Corporation Hypos Flashcards
A, an avid investor, is interested in B-Corp., a startup corporation that has not yet been formally formed. A signs a pre-incorporation subscription agreement. The agreement stipulates that A will buy 200 shares of B-Corp. Three weeks later the Dow Jones Index drops 300 points a day for several days. A pulls out of the markets and wants to revoke her subscription. Can she?
Issue: May an investor back out of a pre-incorporation subscription agreement to buy shares of stock 3 weeks after signing?
Rule: In general, a subscriber is a person or entity who makes written offers to buy stock from a corporation that has not yet been formed. A subscription for stock of a corporation, shall not be enforceable against a subscriber unless it is in writing and signed by the subscriber regardless of whether the subscription was made prior to or following formal incorporation. A stock subscription of a company that has yet to be formed is considered to be irrevocable except with the consent of all other subscribers or the corporation for a period of 6 months from its date.
Analysis: Here, A’s agreement makes her a subscriber of B-Corp because they have not yet officially incorporated. A’s stock subscription is considered to be irrevocable and as such A may not unilaterally revoke her subscription even though she is still within the 6-month window. However, A is able to revoke her subscription with B-Corp’s consent because she is in the 6-month window.
Conclusion: Therefore, an investor may not back out of a pre-incorporation subscription agreement 3 weeks after signing without the consent of the underlying corporation or its other subscribers.
A Corp. is selling 10,000 shares of $3 par stock to B. How much does B have to pay A Corp.?
Issue: What must a corporation receive when it issues stock at par value?
Rule: In general, the par value of a stock issued by a corporation represents the minimum issuance price that may be accepted
Analysis: Here, if A Corp is selling 10,000 shares of stock to B at a par value of $3, B will need to pay A at least $30,000 ($3 per share). B is free to pay more than the par price, but not less.
Conclusion: Therefore, B must pay A Corp at least $30,000 for the
B Corp. desires to purchase Blackacre to open a new factory. Blackacre costs $15k. B Corp. has insufficient cashflow for the acquisition. Can B Corp. issue 5,000 shares of $3par stock to acquire Blackacre?
Issue: May a corporation acquire property in return for issuing shares of par stock?
Rule: In general, a corporation may receive property for par value stock as long as the consideration received is valued in good faith by the board as being work at least par value.
Analysis: Here, 5,000 shares at $3 par value is equivalent to $15,000. Therefore, in order for there to be adequate consideration given, Blackacre must be valued at a minimum of $15,000. Here, the valuation of consideration is met and thus B Corp may offer started of stock at par value as payment to acquire Blackacre.
Conclusion: Therefore, A corporation may acquire property by issuing shares of stock at par value if the property is valued in good faith by the board as being at least the value of the par value shares issued
B Corp. issues 10,000 shares of $3 par stock to A for $15k. The par value of this issuance would be $30k. Can B. Corp. recover the remaining $15k from its directors?
Issue: May a corporation recover losses from its directors following an issuance of stock at below par value?
Rule: In general, stock sold at par value means that the value is the minimum price at which the stock may be sold. Directors lack the authority to authorize an issuance of stock below par value. If directors authorize a sale of par stock at a below par price, then directors are personally liable for the spread between the par value and the below par value to the corporation.
Analysis: Here, the directors did not have the authority to issue shares of stock below par value. Because they did so, they are now personally liable for the remaining $15,000 ($30,000 par value less $15,000 consideration given). In other terms, the directors are liable for any spread remaining from the issuance of par value stock. Here, the par was $3.00 per share but the shares were sold for $1.50 making the spread $1.50 ($3.00 less $1.50). The directors are thus personally liable to the corporation for the outstanding spread being $15,000 (10,000 shares @ $1.50/share).
Conclusion: Therefore, directors are personally liable to a corporation for the spread of any issuance of stock authorized to be sold for below par value.
B Corp. issues 10,000 shares of $3 par stock to A for $15k. The par value of this issuance would be $30k. Can B Corp. recover $15k from A?
Issue: May a corporation recover losses from a shareholder following their purchase of stock at a below par value price?
Rule: In general, stock sold at par value means that the value is the minimum price at which the stock may be sold. Directors lack the authority to authorize an issuance of stock below par value. If directors authorize a sale of par stock at a below par price, the acquiring shareholder remains liable to pay full consideration for the shares (being par value) to discourage any windfall to the shareholder or undue burden to the corporation.
