Corporation, Agency, and Partnerships

Question 1

Agency - What is an agency?

Answer 1

An agency is a fiduciary relationship between a principal and an agent, in which the agent is authorized to act on behalf of the principal or under the principal’s control.

Question 2

Agency - How is an agency relationship created?

Answer 2

Both parties must consent to this relationship. Writing may be required under the Statute of Frauds.

The principal must have contractual capacity, but the agent only needs minimal capacity.

Question 3

Agency - What duties does an agent owe to the principal?

Answer 3

An agent is a fiduciary of their principal and owes them fiduciary duties of care, loyalty, and obedience, in addition to any express contractual duties.

Question 4

Agency - What are the principal’s remedies if the agent breaches their duties?

Answer 4

If an agent breaches their duties, then the principal’s remedies include contract actions, tort actions for secret prodits, equitable actions for an accounting, imposition of a constructive trust, and withholding compensation for intentional torts or intentional breaches of fiduciary duty.

The principal can recover actual profits or properties held by the agent (whether or not the agent’s profit caused any loss), and the principal can terminate the agency prior to any termination date in the contract.

Question 5

Agency - What is the duty of care?

Answer 5

The duty of care requires the agents to use care that a person in like position would reasonably believe appropriate under the circumstances (can be heightened depending on agent’s special skills).

Question 6

Agency - What is the duty of loyalty?

Answer 6

The duty of loyalty requires the agents to discharge their duties in good faith and with reasonable belief their actions are in the best interest of the partnership.

Question 7

Agency - What is the duty of obedience?

Answer 7

The duty of obedience requires the agents to obey all reasonable directions of the principle (illegal instructions are not reasonable).

Question 8

Agency - What duties does a sub-agent owe to the principal?

Answer 8

A sub-agent owes the principal the same duties as the agent. However, if the agent was not authorized to appoint a sub-agent, then the sub-agent only owes duties to the agent.

If a sub-agent breaches their duties, then the agent has absolute liability to the principal.

Question 9

Agency - What are the principal’s duties to the agent?

Answer 9

A principal’s duties to an agent are not fiduciary in nature, but the principal still owes the agent all the duties imposed by the contract, reasonable compensation, and reimbursement for expenses.

Question 10

Agency - What are the agent’s remedies if the principal breaches their duties?

Answer 10

If a principal breaches their duties, then the agent has the usual contract remedies (but also duty to mitigate damages).

Question 11

Agency - What is a real estate broker entitled to in a real estate agency relationship?

Answer 11

In a typical real estate broker’s contract, the broker is entitled to compensation when there is a buyer ready, willing, and able to purchase the property.

If the seller/principal refuses a buyer’s offer that was within the terms agreed by the broker/agent and the seller/principal, the seller/principal will be found to be breaching the duty not to interfere with the agent’s duties and will owe the agent their agreed compensation.

Question 12

Agency - When can an agent bind a principal to a contract?

Answer 12

An agent has the power to bind a principal to a contract the agent enters on the principal’s behalf only if the agent acted with authority.

Question 13

Agency - How can an agent’s authority be terminated?

Answer 13

Termination or revocation of actual authority occurs by: the happening of an event, lapse of a reasonable time; a change in circumstances; agent’s breach of fiduciary duty; either party’s unilateral termination; or, operation of law.

However, agency cannot be unilaterally terminated by the principal if the agency was given to protect the agent’s rights and it is supported by consideration.

Question 14

Agency - Can a principal be bound after an agent’s authority is terminated?

Answer 14

A principal will not be bound by an agent’s contract if the actual authority was terminated prior to the contract.

Question 15

Agency - What is actual authority?

Answer 15

Actual authority is when the agent reasonably believes they have authority based on the principal’s dealings with them. This authority can be expressly stated in an agency agreement, or implied based on the principal’s words or actions.

Question 16

Agency - What is implied authority?

Answer 16

Implied authority is authority that an agent reasonably believes they have based on their actual authority.

