Business Association

Question 1

Agency Creation

Answer 1

When the principal authorizes an agent to act on its behalf. It can be created through mutual assent or by operation of law. Capacity is required only by the principal although capacity may limit the ability to recover for breach if the agent capacity.

Question 2

Duty of Agents

Answer 2

Agents owe a fiduciary duty to the principal and through this flows the duties of loyalty, obedience, and care.

Question 3

Fiduciary Duty

Answer 3

The duty to act for the principals benefit in any transaction related to the agency.

Question 4

Duty of Loyalty

Answer 4

Principal may not be treated as an adverse party, Agent may not work for an adverse party, agent may not compete with principal, and agent may not accept a benefit from a third party for performing business for the principal.

Question 5

Duty of Obedience

Answer 5

Agent must act solely within their scope and abide by all contract terms even if this may harm the principal.

Question 6

Principal’s Duty

Answer 6

Good Faith and Indemnity

Question 7

Duty of Good Faith

Answer 7

Fairly deal with and commit no action that would reasonably and foreseeably harm the agent. The principal also has a duty to warn the agent of any harm that may come to them from performing their duties.F

Question 8

Duty to Indemnify

Answer 8

The principal has a duty to prevent losses to the agent that occur from contractually required payments made while acting under the principals authority, payments made for the benefit of the principal, and for any losses that good faith and fair dealings demand the agent be compensated for.

Question 9

Agent’s Actual Authority

Answer 9

An agent has actual authority to act if the agent reasonably believes, based on the principal’s manifestations to the agent, that the principal wishes the agent to act in that manner on the principal’s behalf. An agent’s actual authority may be express or implied.

Question 10

Express Authority

Answer 10

Express authority exists if the principal specifically states, orally or in writing, that the agent may take a particular action on the principal’s behalf.

Question 11

Implied Authority

Answer 11

Implied authority exists if a reasonable person in the principal’s position could foresee that her conduct would make the agent believe he had the authority to act.

Question 12

Incidental Authority

Answer 12

One type of implied authority is incidental authority, which is the authority to do things that are reasonably necessary to exercise the agent’s express authority.

Question 13

Apparent Authority

Answer 13

An agent has apparent authority if, based on the principal’s words and conduct, a third party could reasonably believe that the agent has actual authority to take a particular action. The agent’s own words or conduct are generally irrelevant; what matters are the principal’s words and conduct. Apparent authority terminates only if it’s no longer reasonable for a third party to believe that the agent has actual authority

Question 14

Inherent Authority

Answer 14

Unlike actual and apparent authority, inherent authority doesn’t arise from a principal’s manifestations to either an agent or a third party. Instead, inherent authority is authority that may be reasonably implied from the very nature of the particular agency relationship or the position the agent holds.

Question 15

Agency by Estoppel

Answer 15

Under the agency by estoppel doctrine, a purported principal may be bound by a purported agent’s acts, even without actual or apparent authority, if, due to the principal’s failure to exercise reasonable care, a third party:

reasonably believes that the purported agent is acting with actual authority, and
foreseeably, reasonably, and detrimentally changes position in reliance on that belief.

Agency by estoppel arises commonly if a purported principal negligently or intentionally induces a third party to believe a purported agent has authority, or fails to use reasonable care in correcting a mistaken belief.

Question 16

Ratification

Answer 16

Ratification confers authority after a purported agent has acted without authority. Ratification relates back to the date on which the agent purported to act on the principal’s behalf.

However, a ratification isn’t effective if the principal acts without full knowledge of all material facts and without knowing that she’s unaware of material facts.

Question 17

How to Ratify an Agent’s Actions

Answer 17

To ratify an act, a principal must manifest assent to be bound by the act. This in turn requires conduct that would justify a reasonable person’s conclusion that the principal consents to be bound. Ratification may be express with the principal’s words or implied through the principal’s conduct. The manifestation of assent doesn’t need to be communicated to any person in particular. For example, a principal may ratify a transaction by knowingly accepting its benefits.

Question 18

Termination of Agency

Answer 18

An agent’s authority doesn’t last forever. Rather, an agent’s actual authority terminates upon:

the principal’s death;
the principal’s loss of capacity;
either party’s revocation of the agency relationship;
the occurrence of circumstances, such as a specified event or a fixed period of time, that should reasonably cause the agent to conclude that the principal would no longer manifest assent; or
any circumstances specified by statute.

However, actual authority may be irrevocable by the principal if it’s related to a power given as security, an irrevocable proxy to vote securities, or an ownership interest that’s irrevocable by statute

Question 19

Security

Answer 19

A power given as security is actual authority to affect the principal’s legal relations. Powers given as security secure payment or performance of obligations. A power given to secure an obligation must be given in exchange for consideration. A power given as security isn’t a true agency relationship, because the power is given not only for the principal’s benefit but also for the benefit of either the holder or a third party.

Question 20

Agent’s Tort Liability

Answer 20

An agent is liable to a third party harmed by the agent’s own tortious conduct, regardless of whether the agent was acting with any type of authority.

Question 21

Principal’s Direct Liability

Answer 21

A principal can be either directly or vicariously liable to a third party who’s harmed by an agent’s tort. Direct liability arises if:

the agent’s tortious conduct is within the scope of the agent’s actual authority;
the agent’s tortious conduct is ratified by the principal, that is, the principal later assents to be bound by the agent’s conduct; or
the principal is negligent in selecting, managing, or retaining the agent.

Question 22

Respondeat Superior

Answer 22

Vicarious Liability. A principal is vicariously liable for an agent’s tort if:

the agent acts with apparent authority, and
the agent’s act either constitutes the tort or enables the agent to conceal the tort.

Respondeat superior, which makes a principal liable for an agent’s tort if:

the agent is an employee of the principal, and
the agent commits the tort within the scope of employment.