Analysis: Here, A is liable to B Corp for the full consideration due of the shares acquired despite having already completed assumed ownership of the shares. The directors were not authorized to issue the stock below par and therefore the sale was not valid because proper consideration was not given. Thus, the shareholder is still liable to the corporation for the full consideration due (10,000 shares at $3/share less $15,000) being $15,000.
Conclusion: Therefore, a shareholder that purchases par stock at below par is liable to the corporation for full consideration of the shares acquired.
A Corp. is selling 10,000 shares of $3 par treasury stock to B. How much does B have to pay A Corp.?
Issue: What must a corporation receive when it issues stock at par value?
Rule: In general, stock sold at par value means that the value is the minimum price at which the stock may be sold. Directors lack the authority to authorize an issuance of stock below par value. However, shares of no par stock and treasury stock are not subject to any minimum par value. Any valid consideration may be received in return for shares of no par or treasury stock if deemed adequate by the board. Directors are not liable for any remaining spread nor is the corporation entitled to any minimum amount for no par or treasury shares.
Analysis: Here, whatever the board of A Corp determines to be adequate consideration for the shares is all that B is required to pay for the shares. The par value minimum does not apply to treasury shares. Therefore, any consideration deemed adequate, even at a below par price, is appropriate consideration for a valid share of treasury stock.
Conclusion: Therefore, a corporation is only entitled to receive what their board deems to be adequate for shares of treasury stock.
B Corp. has 5000 shares outstanding. A owns 1000 shares of B Corp., i.e., 20%. B Corp needs additional cash to acquire a competitor. B Corp. decides to issue 3000 additional shares for cash. A has preemptive rights. What are her rights as it pertains to the new issuance of stock?
Issue: What rights are available to an existing shareholder when a corporation issues new shares for cash?
Rule: In general, preemptive rights are rights given to existing shareholders in which they may keep their stock proportion/percentage of ownership the same by purchasing stock whenever and ONLY IF there is a new issuance of stock for cash. On the other hand, this preemptive right only exists if they are explicitly mentioned in that corporation’s articles of incorporation. Barring any mention of a preemptive right, shareholders do not possess any preemptive right to purchase new shares of stock issued for cash. Although this right exists, the shareholder is not required to exercise the right.
Analysis: Here, because A is an existing shareholder who currently owns 20% of B Corp stock and is entitled to preemptive rights, A is entitled to purchase 20% of any new shares issued by B Corp for cash in order to retain her ownership percentage. Here, A would be entitled to purchase 600 shares (20% of 3000 new shares) for cash. On the other hand, if B Corp.’s articles of incorporation did not include a preemptive right for shareholders, then A would not have any right to the new issuance of shares for cash.
Conclusion: Therefore, an existing shareholder has a preemptive right to retain their ownership percentage when a corporation issues new shares of stock for cash.
B Corp. has 9 directors. According to the bylaws of B Corp. a notice for a Board of Directors meeting is send out. The Board wishes to endorse the new strategic plan for B Corp. 4 Directors are present at the meeting. Can the BoD do business and pass a resolution? How would the situation change if 5 directors were present at the meeting?
Issue: Can a BoD do business and pass a resolution if only a minority number of shareholders attend the meeting?
Rule: In general, a corporation needs a majority of all directors present at the meeting to do business. To pass any resolutions, the corporation needs a majority of the directors present at the meeting. However, if there is no quorum at the time and action is taken, ratification can be implemented later. Corporations generally require three adults to make up the board of directors. The modern trend is to allow a board to exist with just one. The board makes the material decisions surrounding management of a corporation and by default, cannot delegate all of their authority. These material decisions are made by the directors, in person. In order to do business and make decisions at these board meetings, a quorum is required. The quorum consists of a majority of board members who must be present. The votes on decisions are then passed by a quorum of those board members present at the meeting. This quorum can be gained or lost depending on who is in the room at the time. The board may however do business and ratify the proceedings later if the majority of board members vote to accept the changes.
Analysis: Here, there were only 4 directors present which is not a majority and thus they would be unable to do business or pass any resolution. That said, the 4 directors are still free to attempt to pass a resolution, requiring a majority vote of the 4 directors present at the meeting, and have it later ratified by the entire board. If there were 5 directors present, then they would be able to do business because they would have a majority of shareholders present and would be able to pass a resolution that would requires a majority vote of the present directors (meaning 3/5 would make a majority.
