Business Associations (Main Deck)* Flashcards
WHAT MUST YOU CONSIDER WHEN APPROACHING A BUSINESS ASSOCIATIONS QUESTION?
STEP 1: DETERMINE IF AGENCY PRINCIPLES ARE RELEVANT
STEP 2: IDENTIFY THE TYPE OF BUSINESS ORGANIZATION
STEP 3: DISCUSS ISSUES OF FORMATION, OPERATION & DISSOLUTION
Note: Because principles of agency are inherent in many types of business relationships, it is important to determine if agency is relevant regardless of the type of business organization presented on the exam.
AGENCY
(Define)
Definition: Agency is a relationship in which oneperson (the agent) is authorized to act on the behalf of and subject to the control of another (the principal).
LIST 6 WAYS AN AGENCY RELATIONSHIP MAY BE CREATED
1) Express Authority
2) Implied Authority
3) Apparent Authority
4) Ratification
5) Inherent Authority
6) Agency by Estoppel
EXPRESS AUTHORITY
(Define & State the Rule)
Definition: Express authority is actual authority given by a principal to an agent through the parties’ manifestation of consent to enter into an agency relationship.
Rule: An agency relationship based on express authority is created by:
1) The principal’s manifestation of consent that the agent shall act on the principal’s behalf and subject to the principal’s control, AND
2) The agent’s manifestation of consent to acton behalf and subject to the control of the principal.
Note: The consent of the parties can be communicated through words or actions.
IMPLIED AUTHORITY
(Define & State the Rule)
Definition: Implied authority is actual authority implied from the principal’s granting of express authority to the agent.
Rule: An agent is given implied authority to perform the functions that are practically and reasonably necessary to carry out the duties expressly delegated by the principal.
Note: Whether authority is implied is interpreted from the perspective of a reasonable person in the agent’s position.
APPARENT AUTHORITY
(Define & State the Rule)
Definition: Apparent authority results from the principal’s representations to a third party.
Rule: An agency relationship based on apparent authority is found where a principal’s words or actions would cause a reasonable person to believe that the principal has authorized the agent to act on the principal’s behalf.
Note:
1) Whether an agent has apparent authority is interpreted from the third party’s perspective.
2) If the third party has actual or constructive knowledge that the agent did not have actual authority, apparent authority will not be found, regardless of the principal’s representations.
RATIFICATION
(Define & State the Rule)
Definition: Ratification is the principal’s subsequent affirmation of an act that was not authorized by or binding upon the principal at the time the actor committed the act.
Rule: An agency relationship based on ratification is created when:
1) An actor engages in conduct on behalf of the principal without the principal’s consent, AND
2) The principal subsequently affirms the actor’s conduct.
Note: Ratification is all or nothing. Thus, the principal must affirm all of the actor’s conduct or none at all.
HOW CAN A PRINCIPAL AFFIRM THE CONDUCT OF ANOTHER?
Rule: A principal may affirm an actor’s conduct through:
1) Express affirmation, OR
2) Implied affirmation.
Note:
1) Implied affirmation will be found if the principal:
a) Accepts the benefits of the transaction (if it was possible to decline the benefits),
b) Remains silent or takes no action, OR
c) Uses the actor’s conduct for the principal’s benefit (e.g., bringing a lawsuit to enforce a contract signed by the actor).
2) The principal must accept the results of the actor’s conduct with full knowledge of all material circumstances.
3) Once ratified, the act is treated as authorized by the principal, and the actor is retroactively treated as the principal’s agent to carry out the act.
INHERENT AUTHORITY
(Define & State the Rule)
Definition: Inherent authority is found where necessary to protect a third party from harm caused by an agent.
Rule: Where an agent has neither actual nor apparent authority to act on behalf of a principal, public policy considerations may lead a court to find the agent had inherent authority to act.
Note: Inherent authority is often found in three situations:
1) Undisclosed Principals
AGENCY BY ESTOPPEL
(Define & State the Rule)
Definition: Agency by estoppel is a theory of agency that is used to protect third parties who have changed their position in reliance on a principal’s representations.
