Corporation Hypos

Question 1

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?

Answer 1

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.

Question 2

A Corp. is selling 10,000 shares of $3 par stock to B. How much does B have to pay A Corp.?

Answer 2

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

Question 3

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?

Answer 3

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

Question 4

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?

Answer 4

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.

Question 5

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?

Answer 5

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.

Question 6

A Corp. is selling 10,000 shares of $3 par treasury stock to B. How much does B have to pay A Corp.?

Answer 6

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.

Question 7

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?

Answer 7

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.

Question 8

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?

Answer 8

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.

Question 9

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?

Answer 9

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.

Question 10

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?

Answer 10

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.

Question 11

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?

Answer 11

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.

Question 12

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?

Answer 12

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.

Question 13

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?

Answer 13

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.

Question 14

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?

Answer 14

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.

Question 15

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?

Answer 15

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.

Question 16

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?

Answer 16

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.

Question 17

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?

Answer 17

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.

Question 18

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?

Answer 18

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.

Question 19

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?

Answer 19

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.

Question 20

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?

Answer 20

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.

Question 21

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?

Answer 21

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.

Question 22

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.

Answer 22

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.

Question 23

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?

Answer 23

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.

Question 24

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.

Answer 24

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.

Question 25

The articles stipulate that Hardware Inc.’s purpose is to “engage in all legal activities for the purpose of selling hardware”. For the promotion of a new line of electric saws, Ms. Orange, as CEO of Hardware Inc. bakes cookies at home and offers them as a special package “buy two electric saws and get a free bag of cookies”. SH A finds out about the cookie deal and wants to sue Ms. Orange and the board on behalf of the corporation.

Answer 25

Issue: She comes to you and wants advice as to the likelihood of success of the lawsuit.
Rule: In general, absent a specific clause in the Article’s purpose, the corporation’s general purpose is to engage in all lawful activities. An ultra vires act is an act that is outside the scope of the corporation’s Articles. Ultra Vires acts are valid, but the shareholders can get an injunction and the responsible directors and officers are liable to the corporation for any losses caused by the ultra vires activities. A director 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, we must look to the primary purpose of Ms. Orange’s actions. In an effort to sell more tools, Ms. Orange made and freely gave away a bag of cookies along with each qualifying sale. Ms. Orange’s actions did not result in any identifiable losses to her personally or to the corporation. Because the purpose of her actions were to sell more hardware, her actions were directly in line with those of the company and as such were not an ultra vires activity. Therefore, the corporate purpose test is met. Had Ms. Orange gained anything from this transaction or had her actions resulted in a material loss to the company, she may be held personally liable.
Conclusion: Therefore, a shareholder would not likely be successful in suing Ms. Orange and/or the corporation.

Question 26

The articles stipulate that Hardware Inc.’s purpose is to “Engage in all legal activities for the purpose of selling hardware” but Ms. Orange is so enthused by the great success of her promotion that she opens a small bakery next to the entrance of Hardware Inc. to make her customers feel at home in the store. SH A finds out about the bakery and wants to sue Ms. Orange and the board on behalf of the corporation. She comes to you claiming the bakery caused losses of $100k because Hardware Inc. operated at a loss a year after the bakery opened.

Answer 26

Issue: Can SH A successfully sue the board and Ms. Orange?
Rule: In general, absent a specific clause in the Article’s purpose, the corporation’s general purpose is to engage in all lawful activities. An ultra vires act is an act that is outside the scope of the corporation’s Articles. Ultra Vires acts are valid, but the shareholders can get an injunction and the responsible directors and officers are liable to the corporation for any losses caused by the ultra vires activities. A director 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. Nonfeasance on the part of the Board is not excused because the board failed to act when Ms. Orange opened her bakery, they committed nonfeasance and as such are also liable to the corporation for the loss incurred.
Analysis: Here, we must look to the primary purpose of Ms. Orange’s actions. Despite an intention to make customers feel ‘more at home,’ the purpose of the bakery was not aligned with the corporation’s purpose of selling hardware. Therefore, the activity is ultra vires and as such Ms. Orange is liable for losses incurred by the corporation. Because the board failed to act when Ms. Orange opened her bakery, they committed nonfeasance and as such are also liable to the corporation for the loss incurred.
Conclusion: Therefore, Shareholder A may successfully sue Ms. Orange and the BoD for the $100,000 loss to the corporation.