Conclusion: Therefore, a BOD may only do business if a majority of directors are present at the meeting and may only pass a resolution if a majority of present shareholders vote for it.
A is a director of Ocean Racing, Inc. (“OR, Inc.”). OR, Inc. wants to promote its new canting keel line of race yachts for the Volvo around the world ocean race. After studying the issue carefully and interviewing various candidates, A votes to retain Heino, a German country singer, to appear on the new racing yacht at its first presentation to the sailing community and investors. The marketing campaign is a total disaster. Has A violated his duty of care?
Issue: Does a director violate their duty of care to a corporation due to a failed campaign?
Rule:In general, directors owe a fiduciary duty of care to the underlying corporation to which they serve. The director must do what a prudent person would do with respect to her own business affairs. An alleged breach of a duty of care by a director may not be present if the director satisfied all 5 parts of the Business Judgement Rule test. This means, in order for a director to be not liable for taking business risks, they must have acted in good faith, in the best interest of the company, on an informed basis, not in a wasteful manner, and without any self-interest. Analysis: Here, because we know that A took all appropriate measures when making this business decision, A did not breach her duty of care. This bad business decision is a case of misfeasance in which the director made a bad call but did not violate any BJR limitation. Had she violated one of the 5 rules outlines in the BJR test, then A would be in breach of her duty of care.
Conclusion: Therefore, a failed campaign does not illustrate a breached duty of care as long as the director took the appropriate precautions while acting as a director.
B Corp. is in the rare book trading business and has ten directors. A is one of them. On a trip to Paris to buy new rare books for B Corp’s business, A is offered a first edition of Dante’s Divine Comedy by one of the vendors. The first printed edition was published in Foligno, Italy, by Johann Numeister and Evangelista Angelini on April 11, 1472. Of the 300 copies printed, only fourteen still survive. Overjoyed, A buys the book in mint condition for herself for $1mil but later decides to resell it to B Corp. for $2 mil. After careful consideration, however, A discloses her actions to the Board of Directors. After the disclosure, the Board gives proper notice to call for a meeting. 9 of 10 directors attend the meeting. 5 of the 9 directors vote to ratify A’s transaction with B Corp. Is A liable?
Issue: May a tainted decision be later ratified by independent verification?
Rule: In general, a director owes the corporation and its shareholders a duty of loyalty. If a director faced with a claim because of breach of duty of loyalty, they may defend themselves by obtaining independent verification through either a majority vote of independent directors, a majority vote of a committee of at least 2 independent directors, or a majority vole of shares held by independent shareholders. Analysis: Here, A’s disclosure of the act would require one of the 3 methods of independent verification. In this case, a majority vote of present shareholders ratified the contract. On the other hand, had all 10 been present, then 5 would not be enough. Furthermore, if not all 5 are independent directors, the decision may not be verified through this vote. That said, A could use a different method. Thus, as long as all 5 directors who voted to ratify are independent of the conflict, then the decision may be ratified. If A has included herself in that vote, meaning there were only 4 other directors, then it would not be enough for ratification, and she would need to try another method. Because A is clearly an involved party, her vote as a director is not valid for verification.
Conclusion: Therefore, a tainted decision may be later ratified by independent verification.
A is the record owner of B Corp. shares on the record date. On June 4, A sends a signed letter to the secretary of B Corp. The letter authorizes C to vote A’s shares. Can C vote A’s shares at the annual meeting that will be held in July?
Issue: Can a record shareholder elect a proxy to vote on their behalf at an annual meeting?
Rule: In general, a record owner of shares at the record date may vote at a meeting. An exception to a voter not attending in person is to authorize a proxy to vote on their shares in their place. In order for a valid proxy arrangement to be made, the record shareholder must submit a signed writing authorizing the proxy and direct it to the secretary of the corporation in which they authorize another person to vote on the stock on their behalf. These arrangements are generally valid for 11 months unless stated otherwise/extended by the shareholder. Proxies are revocable at any time unless the proxy form states conspicuously that it is irrevocable, and the appointment is coupled with an interest.