Rule: Agency by estoppel will be found where:
1) A principal represents to a third party that an agent has authority to act on the principal’s behalf,
a) Note: The representation may be intentional, reckless or negligent, may consist of words or conduct, and may be a false representation or the concealing of a material fact.
2) The third party reasonably believes the principal’s representation, AND
3) The third party changes its position in reliance on that representation.
Note: The third party must have relied on the principal’s representation in good faith (i.e., the third party did not have actual or constructive knowledge of falsity).
WHAT IS THE EFFECT OF FINDING AN AGENCY RELATIONSHIP TO EXIST?
Principal: Once an agency relationship is found to exist, the principal owes duties to the agent and can be held liable for the consequences of the agent’s acts carried out within the scope of the agency relationship.
Note: The principal can be held liable in tort or in contract:
1) Tort: The principal can be held liable for harm caused by the agent while acting within the scope of the agency relationship
2) Contract: The principal can be bound by contracts entered into by the agent on behalf of the principal.
Agent: Once an agency relationship is found to exist, the agent owes fiduciary duties to the principal.
RESPONDEAT SUPERIOR
(Define & State the Rule)
**Definition: **Respondeat Superior is the doctrine by which a principal can be held vicariously liable in tort for the actions of an agent acting at the principal’s direction and subject to the principal’s control.
Rule: A principal will be held vicariously liable for tortious acts committed by his agent if the tortious acts occur while the agent is acting within the course or scope of the agency relationship.
Note:
1) An act is within the course or scope of the agency relationship if the act is necessary to carry out the agent’s required functions or if it would reasonably be expected that the agent would perform the act.
2) Minor deviations generally are held to be within the course and scope of the agency relationship. Large deviations generally are found to be outside the scope of the agency relationship.
TO WHAT EXTENT CAN AN EMPLOYER BE HELD LIABLE FOR THE TORTIOUS CONDUCT OF AN INDEPENDENT CONTRACTOR?
Rule: Generally, an employer will not be held vicariously liable for the tortious conduct of an independent contractor or for the conduct of an independent contractor’s employees.
Exception: An employer may be held liable for harm caused by an independent contractor or its employees if:
1) The employer maintains control over the area of work from which the tort arises,
2) The employer was negligent in hiring the independent contractor,
3) The independent contractor is engaged in an inherently dangerous activity, OR
4) A nondelegable duty is involved (e.g., constructing a building to code).
WHAT DUTIES DO AGENTS OWE PRINCIPALS?
Rule: The agent owes the principal:
1) A duty of due care,
a) Rule: The agent must act in good faith and in a manner she reasonably believes to be in the best interest of the principal.
2) A duty of loyalty,
a) Rule: The agent cannot serve her own interest at the expense of the principal, make secret profit, or usurp the principal’s opportunities.
3) A duty of obedience and performance,
a) Rule: An agent must obey the lawful instructions of the principal and perform her work in a manner acceptable to the principal.
4) A duty of accountability, AND
a) Rule: The agent must maintain an accurate accounting of all transactions undertaken on behalf of the principal.
5) Any additional duties specified in the contract creating the agency relationship.
WHAT DUTIES DO PRINCIPALS OWE AGENTS?
Rule: The principal owes the agent:
1) A duty to compensate,
a) Rule: The principal must pay the agent the agreed-upon commission or fee, or a reasonable fee if none was agreed upon.
2) A duty to reimburse,
a) Rule: The principal must reimburse the agent for expenses incurred on the principal’s behalf that were paid for by the agent.
3) A duty to facilitate,
a) Rule: The principal must provide the materials and information necessary for the agent to perform her job.
4) A duty to indemnify, AND
a) Rule: The principal must protect the agent for losses incurred during the course of the agency relationship due to the principal’s misconduct.
5) Any additional duties specified in the contract creating the agency relationship.
LIST 9 WAYS TO STRUCTURE A BUSINESS ORGANIZATION
1) Sole Proprietorship
2) Joint Venture
3) General Partnership
4) Limited Partnership
5) Limited Liability Partnership
6) Limited Liability Company
7) Corporation
8) Close Corporation
9) Professional Corporation
SOLE PROPRIETORSHIP
(Define)
Definition: A sole proprietorship is an arrangement in which the business is not a separate legal entity from the owner of the business (i.e., the owner and the business are one and the same).