Question 27

Attorney Y’s paralegal put wrong name of recipient onto the envelope when filing the articles and articles are never actually filed with the Department of State. But for the incorrect recipient name, Ms. Orange, Attorney Y and paralegal took all necessary steps to incorporate Hardware Inc. Jiffy Lube, Inc. signed 5 contracts with Hardware Inc but upon finding out about the lacking legal existence of Hardware Inc. claims that the contracts are invalid and Ms. Orange is personally liable.

Answer 27

Issue: Please advise Ms. Orange about her potential liability.
Rule: In general, in order for a legal corporation to exist, there must be people, paper, and an act. If a corporation does not meet these requirements, a de facto corporation can be formed. A de facto corporation means even if the corporation does not legally exist, it will still be treated as if the corporation exists if 1) the organizers/promoters have made a good faith, colorable attempt to comply with the corporate formation formalities and 2) the organizers/promoted have no knowledge that it wasn’t technically formed and they have done everything to form the entity. If a de facto corporation exists, the organizers/promoters will not be held personally liable and the corporation will be liable as a legal entity.
Analysis: Here, because the articles were not filed, a true legal corporation did not exist. However, a de facto corporation did exist because the promoter/organizer made a good faith attempt to comply with corporate formation formalities and the promoter/organizer were not aware that the articles were not actually filed. On the other hand, had there been proof of any knowledge that the corporation was not properly formed, Ms. Orange would be liable as the promoter.
Conclusion: Therefore, a de facto corporation exists and as such will be held liable. Ms. Orange may not be held personally liable.

Question 28

The board of X-Corp authorizes the issuance of 10k shares of $3 par stock to investor A for 15k. Shareholder B finds out about this transaction and sues the board on behalf of the corporation for violation of fiduciary duties.

Answer 28

Issue: Please assess the likelihood of success for this lawsuit.
Rule: In general, a corporation must receive an appropriate form of consideration (money, property, and/or services already performed) when it issues stock. 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, the board of X-Corp issued 10k shares, valued at $3 par, for $1.50 each. ($15k/10k shares) The par stock price is the minimum price that X-Corp is authorized to issue shares for as consideration. The board of directors lacks the authority to issue stock at below par value. On the other hand, investor A remains liable to X-Corp for full consideration. Because of this, the BoD is liable for the remaining spread of funds outstanding to the corporation. Furthermore, because they breached their duty, the BoD may be liable for further damages to the corporation.
Conclusion: Therefore, Shareholder B is likely to be successful in their suit against X-Corp’s BoD.
Both Board and buyer can be liable. Treated the same as in partnership (indemnification) where one party gets sued and the other would then go after the other for half of the damages. The corporation may not receive double recovery

Question 29

X-Corp has 2 mil. authorized stock, 1 mil. issued and outstanding. After a particularly successful year with substantial improvements in its operating margin (operating income / net sales), X-Corp. buys back 500k of its stock. In the next quarter X-Corp loses half its customers and needs to sell more stock. It decides to sell the stock it had previously reacquired. Investor A is willing to buy 250k stock and offers as consideration a dilapidated office building that had not been maintained since the late 70s. The board of X-Corp. considers the offer and signs off on the transaction. Shareholder B finds out about the transaction and files a lawsuit on behalf of the corporation against the board’s decision to buy back 250k stock in return for the building.

Answer 29

Issue: Assess the likelihood of success for the lawsuit.
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. However, directors may be held liable to a corporation if they are found to have 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, when X-Corp repurchases outstanding shares of stock, the purchased shares become treasury stock. Treasury stock is not subject to a par value and as such may be sold at the discretion of the BoD for whatever consideration it deems adequate. On the other hand, as a control, these decisions are subject to the BJR.
It is highly unlikely that any BoD could, in good faith, value a dilapidated building as being worth $250k worth of stock. On the other hand, the BoD could argue that it is worth the value and not wasteful if they needed a building. However, it is very unlikely this argument would hold water considering the additional funds that would need to go into the building to repair it. Obtaining this building is wasteful and harms the corporation. As such, the BoD violated the BJR by acting in bad faith, in a wasteful manner, and not in the best interest of the corporation.
Conclusion: Therefore, unless Shareholder B can prove the directors violated teh BJR, they are unlikely to succeed.