Analysis: Here, there was a written letter signed by the record shareholder. It was directed to the secretary of the corporation. It authorized C to vote on A’s shares. Thus, all elements are met and this is a valid proxy arrangement.
On the other hand, unless stated differently, the proxy agreement is revocable by A prior to the annual meeting and thus could be revoked by A.
Conclusion: Therefore, C is authorized to vote on A’s shares at the annual meeting held in July.
A is the record owner of B Corp. shares on the record date. On June 4, A sent a signed letter to the secretary of B Corp. The letter authorizes C to vote A’s shares. However, prior to the meeting A sends another signed letter to the secretary of B. Corp. The letter stipulates: “I want D to vote my shares at the meeting.” Is this valid?
Issue: Can a record shareholder revoke a proxy authorization prior to the meeting and elect someone else?
Rule: In general, a record owner of shares at the record date may vote at a meeting. An exception to a voter not attending in person is to authorize a proxy to vote on their shares in their place. In order for a valid proxy arrangement to be made, the record shareholder must submit a signed writing authorizing the proxy and direct it to the secretary of the corporation in which they authorize another person to vote on the stock on their behalf. These arrangements are generally valid for 11 months unless stated otherwise/extended by the shareholder. Proxies are revocable at any time unless the proxy form states conspicuously that it is irrevocable, and the appointment is coupled with an interest.
Analysis: Here, there was a written letter signed by the record shareholder. It was directed to the secretary of the corporation. It authorized C to vote on A’s shares. Thus, all elements are met and this is a valid proxy arrangement. On the other hand, A’s second letter also met the requirements making D her proxy. Because the first letter did not include any conspicuous language making the proxy irrevocable, A’s first letter was revocable. Thus, D is the new proxy and the agreement with C is void.
Conclusion: Therefore, A’s second proxy arrangement with D is valid.
A is the record owner of B Corp. shares on the record date. On June 4, A sends a signed letter to the secretary of B Corp. The letter authorizes C to vote A’s shares and mentions that “this proxy will be irrevocable”. However, prior to the meeting A sends another signed letter to the secretary of B. Corp. The letter stipulates: “I want D to vote my shares at the meeting.” Can A revoke her proxy authorizing C to vote her shares even though it states that it is irrevocable?
Issue: Can a shareholder revoke a prior proxy authorization if they stated in that latter that the proxy is irrevocable?
Rule: In general, a record owner of shares at the record date may vote at a meeting. An exception to a voter not attending in person is to authorize a proxy to vote on their shares in their place. In order for a valid proxy arrangement to be made, the record shareholder must submit a signed writing authorizing the proxy and direct it to the secretary of the corporation in which they authorize another person to vote on the stock on their behalf. These arrangements are generally valid for 11 months unless stated otherwise/extended by the shareholder. Proxies are revocable at any time unless the proxy form states conspicuously that it is irrevocable, and the appointment is coupled with an interest.
Analysis: Here, there was a written letter signed by the record shareholder. It was directed to the secretary of the corporation. It authorized C to vote on A’s shares. Thus, all elements are met and this is a valid proxy arrangement. On the other hand, A’s second letter also met the requirements making D her proxy. In general, both letters would be irrevocable. However, in this case, A’s first letter included conspicuous language making the proxy irrevocable. Therefore, A’s second letter is void and C is still her proxy.
Conclusion: Therefore, A cannot revoke their authorization of C to vote on their behalf because they added conspicuous language making it irrevocable and the proxy couples with some other interest.
A is the record owner of B Corp. shares on the record date. A sells C her shares after the record date but before the annual meeting. After the sale of her shares to C but before the annual meeting, A sends a signed letter to the secretary of B. Corp. giving C an irrevocable proxy to vote her shares at the annual meeting. Can A revoke the proxy?
Issue: Can a record shareholder revoke an irrevocable proxy to vote her shares at an annual meeting after selling her shares?
Rule: In general, a record owner of shares at the record date may vote at a meeting. An exception to a voter not attending in person is to authorize a proxy to vote on their shares in their place. In order for a valid proxy arrangement to be made, the record shareholder must submit a signed writing authorizing the proxy and direct it to the secretary of the corporation in which they authorize another person to vote on the stock on their behalf. These arrangements are generally valid for 11 months unless stated otherwise/extended by the shareholder. Proxies are revocable at any time unless the proxy form states conspicuously that it is irrevocable, and the appointment is coupled with an interest.