Examples include incidental to express authority; arising out of custom known to the agent; resulting from prior acquiescence by the principal; to take emergency measures; to delegate authority in cases of ministerial acts; to pay for an accept delivery of goods where there is authority to purchase; to give general warranties, collect payment, and deliver where there is authority to sell; and, to manage investments in accordance with the prudent investor standard.

Question 17

Agency - What is apparent authority?

Answer 17

Apparent authority is when a third party reasonably believes the agent has authority based on the principal’s words or conduct.

Question 18

Agency - When can a principal remain bound if an agent EXCEEDS their actual authority?

Answer 18

When an agent exceeds their actual authority, a principal will remain bound when (1) the principal previously permitted the agent their express or implied authority and knows the third party is aware of this; or (2) the third party has reasonable belief that the agent was authorized to act in ways that are typical for someone who holds the agent’s title or position.

Question 19

Agency - When can a principal remain bound if an agent HAD NO actual authority?

Answer 19

When an agent has no actual authority, a principal will not be bound based on unilateral agent representations.

However, the principal can be bound if (1) they negligently permit an imposter to appear they have authority (agency by estoppel); or (2) the authority lingers after the actual authority ends (like if the third party never got notice of the termination, or when the agent uses a written authority).

Death of the principal does not automatically terminate an agent’s apparent authority.

Question 20

Agency - Can a principal be bound if there is implied or inherent authority?

Answer 20

When an agent has inherent authority, a principal will remain bound because the authority is derived from the agency relationship.

Examples include respondeat superior and conduct similar to that authorized.

Question 21

Agency - What is ratification?

Answer 21

Ratification is when the principal subsequently validates an agent’s unauthorized act.

Upon ratification, the agent will be relieved of liability for breach of duty and their implied warranty of authority.

Question 22

Agency - How can a principal ratify a transaction?

Answer 22

Ratification can be express or implied, but the principal must (1) have knowledge of all material facts regarding the contract; (2) accept the entire transaction; and (3) have capacity. No consideration is necessary to ratify.

Question 23

Agency - What can a principal ratify?

Answer 23

A principal can ratify anything unless (1) performance was illegal at the time of ratification; (2) the third party withdrew; or (3) there has been a material change in circumstances.

Question 24

Agency - Can an undisclosed principal ratify?

Answer 24

In most states, an undisclosed principal cannot ratify and the agent will remain liable (since agents need to be acting on behalf of a principal). However, the mordern view allows an undisclosed principal to ratify.

Question 25

Agency - When is a principal liable to a third party for an agent’s contract?

Answer 25

A principal will be liable to the third party on a contract entered into by their agent if the agent had valid authority via actual, apparent, or ratification. If the agent did not have authority, then the principal cannot be held liable on the contract.

Question 26

Agency - When is an agent liable to a third party for a contract they made?

Answer 26

An agent will not be liable to the third party on a contract entered into on behalf of the principal if the agent had valid authority via actual, apparent, or ratification. If the agent did not have authority or if the principal is undisclosed, then the agent will be held liable on the contract.

Question 27

Agency - When is a third party liable to a principal or agent for a contract they made with the agent?

Answer 27

A third party will be liable to the principal or agent on a contract unless there was an affirmative fraudulent misrepresentation of the principal’s identity or when there was an unforeseen increased burden to the third party due to the fact that performance is due to the principal and not the agent.

If the agent enforces the contract, then the principal is entitled to the contract benefits.

Question 28

Agency - What is the difference in liability for a disclosed and undisclosed principal?

Answer 28

When the principal is disclosed, then only the principal may enforce the contract and hold the third party liable.

When the principal is undisclosed or unidentified, then either the principal or agent may enforce the contract and hold the third party liable.

Question 29

Agency - When are the two theories in which a principal is vicariously liable for their agent’s torts?

Answer 29

A principal may be vicariously liable for the torts of their agent under (1) respondeat superior and (2) apparent authority.

Vicarious liability means that the principal is directly liable for the agent’s acts (so if the agent is not liable, then the principal is not liable).

Question 30

Agency - When is a principal liable for an agent’s actions under respondeat superior?

Answer 30

The principal is vicariously liable when the agent is an employee and the act was within the scope of employment small deviation okay).

An employee is an agent when the principal can control the manner and method of performance.

