that they create.)

Today when we say that the interests of the company are the interests of the stakeholders, it is not true, but managers say that because institutional investors, in their investment policies, look at the ESG criteria (social goals, environmental, …). That's why directors of the corporation want to prove and to show that they follow these additional goals to attract money. Attracting money is the main goal. So, the directors have to do the interests of long-term shareholders, making profit in a sustainable way.

Lesson 3 (23/09)

Review:

• Difference from equity to debt: debts have to be repaid by money + interests, while equity is repaid by dividends or losses.
• What is the main goal of any financial market regulation? The aim of financial regulators is to allocate resources from families to companies, because companies want money to improve their business.
• What is the main rule of the conflict of financial intermediaries and clients?
• What is the main rule of conflict of interest between directors and shareholders? The interest of the shareholders prevails.
• What is the notion of corporate interest? Compliance and regulation, ON THE LONG-TERM.

Security regulation (financial market regulation)

Set up of a company: Establishment of a company

Historically, a company corporation is established by two or more people, because corporation means "societas" (two or more people).

However, at the beginning of the ‘90s, because of a European directive, our private companies (SRL, similar to dividend companies in other countries) were allowed only one quota holder (one investor had the possibility to establish a private company).

Why do people have an interest in establishing a corporation? Because of responsibility. In Italy, there is a rule about the physical person: when a physical person takes an obligation, of whatever nature, the responsibility is full property. If you want to leave the responsibility, you can do it only by establishing a juridical person (corporation). So, the reason why there is the establishment of a corporation is the limited responsibility.

In a corporation, the shareholders have only one obligation, from a legal point of view: to contribute the initial capital/contribute (that is to give the financial needs necessary to start the business of the corporation, and these are allocated to the share capital). After that, when you complete your contribution, you don’t have any other obligation, but only rights and stuff. All the contributions, together, form the equity of the company. Italian and European law requires all corporations to have a minimum amount of share capital, which is €50,000 (in Italy). Then, this minimum should be complied with and respected.

Shareholders can contribute in money (nominal capital) and also in assets that increase the corporation’s value. It is a problem because of the evaluation of each asset. The evaluation shall be well done because it increases the share capital. And the share capital has to be real. When you allocate value to the share capital, you have to be 100% sure that the value effectively exists; otherwise, you give the impression to 3rd parties that your company has a value higher than in real life.

Option right: The general rule is that when a company wants to increase its equity (share capital), such a company offers previously this increase to the existing shareholders (in a proportional way). And then, the shareholders can decide if they want to exercise their right (by contributing to increasing the capital by putting money). So, first, the option right is a right and not an obligation (the shareholder can decide if they want to exercise or not their rights). Just in a few cases, companies can decide to increase their capital without giving the existing shareholders the option right. The consequence is the decrease in quota (because another person enters the share capital). Why does a company ask for money from others and not from existing shareholders? Because they decided to ???

EXERCISE: Alfa S.p.A

There were two shareholders: Tizio 50% and Caio 50% of the share capital. Share capital 100 shares → Nominal value 1 euro. The company wants to receive a building from the professor valued at 500 euros. The total share capital is 200 because (nominal value= 100) the real value of the company is the equity 400 + 100= 500 and the building is 500. So 100 goes into share values and 400 in reserves.

Share premium reserve: "Riserva sovrapprezzo" is the difference between the increase in nominal capital and the increase in market value (?)(40:00 circa).

Shareholders share value and losses.

Example: Alfa 2019

Revenue 300

Cost 600

Loss 300→ From an accounting perspective, where do you allocate the loss of 300 into the balance sheet? In reserves of 100. (??)

Mandatory redaction: Mandatory because companies are obliged.

Voluntary redaction: Appears not in case of loss, but when the share capital is too big for the business that the company wants to plan. In this case, they can decide to distribute the share capital.

The difference between mandatory and voluntary is that, in the voluntary redaction, corporate creditors have 90 days in which they can oppose the transaction. Why? Because in the corporation, the shareholders are not liable, and so the share capital has an important role, and then because the shareholders cannot review the share capital voluntarily without their consensus.

The voluntary redaction is a real redaction: money goes out of the company; The mandatory redaction is a nominal redaction: money went out of the company because of the cost during the year.

Lesson 4 (27/09)

Case: Share capital increase

(Corporation → share; society → quota. Shares are different from quota: shares and quota have nominal value; shares can be listed and traded on financial (public) markets; quota on private transactions; all shares have the same nominal value; both are limited liability; quota does not physically exist while shares exist.)

Lesson 5 (30/09)

Corporate control and group of companies

Corporate control when a company has the legal own; it controls another one when it has the majority of shares of another company or when it is an important creditor (sometimes being a creditor means having corporate rights). There are the controlling company and the holding company. The first is called the "subsidiaries".

1st case: de iure control if the shareholder has the majority of the shares (more than 50% of the shares);

2nd case: de facto control if the shareholder has a huge control/stake but not.