Analysis: Here, only a record owner at the record date may vote at the meeting. This means that even though A sold C her shares prior to the event, C is not the record owner as of the record date. Therefore, A still holds the voting rights for the shares at the meeting. However, as the record holder, A is able to authorize a proxy. Here, there was a written letter signed by the record shareholder. It was directed to the secretary of the corporation. It authorized C to vote on A’s shares. Thus, all elements are met and this is a valid proxy arrangement. Usually, proxies are revocable. However, in this case, A’s first letter included conspicuous language making the proxy irrevocable.
Conclusion: Therefore, A cannot revoke the proxy.
Corp., a startup corporation, has 120,000 shares outstanding and has 700 shareholders. At the annual meeting, the board of directors proposes to change the business plan to allow for more business with foreign entities. The Articles of Incorporation of B Corp. do not mention a quorum requirement. What constitutes a quorum?
Issue: Is a quorum based on number of shares or number of shareholders?
Rule: In general, a quorum represents the minimum number of people who must be present, physical or by proxy, in order for a decision to be binding. A quorum must be present at a meeting based on the number of OUTSTANDING SHARES represented at the meeting, not the number of shareholders present. Quorum is not ‘lost’ if a voting shareholder leaves the meeting prior to voting.
Analysis: Here, a quorum is present if there are a majority of outstanding shares represented at the meeting. Because they have 120,000 shares outstanding, a majority would be any amount greater than or equal to 60,001. At this meeting, 80,000 shares are represented and thus a quorum is met. It does not matter if there are a minority of shareholders present at the meeting as long as the number of shares represented are a majority amount. Had the articles of incorporation set a different quorum requirement, that would be the governing document.
Conclusion: Therefore, unless stated otherwise in the articles, a quorum is met when more than half of the outstanding shares of a corporation’s stock are present/represented at a meeting.
B Corp., a startup corporation, has 120,000 shares outstanding and has 700 shareholders. The board of directors proposes to change the business plan to allow for more business with foreign entities. At the annual meeting, 80,000 shares are represented but only 50,000 shares vote on the proposal. Votes representing 30,000 shares are cast in favor of the proposal. Was a quorum present? Did the shareholders accept the proposal? What is the minimum number of votes required to approve the action?
Issue: When is a quorum present? When may shareholders approve an action and is the corporation liable?
Rule: In general, a quorum represents the minimum number of people who must be present, physical or by proxy, in order for a decision to be binding. A quorum must be present at a meeting based on the number of OUTSTANDING SHARES represented at the meeting, not the number of shareholders present. Quorum is not ‘lost’ if a voting shareholder leaves the meeting prior to voting. If a quorum exists, a corporate action, other than the election of directors, is approved by a voting group if the votes cast within the voting group favoring the corporate action exceed the votes cast within the voting group opposing the corporate action, unless the articles of incorporation or this title require a greater number of affirmative votes.
Analysis: Here, the quorum is present if there are a majority of outstanding shares represented at the meeting. Because they have 120,000 shares outstanding, a majority would be any amount greater than or equal to 60,001. At this meeting, 80,000 shares are represented and thus a quorum is met. For shareholders, it does not matter that only 50,000 shares actually vote on the proposal because quorum cannot be lost once it is met. Because quorum was met, their shareholders are able to accept a proposal and approve an action. Here, the action would be approved if the number of votes in favor of the proposal outweigh the number of votes rejecting it. Because there were a total of 50,000 votes cast, 25,001 would constitute a majority. Here, 30,000 shares cast in favor represent an acceptance and approval of the proposal.
Conclusion: Therefore, A quorum was present and the shareholders accepted the proposal requiring a minimum of 25,001 votes in favor.
B Corp. is in the ocean race yacht building business. B Corp. has 4 director positions on its board. B Corp’s board is not a staggered board. All 4 directors are up for reelection at the annual meeting. B Corp’s articles stipulate cumulative voting for the election of directors. A, a minority shareholder, owns 105 shares of stock in B Corp. A want to ensure that Ken Read, skipper of Puma’s Il Mostro, in the Volvo around the world ocean race, is elected to the board of B Corp. How many votes can A cast for Ken Read?
Issue: How are cumulative votes calculated and when may they be used by a minority shareholder?
