BAR ESSAY

Question 1

Mandatory Items for Certificate of Formation

Answer 1

Name of the corporation; the nature/purpose of the biz; number of the shares that the corporation is authorized to issue and their par value; the types of shares (if more than one), their privileges and par values; duration (if not indefinite); name and address of the corporate agent; corporate offices; names and addresses of all the organizers; and the number of initial directors, their names, and addresses.

Question 2

Organizer

Answer 2

The person who puts together the certificate of formation; must sign the CoF.

Question 3

Name Requirements

Answer 3

The name of a corporation must contain the word “corporation,” “incorporated,” or “company,
or an abbreviation of those words. The chosen name of a corporation may not be the same as or deceptively similar to the name of another registered business entity doing business in Texas, unless the other entity consents in writing. The corporation may not choose a name that contains any word or phrase that indicates or implies that the entity is engaged in a business that the entity is not authorized by law to pursue.

Question 4

The issuance of stock must be authorized by…

Answer 4

the board of directors. In Texas, shares may be issued by a corporation in exchange for any benefits to the corporation, including cash, promissory notes, services already performed, and contracts for services to be performed. The full consideration agreed upon must be received by the corporation before the shared may be issued.

Question 5

Who sets the price at which the corporation sells its shares?

Answer 5

The board of directors sets the price at which the corporation sells its shares.

Question 6

A corporation may, but is not required to, issue par-value stock. For such stock, the corporation is required to…

Answer 6

receive at least the value assigned to that stock, which not need be, and almost always is not, its market value, and which can even be a nominal amount. When a corporation does not receive consideration at least equal to par value, the stock is characterized as “watered stock.” The shareholder of watered stock is liable to the corporation’s creditors for the difference between par value of the stock and the amount paid for the stock.

Question 7

Preemptive Rights give the shareholder…

Answer 7

Give the shareholder the ability to purchase newly issued stock in proportion to the shareholder’s existing ownership in the corporation. Corporations formed after September 1, 2003 must provide for preemptive rights expressly in the certificate of formation. A shareholder may waive his preemptive rights. A waiver of the right to exercise a preemptive purchase is irrevocable if in writing, but it may be revoked if made orally.

Question 8

Preemptive rights allow a shareholder…

Answer 8

to purchase stock in proportion to their current ownership in the company. Current ownership applies to the shares outstanding. Preemptive rights apply only to stock issued for cash. They do not exist for (i) stock issued for services or property, (ii) stock sold or granted as compensation to directors, (iii) stock issued within six months of incorporation, or (iv) preferred shares or non-voting shares.

Question 9

Board of directors duty of care.

Answer 9

The board of directors of a corporation owes a duty of care to the corporation. In exercising this duty, the board of directors is authorized to rely on expert opinion regarding the appropriateness of its activities in managing and running the corporation.

Question 10

Directors are selected by…

Answer 10

the shareholders at the annual shareholders’ meeting if a quorum is present. However, if there is a vacancy on the board, including a vacancy created by an increase in the amount of directors, either the shareholders or the directors may fill the vacancy. When the vacancy leaves the board without a quorum, the directors remaining may elect a replacement director by majority vote.

Question 11

Regular vs. Special Meetings as pertaining to notice

Answer 11

Regular: directors not entitled to notice unless the bylaws so require;
Special: director is statutorily entitled to notice; notice must specify the date, time, and place of the meeting, but there is no requirement that the notice specify the purpose of the meeting. There is no statutory restriction on the method by which the directors can receive notice of a directors’ meeting. Unless prohibited by the CoF or other agreement, notice by e-mail or facsimile is valid if the director consents.

Question 12

A director’s presence at a meeting constitutes waiver of notice unless…

Answer 12

the director attends for the express purpose of objecting to the meeting.

Question 13

For the board of directors’ acts to be valid…

Answer 13

a quorum of directors must be present at the meeting. A majority of the board constitutes a quorum unless the certificate of formation or bylaws require a different number. The CoF or bylaws may never set a quorum at less than one-third of the number of directors, but they may provide that a quorum is less than a majority.

Question 14

A director may incur liability for illegal or improper actions taken by the board, even though the director does not vote in favor of the action. To prevent such liability, the director must:

Answer 14

(1) ensure that his dissent or abstention is noted in the minutes of the meeting; or (2) not vote in favor of the action and deliver written notice of his dissent to the presiding officer of the meeting before its adjournment or to the corporation via registered mail immediately after adjournment of the meeting.

Question 15

A corporation is required to indemnify an officer for:

Answer 15

any expense, including court costs and attorney’s fees, incurred in the successful defense of a proceeding against the office in his role as an officer. Indemnification is required whether the defense is successful on the merits or for a procedural reason.

