Business Associations Flashcards
What is a corporation?
A corporation is a distinct legal entity that can conduct business in its own right. It can: buy, sell, hold property, sue/be sued, last forever
Why do people choose to form corporations?
- limit liability
- promote investment
What are the characteristics of a promoter?
A person who:
- enters into contracts on behalf of the corporation (even before the corporation exists)
- tries to find investors
- are fiduciaries of the corporation (they cannot make secret profits)
What is the general rule on liability pre-incorporation?
Corporations are not liable for (or bound to) pre-incorporation agreements. Instead, promoters are liable. This ends once a novation agreement shifting liability to the corporation exists
Promoters may have a right of reimbursement based on a quasi contract for the value of the benefit received by the corporation
What is an articles of incorporation?
A contract between the corporation and the shareholders establishing basic rights.
With regard to a contract entered into by a promoter for the benefit of the corporation, an incorporator is…
not liable
When does the limited liability protection attach?
Moment of incorporation is when limited liability begins (when the SoS accepts and files the articles)
What are bylaws?
bylaws set forth the day-to-day rules regarding the operation and management of the corporation
What happens if something goes wrong with the formation of a corporation?
Instead of a de jure corporation, there may be a de facto corporation.
A de facto corporation, with limited liability, exists if the organizers 1) made a good faith effort to comply with the incorporation process and 2) have no actual knowledge of a defect in the corporate status
When may a court “pierce the veil” of limited liability?
to avoid fraud or unfairness. Generally courts are hesitant to do this.
What are the three factors courts consider in determining whether to pierce the veil?
This is a totality of the circumstances test.
1) alter ego (failure to observe any
corporate formalities between the person and the corporation [like no votes or meetings] and personal funds are commingled)
2) under-capitalization (Failure to maintain funds sufficient to cover foreseeable liabilities)
3) fraud (to commit fraud or for shareholders to hide behind to avoid existing obligations, stripping of assets)
When are courts more likely to pierce the veil?
- in tort situations (rather than contractual)
- in corporations with few shareholders
What is the waterfall upon liquidation?
creditors get paid before preferred stockholders, then remaining stockholders get paid
What are the authorized shares?
authorized shares are the maximum number of shares that the directors can sell, as set by the articles of incorporation
Usually only outstanding shares can vote
o
What are treasury shares?
stocks that were previously issued to shareholders, but are reacquired by the corporation
What are outstanding shares?
outstanding shares are all the shares that were issued to shareholders and still remain in the possession of shareholders
What consideration is needed for stocks?
the board of directors can receive any valid consideration that it finds adequate (e.g., labor, IP rights, cash, cancellation of debt owed)
What is watered stock?
watered stock occurs when the corporation sets a par value amount and sells the stock for less than the stated amount
Under common law, the shareholders who bought the watered stock are liable to the creditors of the corporation. However, modernly courts do not recognize liability for watered stock since par value is usually priced arbitrarily.
What is the rule for stock subscription agreements prior to incorporation?
subscription agreements (a contract to buy a specified number of shares) are irrevocable for up to 6 months
What are preemptive rights?
the right to acquire stock to maintain the percentage of ownership any time new shares are issued.
By default, shareholders DO NOT have preemptive rights. They can be negotiated or included in the articles
What are the two ways to get money out of a corporation
- board can declare a dividend (usually cash) (discretionary)
- board can buy back shares of the corporation
When can the board NOT declare a dividend?
- if the corporation is insolvent
- if, by issuing the dividend, the corporation would become insolvent
What happens if the directors vote to authorize an unlawful dividend?
The directors are personally liable, jointly and severally, to the corporation for the amount in excess of the lawful amount
BUT a director will not be liable if he relied in good faith on financial statements
What happens if a stock is classified as “participating?”
Each share in the class collects a dividend as part of the preferred class and then collects an additional amount together with the common class
What are the two exceptions to the general rule that shareholders can freely sell their stock?
- closely held corporations (generally 100 or less shareholders) (must be conspicuously noted)
- federal restrictions
When a shareholder claims that the restriction on sales is an impermissible restraint on alienation, what is the test?
Is the restraint reasonable.
For example, since S corporations can only have 100 shareholders, a restraint is likely to be reasonable. But merely not wanting outsiders is less reasonable.
absolute restrictions on alienability are never reasonable
What is the cause of action for a fraudulent purchase or sale of securities?
10b-5 cause of action
What are the elements of a 10b-5 action?
[EARS think of a sketchy inside trader with big ears]
- D Engaged in fraudulent conduct relating to material information
- D Acted with scienter
- in Reliance on D’s conduct, P purchased or sold the security which involved interstate commerce
- P Suffered harm
What is fraudulent or deceptive conduct?
making an untrue statement of a material fact or failing to state a material fact that is necessary to prevent statements already made from being misleading
Opinions and predictions do not count as untrue statements of material fact
When is a statement material?
a statement is material if a reasonable investor would find that fact important in deciding to purchase or sell the security
What is scienter?