Rule: In general, cumulative voting is allowed for shareholders when voting for directors, but it must be stipulated in the corporation’s articles of incorporation. Cumulative voting allows minority shareholders to concentrate all their voting strengths on one or more individual directors with the hope that they are elected. The number of votes allowed under cumulative voting is equal to the product of the number of shares held by the shareholders by the number of directors to be elected.
Analysis: Here, since B Corp’s articles stipulate cumulative voting to be acceptable when voting for directors, A is allowed to do so. Had the articles not stated this, A would not have the option to do so. Because A holds 105 shares and there are 4 directors up for election, she is entitled to cast 420 cumulative votes.
Conclusion: Therefore, A may cast 420 cumulative votes for Ken Read.
B Corp. is in the blasting and explosives business but does not carry insurance. A is a shareholder and CEO of B Corp. Despite the nature of its business, B Corp. has an initial capitalization of only $1,000. A co-mingles his own funds with those of B Corp. C gets injured at one of B Corp’s blasting sites. Is A liable to C?
Issue: Is a shareholder liable to a third party of a corporation if they co-mingle their funds with the corporation’s?
Rule: In general, shareholder liability of a corporation is limited to their capital contribution making them not liable for the debts of a corporation. However, if a shareholder pierces the corporate veil, they can be held liable. This can occur if the shareholder abused the privilege of incorporation and if giving shareholder limited liability would be seen as inequitable. This can occur by alter ego and undercapitalization. Alter ego is the failure to observe sufficient corporate formalities. Undercapitalization is the failure to maintain sufficient funds to cover foreseeable liabilities.
Analysis: Here, unless A has pierced the corporate veil, they may not be held liable to C for the debt of B corp. The veil can be pierced by alter ego and/or undercapitalization. When A co-mingled his own funds with B-Corp, he pierced the corporate veil and in doing so exposed himself to unlimited liability. This co-mingling is a failure to observe corporate formalities and thus constitutes alter ego. Furthermore, A also pierced the corporate veil by undercapitalizing the corporation for failure to maintain insurance on a highly foreseeable liability working in explosives. Had A not pierced the corporate veil, he could only be held liable for his capital contribution being $1,000.
Conclusion: Therefore, A is liable to C.
B Corp. had a successful year and wants to declare dividends. After paying overhead and salaries, the board of B Corp. decides that the earned surplus justifies paying $400,000 in dividends. How are dividends paid if the outstanding stock of B Corp. is: 100,000 shares of common stock?
Issue: How are dividends paid out to different classes of shareholders?
Rule: In general, dividends may be declared by the BOD at their discretion. A corporation’s earned surplus (earnings less losses and/or previous distributions) is used to pay dividends. However, there is an exception to this rule in which the board does not have discretion if payment of the dividend would make the corporation insolvent. The four types of stock are preferred stock, preferred participating stock, preferred cumulative stock, and common stock. Dividends will always be paid to preferred stock before common stock. For preferred participating stock, dividends will first be paid to preferred stock, and then preferred participating stock will be paid again at the end with common stock. Preferred cumulative stock are paid dividends by adding up the previous years’ dividends in arrears and then will receive that amount. Finally, common stock is always paid last with the remaining funds. Analysis: Here, the Board of Directors is within its right to declare a dividend payment using an earned surplus to fund it. If there are only common stock shares outstanding, then they are the only consideration for payment and will receive the entire amount. Therefore, the $400,000 should be distributed equally between all 100,000 shares at one time making the dividend $4 per share of common stock.
Conclusion: Therefore, B must pay a dividend of $4/share to all of its common stock owners.
B Corp. had a successful year and wants to declare dividends. After paying overhead and salaries, the board of B Corp. decides that the earned surplus justifies paying $400,000 in dividends. How are dividends paid if the outstanding stock of B Corp. is: 100,000 shares of common and 20,000 of preferred with $2 dividend preference?
Issue: How are dividends paid out to different classes of shareholders?