Question 31

Agency - When is a principal vicariously liable for an employee’s intentional tort when the employee was lent to another employer?

Answer 31

The employer is not vicariously liable for the actions of an employee that was lent to another unless the employer had primary right of control over the employee.

Question 31

Agency - When is a principal vicariously liable for an employee’s intentional tort?

Answer 31

The employer is not vicariously liable for an employee’s intentional tort unless (1) the force is authorized or work is generally hostile; (2) the employee is promoting the employer’s business; or (3) the act was authorized or ratified by the employer.

However, an employer is liable for an employee’s misrepresentation if the employee had actual, apparent, or inherent authority to make statements concerning the subject matter involved.

Also, the employer is directly liable for their own tort, like when they were negligent in training, retaining, or supervising the employee, or when a third party detrimentally relied on the principal’s appearance of an employer-employee relationship (estoppel).

Question 32

Agency - When is an agent an independent contractor?

Answer 32

An agent is an independent contractor if the principal cannot control the manner and method of performance. Some factors to consider are the degree of skill required, tools and facilities used, period of employment, basis of compensation, business purpose, and customs.

Question 33

Agency - When is a principal vicariously liable for an independent contractor?

Answer 33

The principal is vicariously liable when the agent is an independent contractor and the act was either (1) the act was inherently dangerous, (2) the duty was nondelegable, or (3) the principal knowingly selected an incompetent independent contractor, then the principal is liable for the act.

Question 34

Agency - When is a principal liable for an agent’s tort under apparent authority?

Answer 34

Apparent authority means the principal will be vicariously liable for an agent’s tort if they gave the agent actual authority to commit the tort or ratified the tort.

This requires the agent to deal or communicate on behalf of the principal and the agent’s apparent authority enables the agent to (1) commit a tort or (2) conceal its commission. The agent’s tortious conduct and the agent’s apparent authority must be closely linked.

Question 35

Partnerships - What is a partnership?

Answer 35

A partnership exists when two+ people act as co-owners in a business for profit.

Question 36

Partnerships - How are general partnerships formed?

Answer 36

No formalities are required to form a partnership, so courts will look at the parties’ intent – if the parties physically manifested intent to carry on a business as co-owners, then there is a partnership.

Question 37

Partnerships - What counts as evidence of intent to form a general partnership?

Answer 37

When the parties’ intent is unclear, then the sharing of profits (no debt or wage or etc.) and right to participate in control of the business create (rebuttable) presumptions of partnership. Other evidence includes property held in joint tenancy or in common, designating their relationship as a partnership, venture undertaken requiring extensive activity, and sharing of gross returns

Question 38

Partnerships - Do partnerships require writing?

Answer 38

Partnerships do not need an agreement unless the Statute of Frauds requires it.

If there is no agreement, then RUPA applies.

If there is an agreement, then it is binding (though certain statutory provisions cannot be waived). An agreement can be written, oral, or implied.

Question 39

Partnerships - What rights do partners have in a general partnership?

Answer 39

Partners have rights to management, distribution, remuneration/compensation, indemnification, inspection, and lawsuit.

Question 40

Partnerships - Are partners personally liable for the partnership’s obligations?

Answer 40

RUPA provides that each partner is an agent of the partnership. Thus, a partnership is liable for loss or injury caused to a third party because of the partner’s tortious acts in the ordinary course of business or with authority of the partnership.

Also, a partnership is liable for all contracts entered into by a partner with actual or apparent authority of the partnership, but there will be no liability if there was no authority to enter the contract.

Question 41

Partnerships - When do partners have authority to enter into contracts on behalf of the partnership?

Answer 41

Generally, partners have actual authority to enter into transactions within the ordinary course of business require a majority vote, and transactions outside the ordinary course of business require a unanimous vote (as per management rights).

Partners may also have apparent authority if a third party reasonably believes the partner has authority because it is within the ordinary course of business or business of the kind carried out by the partnership.

If the contract is outside the scope of partnership or if the third party had notice that the partner lacked actual authority, then the partnership will not be bound and the partner will be individually liable.

