Business Organizations - Quiz 3 Flashcards
1
Q
T/F: Limited liability is the default rule for corporations, LLCs, and LPs
A
True
2
Q
T/F: Partnerships cannot elect limited liability.
A
False. They CAN elect limited liability
3
Q
What is the two-pronged test for veil piercing?
A
(1) the court must find a unity of interest and ownership between the parent and subsidiary such that their separate personalities no longer exist; and
(2) the court must satisfy itself that if the acts are treated as those of the subsidiary alone, an equitable result will follow.
4
Q
Who has the burden of establishing the elements of veil piercing?
A
The plaintiff
5
Q
T/F: No causal connection needs to exist between the first and second prong of veil piercing
A
False. A causal connection MUST exist.
6
Q
What are the factors to determine whether the two-pronged veil piercing test is met?
A
(1) Undercapitalization
(2) Absence of corporate records
(3) fraudulent representation by corporation shareholders or directors
(4) use of the corporation to promote fraud, injustice, or illegal activities
(5) payment by the corporation of individual obligations
(6) failure to observe required corporate formalities
(7) other shareholder acts or conduct ignoring, controlling, or manipulating the corporate form
7
Q
T/F: Under choice of law, most states apply the law of the chartering state to actions seeking to pierce the corporate veil
A
True
8
Q
What is judgement-proofing?
A
an action that seeks to render an entity judgement-proof even while the entity continues to participate in the operation of a business
9
Q
When is an entity judgement-proof?
A
When a creditor holding a judgement against an entity would be unable to collect
10
Q
Who are equitable owners?
A
People who control an entity by means other than owning its shares or interest
11
Q
What is the two-pronged test to hold equitable owners liable under equitable ownership theories?
A
(1) the court must find a unity of interest and ownership between the parent and subsidiary such that their separate personalities no longer exist; and
(2) the court must satisfy itself that if the acts are treated as those of the subsidiary alone, an equitable result will follow.
12
Q
What are the factors courts consider when determining whether to hold equitable owners liable under equitable ownership theories?
A
(1) Undercapitalization
(2) Absence of corporate records
(3) fraudulent representation by corporation shareholders or directors
(4) use of the corporation to promote fraud, injustice, or illegal activities
(5) payment by the corporation of individual obligations
(6) failure to observe required corporate formalities
(7) other shareholder acts or conduct ignoring, controlling, or manipulating the corporate form
13
Q
What is reverse veil piercing?
A
A process that allows the owner’s personal creditors to seize an entity’s assets to satisfy an owner’s debts.
14
Q
What is enterprise liability?
A
a court may hold sister entities liable as if they were a single entity
15
Q
What two conditions are generally required for the application of joint enterprise liability?
A
(1) Such a unity of interest and ownership that the separate corporate personalities are merged, so that one corporation is a mere adjunct of another or the two companies form a single enterprise; and
(2) An inequitable result if the acts in question are treated as those of one corporation alone
16
Q
T/F: A majority of states recognize enterprise liability
A
False. A MINORITY of states recognize enterprise liability
17
Q
What are the general principles of agency law?
A
One who acts through another is in law himself the actor.
18
Q
How can sole owners of an entity ever not be liable for tortious or illegal action?
A
(1) For a parent corporation, the solution is to elect the subsidiary’s board of directors and not tell them, or anyone else working for the subsidiary, what to do.
(2) For one person entities, passing the decision making along to someone else is more difficult. The Supreme Court has cautioned that “one-person corporations are authorized by law and should not lightly be labeled sham.”
19
Q
When will a parent corporation be held vicariously liable for the acts of a subsidiary?
A
If an agency relationship exists between the parent and subsidiary, which requires:
(1) a close relationship or domination between the parent and subsidiary
(2) the finding that the injury alleged inflicted by the subsidiary, for which the parent is being held liable, was within the scope of the subsidiary’s authority as an agent
(3) the arrangement must be relevant to the plaintiff’s claim of wrongdoing
20
Q
What is the test for determining whether the subsidiaries and parent corporations are alter egos?