Rule: In general, dividends may be declared by the BOD at their discretion. A corporation’s earned surplus (earnings less losses and/or previous distributions) is used to pay dividends. However, there is an exception to this rule in which the board does not have discretion if payment of the dividend would make the corporation insolvent. The four types of stock are preferred stock, preferred participating stock, preferred cumulative stock, and common stock. Dividends will always be paid to preferred stock before common stock. For preferred participating stock, dividends will first be paid to preferred stock, and then preferred participating stock will be paid again at the end with common stock. Preferred cumulative stock are paid dividends by adding up the previous years’ dividends in arrears and then will receive that amount. Finally, common stock is always paid last with the remaining funds. Analysis: Here, the preferred stock must always be paid before common stock. Because of their $2 dividend, we must first calculate what they are owed for the year. They will receive $2 per share which equals $40,000. The common stockholders will receive an equal share of the remaining funds. $400,000 less $40,000 divided by 100,000 shares of common stock equals $3.60/share of common stock.
Conclusion: Therefore, B Corp must first pay dividends to the preferred shareholders at $2/share and then distribute the remaining dividends to common stockholders at $3.60/share.
B Corp. had a successful year and wants to declare dividends. After paying overhead and salaries, the board of B Corp. decides that the earned surplus justifies paying $400,000 in dividends. How are dividends paid if the outstanding stock of B Corp. is: 100,000 shares of common and 20,000 of $2 preferred participating stock?
Issue: How are dividends paid out to different classes of shareholders?
Rule: In general, dividends may be declared by the BOD at their discretion. A corporation’s earned surplus (earnings less losses and/or previous distributions) is used to pay dividends. However, there is an exception to this rule in which the board does not have discretion if payment of the dividend would make the corporation insolvent. The four types of stock are preferred stock, preferred participating stock, preferred cumulative stock, and common stock. Dividends will always be paid to preferred stock before common stock. For preferred participating stock, dividends will first be paid to preferred stock, and then preferred participating stock will be paid again at the end with common stock. Preferred cumulative stock are paid dividends by adding up the previous years’ dividends in arrears and then will receive that amount. Finally, common stock is always paid last with the remaining funds. Analysis: Here, preferred stock would generally be distributed first, however, there is none. Therefore, preferred participating stock is paid at the same time as common stock but in its set amount. Thus, the fixed amount of preferred stock must be divvied out first. 20,000 shares at $2 each equals $40,000. Then, the preferred participating stockholders will be included in the calculation of the common stock dividend. The remaining amount ($360,000) will be divided between the common stock and preferred participating stock (100,000 + 20,000). $360,000 divided by 120,000 shareholders equals $3 per share.
Conclusion: Therefore, preferred participating stockholders will receive a total of $5 ($2+$3) per share of participating stock and common stockholders will receive $3 per share of common stock.
B Corp. had a successful year and wants to declare dividends. After paying overhead and salaries, the board of B Corp. decides that the earned surplus justifies paying $400,000 in dividends. How are dividends paid if the outstanding stock of B Corp. is: B corp. did not pay any dividends in the prior three years. B Corp. has 100,000 shares of common stock and 20,000 shares of $2 preferred cumulative stock.
Issue: How are dividends paid out to different classes of shareholders?
Rule: In general, dividends may be declared by the BOD at their discretion. A corporation’s earned surplus (earnings less losses and/or previous distributions) is used to pay dividends. However, there is an exception to this rule in which the board does not have discretion if payment of the dividend would make the corporation insolvent. The four types of stock are preferred stock, preferred participating stock, preferred cumulative stock, and common stock. Dividends will always be paid to preferred stock before common stock. For preferred participating stock, dividends will first be paid to preferred stock, and then preferred participating stock will be paid again at the end with common stock. Preferred cumulative stock are paid dividends by adding up the previous years’ dividends in arrears and then will receive that amount. Finally, common stock is always paid last with the remaining funds. Analysis: Here, B did not pay any dividends the last 3 years. This means that there are 3 years of dividends in arrears due to the preferred cumulative shareholders before any money may be distributed to the common stockholders. The preferred shareholders will be paid $2 per share being $40,000 times 3 unpaid years. This equals $120,000 owed to the preferred cumulative stockholders. Next, preferred cumulative stockholders will be paid for the current year prior to the common stockholders. They will receive another $2 per share netting $40,000. In total, preferred cumulative shareholders will receive $8 ($6+$2) per share of preferred cumulative stock. Finally, the remaining amount will be distributed equally between the remaining 100,000 common stockholders. $400,000 less $120,000 dividends in arrears less $40,000 dividends to preferred cumulative stockholders leaves $240,000 for outstanding common stock. $240,000 divided between 100,000 shares equals $2.40 per share of common stock.