Question 30

X-Corp a Delaware corporation has 2 mil authorized stock, 1 mil. issued and outstanding. Shareholder A holds 55% of X-Corp. stock. X-Corp. decides to issue 500k stock for cash. The articles do not provide for preemptive rights. A wants to buy stock to maintain her 55% ownership stake.

Answer 30

Issue: What are her rights as it pertains to the issuance of stock?
Rule: In general, 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, X corp’s Articles do not provide for preemptive rights. Therefore, A does not have any. In general, because this offering is a new issuance for cash, preemptive rights would apply had they been explicitly allowed in the corporation’s articles.
Conclusion: Therefore, A does not have an existing right to buy stock prior to the general marketplace in order to retain her ownership percentage.

Question 31

The board of X-Corp has 10 directors. The Board of X-Corp has to vote on whether to approve a new line of products after extensive production design changes. The board also has to approve several contracts in this context. To save time, Chairman of the board A proposes to act without a meeting. 9 of 10 directors approve to act without a meeting.

Answer 31

Issue: Has the new product line been approved?
Rule: In general, a board of directors is created for the purpose of making material decisions surrounding the management of a corporation. A Board of Directors must meet in person to act. The exception to the general rule is the Board can act without meeting if there is unanimous agreement to act without meeting. In order to meet, there must be notice, which can be specified in the bylaws. Special meetings can be called with at least two days’ notice. Directors may not delegate their duties via proxy or voting agreement. A corporation needs a majority of all directors present at the meeting to do business and. In order to pass a resolution, a majority of present shareholders must vote in favor of its execution. If there is no quorum at the time and action is taken, ratification can be implemented later. A quorum represents the minimum number of people who must be present in order for a decision to be binding. If there is no quorum, the action can be ratified later by the overall board. A quorum can be lost if a director leaves the meeting before the vote.
Analysis: Here, the meeting is void for several reasons. First, a BoD is not permitted to act without an in-person meeting absent a written agreement in which there is a unanimous decision by directors to act without a meeting. Here, only 9 of 10 directors voted to act without a meeting. Therefore, the board may not act.
Conclusion: Therefore, the new product line was not approved.

Question 32

The board of X-Corp has 10 directors. The Board of X-Corp has to vote on whether to approve a new line of products after extensive production design changes. The board also has to approve several contracts in this context. Because of the urgency of the situation, the chairman of the Board calls a special meeting the next day. 5 of 10 directors vote in favor of the resolution.

Answer 32

Issue: Has the new product line been approved?
Rule: In general, a board of directors is created for the purpose of making material decisions surrounding the management of a corporation. A Board of Directors must meet in person to act. The exception to the general rule is the Board can act without meeting if there is unanimous agreement to act without meeting. In order to meet, there must be notice, which can be specified in the bylaws. Special meetings can be called with at least two days’ notice. Directors may not delegate their duties via proxy or voting agreement. A corporation needs a majority of all directors present at the meeting to do business and. In order to pass a resolution, a majority of present shareholders must vote in favor of its execution. If there is no quorum at the time and action is taken, ratification can be implemented later. A quorum represents the minimum number of people who must be present in order for a decision to be binding. If there is no quorum, the action can be ratified later by the overall board. A quorum can be lost if a director leaves the meeting before the vote.
Analysis: Here, a special meeting was called which requires a minimum 2 day notice to directors. The chairman of the board did not follow this requirement and instead gave a one day notice to directors. Based on that, anything that happened at the meeting is not valid. However, even if it was, a majority vote between 10 directors would be 6 votes. Even if the special meeting was correctly called, the new product line would have still not passed as a majority vote was not cast in its favor.
Conclusion: Therefore, the new product line was not approved at the special meeting.