Question 42

Partnerships - Can a third party hold a partner personally liable for the partnership’s obligations?

Answer 42

Each partner is jointly and severally liable for all the partnership’s obligations.

However, plaintiffs must exhaust partnership resources before seeking to collect from an individual partner’s assets.

A judgment is not personally binding on a partner unless they have been served and the creditor has exhausted partnership assets, or exhaustion is excused by agreement or court order or because the partnership is bankrupt.

Question 43

Partnerships - What duties does a partner owe the partnership, and what are they?

Answer 43

Partners owe the partnership a duty of loyalty, care, disclosure, and obedience.

The duty of loyalty requires the partners to discharge their duties in good faith and with reasonable belief their actions are in the best interest of the partnership.

The duty of care requires the partners to use care that a person in like position would reasonably believe appropriate under the circumstances.

The duty of disclosure requires partners to provide complete and accurate information regarding the partnership.

The duty of obedience requires the partnership to obey all reasonable directions of the partnership and not act outside the scope of their authority

Question 44

Partnerships - What is a dissociation and how can a partner dissociate?

Answer 44

A dissociation is when a partner ceases to be associated with the partnership’s business.

A partner can be dissociated by (1) oral or written notice of partner’s express will; (2) happening of an agreed event; (3) valid expulsion of partner; (4) partner’s bankruptcy; (5) partner’s death or incapacity; (6) court order; or (7) termination of a business entity that is a partner.

Upon termination, the partnership is either (1) dissolved, wound up, and liquidated, or (2) preserved by buying out the dissociating partner. Additionally, the dissociating partner’s right to participation in management ceases, their interest must be bought out, and they must be indemnified from pre/post liabilities.

Question 45

Partnerships - What is a dissolution and what happens when a company dissolves?

Answer 45

A dissolution requires the partnership business to be wound up by using partnership assets (and partner assets if partnership assets insufficient) to discharge partnership liabilities (creditors, then partners’ capital contributions, then profits/losses).

Dissolution is triggered by an act of the partners, operation of law, or court order. A partnership can continue to exist after dissolution until the business is wound up, but this can cause partners to retain apparent authority to bind other partners. Partners may also waive dissolution and continue business before winding up is complete.

Question 46

Corporations - What is a corporation?

Answer 46

A corporation is a legal entity that is created by filing certain documents with the state. It is comprised of shareholders (owners of the corporation), board of directors (group in charge of management of the corporation), and officers (agents of the corporation appointed to carry out the corporation’s policy).

Question 47

Corporations - How are corporations formed?

Answer 47

Corporations are created by complying with state corporate law (most are based on the MBCA). Generally, a corporation is formed when (1) incorporator(s) to execute and deliver (2) the articles of incorporation containing all required information and (3) to file the articles of incorporation with the secretary of state. A corporation is formed the moment filing is completed.

Question 48

Corporations - What must the articles of incorporation include?

Answer 48

Articles must include the corporation’s name (including “Corp.”), each incorporator’s name and address, the registered agent’s name and office (who can be served with process, must be in state), and the corporation’s stock information. Optional provisions consistent with state law are okay.

Question 49

Corporations - What happens when a corporation is wrongly incorporated?

Answer 49

When a company is wrongly incorporated, then the incorporators may still escape personal liability if there is a de facto corporation or a corporation by estoppel. A de facto corporation requires a relevant incorporation statute (all states have one), good faith and colorable attempt to comply with the statute, and exercise of corporate privileges (parties are unaware there is no valid incorporation). A corporation by estoppel stops people who dealt with the corporation as if it were real from backing out of their contracts (it only applies in contracts, not torts).

Question 50

Corporations - What is a promoter and what is their relationship with a corporation?

Answer 50

Corporations can use promoters to procure commitments for capital and instrumentalities. Promoters are joint venturers (unless otherwise provided), have a fiduciary relationship with other promoters, and have a fiduciary duty of disclosure and good faith to the corporation.

Question 51

Corporations - Can a promoter be liable for profiting off the sale of property to a corporation?