Intent or knowledge of wrongdoing
Negligence is NOT enough, but recklessness is ok.
How do you compute damages in a 10b-5 cause of action?
A plaintiff can recover his “out-of-pocket” loss, which is the difference between the stock’s value at the time of the fraud and the price that the P paid or received the stock
Punitive damages are not allowed
What corporations does section 16(B) apply to?
only:
- corporations with securities trading on a national securities exchange OR
- corporations with assets of more than $10 million and more than 500 shareholders
Who are corporate shareholders under section 16(B)
- directors and officers (president, vp, secretary, treasurer etc)
- shareholders who hold more than 10% of any class of stock
What is the sanction for a violation of section 16(B)?
During any 6 month period, a corporate insider who both buys or sells the stock is liable to the corporation for any profits made on those transactions. Any profits will be disgorged
Who elects the board of directors?
shareholders
What are the meetings in a corporation?
- mandatory annual meeting (to elect directors and conduct other shareholder business)
- special meetings (to vote on fundamental changes)
What are the notice requirements when calling a meeting?
- notice must be given to shareholders 10-60 days before the meeting
- must include the time, date, and location
- special meetings must include purpose of the meeting
What happens if a shareholder attends a meeting when there was insufficient notice?
actual attendance at a meeting waives the shareholder’s right to challenge any actions taken at the meeting
What is the record date?
When must the record date occur?
- the cut-off date to determine which shareholders are eligible to receive a dividend or vote at a shareholders’ meeting
- 70 days or less before the meeting
What is required for a proxy to be effective?
- in writing
- signed by the shareholder as of the record date
- sent to the secretary of the corporation
- states authorization of another to vote the shareholder’s shares
- cannot be valid for more than 11 months
What is required for shareholders to take action without a meeting?
there must be unanimous written consent of ALL shareholders
Practically unlikely in a large corporation
What is needed for a quorum to be met in a shareholder meeting?
A quorum is a majority of the corporation’s outstanding shares represented at the start of the meeting
When is a shareholder vote effective?
1) a quorum is present AND
2) the votes case in favor of the proposal exceed the votes against the proposal
Ex of cumulative voting (which applies only to election of directors)?
If you own 10,000 shares of a corporation and there are nine director positions up for election, you will be able to cast 90,000 votes for only one or a few candidates instead of 10,000. The effect of cumulative voting is to allow minority shareholders to elect representatives to the board.
What are a shareholder/director’s inspection rights?
A shareholder/director may inspect the corporation’s records in person or through an agent as long as the shareholder states a proper purpose (related to their financial interest in the corporation)
What is a direct lawsuit?
Shareholder is suing in the shareholder’s own name for damages and the damages go directly to the shareholder.
Harms include: Interference in voting rights or dividends, misinformation about important issues, and tort
injury.
What is a derivative lawsuit?
the shareholder is suing on behalf of the corporation because the harm principally impacts the corporation (e.g., disloyalty)
Any recovery goes to the corporation
What are the standing requirements to bring a derivative lawsuit?
- must have been a shareholder at the time of the harm and hold the shares throughout the litigation;
- must fairly and adequately represent the interests of the corporation; AND
- make a written demand to the board of directors and allow them 90 days to respond before filing suit
What must the plaintiff generally do in a derivative lawsuit?
The plaintiff shareholder is generally required to first demand that the board of directors bring the lawsuit in the corporation’s name or redress the issue before the shareholder can bring the suit.
In some jurisdictions, the “demand futility” exception negates this obligation to demand action if it would be futile (e.g., directors have been named as the potential defendants). Modernly, it is required.
What happens to the recovery in a derivative lawsuit?
any recovery goes to the corporation, NOT the shareholder
If the litigation produces a “substantial benefit” to the corporation, the P’s attorneys are entitled to have their fees paid by the corporation
What is the general rule regarding shareholder duty to fellow shareholders?
Shareholders do NOT owe a duty to fellow shareholders in the corporation.
When may a controlling shareholder owe a duty to minority shareholders?
1) sale of stock to an outsider/looter
2) controlling shareholder transacts with the corporation
Who is a controlling shareholder?
- one who owns 50% plus one of the shares
- one who controls a significant stake and the remaining shares are widely dispersed
What are the main tasks of the board of directors?
-appoint officers
-oversee officers
make high-level corporate decisions
Generally shareholders may remove directors with or without cause. What is the main exception?