Note:
1) A sole proprietor has unlimited personal liability for the debts and obligations of the business.
2) Creditors may recover claims against the business from the sole proprietor’s personal assets.
JOINT VENTURE
(Define)
Definition: A joint venture is an agreement between two or more parties to undertake an economic activity for mutual profit, usually for a specific project or a specified period of time.
Note:
1) Joint ventures are governed by partnership and contract law.
2) The parties involved in joint ventures may be people, groups of people, or companies.
3) All parties contribute capital and share in revenues, expenses, and control.
PARTNERSHIP
(Define)
Definition: A partnership is an association of two or more persons to carry on as co-owners of a business for profit.
Note:
1) Partnerships are governed by state law, which is largely based upon the uniform partnership acts.
2) In most cases, a partnership agreement can override the default provisions provided by the uniform partnership acts.
GENERAL, LIMITED, & LIMITED LIABILITY PARTNERSHIP
(Define)
General Partnership: A general partnership is a partnership in which each partner is held fully liable for all debts and obligations of the organization.
Limited Partnership: A limited partnership is a partnership in which general partners may be held fully liable for the debts and obligations of the organization but limited partners are granted limited liability.
Limited Liability Partnership: A limited liability partnership is one in which all partners are granted limited liability.
FORMATION OF A GENERAL PARTNERSHIP
(State the Rule)
Rule: A general partnership may be formed by:
1) Voluntary agreement of the partners,
2) Conduct ofthe partners, OR
3) Estoppel.
Note: An agreement to form a general partnership may be formal or informal and need not be in writing.
TO WHAT WILL COURTS LOOK TO DETERMINE IF A PARTNERSHIP EXISTS IN THE ABSENCE OF A FORMAL PARTNERSHIP AGREEMENT?
Rule: To determine whether a partnership exists in the absence of a formal partnership agreement, courts look to:
1) The intention of the parties,
2) Whether profits and losses are shared,
3) Whether the parties exercise joint administration and control over the business operation,
4) The level of capital investment by each partner, AND
5) Whether partnership property is commonly owned.
Note:
1) The sharing of profits (i.e., net returns) is prima facie evidence that a partnership exists.
2) Joint ownership of property, sharing of gross returns, or contribution of capital alone generally will not establish the existence of a partnership.
PARTNERSHIP BY ESTOPPEL
(Define & State the Rule)
Definition: Partnership by estoppel is a partnership created by operation of law when an individual holds himself out to others as a partner.
Rule: Partnership by estoppel will be found where:
1) An individual represents to others, through words or conduct, that he is a partner,
2) A third party reasonably believes that representation, AND
3) The third party changes her position in reliance on that representation.
FORMATION OF A LIMITED PARTNERSHIP
(State the Rule)
Rule: A limited partnership is formed by two or more people executing and filing with the Secretary of State a Certificate of Limited Partnership that includes:
1) The name ofthe limited partnership,
2) The address of the principal office,
3) The name and address of the agent designated to receive service of process,
4) The names and addresses of the general partners, AND
5) Any other matters the person filing the certificate deems important to include.
FORMATION OF A LIMITED LIABILITY PARTNERSHIP
(State the Rule)
Rule: A limited liability partnership is formed by filing with the Secretary of State a Registration that includes:
1) The name of the partnership,
2) The address of its principal office,
3) The name and address of the agent designated to receive service of process,
4) A brief statement of the business in which the partnership engages,
5) A statement that the partnership is registering as a limited liability partnership, AND
6) Any other matters the partners deem importantto include.
Note:
1) The name of a registered limited liability partnership must contain the words “Limited Liability Partnership” or “Registered Limited Liability Partnership,” or the initials “LLP” or “RLLP’ must be included as the last letters of its name.
2) In California, only accountants, lawyers, and architects may form limited liability partnerships, and all partners must be licensed in the profession.
WHAT ARE THE DEFINING CHARACTERISTICS OF A GENERAL PARTNERSHIP?