A
Requires a determination of whether:
(1) there is such a unity of interest between the corporate personalities that they do not function as separate personalities
(2) lack of respect toward the separate nature of the corporate entities that would result in fraud or injustice
21
Q
When is a partnership held liable?
A
A partnership, including a joint venture, is liable for the obligations of the partnership.
22
Q
When will a parent be liable for a subsidiary in a partnership?
A
If the creditor or subsidiary can show that the subsidiary is in an unintended partnership with its parent.
23
Q
When can partners shield themselves from partnership liabilities?
A
By causing the partnership to elect limited liability
24
Q
What is a partnership by estoppel?
A
If a person who is not a partner consents to being represented as a partner, the person can be held liable as a partner
25
What is the test for substantive consolidation?
The court can order substantive consolidation when
(1) Creditors dealt with the entities as a single economic unit and did not rely on their separate identity in extending credit; or
(2) the affairs of the debtors are so entangled that consolidation will benefit all creditors (DISJUNCTIVE test)
26
What is mandatory indemnification?
corporations are required to indemnify directors and officers who are successful in investor litigation
27
What does "success" in investor litigation litigation encompass?
adjudication, voluntary dismissal, or even settlement, provided that the director or officer did not make any settlement payment
28
what is permitted and prohibited indemnification
corporations MAY indemnify their managers
29
T/F: the decision to indemnify may be made before or after occurrence of the act alleged to be wrongful
True
30
T/F: If a commitment or decision to indemnify is made prior to the act alleged to be wrongful, the managers rights to indemnification vest and the entity cannot revoke them with respect to that act.
True
31
Under indemnification, who determines whether the directors or officers acted in good faith?
The corporation
32
What is the default rule for indemnification for partnerships, LLCs, and LPs?
those entities shall indemnify their current and former partners, members, and managers
33
What claims are excluded from indemnification that arise from the managers for partnerships, LLCs, and LPs?
(1) Approval of an improper distribution; or
(2) Breach of fiduciary duty of loyalty, the duty of care, or the obligation of good faith and fair dealing.
NOTE: The fundamental documents may reduce the scope of those underlying claims, which reduces the need for indemnification
34
What are fees on fees?
if an indemnitor obligated to pay attorneys’ fees fails to do so, the indemnitee must incur more attorneys’ fees to sue for the unpaid fees.
35
What is advancement?
an entity’s payment of manager’s litigation expenses before the litigation is concluded.
36
When may corporations pay advancement?
Only upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall untimely be determined that such person is not entitled to be indemnified
37
What is D&O insurance?
insures managers against liability and litigation expense with respect to their actual or alleged wrongful acts
38
T/F: D&O insurance does not cover actions taken in bad faith, breaches of fiduciary duties, and even some kinds of intentional misconduct.
False. D&O insurance CAN cover all of these actions
39
T/F: D&O insurance can indemnify any conduct the insurer is willing to cover, subject to much narrower public policy limitations on what insurance can cover.
True
40
What are the functions of investor litigation?
(1) To enforce law and fundamental document provisions through injunctions
(2) To require managers to defend their actions publicly
(3) To deter wrongdoing through publicity
(4) To provide work for lawyers and business for insurers
41
What is the default rule for the level of agreement for partnerships, LLCs, and LPs?
the level of agreement is set at a majority of the members or partners in the ordinary course and unanimity of the members or partners for other actions
42
What is the default rule for the level of agreement for corporations?
a majority of directors is required for any action other than amending a shareholder agreement
43
T/F: each partner has equal rights in the management and conduct of the partnership’s business
True
44
How many partners are needed to decide a difference arising as to a matter in the ordinary course of business of a partnership?
A majority
45
In a partnership, when is consent of all the partners required for decision making?