Question 23

Employee vs Contractor

Answer 23

Respondeat superior holds a principal liable for an employee’s torts, but not for the torts of an independent contractor. Whether a person is an employee or an independent contractor depends on whether the person’s physical conduct in the performance of services is subject to the principal-employer’s control or right to control. This is generally a question of fact.

Question 24

Scope of Employment

Answer 24

An employee acts within the scope of his employment if his conduct:

is of the kind that the employee was hired to perform;
occurs substantially within the authorized time and space limits for the employee’s work; and
is motivated, at least in part, by a purpose to serve the employer

Question 25

Frolic

Answer 25

A frolic occurs when an employee substantially departs from the employer’s business. An employee on a frolic no longer has any significant motive to serve the employer. Conduct during a frolic is outside the scope of employment.

Question 26

Contract Liability of the Principal

Answer 26

A principal’s and agent’s liabilities on contracts the agent enters into depend on whether the principal is disclosed, partially disclosed, or undisclosed. The principal may also be liable for contracts for which the agent lacks authority when entered but which the principal later ratifies.

Question 27

Disclosed Principle

Answer 27

A principal is disclosed if a third party dealing with the agent knows or has reason to know of the agency relationship and the principal’s identity. A principal is also disclosed if a third party can reasonably infer the principal’s identity based on any available information, even if the principal’s identity isn’t overtly disclosed.

A disclosed principal is liable for contracts the agent enters with actual or apparent authority. An agent isn’t personally liable for contracts entered on behalf of a disclosed principal unless the agent agrees to be liable.

Question 28

Partially Disclosed or Unidentified Principal

Answer 28

A principal is partially disclosed if a third party dealing with an agent knows or has reason to know that the agent is acting on a principal’s behalf but doesn’t know the principal’s identity. Partially disclosed principals are sometimes called unidentified principals.

A partially disclosed or unidentified principal is liable on a contract entered into by an agent with actual or apparent authority. An authorized agent is also liable on a contract entered on behalf of a partially disclosed or unidentified principal, unless the agent agrees otherwise. The third party who contracts with the agent is liable to both the partially disclosed principal and the agent in the event of any breach.

Question 29

Undisclosed Principal

Answer 29

A principal is undisclosed if a third party dealing with an agent has no notice of the fact that the agent is acting for a principal at all, let alone the principal’s identity. In a situation involving an undisclosed principal, the third party believes that the agent is acting on the agent’s own behalf.

Both an undisclosed principal and an agent are liable on contracts entered into by an agent with actual authority. The third party is also liable to both the principal and the agent because both are deemed parties to the contract.

Note that the agent can’t have any apparent authority in the undisclosed principal context. Apparent authority hinges on the third party’s reasonable understanding of a principal’s manifestation of assent to be bound by the agent. When the principal is undisclosed, there aren’t any manifestations from the principal to the third party.

Question 30

Liability for Agents acting with Undisclosed Principal

Answer 30

When an agent acts on behalf of an undisclosed principal but the agent lacks actual authority to enter the contract, the agent is liable as a party to the contract. However, the principal isn’t liable.

Question 31

When is a Principal Liable for an Agent who Falsely Represents Their Authority?

Answer 31

If an agent for a disclosed or partially disclosed principal falsely represents his authority to a third party, then the principal isn’t liable on the contract unless:

the agent made the false representations with actual or apparent authority, and

the third party doesn’t know or have reason to know that the agent’s representation is false.

A third party may void a contract by an agent acting for an undisclosed principal if the agent falsely represents that he acts for no principal and either the undisclosed principal or the agent knows or has reason to know that the third party would’ve never had dealings with the principal.

Question 32

Ratifying a Contract entered by an Agent without authority

Answer 32

A principal may still be liable on a contract entered into by an agent without actual or apparent authority if the principal later ratifies the agent’s conduct. However, a principal can’t ratify an unauthorized transaction with a third party unless the agent purported to be acting for the ratifying principal.

Question 33

Formation of a general partnership

Answer 33

A general partnership is formed if

two or more persons join as co-owners to carry on a business for profit, and
the arrangement doesn’t meet the legal requirements to form a different business entity, such as a corporation.

No special formalities are required to form a general partnership. Nonetheless, partners often enter into a written or oral partnership agreement, which is a contract that governs the partners’ rights and obligations within the partnership.

Question 34

What happens when a person attempts to do business in a form but fails to manifest the relationship?

Answer 34

A general partnership is formed instead.

Question 35

Partner

Answer 35

A partner is an agent of the partnership. The hallmark rights of a partner are the rights to receive a share of the profits and to manage and control the business. Similarly, a person who is obligated to share in the business’s losses or who contributes capital to the business is likely a partner. Be aware that the transfer of money must be a sharing of profits, transfers of wealth that amount to payments or compensations or sharing the value of co-owned property does not constitute the sharing of profits of a business relationship.

Question 36

Limited Partnership

Answer 36

A limited partnership is one composed of at least one general partner and at least one limited partner and formed according to procedures specified by state law. Unlike general partnerships, limited partnerships require some formalities, such as filing a certificate of limited partnership, in order to form.

A general partner in a limited partnership has the same rights and responsibilities as in a general partnership. By contrast, a limited partner typically contributes capital to the business but doesn’t participate in business decisions

Question 37

How do you become a limited partner?

Answer 37

Generally, a person becomes a limited partner

by being designated a limited partner in the certificate of limited partnership or other governing partnership document,
if all general and limited partners consent, or
as provided in the partnership agreement.

Question 38

Limited-Liability Partnership

Answer 38

A limited-liability partnership, or LLP, is a particular type of general partnership that has

obtained approval from the requisite number of partners to operate as an LLP,
properly completed and filed a statement of qualification with the appropriate state office, and
paid the requisite fee.