Question 33

The board of X-Corp has 10 directors. The Board of X-Corp has to vote on whether to approve a new line of products after extensive production design changes. The board also has to approve several contracts in this context. The bylaws require a monthly meeting. At the monthly meeting, 9 of 10 directors are present. 4 of the 9 directors vote in favor of the new products and the required contracts.

Answer 33

Issue: Has the new product line been approved? When may a board of directors approve a new product line at a monthly meeting?
Rule: In general, a board of directors is created for the purpose of making material decisions surrounding the management of a corporation. A Board of Directors must meet in person to act. The exception to the general rule is the Board can act without meeting if there is unanimous agreement to act without meeting. In order to meet, there must be notice, which can be specified in the bylaws. Special meetings can be called with at least two days’ notice. Directors may not delegate their duties via proxy or voting agreement. A corporation needs a majority of all directors present at the meeting to do business and. In order to pass a resolution, a majority of present shareholders must vote in favor of its execution. If there is no quorum at the time and action is taken, ratification can be implemented later. A quorum represents the minimum number of people who must be present in order for a decision to be binding. If there is no quorum, the action can be ratified later by the overall board. A quorum can be lost if a director leaves the meeting before the vote.
Analysis: Here, the board is composed of 10 directors meaning if the board wishes to do business, a majority of directors must be present at the monthly meeting. In this case, a minimum of 6 directors must be present at the meeting in order for the board to do business. On the other hand, if the board acts without a quorum, their actions may be later ratified by the board. Here, 9 of the 10 directors were present at the meeting and thus a quorum was met. Because all 9 board directors voted, we can assume the quorum was maintained throughout the meeting. In order for the board to be able to pass a resolution to institute a new product line, a majority vote would need to occur between present directors. Here, there are 9 directors present and thus a majority vote would be 5 or more votes. This new product line only received 4 votes and as such did not pass.
Conclusion: Therefore, the new product line was not approved at the monthly directors meeting.

Question 34

After the new product line is approved by the board, X-Corp. substantially increases its profit margin in the next quarter. On the agenda for the next monthly board of directors meeting is the declaration of a dividend. To accelerate the approval of the dividend, Chairman A asks the compensation committee to declare the dividend. The compensation committee passes a resolution to pay an increased dividend. SH C finds out about this and sues the board on behalf of X-Corp.

Answer 34

Issue: Assess the likelihood of success of this lawsuit.
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. Dividends can be sourced from earned surplus or capital surplus, while stated capital cannot be used. When first announcing dividends, you must note the type of funds used, the amount of the dividends, and the type of stocks for payout. Directors have a duty to manage the business of the corporation. The default rule is that directors cannot delegate duties. However, directors can delegate management duties to a committee or one or more directors. Committees cannot declare dividends, amend bylaws, or fill a board of directors vacancy.
Analysis: Here, the Board of Directors has authorization to pay dividends from the corporation’s earned surplus but not from any other funds. However, they are not authorized to pay dividends if that payment would make the corporation insolvent. The Board of Directors, here, had the authority to issue a dividend and is allowed discretion as to its amount. Chairman A has the ability to delegate duties except for his duty to manage. Committees are never allowed to declare dividends nor increase a dividend. As such, Chairman A violated his duty of management by delegating a duty reserved solely for the board of directors to a committee.
Conclusion: Therefore, Shareholder C will likely be successful in suing the board on behalf of X-Corp.

Question 35

As X-Corp’s board is considering the approval of the new product line, Director B attends only the last of 6 meetings and fails to read any of the memos provided by the board by Skadden & Arps partners. Nevertheless, B votes in favor of the new product line. The new product line proves a complete disaster and causes $200 mil loss in the next quarter. SH A finds out about B’s lack of attendance and sues B on behalf of X-Corp.