Staggered boards (e.g., 3 elected year 1, 3 elected year 2). In this case the directors may only be removed for cause and only if the articles provide
Different classes of shareholders may elect different directors. Therefore, only directors elected by a particular class may be removed by that class
How are new directors selected when there is a vacancy or the size of the board increases?
shareholders at a special meeting OR by the board of directors
What are the rules for board meeting notice and waiver?
- directors must be given notice for special meetings, but not for regular meetings
- attendance waives notice, unless the director promptly objects at the meeting
Directors CANNOT vote by proxy or enter into voting agreements
o
What quorum is needed for a meeting of the board of directors?
A majority of the total number of the directors at the time of the vote, unless the bylaws specify a higher or lower number
Unlike shareholders, a director can break quorum by withdrawing before the vote is taken
When will a resolution of the board pass?
Assuming a quorum, a resolution will pass upon a majority vote of those present at the meeting
To avoid potential liability for a board decision with which a director disagrees, what are the ways the director can dissent?
- entering dissent in the meeting minutes
- file written dissent before the meeting is adjourned; OR
- provide written dissent by certified or registered mail to the corporation’s secretary immediately following the adjournment of the meeting
When must directors be notified of a meeting?
Directors must be given notice for special meetings, but not for regular meetings
What are the duties that officers owe to the corporation?
[LCD]
loyalty, care, disclose
What is the business judgment rule?
In the absence of fraud, illegality, or self-dealing, courts will not disturb good-faith business decisions. This is a rebuttable presumption.
This rule protects directors and officers because it is presumed that they will manage the corporation in good faith and in the best interest of the corporation.
What is the standard of care when judging the duty of care of an officer/director?
Ordinarily prudent person in a like position and circumstances
If someone has special skills (e.g., lawyer, accountant), they will be held to a higher standard as they are expected to use those skills.
What is the reliance defense?
A director or officer is entitled to rely on the expertise of officers and other employees, outside experts, and committees of the board
Who selects officers?
The board of directors
What is the general rule of the duty of loyalty in a corporation?
one who is under a duty of loyalty may not receive an unfair benefit to the detriment of the corporation without effective disclosure and ratification
What is the corporate opportunity doctrine?
the duty of loyalty is violated when the director, officer, or their relative usurps a corporate opportunity rather than first offering the opportunity to the corporation
The remedy is disgorgement of profits or turn over the opportunity
What is a self-dealing transaction by one who has a duty of loyalty to a corporation?
The duty of loyalty is violated when a director, officer, or their relative receives a substantial benefit directly from the corporation
When may a director/officer avoid liability for a violation of their duty of loyalty? [Safe Harbor Rule]
the transaction is disclosed and ratified by:
-a majority of disinterested directors; OR
-a majority of disinterested shareholders
[but ratification may not win the case, it may only shift the burden]
-The best option is to show that the transaction was fair
When must the corporation pay the cost of defense for a director/officer?
when the director/officer successfully defends the case
When is the corporation prohibited from paying the cost of defense for a director/officer?
when the director/officer is liable for receiving an improper benefit from the corporation OR committed intentional wrongful acts or crimes
When MAY (not must) the corporation pay the cost of defense for a director/officer?
when the director/officer:
- acted in good faith with no intent to harm the corporation; OR
- had no reasonable cause to believe the conduct was illegal
Who must approve fundamental changes?
BOTH shareholders and directors. Fundamental changes require a majority of shares entitled to vote
What is a merger?
the combination of two or more corporations where one corporation survives and assumes the assets and liabilities. The shareholders of each corporation generally must approve of the merger.
[remember: murdering the subsumed corporation]
What is a consolidation?
the combination in which neither of the two corporations survives. A new entity is created and this new entity assumes the assets and liabilities of both corporations.
[remember c for create]
What are the ways that a corporation is extinguished?
- voluntarily by the shareholders and directors
- involuntarily by disgruntled parties (creditors or shareholders)
What must shareholders show to have a corporation dissolve?
- the assets are being wasted;
- the directors are acting fraudulently; or
- the directors and shareholders are deadlocked
What happens if the shareholder does not want to participate in a fundamental change? (merger, asset sale, share exchange, amendment of the articles/bylaws, conversion, dissolution)
the shareholder is entitled to dissenters’ or appraisal rights
How does a shareholder invoke their dissenters’ rights?
[NAD because thats what it is needed to dissent]
1) send written Notice to the corporation of intent to dissent
2) at the meeting, Abstain or vote “no” AND
3) make prompt written Demand for fair market value after the action is approved
What happens if the shareholder and the corporation disagree as to fair market value of the stock?
a court can appoint an expert appraiser to issue a binding appraisal of the value
What are the unique terms used in an LLC?
rather than shareholders, LLCs have members.
rather than articles of incorporation, LLCs use articles of organization