Question 39

Converting to a Limited-Liability Partnership

Answer 39

If an LLP is formed by converting an existing general partnership to an LLP, typically, the number of partners required for approving the change is the same number required to amend the partnership agreement. Typically, a statement of qualification requires the name of the partnership, its principal office, and its election to be an LLP.

Another way to convert a general partnership to an LLP is to form a new LLP and transfer the general partnership’s assets to the new LLP.

Question 40

Relationship of Partners

Answer 40

In general, partners are agents of the partnership for the purpose of partnership business. A partner therefore binds the partnership, both with respect to the partner’s wrongful acts or on contracts entered into on the partnership’s behalf, so long as the partner acts

with actual authority,
with apparent authority, or
in the ordinary course of the partnership’s business.

Moreover, as a rule, a general partner is personally, jointly, and severally liable for the partnership’s obligations unless the claimant agrees or the law provides otherwise.

Question 41

Who may recover from a Partnership?

Answer 41

A partnership creditor may recover from the partnership or from any individual partner against whom the creditor has obtained a judgment. If a partner is liable for reasons other than her partnership status, for example, if a partner is the primary tortfeasor, then the creditor may proceed against that partner regardless of any partnership assets. However, if a partner is vicariously liable solely because she’s a partner, then with limited exceptions, the creditor must exhaust the partnership’s assets before proceeding against that partner personally.

Question 42

How is Liability Portioned in a Limited Partnership?

Answer 42

The general partners in a limited partnership are liable to the same extent as in a general partnership.

In contrast, a limited partner isn’t personally liable for any partnership obligations. A limited partner remains at risk of losing her capital contributions to the limited partnership, but that’s because those contributions are partnership assets, not because the limited partner is personally liable. This liability shield is consistent with a limited partner’s status as a passive investor, as opposed to someone who manages the partnership.

Question 43

Partner Liability in an LLC

Answer 43

Partners in an LLP have no personal liability for partnership obligations merely because they’re partners. Nonetheless, a partner may be personally liable for his own tortious conduct. Obligations incurred while the partnership is an LLP are solely the obligations of the partnership, not the partners personally. However, partners don’t receive LLP protection for obligations incurred before a partnership qualified as an LLP. Rather, partnership obligations incurred before qualification are treated as ordinary partnership obligations.

Question 44

Non-Renumeration Rule

Answer 44

Partners aren’t entitled to separate remuneration for their services to the partnership on the theory that the partner’s compensation is his share of the profits.

Question 45

Exceptions to the Non-Renumeration Rule

Answer 45

There are two exceptions to the non-remuneration rule. First, a partner is entitled to reasonable compensation for efforts rendered in connection with winding up the business. Second, the partners can agree to pay a partner for his efforts. Some courts require that partners explicitly agree to remunerate partners over any share of the profits, while other courts permit remuneration based on an implied agreement.

Question 46

Division of Power in a Partnership

Answer 46

In a partnership, each partner is the coequal of all of the other partners, and no partner is under the control of any other partners. Each partner therefore has equal rights in the management and conduct of the partnership’s business. Unless the partnership agreement provides otherwise, a difference arising as to a matter in the ordinary course of the partnership’s business may be decided by a majority of the partners. Acts outside the partnership’s ordinary course of business and any amendment to the partnership agreement require an affirmative vote or consent of all of the partners.

Question 47

Fiduciary Duties of a Partnership

Answer 47

In a general partnership, each partner owes fiduciary duties of care and loyalty to both the partnership and the other partners. For example, a partner must account to the partnership for any personal gains derived from partnership business, and a partner must safeguard the partnership’s confidential information.

Question 48

Dissociation

Answer 48

A partner’s withdrawal is called dissociation. Most state partnership statutes name events causing dissociation, such as a partner’s death, incapacity, or personal bankruptcy. The partnership agreement may also specify events triggering a dissociation.

Partners may dissociate voluntarily by providing notice to the other partners of their express will to withdraw. The notice doesn’t have to be written. Partners may dissociate voluntarily at any time, regardless of whether withdrawing breaches any partnership agreement.

Withdrawing from a partnership that has a required time frame is wrongfully and the person becomes liable for breach.

Question 49

Buyout of Dissociating Partner

Answer 49

The partner’s right to manage and conduct partnership business ends at dissociation. A partner’s fiduciary duties also terminate upon dissociation, except for matters arising before the dissociation or in the course of winding up, if winding up occurs.

In some states, a partnership must buy out a dissociated partner. Under the Revised Uniform Partnership Act, the buyout price is what the partner would receive if the partnership were either sold as a going concern or, if greater, liquidated on the date of the dissociation, minus any damages if the dissociation is wrongful and any amounts the dissociating partner owes the partnership.

Question 50

Dissociated Partner’s Liabilities

Answer 50

A partner dissociating from a partnership that continues remains personally liable for partnership obligations incurred before dissociation. The dissociating partner is also personally liable for partnership obligations incurred within two years after dissociation if, at the time of the transaction, the creditor

reasonably believed that the dissociated partner was still a partner, and
didn’t know or have actual or constructive notice of the dissociation.

A dissociated partner may be released from partnership liability by agreement with the creditor and the continuing partners. To cut off any lingering liability, a partner may also file a statement of dissociation with the appropriate state office. The statement provides constructive notice of the partner’s withdrawal 90 days after filing.

Question 51

Partnership Liability for Dissociated partners Acts

Answer 51

If the partnership continues, then the partnership is bound by the dissociated partner’s acts for two years after the dissociation, if

the act would’ve bound the partnership before the dissociation,
the other party reasonably believed the dissociated partner was a partner, and
the other party lacked actual or constructive notice of the dissociation.

The dissociated partner is liable to the partnership for any damages resulting from this liability.