Rule: The defining characteristics of a general partnership include:
1) Each partner has unlimited personal liability for all obligations of the partnership,
a) Note: The amount or percentage of each partner’s financial contribution is irrelevant to determining her liability for the debts or obligations of a general partnership.
2) All partners have equal authority over the management ofthe enterprise, a) Note: This can be altered through agreement.
3) Matters are generally determined by majority vote, AND
a) Note: This can be altered through agreement.
4) Profits and losses are shared equally among partners.
a) Note: This can be altered through agreement.
EXPLAIN THE DIFFERENCE BETWEEN THE UPA & THE RUPA FOR PURPOSES OF GENERAL PARTNERS’ LIABILITY
Uniform Partnership Act (UPA):
1) Tort Obligations: Partners have joint and several liability.
2) Contract Obligations: Partners have joint liability, but not several liability.
Revised Uniform Partnership Act (RUPA):
1) Partners are held jointly and severally liable for all partnership obligations.
2) A partner’s personal assets can be reached by a creditor only if a judgment has been obtained against the partner in his personal capacity, AND
a) The assets of the partnership have been exhausted,
b) The partner has agreed that the creditor need not exhaust partnership assets,
c) A court grants the creditor permission to levy the personal assets ofthe partner,
d) A legal obligation exists that permits attaching the partner’s personal assets. OR
e) The partnership has filed for bankruptcy.
Note: In a partnership, every partner is deemed an agent of the partnership. Thus, the acts of a partner performed on behalf of the partnership and within the scope of its business are binding upon all co-partners.
WHAT ARE THE DEFINING CHARACTERISTICS OF A LIMITED PARTNERSHIP?
Rule: The defining characteristics of a limited partnership include:
1) Management and control:
a) General partners are responsible forthe management ofthe business and may also contribute capital.
b) Limited partners invest capital in the partnership and share in the profits ofthe partnership, but do not participate in the management of the business.
2) Liability:
a) General partners may be held personally liable for the obligations of the partnership.
b) Each limited partner’s liability is limited to the amount ofthe capital she invested in the partnership.
**Note: **A limited partnership must have at least one general partner who can be held personally liable for the partnership’s obligations. However, the general partner may be a corporation or an LLC, thereby protecting individuals from unlimited personal liability.
WHAT ARE THE DEFINING CHARACTERISTICS OF A LIMITED LIABILITY PARTNERSHIP?
Rule: In a limited liability partnership (LLP), a debt or obligation incurred by the partnership is solely the obligation ofthe partnership. Partners will not be held personally liable for:
1) The partnership’s debts (beyond the amount ofthe partner’s investment into the partnership), OR
2) The tortious conduct of other partners (i.e., no vicarious liability).
Note: Limited liability partners share management and control functions in a manner similar to general partners.
WHAT CHARACTERISTICS ARE SHARED BY GENERAL, LIMITED, & LIMITED LIABILITY PARTNERSHIPS?
Shared characteristics of general, limited and limited liability partnerships include:
1) Partnerships are taxed at only one level (each individual partner), thereby avoiding the double taxation experienced at the corporate level,
a) Note: Double taxation refers to the taxation of a corporation on its earnings, and the subsequent taxation of employees/shareholders on their earnings from the corporation.
2) Profits are shared equally among all partners unless altered through agreement ofthe partners,
3) Partners owe fiduciary duties to the partnership and to one another.
a) General partners always owe fiduciary duties to other partners and to the partnership.
b) Limited partners historically did not owe the same level of fiduciary duties as did general partners. However, under the modern statute (Re-RULPA) and recent case law, limited partners may owe fiduciary duties if they exert any influence or control over the partnership.
WHAT DUTIES ARE OWED BY PARTNERS IN A PARTNERSHIP?
Rule: In a partnership, partners owe one another and the organization:
1) A duty of care,
a) Note: Partners must not engage in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation ofthe law.
2) A duty of loyalty, AND
a) Note: Partners cannot serve their own interest at the expense ofthe partnership, engage in secret profit, or compete with the partnership.
3) A duty of good faith and fair dealing.