Answer 51

A promoter who profits from selling property to the corporation may be liable for their profit unless the transaction was disclosed to an independent board and approved. If the board is not completely independent, then the promoter is not liable if the subscribers knew of the transaction at the time and unanimously ratified the transaction after full disclosure.

Question 52

Corporations - Can a promoter who made fraudulent misrepresentations be liable for damages?

Answer 52

A promoter who made fraudulent misrepresentations or fraudulently failed to disclose all material facts will always be liable to plaintiffs who can show damages.

Question 53

Corporations - Can a promoter enter into contracts on behalf of pre-incorporated corporations?

Answer 53

A promoter can enter into contracts on behalf of pre-incorporated corporations, but the promoter will be personally liable until the corporation is fully formed and ratifies the contract. The promoter will only be released from liability when there is an express or implied novation, or if the contract expressly relieves the promoter of liability (though these are not really contracts and are more like revocable offers).

Question 54

Corporations - What happens when a corporation borrows money and what is the resulting loan called?

Answer 54

When the corporation borrows money, it issues a debt security (bond) that promises the corporation will repay the loan with interest. If the loan is unsecured by corporate assets, then it may be called a debenture. The holder of debt securities is a creditor, but not an owner.

Question 55

Corporations - What happens when a corporation sells an ownership interest?

Answer 55

When the corporation sells ownership interests, it issues equity securities or stocks. Authorized stocks are set in the articles, issued and outstanding are sold, and authorized but unissued are repurchased. Common shares give each shareholder an equal ownership right, but stocks can also be divided into classes and give varied ownership rights. A corporation can also issue share options (a right to purchase shares in the future).

Question 56

Corporations - What is a subscription?

Answer 56

Subscriptions are written offers to buy stock from a corporation. Under MBCA, pre-incorporation subscriptions are irrevocable for 6 months and payment is due upon demand of the board unless otherwise provided in the subscription agreement or if all subscribers consent to revocation. A subscriber who fails to pay may be penalized by sale of the shares or forfeiture of the subscription and any amounts paid on the subscription.

Question 57

Corporations - What is proper consideration for issued stock?

Answer 57

Consideration must be given for stock to be issued. Under MBCA, stock may be issued for any tangible or intangible property or benefit to the corporation. This includes money, property, services already performed for the corporation, discharge of a debt, and promissory notes to the corporation and future services to the corporation.

Question 58

Corporations - What is par value?

Answer 58

Under the traditional view, stock cannot be issued by a corporation for less than the stock’s stated minimum issuance price (par) value. Consideration received for par value stock must be held in a certain account containing at least the aggregate par value of the outstanding par value shares.

Under MBCA, par has been eliminated and corporations are allowed to issue shares for whatever consideration the directors deem appropriate. Consideration does not need to be held in any special account.

Question 59

Corporations - What are preemptive rights?

Answer 59

Preemptive right is the right of an existing shareholder of common stock to maintain their percentage of ownership in the company by buying stock whenever there is a new issuance of stock for money.

Under MBCA, shareholders do not have a preemptive right to purchase newly issued shares to maintain their proportional ownership interest unless the articles provide the right.

If the articles are silent, then there are no preemptive rights. Even if the articles do provide preemptive rights, then shareholders might not have a preemptive right (1) for consideration other than cash; (2) within 6 months after incorporation; or (3) without voting rights but having a distribution preference.

Question 60

Corporations - Who are directors and what are they responsible for?

Answer 60

Directors are responsible for the management of the business and affairs of the corporation. Directors must have legal capacity and do not need to be shareholders (unless otherwise provided). They must meet the (reasonable and lawful) qualifications noted in the articles and bylaws.

Question 61

Corporations - How are directors selected?

Answer 61

Initial directors are named in the articles or elected by the incorporator at the organizational meeting – afterwards, they are elected by shareholders at each annual shareholders’ meeting.

Question 62

Corporations - When can directors be removed before their terms expire?

Answer 62

Shareholders can remove directors before their terms expire, with or without cause. Some states only allow removal with cause if there is a staggered board. A director elected by cumulative voting cannot be removed if the votes to remove would be sufficient to elect them if cumulatively voted at an election of directors. Likewise, a director elected by a voting group of shares can be removed only by that class.