Question 16

A corporation MAY indemnify an officer when:

Answer 16

(1) the officer acted in good faith with the reasonable belief that his conduct was in the best interest of the corporation, or that his conduct was at least not opposed to the best interest of the corporation; and (2) in the case of a criminal proceeding, the officer did not have reasonable cause to believe his conduct was unlawful. A corporation may indemnify a director or officer for all amounts expended, including unreasonable expenses. However, if liability was imposed in a derivative action, or a personal benefit was improperly received, only reasonable expenses may be indemnified.

Question 17

A corporation has several statutory powers to carry out its business and affairs. The powers of a corporation include:

Answer 17

the power to make contracts and guarantees; lend money to its managerial officers, owners, members, and employees, as necessary or appropriate if the loan or assistance reasonably may be expected to benefit the entity; pay pensions and establish profit-sharing plans; make donations for the public welfare or for a charitable purpose; and take other action necessary or appropriate to further the purpose of the corporation.

Question 18

A director owe’s two basic duties to a corporation:

Answer 18

(1) duty of care; and (2) duty of loyalty. In discharging these duties, a director is required to act in good faith. Traditionally, the duty of care has been defined as the duty to act with the care of an ordinarily prudent person in a like position and similar circumstances. The duty of loyalty requires a director to act in a manner that the director reasonably believes is in the best interest of the corporation.

Question 19

Merger and dissent.

Answer 19

A merger is a fundamental change in the corporation in which two or more corporations combine, resulting in one surviving entity. Any shareholder who objects to the merger may dissent and force the corporation to buy his stock at fair value as determined by an appraisal. Any person who holds shares in the corporation that is a party to a merger may dissent. However, when a corporation’s shares are listed on the national securities exchange, or held of record by more than 2,000 shareholders, a shareholder does not have the right to dissent to the fundamental change because he has an opportunity to sell stock at its fair value.

Question 20

How to exercise right of appraisal by shareholders.

Answer 20

To exercise the right of appraisal, the dissenting shareholder must follow the procedure set out by state law. First, the dissenting shareholder must give notice of his dissent to the president and secretary of the corporation, stating that the owner’s right to dissent will be exercised if the action takes effect. The notice must include the address to which notice of effectiveness of the action should be delivered or mailed. The notice of dissent must be submitted to the entity’s principal executive offices before the meeting. When the proposed corporate action is submitted to the shareholders for approval, the dissenting shareholder may not vote in favor of the action in person or consent to the action approved in writing.
After the merger is approved, the shareholder must make a written demand for payment. The demand must (i) be addressed to the president and secretary of the responsible organization, (ii) demand payment of the fair value of the ownership interests for which the right of dissent and appraisal are sought, (iii) provide to the organization an address to which a notice relating to the dissent and appraisal procedures may be sent, and (iv) state the number and class of the ownership interests of the domestic entity owned by the owner and the fair value of the ownership interests as estimated by the owner. The demand for payment must be delivered to the responsible organization at its principal executive offices no later than 20 days after receiving notice that the action was approved. Within 20 days after an owner makes a demand, the owner must submit to the responsible organization any certificates representing the owner’s ownership interests. The corporation must respond to the shareholder’s demand for payment within 20 days after receiving the demand. If the corporation accepts the amount claimed, it must pay the amount within 90 days after the proposed action is approved. The corporation may also counter the shareholder’s estimate of fair value with its own estimate. If the parties come to an agreement on fair value, the amount must be paid within 120 days after the agreement is reached. If the shareholder and the corporation do not agree on a price of the stock, the fair value of the stock may be determined through a court action.

Question 21

De jure corporation

Answer 21

Assuming this doctrine has not been abolished in Texas, a de jure corporation is created when all of the statutory requirements for incorporation have been satisfied. A corporation’s failure to comply with a mandatory statutory provision precludes de jure status.

Question 22

De facto corporation

Answer 22

Even if a CoF does not completely comply with the statute, organizers may avoid personal liability for the corporation’s liabilities under the de facto corporation doctrine, if it has not been abolished in Texas. There are three requirements for the common-law doctrine of de facto corporation: (a) a statutory law for formation fo a corporation; (2) a good faith effort to comply with the law; and (3) the owners and operators must operate under the corporate name.

Question 23

Close Corporation

Answer 23

A close corporation refers to a corporation with only a few shareholders and a more relaxed style of governance. Often shareholders serve as both directors and officers of the corporation. The stock of a closely held corporation is not publicly traded. A close corporation may be managed according to a shareholder’s agreement rather than by a board of directors or bylaws. The shareholders may agree to limit the conditions under which shares may be transferred or sold, apportion profits and losses in a specific manner, or set terms and conditions for ownership or management positions.