Answer 35

Issue: Will B be liable?
Rule: In general, directors have a duty to a corporation/shareholders to manage the business. The Business Judgment Rule (“BJR”) is a presumption that the directors must manage the corporation by acting (1) in good faith, (2) in the best interest of the corporation, (3) on an informed basis, (4) not in a wasteful manner, and (5) with a self-involved interest. The BJR protects directors from liability resulting from innocent mistakes of judgment. In general, a director’s actions are not second-guessed unless they violate one of the factors of the BJR. Furthermore, a director must act with the standard of care that a prudent person would use with regard to their own business. An act of nonfeasance or misfeasance will breach this duty of care. Nonfeasance occurs when the director/board fails to act. Misfeasance occurs when a director acts and the resulting action becomes harmful to the corporation. In general, the BJR does not protect nonfeasance but will protect misfeasance unless a factor of the BJR has been violated.
Analysis: Here, Director B owed X-Corp a duty of care, a duty to manage the business, and his actions were subject to the BJR. Director B violated his duty to care by nonfeasance, failing to act. Nonfeasance, unlike misfeasance, is not protected by the BJR. Director B did not act with the standard care a prudent person would use with their own business in acting on behalf of the corporation. Not only did B fail to attend 5 of 6 prior meetings but he also failed to read important company memos which would have educated him to the true risk of the project. Because he did not act as a reasonable person would when conducting their own business by his nonfeasance, B breached his duty of care and as such may be held liable. On the other hand, had Director B done everything he needed to and the new product line simply failed, the BJR would have protected his misfeasance from personal liability assuming he did not breach any tenant of the BJR. Here, Director B did violate a tenant of the BJR. By acting on an uninformed basis (considering he did not attend all of the meeting nor read the memos), B violated tenant (3) and as such may be held personally liable to X-Corp.
Conclusion: Therefore, Director B breached his duty of care and will likely be liable to X-Corp.

Question 36

Director A gets sued for her involvement in developing a new product line. After 2 years of depositions and court proceedings the court decides that A did not breach her duty of care. A now demands indemnification of $1 mil. in attorneys costs. X-Corp’s last quarterly results were abysmal. The board refuses to grant A indemnification. A sues X-Corp. for reimbursement of the attorney’s fees.

Answer 36

Issue: Assess the likelihood of success of the lawsuit.
Rule: In general, a corporation may indemnify directors and officers for litigation expenses brought against them by virtue of their positions. If a director is successful in defending a suit in which they are a party, a corporation is required to indemnify them. If a director is found liable to the corporation in defending a suit, a corporation is prohibited from indemnifying the director. If a corporation is liable to third parties or settles with a third party but the director incurs expenses when defending the lawsuit, the director may be able to receive passive indemnity. Passive indemnification is available if the director acted in good faith and in the best interest of the corporation. Passive indemnification is not required but it may be authorized by (1) a majority vote of the directors who are not parties to the action; (2) a majority vote of a committee of at least two directors who are not parties to the action; (3) a majority of shares held by shareholders who are not parties to the action; or (4) independent legal counsel.
Analysis: Here, Director A won the lawsuit and was found to have not breached her duty of care. Because she was successful in defending the suit, the corporation is required to indemnify her expenses. The board is not able to ‘refuse’ even if their current financial position is bad. Had Director A been liable to X Corp, they would be unable to indemnify her. Furthermore, had there been a third party liability resulting from the lawsuit but A acted in good faith and in the interest of the corporation, passive liability would be available, but the board would be within their rights to refuse it. On the other hand, passive indemnification may be authorized by other means than a majority board vote and as such she may be able to receive indemnification by another method.
Conclusion: Therefore, A will likely be successful in her lawsuit because X-Corp is required to indemnify her regardless of their current financial position.

Question 37

X-Corp gets sued for malfunctioning products that were approved by A as the board considered the approval of the new product line. A spends one year of her own time and $1.5 mil. in attorney fees to represent X-Corp. in defending the lawsuit. X-Corp settles the product liability lawsuit for $600 mil. The court concludes that A acted in good faith and in the best interest of X-Corp when approving the new product line. After the conclusion of the lawsuit, independent Director C approves the indemnification of A for her attorney’s fees. SH D finds out about the indemnification and sues the board on behalf of X-Corp.