When the act is outside the ordinary course of business of a partnership AND when there is an amendment to the partnership agreement
46
T/F: Members in LLCs do not have equal rights in the management and conduct of a company's activities and affairs
False. Members DO HAVE equal rights
47
How many members are needed to decide a difference arising as to a matter in the ordinary course of business of an LLC?
A majority
48
In an LLC, when is consent of all members required for decision making
To undertake an act outside the ordinary course of the activities and affairs of the company
49
In an LLC, what document may provide governance rules for decision making?
The operating agreement
50
In LPs, who has the authority to manage the LP's activities and affairs
The general partner or partners and they may do so by a majority vote.
51
In an LP, when is the consent of all partners necessary to act?
On specified issues, including amendment of the fundamental documents, sale of all or substantially all of the partnership’s assets, the admission of a new partner, merger, and conversion.
52
What is a two-tiered system in corporation decision making?
the investors elect or accept managers and then share decision-making authority with them
53
T/F: in corporations, shareholders elect a board of directors and the board manages the corporation
True
54
T/F: a corporation cannot elect to be shareholder-managed (i.e., not have a board of directors)
False. A corporation CAN elect to be shareholder-managed
55
In corporations, do the shareholders or board of directors have more voting rights?
The board in order to protect the corporation from the shareholders
56
What is the default rule for election of a board of directors in a corporation?
They are elected every year.
57
How can shareholders elect directors other than the board's slate?
challengers must nominate their own candidates and solicit votes in their favor by sending the challenger’s own proxy statements and cards to the shareholders.
58
What is the default rule for removal of director in a corporation?
shareholders have the power to remove directors without cause. Once a director has been removed, a vacancy exists. Either the board or the shareholders may fill that vacancy
59
What is a staggered board?
An arrangement under which only one-third of the board is elected each year and the persons elected serve for three-year terms
60
How are shareholder voting rights allocated?
by assigning voting rights to shares and issuing the shares.
61
In a customary structure, what are shareholders limited to voting on?
(1) The election and removal of directors;
(2) Certain fundamental decisions (amendment to the certificate of incorporation, merger, sale of all or substantially all assets, conversion, or dissolution) but only if the directors propose them;
(3) Corporate bylaw amendments; and
(4) Resolutions proposed by directors or shareholders.
62
What are shareholders entitled to vote on?
(1) Amendments to the certificate or articles of incorporation;
(2) Some mergers;
(3) Sale of all, or substantially all assets;
(4) Conversions; and
(5) Dissolutions.
NOTE: The Board must approve each of the above before it can be put to a shareholder vote.
63
T/F: Shareholders may vote to ratify nearly any action taken by the board, other than a fundamental decision or transaction.
True
64
T/F: When shareholders take governance actions, they generally do so by adopting resolution (shareholder proposals).
True
65
In the customary public corporation structure who has the power to adopt or repeal bylaws by voting?
Shareholders AND directors
66
T/F: In a customarily structured public corporation, the directors and the shareholders can strip the other group on its power to adopt bylaws.
False. NEITHER the directors NOR the shareholders can strip the other group on its power to adopt bylaws.
67
Under federal law, what is the procedure to submit a shareholder proposal?
(1) The shareholder must be eligible (must have continuously held at least $2,000 in market value, or 1% of the company's securities for at least one year before submission)
(2) The proposal and the shareholder’s supporting statement can be no longer than 500 words.
(3) The corporation must notify the proposing shareholder of any “procedural or eligibility deficiencies” within 14 calendar days of receiving their proposal.
(4) The shareholder then has 14 days in which to cure the deficiencies if they can.
(5) If the corporation intends to exclude the shareholder’s proposal from its proxy statement, the corporation must file its reasons with the SEC no later than 80 calendar days before the corporation files with the SEC the proxy statement to which the shareholder is seeking access.
(6) If the shareholder’s proposal is included in the corporation’s proxy statement, the shareholder or their representative must attend the meeting and perhaps present the shareholder’s proposal.
68
What is the default rule for investor voting in corporations?