If the partnership dissolves after dissociation, a dissociating partner can’t avoid liability for partnership debts incurred during winding up, regardless of whether the dissociation was rightful or wrongful.

Question 52

Dissolution of a Partnership at Will

Answer 52

A partnership at will lacks a defined term and any particular undertaking having an ending point. A partnership at will dissolves if a partner provides the partnership notice of her express will to withdraw from the partnership or to dissolve the partnership. However, that dissolution can be rescinded, and the partnership continues, by the affirmative vote or consent of all remaining partners. In that case, the dissociating partner isn’t a partner anymore and doesn’t participate in the decision to continue.

Question 53

Dissolution of a Partnership for Definite Term

Answer 53

A partnership for a definite term or particular undertaking is dissolved if

a partner wrongfully dissociates or dissociates through death, bankruptcy, or incapacity, and within at least 90 days half the remaining partners agree expressly to wind up the business;

all of the partners expressly agree to wind up the business;
the definite term expires; or
the particular undertaking is completed.

Once an event triggering dissolution occurs, a partnership continues only for the purpose of winding up. Once winding up is concluded, the partnership terminates. By itself, termination doesn’t affect any partner liability for partnership business.

Question 54

Winding Up

Answer 54

Winding up involves settling the partnership’s accounts and distributing its assets. Any partner who hasn’t wrongfully dissociated from a dissolved partnership may participate in winding up.

Partnership assets include partnership property and any partner contributions needed to satisfy obligations. In general, the priority of distribution is to

pay debts owed to third parties;
pay debts owed to partners, other than profits or returning capital;
return partners’ capital contributions; and
pay partners whatever is left according to their respective shares of profits.

If partnership assets are insufficient to satisfy obligations, each partner must contribute to the deficiency in proportion to her share of losses. If a partner can’t contribute her share, then the other partners must make up the difference, again in proportion to their share.

Question 55

The Control Test

Answer 55

Some states recognize an exception to the limited-partner shield called the control test. Under this test, a limited partner who participates in controlling the business may become personally liable to the same extent as a general partner. Many states apply control-test liability only if the obligation is to a third party who reasonably believed that the limited partner was a general partner, based on the limited partner’s conduct. In addition, some states recognize safe harbors for the control test, that is, activities that don’t count as exercising control. These activities include things such as:
working for the limited partnership as an agent, employee, or independent contractor;
acting as an officer, director, or shareholder of a corporation that’s a general partner; and
voting on whether to approve specified partnership actions such as incurring debt or winding up the partnership.

Question 56

Required Information

Answer 56

While limited partners do not participate in controlling the business directly, they do have the right to request certain information from general partners, in order to make informed investment decisions. A limited partner’s ability to request information and the procedures for requesting that information vary depending on the nature of the information itself. Required information is information a limited partnership must maintain and is set forth in § 108 of the Revised Uniform Partnership Act. For example, required information includes a current list of all partners, the certificate of limited partnership, any partnership agreement, financial statements and annual reports for the past three years, and any voting records for the past three years. To request required information, a limited partner must make a written demand received by the limited partnership, providing the partnership with at least 10 days’ notice. The limited partner may then inspect required information during regular business hours in the limited partnership’s principal office. A limited partner does not have to have any particular purpose for seeking required information.

Question 57

Corporation

Answer 57

A corporation is a business entity that’s owned by its shareholders and managed by its directors and officers. Shareholders generally don’t participate in managing the corporation unless they also happen to be officers or directors. In general, the shareholders have no personal liability for the corporation’s actions, debts, or other obligations merely because they own shares. However, in exceptional situations, courts may pierce the corporate veil by disregarding the corporate form to impose personal liability on shareholders.

Question 58

Alter Ego Theory and Piercing the Veil

Answer 58

a court might pierce the veil if a shareholder controls the corporation to such an extent that it’s merely an extension of the shareholder’s will. A court might also pierce the veil if a shareholder has deliberately undercapitalized the corporation, commingled corporate and personal assets, or used the corporate form to facilitate a fraud or a crime.

Question 59

Requirements for forming a corporation

Answer 59

Articles of Incorporation, File the articles, adopt bylaws

Question 60

Bylaws

Answer 60

the corporation must adopt bylaws, which are the internal rules by which the corporation will operate. The bylaws may address things such as the nature of the corporation’s business, its internal management procedures, or shareholders’ rights. The bylaws must be consistent with state law and with the articles of incorporation. If there are inconsistencies, then the articles trump the bylaws, and state law trumps both the articles and the bylaws.

Question 61

Artricles of Incorporation

Answer 61

the corporation’s name,
how many shares the corporation may issue,
each incorporator’s name and address,
the address of the corporate office, and
the corporation’s agent for service of process.

The articles might also include a statement of the corporation’s purpose, the names of the initial directors and officers, and other general information. What matters is the date on which the articles are filed, which can’t relate back to any earlier date.

Question 62

Forming an LLC

Answer 62

LLC formation is similar to corporate formation. Instead of filing articles of incorporation, the organizers must file a certificate of organization with the appropriate state authority, again, usually the secretary of state. Like articles of incorporation, a certificate of organization provides basic information such as the company’s name, address, and agent for service of process. The LLC may then adopt an operating agreement, which serves much the same function as a corporation’s bylaws.

Question 63

Promoter

Answer 63

A promoter is a person who participates in forming a corporation, often by entering into business transactions on the prospective corporation’s behalf. Promoters are fiduciaries of the prospective corporation who owe duties of care and loyalty. Promoters or persons purporting to act as or on behalf of a corporation, but who in fact know that there has been no incorporation, are jointly and severally liable for all liabilities created while so acting. An erroneous but good-faith belief that incorporation has happened does not constitute knowledge.