Question 63

Corporations - Can an individual director make decisions?

Answer 63

No. The board must act as a group – an individual director is not an agent of the corporation, so they do not have authority to speak for or bind the corporation.

Question 64

Corporations - How can a board make decisions?

Answer 64

Directors must act as a group via unanimous agreement in writing or at a meeting (with quorum and voting requirements).

Any board action or resolution requires a quorum, unless otherwise provided. If quorum is present, then passing a resolution requires a majority vote of those present. Alternatively, the action or resolution can be approved by unanimous consent, in writing, without a meeting.

Question 65

Corporations - What happens when there is a defect in the board meeting or corporation action?

Answer 65

Directors can waive the notice defect by writing or attending the meeting without objecting.

Directors, incorporators, and officers may ratify defective corporate actions. The board can ratify by stating the action to be ratified and the nature of the failure of authorization, approve the ratification, and seek shareholder approval if necessary.

Question 66

Corporations - What duties does the board owe the corporation?

Answer 66

The directors and officers owe a duty of loyalty and care.

Question 67

Corporations - What is the duty of loyalty?

Answer 67

Under the duty of loyalty, a director must discharge their duties in good faith and with the reasonable belief that their actions are in the best interest of the corporation.

Question 68

Corporations - What is the duty of care?

Answer 68

Under the duty of care, they must also use the care that a person in like position would reasonably believe appropriate under the circumstances.

Question 69

Corporations - What is the business judgment rule?

Answer 69

The business judgment rule may protect a director against liability if the court finds the business decision was made in good faith, was informed, and had a rational basis.

Business judgment may be based on information, opinions, reports, or statements prepared or presented by (1) reliable and competent corporate officers or employees; (2) competent legal counsel, accountants, or other professionals; or (3) a board committee of the board.

Question 70

Corporations - Who proves a breach in the duty of care and how do they prove it?

Answer 70

The burden to prove a breach in duty of care is on the plaintiff.

Nonfeasance occurs when a director does nothing and that causes loss to the corporation – this can be difficult to show if the corporation would have lost money anyways.

Misfeasance occurs when the board makes a decision that hurts the business – this is easier to show because causation is clear.

Question 71

Corporations - Who proves a breach in the duty of loyalty and how do they prove it?

Answer 71

The burden to prove a breach in duty of loyalty is on the defendant. This is mainly when the director is on both sides of the transaction (conflicting transactions), the director competes with the corporation, and when the corporate officer usurps a corporate opportunity.

BREACH OF DUTY OF LOYALTY IS BCC: BOTH SIDES, COMPETES, CORPORATE OPPORTUNITY

Question 72

Corporations - What does the business judgment rule protect?

Answer 72

The business judgment rule protects directors and officers from claims regarding the breach of the duty of care. However, it does not protect against claims regarding the breach of the duty of loyalty.

Question 73

Corporations - What is a conflicting transaction and when is it okay?

Answer 73

A conflicting transaction is a transaction between (1) the corporation and a director, or (2) the corporation and a director’s close relative or other business.

A conflicting interest transaction will be okay if (1) the material facts were disclosed to or were known to the board or shareholders, and the transaction was approved by a majority of the disinterested directors or shareholders; or (2) when considering the circumstances at the time of the transaction, it was fair to the corporation

Question 74

Corporations - What are

Question 75

Corporations - What are exculpatory provisions and when are they okay?

Answer 75

Exculpatory provisions in the articles may limit or eliminate a director’s personal liability for money damages to the corporation or a shareholder’s actions (or failure to act). However, the articles cannot limit or eliminate liability when a director received a benefit to which they were not entitled, intentionally inflicted harm on the corporation or shareholders, approved unlawful distributions, or intentionally committed a crime.

Question 76

Corporations - What is the relationship between officers and corporations?

Answer 76

Officers are agents of the corporation and can bind the corporation if they have authority to do so. Unauthorized actions may become binding if ratified, adopted, or estopped. Corporations are liable for the actions by its officers within the scope of their authority.

Question 77

Corporations - When can a corporation NOT indemnify a director?