HOW CAN A PARTNERSHIP BE DISSOLVED?
Rule: A partnership may be dissolved by:
1) Act of the partners,
2) Operation of law, OR
3) Judicial decree.
WHEN WILL A PARTNERSHIP BE DISSOLVED BY AN ACT OF THE PARTNERS?
Rule: A partnership may be dissolved by:
1) Expiration of the time or termination of the purpose stated in the partnership agreement,
2) Withdrawal of a partner,
3) Expulsion of a partner, OR
4) Mutual agreement of all partners.
Note: Under the UPA, the expulsion of a partner results in the dissolution of the partnership followed immediately by the formation of a new partnership with the remaining partners.
WHEN WILL A PARTNERSHIP BE DISSOLVED BY OPERATION OF LAW?
Rule: A partnership will be dissolved by operation of law if:
1) A partner dies,
2) A partner becomes bankrupt,
3) The partnership becomes bankrupt, OR
4) A supervening event has made the partnership’s purpose illegal.
WHEN WILL A PARTNERSHIP BE DISSOLVED BY JUDICIAL DECREE?
Rule: A partnership may be dissolved by judicial decree when:
1) A partner is determined by the court to be insane,
2) A partner is found guilty of conduct that prejudices her ability to act as a partner, OR
3) The partnership can be carried on only at a loss.
HOW ARE ASSETS DISTRIBUTED UPON DISSOLUTION OF A PARTNERSHIP?
Rule: Upon dissolution of a partnership, the partnership’s assets are liquidated and distributed in the following order to satisfy the partnership’s obligations:
1) Creditors (excluding partners who are also creditors),
2) Creditor-partners,
3) Capital contributors,
4) Profits.
WHAT ARE THE PARTNERS’ RIGHTS UPON DISSOLUTION OF A PARTNERSHIP?
Rule: In the absence of an agreement otherwise:
1) Each partner is repaid the amount he contributed,
2) Any profits are shared equally among the partners (per capita), AND
3) Losses are shared equally among the partners (per capita).
LIMITED LIABILITY COMPANY
(Define)
Definition: A limited liability company (LLC) is a business organization that combines characteristics of corporations and partnerships. It is designed primarily to limit the liability of its members.
Note:
1) An LLC is a distinct legal entity and may carry out its business functions in the same manner as a corporation.
2) An LLC provides liability protection similar to that which shareholders receive in a corporation, but avoids the double taxation that corporations experience by allowing the owners of the LLC to be taxed personally (as in a partnership).
FORMATION OF A LIMITED LIABILITY COMPANY
(State the Rule)
Rule: An LLC is formed by filing Articles of Organization with the Secretary of State that include:
1) The name of the LLC,
2) The purpose of the LLC,
3) The name and address of the agent for service of process, AND
4) Whether the LLC will be managed by members or by non-member managers.
Note:
1) The name of the LLC must contain language demonstrating that the business entity is an LLC (e.g., “Limited Liability Company” or a “LLC”).
2) If the LLC is formed for a term, the articles must contain the time at which the LLC is to dissolve.
FUNDING OF A LIMITED LIABILITY COMPANY
(State the Rule)
Rule: An LLC must be adequatelyfunded through capitalcontribution by its members. If an LLC is under-capitalized for the type of business in which it is engaged, a court may ignore the liability protection of the LLC and hold the individual members personally liable.
TAXATION OF A LIMITED LIABILITY COMPANY
(State the Rule)
Rule: An LLC is treated like a partnership for tax purposes unless the LLC chooses to be taxed like a corporation. Thus, members of an LLC are taxed on their share of the LLC’s profit (i.e., pass-through taxation).
Note: California imposes an annual franchise tax on LLCs, but otherwise taxes members only on their share of the LLC’s profits.
DISTRIBUTION OF INCOME & LOSSES IN A LIMITED LIABILITY COMPANY
(State the Rule)
Rule: The distribution of income and losses among the members is determined by the Articles of Organization. If the articles do not determine the distribution, the default rules of the state in which the LLC is formed will apply.
Note:
1) Income and losses may be distributed in two ways: in proportion to the amount of investment or equally divided among the members.