Question 64

De Facto Corporation and Incorporation-By-Estoppel

Answer 64

courts may infer limited corporate liability in two situations. Under the de facto corporation doctrine, courts recognize limited corporate liability if there was a colorable, good-faith attempt to incorporate and actual use of the corporate form, such as by contracting in the corporate name. Under the incorporation-by-estoppel doctrine, most jurisdictions recognize limited corporate liability if a third party deals solely with the purported corporation and hasn’t relied on the promoter’s personal assets.

Question 65

Adoption of Preincorporation

Answer 65

Once a corporation exists, it may adopt a preincorporation contract and become liable on it. A corporation may adopt the contract expressly through a board resolution, or impliedly through its conduct. A novation relieves the promoter of personal contractual liability.

Question 66

Common Stock

Answer 66

The two main types of stock are common stock and preferred stock. Common stock often entitles a shareholder to receive periodic dividends, which are payments allocated per share from the company’s profits. Common stock also generally entitles a shareholder to vote on important corporate matters such as electing directors or approving a merger.

Question 67

Preferred Stock

Answer 67

Preferred stock usually does not carry voting rights. However, preferred stock generally offers higher dividends than common stock. Moreover, preferred stock takes priority over common stock when the corporation pays dividends or other distributions.

Question 68

Treasury Stock

Answer 68

Treasury stock refers to shares that are not outstanding because they have been repurchased by the corporation.

Question 69

Issuing Stock

Answer 69

A corporation may issue new stock after becoming incorporated, so long as the issuance is authorized by the articles of incorporation and the corporation receives some return value for the stock. Some states require the corporation to state a par value for the shares upon issuance.

Question 70

Par Value and Watered Stock

Answer 70

A par value is the minimum price at which the corporation may sell the stock initially. Stock that the corporation sells below par value is called watered stock. Someone who receives watered stock from the corporation may be liable to the corporation, or even to its creditors, for the difference between the amount paid and the par value. Par value is relevant only to the initial purchase of newly issued stock. Someone who buys the new stock may later sell it without reference to its par value.

Question 71

Preemptive Right

Answer 71

A preemptive right is a shareholder’s right to buy a percentage of newly issued stock equal to her current ownership percentage in the corporation, and to do so before the company offers the stock to the public. Preemptive rights enable investors to retain their percentage of overall ownership in a corporation as new stock is issued. These rights usually carry a time limit, such as 30 or 60 days after issuance. Preemptive rights usually arise as a matter of contract, though a few states confer them as a matter of law, subject to the articles of incorporation. A person who holds a preemptive right is not required to exercise it but may do so at her option.

Question 72

Repurchasing Shares

Answer 72

A corporation generally may repurchase its own shares. Market forces dictate that the corporation usually will pay market value. To accomplish the repurchase, the corporation may enter into a share-repurchase agreement with a shareholder. The corporation might then hold the repurchased shares for business reasons or reissue them to raise more money. Repurchases are generally lawful, subject to some caveats. First, the articles of incorporation might limit the corporation’s ability to repurchase shares. Second, the Model Business Corporation Act treats a stock repurchase as a distribution to shareholders. Distributions might be improper if they would make the corporation unable to pay its debts in the normal course of business, or if they would make the corporation’s liabilities greater than its assets.

Question 73

Record Date

Answer 73

A record date determines who is entitled to vote at a given shareholder meeting. The record date is used for determining the identity of the corporation’s shareholders and their holdings for purposes of the meeting. Only shareholders of record on the record date are entitled to vote the shares they own on the record date at the meeting.

Question 74

Proxy Voting

Answer 74

In proxy voting, a shareholder appoints another person, called a proxy, to vote that shareholder’s shares in his place. A proxy must be in a writing submitted to the officer in charge of counting votes. Proxies are valid for as long as their terms provide, or for 11 months if no expiration is specified. Proxy agreements are generally revocable unless their terms state that they are irrevocable and they are coupled with an interest. Any action inconsistent with the proxy revokes the proxy.

Question 75

Outstanding Share

Answer 75

Outstanding shares are all shares that a corporation has issued. Shares issued but then repurchased by a corporation, called treasury shares, are authorized but not outstanding. Each outstanding share is entitled to one vote on each matter voted.

Question 76

Shareholder Votes

Answer 76

A vote requires a quorum present at the shareholder meeting. The presence of a quorum is determined for each voting group, that is, for each class of shares entitled to vote. In general, a voting group has a quorum if a majority of the shares in that group are validly present at the meeting. A group lacking a quorum cannot hold a vote.

Question 77

Shareholder Meetings

Answer 77

A corporation must provide shareholders entitled to vote with notice of any meeting between 10 and 60 days before the meeting date. For special meetings, the notice must include the meeting’s purpose. Only business related to that purpose may be considered at the special meeting. If a matter not described in the notice is raised at a meeting, a shareholder attending the meeting may waive any objection to considering it by failing to object promptly once the matter is raised.

Question 78

Board Meetings

Answer 78

A board acts at regular and special meetings. A regular meeting is a recurring meeting provided for in the articles or board resolution. A special meeting is a one-time meeting called for a specific purpose. Regular meetings do not require notice. In contrast, special meetings require at least two days’ notice stating the date, time, and place of the meeting to all directors. Unlike notice for special shareholder meetings, notice for special board meetings does not have to specify the meeting’s purpose. A director may waive notice in a signed writing or by attending and participating in the meeting. However, a director does not waive notice if she attends the meeting, promptly objects to the lack of notice, and does not vote on or assent to any action at the meeting.

Question 79

Quorum

Answer 79

A quorum is the minimum number of directors who must participate in a meeting for the board to take official action. Under the Model Business Corporation Act (MBCA), unless the articles of incorporation or bylaws specify otherwise, a quorum for a board with a fixed number of directors is a majority of the fixed number. If a quorum is present, an affirmative vote of a majority of the directors participating in the meeting is the act of the entire board. Generally, directors may participate in a meeting by attending in person or by using any remote communication permitting the directors to hear and be heard by one another simultaneously. If a director participates remotely but cannot hear and be heard simultaneously, that director is not validly present, and the director’s vote is not counted.