Answer 77

A corporation cannot indemnify a director who is (1) held liable to the corporation or (2) held to have received an improper benefit.

Question 78

Corporations - When MUST a corporation indemnify a director?

Answer 78

A corporation must indemnify a director or officer who was successful in defending a proceeding on the merits or otherwise against the officer or director for reasonable expenses, including attorneys’ fees, incurred in connection with the proceeding.

Question 79

Corporations - When MAY a corporation indemnify a director?

Answer 79

A corporation may indemnify a director for reasonable litigation expenses incurred in unsuccessfully defending a suit brought against the director on account of the director’s position if the director: (1) acted in good faith; and (2) believed that her conduct was in the best interests of the corporation.

Question 80

Corporations - Who can make the decision to indemnify a director?

Answer 80

The determination to indemnify is made by a disinterested majority of the board. If there is no disinterested majority, then it is by a majority of a disinterested committee or by independent legal counsel.

Question 81

Corporations - What duties do shareholders owe to the corporation?

Answer 81

Shareholders generally do not directly manage the corporation. They may act in their own personal interests and do not owe fiduciary duties to the corporation or fellow shareholders. Their liability is limited to liabilities for unpaid stock, pierced corporate veil, or absence of a de facto corporation.

Question 82

Corporations - What duties to shareholders owe to closed corporations?

Answer 82

Shareholders that directly run close corporations will owe duties of care and loyalty to the corporation (since they manage it) and to other shareholders (since it runs similarly to a GP). Thus, controlling shareholders cannot use their power to benefit at the expense of minority shareholders, and oppressed minority shareholders can sue the controlling shareholders for breach of this fiduciary duty.

Question 83

Corporations - What is a closed corporation?

Answer 83

Shareholders can directly run close corporations (these are corporations with few shareholders and private stocks) by dispensing with the board and vesting management power in the shareholders via shareholder management agreement. The agreement can either be in the articles and approved by all shareholders, or by unanimous written shareholder agreement. It must be conspicuously noted on the front and back of stock certificates (though failure to do so does not affect the agreement’s validity).

Question 84

Corporations - When can a shareholder be liable for corporate debts?

Answer 84

Shareholders cannot be held liable for corporate debts unless the court pierces the corporate veil.

Question 85

Corporations - When does a court pierce the corporate veil and what are the three most common instances of piercing?

Answer 85

This requires the shareholders to have abused the privilege of incorporating, and fairness must require holding them liable.

The three most common instances of piercing are: (1) alter ego, when shareholders ignore corporate formalities by commingling their assets with corporate assets and injustice results; (2) undercapitalization, when a corporation does not have enough capital to reasonably cover prospective liabilities at the time of formation; and (3) where necessary to prevent fraud or prevent the shareholder from using the entity to avoid their existing personal obligations

Question 86

Corporations - What kind of suits can shareholders bring against a corporation?

Answer 86

Shareholders can bring direct (asserting personal rights) and derivative (asserting corporation’s rights) suits.

Question 87

Corporations - What does a derivative suit require?

Answer 87

A derivative suit requires (1) the shareholder to be a shareholder, or to have received stock from someone who was a shareholder, at the time the claim arose; (2) the shareholder to fairly and adequately represent the corporation’s interest; (3) the shareholder to make a written demand on the corporation to take suitable action unless the demand is futile; and (4) the corporation to be joined to the suit as a defendant.

Question 88

Corporations - When will a derivative suit be dismissed?

Answer 88

The parties can settle or dismiss a derivative suit only with court approval. Dismissal must be based on an investigation, by independent directors (special litigation committee) or a court-appointed panel of independent persons, that concluded that the suit is not in the corporation’s best interest.

The court will dismiss if it finds that (1) those recommending dismissal were truly independent, and (2) they made a reasonable investigation.

Question 89

Corporations - How can a shareholder avoid dismissal of a derivative suit?

Answer 89

To avoid dismissal, the shareholder bringing the suit has the burden of proving the decision was not made in good faith after reasonable inquiry. However, if majority of the directors had a personal interest in the controversy, then the corporation will have the burden of showing good faith after reasonable inquiry.