They can make decisions by voting or consent
69
T/F: Every corporation may issue one or more classes of stock or one or more series of stock within any class thereof, which classes or series may have such voting powers, full or limited, or no voting powers, as shall be stated and expressed in the certificate of incorporation
True
70
What must a corporation authorize (voting)?
(1) The issuance of shares entitled to receive the corporation's assets; and
(2) the issuance of shares entitled to voting rights
71
How must controlling shareholders vote under their fiduciary duties
They have fiduciary duties to the minority shareholders and the corporation and must vote their shares accordingly
72
Do non-controlling shareholders have the same fiduciary duties in voting as controlling shareholders do?
No. They can vote however they choose.
73
What is the default rule for voting in partnerships?
each general partner or member has one vote, regardless of the number of shares or interests the general partner or member holds
74
Can partnership agreements eliminate the necessity for the consent of partners with limited liability to a change that would give them unlimited liability?
No.
75
For private companies, when and where are annual meetings held?
When: at a date and time fixed by or in accord with the bylaws
Where: can take place anywhere, or even “by means of remote communication.”
76
In private companies, when must the corporation notify the shareholders entitled to vote at the meeting the date, time, and place of the meeting?
No fewer than ten and no more than sixty days before an annual or special meeting of shareholders
77
T/F: in private corporations, the effect of a failure to comply with the notice requirements is that the actions taken at the meeting are invalid.
True
78
Who determines the order of business and establishes rules for conduct of meetings in private companies?
The chair, who is appointed as provided by the bylaws or in an absence of the provision, by the board.
79
What is the MBCA default rules for record dates and record owners?
the bylaws or board of directors of an MBCA corporation may fix a record date (the period is not more than 70 days before the meeting)
80
What is the DGCL default rule for record dates and record owners?
under Delaware rules, the record date for a shareholders’ meeting must be not more than 60 days nor less than 10 days before the meeting
81
What are indirect securities?
shareholders can hold shares indirectly, in securities accounts, without registering them on the stock ledger.
82
T/F: the owner of a securities account owns the securities represented by the account?
False. The SHAREHOLDER owns the securities, not the owner of the securities account.
83
Is a securities entitlement a contract right?
Yes. It is a contract right against the securities intermediary for the value of the shares
84
How is a securities entitlement issued?
the securities intermediary is required by law to own that number of shares directly – or to own a securities entitlement to that number of shares.
85
What is the custom for the bylaws in regard to the date and time of annual meetings in public companies?
the custom is for the bylaws to authorize the board of directors to set a date and time each year for the annual meeting.
86
In public companies, who can call a special meeting?
The board of directors or holders of 10% of the voting power
87
What is the default rule for record dates and record owners in public corporations?
the board of directors of a public corporation or its bylaws may fix a record date.
88
T/F: Shareholders of record in a public corporation do not have the right to vote
False. Shareholders of record DO have the right to vote
89
What is the default rules for holding a meeting in a public corporation?
requires that each corporation hold an annual meeting of shareholders.
90
What is the quorum default rule in public corporations?
defines a quorum as a majority of the shares entitled to vote.
91
What are the consent procedures?
By consent, shareholders can take without a meeting any action that they could take by voting at a meeting.
Consent is accomplished by shareholders delivering to the corporation written consents, signed by the shareholders, setting forth the action taken.
92
What is the default rule for consent procedures?
requires that consent be unanimous.
93
What is straight voting?
(1) To be elected by straight voting in a public company, a director candidate needs to win a plurality of the votes
(2) If a public company adopts typical majority voting in its bylaws, a director candidate is elected only if the candidate receives a majority of the votes cast.
(3) The default rules is that a director serves until his or her successor has been elected.
94
What is cumulative voting?
each shareholder has the right to cast all their votes for a single candidate or distribute them among two or more candidates
95
What is class voting?
occurs if the articles or certificate of incorporation provide: (1) for the issuance of more than one class of voting shares; and (2) for the classes to vote separately.
96
What are the voting by alliance devices?