Question 80

Director Pressence

Answer 80

Any director who is present when action is taken is deemed to assent to that action unless (1) the director promptly objects to the meeting or to transacting business at the meeting, (2) the director’s abstention or dissent is noted in the meeting minutes, or (3) the director delivers written notice of the dissent or abstention to the presiding officer during the meeting or to the corporation itself immediately after the meeting. By indicating dissent or abstention, the director may avoid personal liability for the action.

Question 81

Committees

Answer 81

Committees consist of one or more but fewer than all directors and perform functions normally left to the board at large. Under the Model Business Corporation Act, or MBCA, at least a majority of directors must approve the committee and its members, unless the law or the articles provide otherwise. A committee’s act within the scope of its authority is the act of the entire board. However, under the MBCA, the full board cannot confer upon a committee the power to: (1) approve distributions to shareholders, except according to a formula or within limits prescribed by the full board; (2) approve or propose to shareholders any act the shareholders must approve; (3) fill board vacancies; or (4) adopt, amend, or repeal the bylaws.

Question 82

Appointment and Removal of Officers

Answer 82

Generally, the board of directors elects or appoints officers. However, officers may also appoint other officers if the bylaws or the board authorizes them to do so. The board, its chairperson, the appointing officer, and any other officer authorized by the bylaws or board resolution may remove an officer at any time and for any reason or no reason at all.

Question 83

Officer and their liability

Answer 83

An officer is an agent of the corporation. As an agent of the corporation, an officer may act with actual, apparent, or inherent authority to bind the corporation to contracts. For example, a corporate officer who acts on behalf of a disclosed-principal corporation binds the corporation to contracts entered into with actual or apparent authority. As a general rule, directors and officers are not personally liable for corporate obligations solely due to their status as directors or officers. An officer contracting on behalf of a disclosed-principal corporation is not liable on a contract entered into with actual or apparent authority unless the officer agrees to be bound.

Question 84

Resignation

Answer 84

An officer may resign at any time by providing written notice to the board, the board’s chairperson, the appointing officer (if any), or the corporation’s secretary.

Question 85

How many Officers must a corporation have?

Answer 85

Every corporation must have officers. Many states require a president, secretary, and treasurer. The Model Business Corporation Act (MBCA) requires that at least one officer be responsible for maintaining any required records. Beyond this requirement, a corporation may have as many or as few officers as are provided in the bylaws, or as the board of directors might appoint in accordance with the bylaws.

Question 86

LLC Management

Answer 86

An LLC can be either member-managed or manager-managed. An LLC is presumed to be member-managed unless its formation documents, such as the certificate of organization or operating agreement, say otherwise.

Question 87

Membership in an LLC

Answer 87

In a member-managed LLC, the members closely resemble partners in a general partnership. Each member in a member-managed LLC has equal rights in the management and conduct of the company’s activities, regardless of that member’s percentage ownership interest. As agents of the LLC, each member acting with authority has the ability to bind the company to contracts it enters in the company’s ordinary course of business. In a member-managed LLC, the members owe one another the same fiduciary duties as a manager in a manager-managed LLC.

Question 88

What duties are owed in the corporate settings?

Answer 88

Fiduciary, care, good faith, loyalty

Question 89

Who does actors that manage and control a business owe a fiduciary duty to?

Answer 89

In general, actors who manage and control a business in corporate form owe fiduciary duties to the business itself and to the business’s owners. A breach of a fiduciary duty renders the actor personally liable to the business and to its owners.

Question 90

Who does actors in an LLC owe a fiduciary duty to?

Answer 90

Similarly, members in a member-managed limited-liability company, or LLC, owe fiduciary duties to the company and to one another. However, members in a manager-managed LLC don’t owe any fiduciary duties because they don’t participate in operating the company. Rather, the managers owe fiduciary duties to the company and to the members.

Question 91

What does the duty of good faith require of those bound by it?

Answer 91

The duty to act in good faith prohibits knowingly illegal conduct, even if the conduct might benefit the corporation. Therefore, the journalist can’t act on the official’s solicitation for a bribe, even if expedited regulatory approval would save the corporation millions. Fiduciaries must also act on any red flags of corporate illegality. The duty of good faith requires corporate directors to establish procedures to ensure the business’s compliance with legal norms, including reporting systems providing timely, accurate information concerning the business’s compliance with law and its business performance.

Question 92

What is the Duty of Care?

Answer 92

The duty of care requires an officer, director, or other controlling agent of the business to exercise the level of care that a reasonable person would exercise under the circumstances. The duty of care in turn requires an actor to be attentive to the corporation’s affairs and to make informed decisions.

Question 93

What is an informed decision?

Answer 93

To make informed decisions, a fiduciary must take reasonable, proactive steps to become adequately informed in connection with each decision he makes for the business. In general, a fiduciary must

review information provided,
actively participate in meetings, and
gain reasonable familiarity with the context for any decision.

However, a fiduciary isn’t expected to become an expert or to research everything independently. Unless an actor has knowledge making reliance unwarranted, he may reasonably rely on information provided by

corporate officers and employees,
board committees tasked with studying a matter, and
reports prepared by third-party professionals, such as lawyers and accountants, within the scope of their expertise.

Question 94

Business-Judgement Rule

Answer 94

The business-judgment rule can provide a defense for a director who’s alleged to have breached the duty of care by making a bad business decision.

Under this rule, a court will presume that the director acted

in good faith,
upon reasonable information, and
in the honest belief that the decision was in the corporation’s best interests.