Conclusion: Therefore, preferred cumulative shareholders will receive $8 per share of preferred cumulative stock and common stock shareholders will receive $2.40 per share of common stock.
Ms. Orange buys property to provide Hardware Inc. with a store to sell hardware. She drafts and files the Articles of Incorporation for Hardware Inc. with the Department of State and elects a board of directors. Attorney Y drafted the articles for Ms. Orange and counseled her during the incorporation process. Attorney’s paralegal filed all the paperwork on behalf of Ms. Orange with the Department of State. Attorney thereafter sends Hardware Inc. the first bill. The board refuses to pay the legal bill. Is the corporation liable?
Issue: Is a corporation liable for debts incurred by the promoter during its formation but prior to official incorporation?
Rule: In general, a corporation is not liable for pre-incorporation contracts (nor their resulting debts) between promoter and third party. A person acting on behalf of the corporation that is not yet formed is considered a promoter. An exception to this rule exists when the corporation adopts the contract creating novation. Adoption can be express or implied. Express adoption occurs when a board of directors passes a resolution adopting the contracts. Implied adoption occurs when there is knowledge of a contract between a promoter and third party and the corporation accepts the benefits of the contract. A promoter is liable for the contracts until there has been adoption and novation of the contracts. Novation is an agreement between the promoter, the corporation, and the other party. If the corporation accepts the contracts but there is no novation, the corporation and promoter are both liable until novation occurs.
Analysis: Here, Ms. Orange was acting on behalf of Hardware Inc. prior to its legal conception making her a promoter. Unless novation occurs, Ms. Orange will be liable in some capacity. Because Hardware Inc. refuses to pay the bill, express adoption has not occurred. On the other hand, an argument can be made that implied adoption has occurred. The corporation has knowledge that a contract exists between the promoter and third party and the corporation accepted the benefits of the contract considering they are now officially incorporated as a product of that contract. Because adoption has occurred, Ms. Orange is no longer entirely personally liable for the contract. Novation is the next step required in order for Ms. Orange to avoid all personal liability. On the other hand, if novation does not occur, Ms. Orange and the corporation will remain jointly and severally liable.
Novation may occur in the form of the corporation paying the attorney’s bill and/or
Conclusion: Therefore, until novation occurs, both Ms. Orange and Hardware Inc. are jointly and severally liable to Attorney Y.
Ms. Orange paid $200k for the storefront property and paid attorney Y $5000 in closing costs and fees. After informing the board about the valuation, she sells the property to Hardware inc. for $220k. SH A finds out about this and sues the board on behalf of Hardware Inc. for a violation of fiduciary duties.
Issue: Assess the likelihood of success and the payment of damages for this lawsuit.
Rule: In general, a person acting on behalf of the corporation that is not yet formed is considered a promoter. A promoter cannot sell his/her own property to the corporation for a profit without disclosing the profit. If the property was acquired by the promoter before becoming the promoter, the promoter must give back anything received over fair market value to the corporation. If the property was acquired after becoming the promoter, the promoter must give back anything over cost. A promoter may be held liable to a corporation if they are found having violated the Business Judgment Rule. The business judgment rule is a presumption that the directors manage the corporation in good faith and in the best interests of the corporation, its shareholders. This means they must have acted in good faith, in the best interest of the company, on an informed basis, not in a wasteful manner, and without any self-interest.
Analysis: Here, Ms. Orange is a promoter acting on behalf of the corporation. Because Ms. Orange had disclosed to the corporation the historical cost of her property including any other fees involved in acquiring it, the corporation had full knowledge of whether or not Ms. Orange would make a profit off of their deal or, at a minimum, when she would break even. Therefore, because Orange acted in good faith, in the best interest of the company, on an informed basis, not in a wasteful manner, the BJR was not violated. On the other hand, Ms. Orange profiting off of this transaction would generally violate the fifth tenant of the BJR disallowing acting in one’s self interest. However, because Ms. Orange disclosed the fact that she would profit off of the deal and the corporation decided to go through with it even so, she did not violate the BJR.Had Ms. Orange asked for $220k without disclosing her sunk cost of $205k while pocketing the remaining $15k, she would have violated the BJR.
Conclusion: Therefore, Ms. Orange did not breach her duty and as such is not liable to the corporation.