(1) One or more shareholders may create a voting trust by transferring shares to a person who, by written agreement, agrees to hold them in trust and vote them in accord with the terms of the trust.
(2) Two or more shareholders may agree in writing on the manner in which they will vote their shares.
(3) Irrevocable Proxies
97
What are irrevocable proxies?
a shareholder’s written authorization to cast votes on a shareholder’s behalf.
98
Where is record information kept?
kept in any storage medium, provided that the information can be converted into clearly legible paper form within a reasonable time
99
What records must corporations maintain?
(1) its current articles of incorporation;
(2) its current bylaws;
(3) accounting records;
(4) lists of its current officers, directors, and shareholders;
(5) most recent annual report;
(6) minutes of meetings of its shareholders, board of directors, or board committees;
(7) records of actions taken without meetings;
(8) written communications within the past three years to shareholders generally, and notices to shareholders
100
T/F: The failure of a partnership or LLC to observe formalities relating to the exercise of its powers or management of its business or activities and affairs is not a ground for imposing liability on a partner, member, or manager
True
101
T/F: Federal securities laws require public companies to disclose large amounts of information without request
True
102
T/F: Private companies are also subject to the federal securities laws and must disclose large amounts of information without request.
False. Private companies are NOT subject to the federal securities laws.
103
What documents/information must partnerships disclose to partners automatically (i.e., without demand)?
any information concerning the partnership’s business, financial condition, and other circumstances which the partnership knows and is material to the proper exercise of the partner’s rights and duties under the partnership agreement or this act, EXCEPT to the extent the partnership can establish that it reasonably believes the partner already knows the information
104
T/F: In a partnership, a member-managed LLC, or a limited partnership, each general partner or member does not have both the duty to furnish and the right to receive the information
False. They DO HAVE the duty to furnish and the right to receive information.
105
Directors’ fiduciary duties of care or loyalty require that directors disclose information without demand in what three circumstances?
(1) Ratification
(2) Shareholder Decisions
(3) Purchase and Sale of Shares
106
T/F: Shareholders have a long-standing right to “inspect and copy” the “books and records” of a corporation for any “proper purpose.”
True
107
A shareholder may inspect and copy records only if (three conditions):
(1) Their demand is made in good faith and for a proper purpose;
(2) They describes with reasonable particularity his purpose and the records they desires to inspect; and
(3) The records are directly connected with their purpose
108
Who has the burden of proof to establish that each category of books and records requested is essential and sufficient to the party's stated purpose?
The burden of proof is always on the party seeking inspection
109
What is a "proper purpose" for examining records?
The requester's primary purpose, NOT a pretext.
110
T/F: Corporations must bear the cost of producing requested documents for a shareholder.
False. The corporation may impose a reasonable charge to cover the costs of providing copies of documents to the shareholder, which may be based on an estimate of such costs.
111
T/F: Although certificate of incorporation and bylaw provisions can expand shareholder inspection rights, they cannot impair or eliminate them.
True.
112
What inspection rights to partners and members have?
Partners and members have:
(1) the right to inspect existing entity records,
(2) the right to some information without demand, and
(3) the right to other information—recorded or unrecorded— regarding the entity’s activities, affairs, or financial condition on demand.
113
T/F: If a shareholder dies, the shareholder’s estate holds the shares and has inspection rights.
True
114
T/F: If a partner or member dies, the shareholder’s estate holds only the partner or member’s economic rights
True.
115
What is a controlling investor?
A controlling investor is an investor that holds a majority of an entity’s voting power or a sufficient proportion of it to control the entity’s decisions
116
What is the controlling investor rule?
controlling investors owe fiduciary duties to the entities they control.
117
T/F: A minority of jurisdictions apply the controlling investor rule to all entity types, without regard to how many investors the entities have
False. Substantially ALL jurisdictions apply the controlling investor rule to all entity types.
118
What is the controlling shareholder's duty?