Unless these presumptions are rebutted, a director isn’t liable for breaching the duty of care based on honest mistakes or poor business judgment. The rule prevents a court from second-guessing a director’s reasonable business decisions, even if they turn out to be bad ones.

Question 95

Fiduciary Duty of Loyalty

Answer 95

The duty of loyalty requires fiduciaries to discharge their responsibilities in a way that places the interests of the business and its owners ahead of

the fiduciary’s own personal interest, and
the interest of any single owner, group of owners, or third party. 

In particular, the duty of loyalty prohibits a fiduciary from improperly personally benefiting in the conduct of the business’s activities. A fiduciary who receives an improper benefit may not keep it but should instead account for it and hold it as trustee for the business.

Question 96

Conflicting-interest transactions

Answer 96

A cornerstone of the duty of loyalty is the obligation to avoid conflicting-interest transactions. In general, a conflicting-interest transaction is one in which a fiduciary has a meaningful incentive to act contrary to the business’s best interests. More specifically, a conflicting-interest transaction is one in which the business is a party and

the fiduciary, individually, is also a party;
the fiduciary knows of the transaction and knows that he has a material financial interest in it; or
the fiduciary knows that a related person either is a party or has a material interest in the transaction.

A material financial interest is a monetary interest that one could reasonably expect to impair or influence the fiduciary’s exercise of objective judgment regarding the transaction.

Question 97

Who is a ‘related person’ that could create a conflict for a fiduciary?

Answer 97

A related person is any person whose business, financial, family, or other relationship with the fiduciary could reasonably be expected to taint or impair the fiduciary’s objective judgment.

Question 98

How can a fiduciary act without liability for a conflicting-interest transaction?

Answer 98

In the corporation context, a fiduciary may escape liability for a conflicting-interest transaction if

the board of directors properly approves it,
the shareholders properly approve it, or
the transaction is objectively fair to the corporation.

Board or shareholder approval requires that the conflicted fiduciary fully disclose all material facts known about the transaction and the conflict. A majority of qualified, disinterested directors or qualified, disinterested shareholders with no material relationship with the conflicted fiduciary must then approve the transaction.

Question 99

Corporate-Opportunity Doctrine

Answer 99

In general, the duty of loyalty also requires fiduciaries to refrain from competing with the business. Under the corporate-opportunity doctrine, a fiduciary generally must not take personal advantage of a business opportunity if

the fiduciary should reasonably believe that the other party expects the opportunity to be offered to the corporation or LLC instead;
the fiduciary becomes aware of the opportunity via confidential information, by using corporation or LLC property, or in performing his functions as a fiduciary, and should reasonably expect that the corporation or LLC would be interested in the opportunity; or
the opportunity involves a line of business in which the corporation or LLC either currently engages or expects to engage in the future. 

However, a fiduciary may take personal advantage of an opportunity if he gives the business the first opportunity to accept or reject the opportunity and the business ultimately rejects it. In addition to providing the business with all material facts about the opportunity, at least one of the following three requirements must be met:

rejecting the opportunity is fair to the corporation;
a majority of qualified directors on the full board, or on the committee appointed to consider the matter, votes in advance to reject it in a manner conforming to the voting directors’ duties of care and loyalty; or

a majority of disinterested shareholders vote in advance to reject the opportunity or to ratify the transaction after the fact.

Question 100

Business-judgment rules vs conflicting-transactions

Answer 100

Board or shareholder approval requires that the conflicted fiduciary fully disclose all material facts known about the transaction and the conflict. A majority of qualified, disinterested directors or qualified, disinterested shareholders with no material relationship with the conflicted fiduciary must then approve the transaction. When analyzing board decisions about conflicting-interest transactions, the duty of care still applies to the directors’ deliberations. However, the presumptions in the business-judgment rule do not apply if directors were financially interested in the transaction they decided upon.

Question 101

Close Corporation

Answer 101

A close corporation is one with fewer than a specified number of shareholders and stock that isn’t publicly traded. State law specifies the maximum number of shareholders a close corporation may have. Close corporations are usually small, family-run businesses for which traditional corporate governance would be unduly costly and burdensome.

Commonly, a close corporation is subject to a shareholder agreement providing that the shareholders, or a certain number of shareholders, will manage the corporation directly. These managing shareholders function much like a board of directors. To the extent a close corporation’s shareholders assume the traditional powers of a board of directors, they also assume the corresponding fiduciary duties and potential liabilities.

Question 102

Share-Transfer Restrictions

Answer 102

Transfer restrictions are an exception to the general rule that shares be freely transferable. To be enforceable, the restriction must be reasonable under the circumstances. A total ban against all transfers isn’t enforceable. However, a transfer restriction might require a selling shareholder to obtain prior approval from the board or other shareholders for the sale. Alternatively, a restriction might give the corporation or other shareholders a right of first refusal, or require a seller to sell to existing shareholders at a specified price.

For the restriction to bind any transferee or purchaser of the shares, the restriction must be noted conspicuously on the stock certificate. However, a restriction is still enforceable, despite no conspicuous notice, against a transferee with knowledge of the restriction.

Question 103

Deadlock

Answer 103

Deadlock means that the directors or shareholders are so divided on a matter that the corporation can’t act, making progress impossible. Many close corporations’ governing documents contain mechanisms to prevent or resolve deadlock. Two of the most common mechanisms are buy-sell agreements and third-party intervention.

Question 104

Buy-sell agreement

Answer 104

A buy-sell agreement is a legally binding commitment between the corporation and its shareholders, or among the shareholders, that the corporation or other shareholders will purchase a particular shareholder’s shares if a specified event occurs.

Question 105

Document hierarchy

Answer 105

When the articles of incorporation conflict with a corporation’s bylaws on a given issue, the articles control. If the articles of incorporation or the bylaws are contrary to governing law, then the governing law controls. Put differently, the articles of incorporation may contain any provision that’s consistent with governing law. The bylaws may contain any provision that’s consistent with governing law and the articles of incorporation.