Question 24

A close corporation must explicitly state in its CoF that…

Answer 24

“this is a close corporation.” There are no limitations regarding the number of shareholders that a close corporation may have.

Question 25

Texas requires that any close corporation operating under a shareholder’s agreement file a statement of operation with the SoS, stating:

Answer 25

(1) the name of the corporation; (2) that the corporation is being operated under a shareholder’s agreement; and (3) the date the corporation commenced operations. This statement of operation must be executed by an officer on behalf of the corporation.

Question 26

A derivative action

Answer 26

A lawsuit in which a shareholder sues on behalf of the corporation for harm suffered by the corporation. It may be brought to hold the directors and officers of the corporation personally liable for losses resulting from an ultra vires act or to enforce a cause of action on behalf of the corporation when the corporation has failed to do so.

Question 27

What must shareholders do when filing a derivative action?

Answer 27

A shareholder must make a written demand upon the board to take action. The demand must be filed with the corporation. After the demand is filed, there is a 90-day waiting period during which a shareholder may not file the derivative suit. However, this waiting period is terminated if the corporation rejects the demand sooner than 90 days, or if delay would cause irreparable injury to the corporation.

Question 28

Derivative Action Standing

Answer 28

In Texas, only shareholders who were shareholders of the corporation at the time the act or omission complained of occurred have standing to bring a derivative action. Shareholders who became shareholders by operation of law, but not by purchase, also have standing. Finally, to have standing, the shareholder must fairly and adequately represent the interest of the corporation.

Question 29

Corporation

Answer 29

A corporation is a distinct entity, separate from its shareholders. Once created, the corporation, and not the persons associated with it, is liable for the obligations of the corporation unless the corporate veil is pierced.

Question 30

Corporation Taxation

Answer 30

As a separate entity, a corporation is taxed on its income. Shareholders who own the corporation are entitled to distributions from the corporation. The shareholders are then taxed on their income, including the distributions. Thus, there is double taxation of the business’ profits.

Question 31

Management of a corporation

Answer 31

The management of a corporation is complex. Officers, directors, and shareholders all have roles in the management of the corporation. Officers manage day-to-day operation of the corporation and answer to the BoD. The degree of control exercised by the BoD over the corporate officers varies greatly.

Question 32

Activities that for-profit corporations may not operate together under the TBOC.

Answer 32

Engaging in the business of raising cattle, the business of operating stockyards, or the business of slaughtering, canning, or packing meat.

Question 33

General Partnership Taxation

Answer 33

A general partnership operates as a pass-through tax entity. This means that the profits and losses flow through the entity and are taxed as profits and losses of the owners. Thus, a partnership avoids double taxation.

Question 34

Limited Liability Company

Answer 34

A LLC is neither a partnership nor a corporation, although it combines both features. The owners of a LLC are called members. The members of the LLC are not personally liable for the obligations of the LLC, unless the corporate veil is pierced.

Question 35

Taxation of LLC

Answer 35

Unless a Texas LLC elects to be treated for federal tax purposes as a corporation, the LLC itself is not subject to federal income taxation. If the LLC has two or more members, the default rule is that it is treated for federal tax purposes as a partnership. This means that profits and losses flow through the entity and are taxed as profits and losses of the owners. If a Texas LLC has only a single member, the default rule is that it is disregarded for federal tax purposes. In either case, each individual member reports his profits or losses on his personal income tax return.

Question 36

Transferability of LLC interest.

Answer 36

A member of an LLC may transfer or assign his interest unless prevented from doing so by the certificate of formation or the company agreement.

Question 37

Officer liability (corporations)

Answer 37

Officers of corporations, as agents for the corporation, do not incur liability to third parties merely for the performance of duties for the corporation. However, an officer may be held liable to a third person when the officer has engaged in purposeful tortious behavior.

Question 38

Shareholder Liability (corporations)

Answer 38

In general, shareholders of a corporation are liable only to the extent of their investment in the corporation. In some circumstances, a corporation’s existence may be ignored (the corporate veil may be pierced) and the shareholders of the corporation are held liable as an equitable remedy to avoid injustice. There are several factors the court considers to determine whether the corporate existence should be ignored. Among these are undercapitalization of the corporation, disregard of corporate formalities, use of the corporation’s assets as if they were the shareholder’s personal assets, self-dealing with the corporation, siphoning off of corporate funds, use of the corporate form to avoid statutory requirements or other legal obligations, shareholders’ impermissible control or domination over the corporation, and wrongful or fraudulent dealings with a corporate creditor.