Answer 37

Issue: Assess the likelihood of the success of the lawsuit.
Rule: In general, a corporation may indemnify directors and officers for litigation expenses brought against them by virtue of their positions. If a director is successful in defending a suit in which they are a party, a corporation is required to indemnify them. If a director is found liable to the corporation in defending a suit, a corporation is prohibited from indemnifying the director. If a corporation is liable to third parties or settles with a third party but the director incurs expenses when defending the lawsuit, the director may be able to receive passive indemnity. Passive indemnification is available if the director acted in good faith and in the best interest of the corporation. Passive indemnification is not required but it may be authorized by (1) a majority vote of the directors who are not parties to the action; (2) a majority vote of a committee of at least two directors who are not parties to the action; (3) a majority of shares held by shareholders who are not parties to the action; or (4) independent legal counsel. A Shareholder is able to engage in a derivative suit in which they suit a third party on behalf of a corporation if the third party is causing harm to the corporation and 3 requirements are met. First, the shareholder must own stock in the corporation at the time the claim arose and throughout the entire litigation. Second, they must represent the interests of the corporation and of other shareholders. Finally, they must make a written demand to the directors that the corporation bring the suit on its own behalf, and the board has either rejected the demand or 90 days have passed. An exception to this final requirement exists if the demand is found to be futile and it is clear the directors will oppose the demand.
Analysis: Here, because A was not a party to the suit, she was not required to be granted indemnification for her personal expenses despite having ‘won’ the case. Furthermore, because A was not found to be liable to the corporation, indemnification is not prohibited. Here, because the corporation ended up settling the third party suit, passive indemnification is available in which her expenses may be approved. In general, either it must have been approved by either (1) a majority vote of the directors who are not parties to the action; (2) a majority vote of a committee of at least two directors who are not parties to the action; (3) a majority of shares held by shareholders who are not parties to the action; or (4) independent legal counsel. Here, none of those events occurred. A single independent director is not authorized to approve passive indemnity. On the other hand, if any of the other options occurred instead, A’s indemnification would have been valid and D would not have succeeded in the derivative suit. Furthermore, Shareholder D will need to meet all three requirements in order to engage in a derivative suit. Assuming nothing changes in her ownership or intention and that the board’s approval of the request would be futile excusing tenant three, Shareholder D will be able to file a derivative suit.
Conclusion: Therefore, it is likely that Shareholder D is able to prove the board did not validly grant indemnification to Director A and as such the board will be liable.

Question 38

All members of this BA class own Coca Cola Stock. 50% of the BA class decides that voting jointly to elect one of their classmates to the Board of Directors would give them the best shot at increasing the profitability and sustainability of the Coca Cola Company. However, they cannot agree on who should have the voting power on their behalf. They approach you to write a legal memo on how to increase the likelihood of electing their classmate to the board of Coca Cola Inc.

Answer 38

Issue: How would you advise your classmates?
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. Another way for shareholders who own relatively few shares of stock to influence the results of a vote is to use block voting in order to get more shareholders to vote alike. Block voting can be accomplished by either a voting trust or voting agreement. A voting trust is a formal delegation of voting power to a voting trustee. Shareholders must write a trust agreement, file a copy with the corporation, transfer legal title to shares to the voting trustee. The shareholders will then get a trust certificate. The shareholders retain all rights to their shares except for the right to vote. Voting trusts are generally valid for 10 years unless extended by an agreement. A voting agreement is when shareholders agree in writing to vote their shares as agreed by all pirates involved. However, courts are split on determining their enforceability.
Analysis: Here, the students have the best chance of electing a favorable student when they do not have a majority voting power by using cumulative voting. Because they are voting for a director, they are able to use cumulative voting. Cumulative voting would be most beneficial because not all classmates need to decide on one person but rather they can ensure someone from their class gets elected. The more students can agree on a candidate, the stronger the voting gets and the more certain an outcome becomes. The strength will also be determined by the number of director positions open for voting at the meeting. On the other hand, if the articles of incorporation do not allow for cumulative voting, they will not be able to do so. In that case, their best option would be a voting trust because a voting agreement is not always held enforceable in court. They just need to write a formal delegation of voting power to a voting trustee to be filed with the corporation that transfers legal title shares to the voting trustee and get a trust certificate in return. However, it should be noted that voting trusts are generally enforceable for 10 years unless stated otherwise. Furthermore, the class will need to decide on one person to cast the vote and they will still need to decide collectively on who to nominate. The benefit of this is that you can be certain that the power of the masses goes towards one candidate and in that way mitigate the risk of many shareholders voting for different people diluting their power. On the other hand, the voting trustee holds the power to vote for whoever they want, even if it is not who was verbally agreed to.
Conclusion: Therefore, the students should use cumulative voting power to elect a classmate if it is allowed in the Coca Cola articles of incorporation. If that is not approved, they should use a voting trust.