Question 106

Amending the Articles prior to issuing shares

Answer 106

Most state statutes give the board of directors the exclusive power to initiate amendments to the articles of incorporation. If the corporation hasn’t yet issued shares, the board of directors may amend the articles of incorporation. If there’s no board, then the corporation’s incorporators may amend the articles

Question 107

Amending the Articles after issuing shares

Answer 107

If the corporation has issued shares, shareholder approval is required. Most amendments to the articles must be

first, adopted by the board, and
second, submitted to shareholders for their approval.

Any amendment to the articles then becomes effective once the shareholders entitled to vote on it approve it. The board must recommend that shareholders approve the amendment, unless

the board determines that, due to special circumstances such as conflicts of interest, the amendment shouldn’t be approved, or
the transaction involves a merger or similar deal for which the corporation is contractually obligated to seek shareholder approval.

Question 108

Amending Bylaws

Answer 108

In general, shareholders have the power to adopt, amend, and repeal the bylaws. The board shares the power to amend the bylaws with the shareholders, unless

the articles of incorporation reserve that power exclusively to the shareholders, or
the shareholders in amending, repealing, or adopting a bylaw expressly provide that the board of directors may not amend, repeal, or reinstate that bylaw.

Shareholder-approved bylaw provisions can amend or repeal existing bylaw provisions, regardless of whether the board or the shareholders originally approved those existing provisions.

Question 109

Merger

Answer 109

A merger is a transaction in which two corporations combine. One corporation survives the merger, and the other ceases to exist. Shareholders in the dissolving entity effectively exchange their shares for shares in the surviving entity. The surviving entity has the combined assets, powers, and liabilities of both entities.

Question 110

Approval of Mergers

Answer 110

Shareholders in both corporations must approve the transaction. Shareholders in both corporations also typically have appraisal rights.

Question 111

Appraisal Rights

Answer 111

In general, appraisal rights are triggered when a shareholder dissents from an extraordinary corporate action, like a merger, which will fundamentally change the existence or nature of particular shares. Appraisal rights entitle the dissenting shareholder to compel the corporation to buy back her shares at an appraised or judicially determined fair market value.

In mergers, appraisal rights arise anytime shareholder approval is required or when a subsidiary merges with either its parent or another subsidiary under a common parent. However, if the merger requires shareholder approval, a shareholder doesn’t have appraisal rights to the extent that her shares would remain outstanding after the merger.

Question 112

Exercising Appraisal Rights

Answer 112

To exercise appraisal rights, a shareholder must deliver written notice of her intent to demand payment before the vote on the proposed action and must not vote any shares in favor. The corporation must then pay the fair market value of the shares in cash to the shareholder within 30 days after submission of the required appraisal form. If the shareholder properly disputes the payment’s amount, then the corporation must initiate judicial proceedings to determine the shares’ value within 60 days after receiving the demand. If the corporation doesn’t commence proceedings, then it must pay the shareholder’s demanded value.

Question 113

Combining Corporations

Answer 113

Corporations may also combine when one corporation sells substantially all of its assets and goodwill to another corporation outside the usual course of business.

Unless the sale is to the selling corporation’s wholly owned subsidiary, the sale requires approval by the selling corporation’s shareholders, at least if the selling corporation would be left without substantial continuing business activity. The board of the selling corporation must adopt a resolution approving the sale and present it to the shareholders. The shareholders must then approve the sale. Shareholders in the selling corporation have appraisal rights. The board of Directors must approve in the buying company.

Question 114

de facto merger doctrine

Answer 114

in some states, a sale of substantially all assets qualifies as a merger under the de facto merger doctrine. If this doctrine applies, then the sale must meet all of the statutory requirements of a merger. Most notably, unlike a sale, a merger requires approval from shareholders in both the selling and the purchasing corporations.

Question 115

Recapitalization

Answer 115

Holders of a corporation’s debt or equity securities receive, in exchange for their existing securities, new securities of a different type or amount. The existing investments change in form but not in value. For example, a recapitalization occurs when common stock is received in exchange for preferred stock.

Question 116

Exchanges

Answer 116

In an exchange, one corporation acquires all securities, or all of a class of shares, in another corporation, in exchange for securities, cash, or other property. The shareholders in the acquiring corporation don’t need to approve the exchange. Shareholders in the corporation whose securities are acquired must approve the transaction under the same procedures as a merger. Shareholders in the corporation whose securities are acquired have appraisal rights, but only to the extent that their shares are being acquired in the exchange.

Question 117

Voluntary Dissolution

Answer 117

A corporation that has issued shares and conducted business may be voluntarily dissolved by the directors and the shareholders. First, the board of directors must adopt a resolution authorizing dissolution. Next, the shareholders who are entitled to vote must approve the dissolution. Finally, the corporation must file articles of dissolution with the appropriate state authority, usually the secretary of state.

Question 118

Ending a Corporation

Answer 118

Dissolution doesn’t immediately end the corporation’s existence, nor does it wipe out corporate obligations. The corporation may not undertake new business after dissolution, but it must continue operating to the extent necessary to wind up its affairs. The winding-up process includes collecting and disposing of corporate assets, making provisions to pay creditors, concluding any pending litigation, and distributing assets to shareholders. Only after winding up is complete does the corporation cease to exist.

As part of winding up, the directors must make reasonable provisions to pay any claims against the corporation. Directors who fail to do so may be personally liable for the claims. Moreover, creditors must be paid or provided for before assets are distributed to the shareholders. A shareholder who receives improper distributions ahead of the corporation’s creditors may be personally liable for his portion of the creditors’ claims, not to exceed the amount of the distribution the shareholder received.