The controlling shareholder’s duty is to serve the interests of the entity and its investors as a group
119
T/F: Controlling shareholders are liable only for their own decisions
True
120
In what two circumstances are controlling shareholders liable for their own decisions?
(1) The first is when a matter is submitted to a vote of the shareholders, and the controlling shareholder outvotes the minority.
(2) The second is when the controlling shareholder directs the actions of the managers in what one court described as a puppet-puppeteer relationship.
121
When are controlling shareholders not liable for decisions?
Controlling shareholders are not liable for the decisions of independent directors— even independent directors the controlling shareholders nominated and elected.
122
When does a controlling investor have actual control over the entity?
(1) When the investor holds a majority of an entity’s voting power; or
(2) when the investor holds a sufficient proportion of the voting power to control the entity’s decisions
123
What do plaintiffs need to establish to demonstrate that a group of stockholders exercises control collectively?
They must establish that they are connected in some legally significant way—such as by contract, common ownership, agreement, or other arrangement—to work together toward a shared goal.
124
What does a minority shareholder have to show to establish that a stockholders in a group exercising collective control is connected in some legally significant way?
To show a legally significant connection, the minority shareholder must allege that there was more than a mere concurrence of self-interest among certain stockholders and there must be some indication of an actual agreement, although it need not be formal or written
125
What is the entire fairness standard?
the transaction must be entirely fair to the entity, both in the price paid and the procedures followed.
126
When does the entire fairness standard apply?
The standard applies to transactions in which the entity is dealing with the controlling investors (self-dealing) or in which the controller receives a non-ratable benefit
127
When it is determined that the entire fairness standard does not apply, what standard usually does apply?
The business judgement rule
128
T/F: The entire fairness standard applies to a transaction between the entity and its controlling investor even if independent directors or an independent committee made the decision on the entity’s behalf, but not if the board and the disinterested shareholder made the decision in the required manner
True
129
What does "non-ratable" mean?
means the controller did not share the benefit pro-rata with the other shareholders
130
If the entire fairness standard applies, what does the controlling shareholder have the burden of proving?
the controlling shareholder has the burden of proving that the transaction was entirely fair to the corporation
131
Under the entire fairness standard, how can the shareholder shift the burden of proof back to the corporation?
(1) the vote of an independent board or board committee to approve the transaction on behalf of the corporation, or
(2) the affirmative vote in favor of the transaction by a majority of the minority shareholders of the corporation
132
Under the concept of fairness, what does the principle of fair dealing encompass?
embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained
133
Under the concept of fairness, what does the principle of fair price encompass?
relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock
134
What are the elements to establish a safe harbor for avoidance of the entire fairness standard in a merger?
(1) The controlling shareholder should announce in advance the deal it wants and promise the minority shareholders that nothing bad will happen to them if they don’t accept it,
(2) An independent board or committee should approve the deal, and
(3) A majority of the disinterested should shareholders vote in favor of the deal.
135
In controlled buyouts, when will the business judgment standard of review be applied?
the business judgement standard of review will be applied IF AND ONLY IF:
(1) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders;
(2) the Special Committee is independent;
(3) the Special Committee is empowered to freely select its own advisors and to say no definitively;
(4) the Special Committee meets its duty of care in negotiating a fair price;
(5) the vote of the minority is informed; and
(6) there is no coercion of the minority.
136
T/F: If a vote of the shareholders is “coerced,” it has no effect
True.
137
What three tactics have Courts identified as coercive?
(1) It is coercive to combine a transaction that shareholders will obviously want to approve with a second transaction they would not approve alone.
(2) It is coercive to propose an undesirable transaction in a context where its rejection would have even worse consequences for the entity and the shareholders.
(3) It is coercive for the board to refuse to take some action the shareholders want until the shareholders approve some action the board wants.
138
What is the duty-to-coinvestors rule?
all investors owe fiduciary duties to both the entity and their coinvestors
139
What is a freeze out?
strategy in which a majority shareholder exercises control in a manner that distributes all profits to the majority shareholder and non to the minority