2) In California, income and losses will be allocated in proportion to the amount of capital investment by each member if the articles are silent on the matter.
HOW IS AN LLC MANAGED?
Rule: The Articles of Organization determine whether the LLC will be member-managed or manager-managed. If the articles do not contain a statement vesting management authority in members or managers, the default rules of the state in which the LCC is formed will apply.
Note: In California, LLCs will be member-managed if the articles are silent on the matter.
HOW ARE MANAGEMENT DECISIONS MADE IN A LIMITED LIABILITY COMPANY?
Rule: Generally, the Articles of Organization determine how decisions are made. In the absence of instruction by the articles, the method by which decisions are made depends upon how the LLC is managed:
1) If member-managed: Decisions are made through a majority vote of the members. Each member’s vote is weighted in proportion to the member’s capital contribution.
2) If manager-managed: Decisions are made through a majority vote of the managers. Each manager’s vote is weighted equally.
CAN MEMBERS OR MANAGERS BE HELD PERSONALLY LIABLE FOR AN LLC’S LIABILITIES?
Rule: The members and managers of an LLC will not be held personally liable for any debts, obligations or liabilities of the LLC simply by virtue of being a member or manager of the LLC.
Note: Members and managers remain personally liable for any torts they commit in the course of performance of their duties for the LLC.
MAY A MEMBER ASSIGN HER INTEREST IN A LIMITED LIABILITY COMPANY?
Rule: Generally, a member may assign her interest in an LLC, in whole or in part, as long as the assigning member obtains the consent of the majority interest of the non-assigning members.
Note:
1) A member may assign the right to distribution of income from the LLC freely and without the consent of the other members.
2) Assigning the right to distribution does not assign one’s management rights.
DISSOLUTION OF A LIMITED LIABILITY COMPANY
(State the Rule)
Rule: An LLC can be dissolved by:
1) Agreement of all members to end the LLC,
2) The incapacity, death, resignation or bankruptcy of a member (unless the remaining members vote to continue the LLC),
3) An order by a court or administrative agency dissolving the LLC, OR
4) The expiration of the stated term (if the LLC is a term LLC).
CORPORATION
(Define)
Definition: A corporation is a fictitious legal entity created in accordance with statutory requirements.
Note: Defining characteristics of a corporation include:
1) Limited liability of shareholders (generally liable only for the amount of their capital contributions),
2) Free transferability of shares,
3) Perpetual existence (unless otherwise noted in the corporation’s articles),
4) Centralized management (i.e., board of directors).
FORMATION:
CORPORATION BY ESTOPPEL
(Define & State the Rule)
Definition: Corporation by estoppel results from a court decree stating that an unincorporated organization will be treated as a corporation.
Rule: Estoppel may require that an organization be treated as a corporation in two situations:
1) A person or entity that treats an organization as a corporation, regardless of that organization’s effort to incorporate, may be estopped from later claiming the entity is not a corporation.
2) An organization that holds itself out as a corporation may later be estopped from denying liability as such if sued by a plaintiff who treated the organization as a corporation in reliance on the organization’s representation.
Note: Corporation by estoppel is applied only in contractual (not tort) disputes.
FORMATION:
DE FACTO CORPORATION
(Define & State the Rule)
Definition: A de facto corporation is that which may arise if an attempt to create a corporation fails.
Rule: A de facto corporation will be created if:
1) A statute establishes the requirements for the creation of a legal corporation,
2) A good faith effort to comply with the statute has been made, AND
3) An agent of the corporation acted on the corporation’s behalf.
Note: If a de facto corporation is created, the entity will be treated as a corporation for all purposes.
FORMATION:
DE JURE CORPORATION
(Define & State the Rule)
Definition: A de jure corporation is created when the incorporator complies with all statutory requirements and the corporation is granted a state charter.
Rule: The incorporator must file Articles of Incorporation with the Secretary of State:
1) The Articles of Incorporation must contain:
a) The name of the corporation,
b) The name and address of the corporation’s authorized agent and all incorporators, AND
c) The number of shares the corporation may issue.