Question 39

X-Corp produces bushings. After a disastrous first venture into cosmetics, X-Corp wants to start a new cosmetic product line. 8% of the shareholders find out about the new venture and decide to call a special meeting of shareholders. At the meeting 30k of the 50k stock outstanding are present. 20k of the stock are voted against the new cosmetic product line.

Answer 39

Issue: Can the board pass a resolution to start production?
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. A special meeting may be called in one of three ways. (1) A BoD can call a special meeting. (2) 10% or more of the voting shares represented can call a special meeting. (3) The articles can specify other alternative methods for calling a special meeting. A special meeting also requires that the topic be something they can act on. A business can act on activities assuming they fall within the purpose of the corporation, a general purpose is presumed in the absence of any specific clause.
Analysis: Here, although only 8% of shareholders call a meeting, we do not know if the 8% of shareholders represent 10% or more of the outstanding shares. If they do not, then the special meeting was called invalidly unless the corporation’s articles allow for 8% to call a meeting. In that case, any vote that occurred is subsequently not valid and no action may be taken even if there is a quorum and a majority vote in favor of the resolution. If they do represent over 10% of the outstanding shares, then they called the special meeting correctly. Assuming such, a quorum is required for voting on an issue to happen. Because there are 50k shares outstanding, a quorum would occur if at least 25,001 are represented at the meeting. Here, there were 30K shares represented and thus a quorum was met. Shareholder meetings cannot lose quorum once it is met. Thus, voting was valid and as such the shareholders were correct to vote and their decision will be binding. For a resolution to pass, a majority of shares represented at the meeting must vote in favor of it. Because there are 30K shares represented, a majority vote occurs with a minimum of 15,001 votes. Here, only 10K shares voted for the passage and as such the vote failed and the new product line cannot be added. This decision is binding.
Conclusion: Therefore, the board can not pass a resolution to start production at this special meeting.

Question 40

X-Corp produces bushings. After a disastrous first venture into cosmetics, X-Corp wants to start a new cosmetic product line. Board calls a special meeting of shareholders and gives proper notice. At the meeting 30k of 50k stock outstanding are present. 20k of the 30k shares present are voted against the new cosmetic product line.

Answer 40

Issue: Can the board pass a resolution to start production?
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. A special meeting may be called in one of three ways. (1) A BoD can call a special meeting. (2) 10% or more of the voting shares represented can call a special meeting. (3) The articles can specify other alternative methods for calling a special meeting. A special meeting also requires that the topic be something they can act on. A business can act on activities assuming they fall within the purpose of the corporation, a general purpose is presumed in the absence of any specific clause.
Analysis: Here, the BoD called a special meeting giving proper notice and regarding an actionable proposal. Therefore, the special meeting is valid and will be binding if a quorum is met. Because there are 50k shares outstanding, a quorum would occur if at least 25,001 are represented at the meeting. Here, there were 30K shares represented and thus a quorum was met. Shareholder meetings cannot lose quorum once it is met. Thus, voting was valid and as such the shareholders were correct to vote and their decision will be binding. For a resolution to pass, a majority of shares represented at the meeting must vote in favor of it. Because there are 30K shares represented, a majority vote occurs with a minimum of 15,001 votes. Here, only 10K shares voted for the passage and as such the vote failed and the new product line cannot be added. This decision is binding.
Conclusion: Therefore, the vote is not a majority and as such the resolution to start production fails.