2) The Articles of Incorporation often (but are not required to) contain:
a) A statement of purpose, AND/OR
b) A statement of duration.
DEFINE THE VARIOUS PARTIES YOU MAY ENCOUNTER IN A CORPORATION’S QUESTION
Promoter: The person or persons who take the steps necessary to procure financing and capital for the corporation.
Incorporator: The person (often the promoter) who incorporates the entity by filing the Articles of Incorporation with the Secretary of State.
Directors: The elected or appointed persons who make up the board of directors and who manage the affairs of the corporation through the appointment of officers.
Officers: The persons who are responsible for the daily operations of the corporation.
Shareholders: The holders of shares in the corporation.
ARTICLES OF INCORPORATION
(Define)
Definition: The Articles of Incorporation are a contract between the corporation and the state, as well as between the corporation and its shareholders. The articles state the business purpose of the corporation and provide the primary rules for management of the corporation.
ULTRA VIRES ACTS
(Define & State the Rule)
Definition: Ultra vires acts are acts beyond the scope ofthe business purpose stated in the corporation’s Articles of Incorporation.
Rule: If a corporation engages in an activity that is outside the scope of its stated business purpose, then:
1) Shareholders may bring suit to enjoin the activity,
2) The corporation may bring suit against the directors or officers for exceeding their authority, AND/OR
3) The state Attorney General may bring suit to dissolve the corporation.
PROMOTER’S LIABILITY TO THIRD PARTIES
(State the Rule)
Rule: Generally, a promoter remains personally liable to third parties for contracts the promoter enters into on behalf of the organization before it is incorporated.
Exception: A promoter’s liability may be extinguished if:
1) An agreement substituting the corporation for the promoter is made (i.e., a novation), OR
2) The pre-incorporation contract entered into by the promoter expressly states that the promoter will not be held liable for a breach arising from the contract.
CORPORATION’S LIABILITY FOR PROMOTER CONTRACTS
(State the Rule)
Rule: A corporation cannot be held liable until formed. Once formed, the corporation may be held liable for contracts entered into by the promoter if:
1) The board of directors ratifies the contract, OR
2) The corporation accepts the benefits of the contract.
PROMOTER’S DUTY OF LOYALTY TO THE CORPORATION
(State the Rule)
Rule: Promoters owe a duty of loyalty to the corporation and may not act for their own benefit in dealings with the corporation.
Exception: A promoter may profit from his dealings with the corporation if:
1) All material facts of the transaction are fully disclosed to all parties AND
2) The board of directors ratifies the transaction
PIERCING THE CORPORATE VEIL
(Define & State the Rule)
Definition: Piercing the corporate veil refers to the method by which creditors are able to reach the personal assets of shareholders, or the assets of sister or parent corporations, by removing the liability protection offered by the corporate structure.
Rule: To pierce the corporate veil, the claimant must establish:
1) A unity of interests and ownership (i.e., alter ego), AND
2) That maintaining the corporate facade would facilitate fraud or injustice.
Note: The claimant’s inability to collect on his claim if the veil is not pierced is generally not a sufficient showing of injustice to pierce the veil.
PIERCING THE CORPORATE VEIL:
HOW IS UNITY OF INTERESTS & OWNERSHIP PROVEN?
Rule: To determine whether a unity of interests and ownership exists, courts will look to:
1) The extent to which corporate formalities have been disregarded,
2) Whether the corporation is grossly undercapitalized,
3) Whether the corporation’s assets are intermingled with those ofthe officers or directors, or those of a sister or parent corporation,
4) Whether the officers or directors treat the corporation’s assets as their own,
5) Whether parent, subsidiary or sister corporations share directors, officers, or employees, AND
6) Whether parent, subsidiary or sister corporations maintain completely separate operations.
VERTICAL, HORIZONTAL, & REVERSE PIERCING
(Define)
Vertical Piercing: Vertical piercing allows a corporation’s claimants to reach the assets of dominant shareholders.
Horizontal Piercing: Horizontal piercing allows a corporation’s claimants to reach the assets of sister corporations.
Reverse Piercing: Reverse piercing allows a dominant shareholder’s claimants to reach the assets of a corporation.
