Corporations

Question 1

promoter

Answer 1

a person who, prior to formation of corporation, procures capital & enters into contracts to bring corporation into existence

Question 2

liability for pre-incorporation agreements

Answer 2

a promoter is personally liable for a contract entered into pre-incorporation, even after the corporation comes into existence

exceptions:

1. novation: if the corp & other party to K agree to substitute the corp for the promoter in the K, the promoter will no longer be liable
2. adoption: if the corp adopts the K (express or by using benefits of the K) & agrees to accept sole liability on the K, the promoter may no longer be liable

a corporation is not liable for pre-incorporation K entered into by a promoter unless a novation occurs or it adopts the K

Question 3

incorporation overview

Answer 3

moment of incorporation is when limited liability begins

• procedure
• ultra vires
• de jure corporation
• failure to meet requirements (de facto & by estoppel)

Question 4

incorporation: procedure

Answer 4

to form a corp, a document (articles of incorporation) must be signed & filed with the state.

the articles must include a statement of the corporation’s purposes; a broad statement is acceptable

no obligation to file bylaws (day-today rules), easier to amend, articles win if conflict

Question 5

ultra vires

Answer 5

if a corp has a narrow business purpose in its articles of incorporation and engages in activities outside the purpose, it has engaged in an ultra vires act

if an ultra vires act occurs, a SH can file a suit to enjoin the action and/or the corp can take action against a director, officer, employee who engaged in the act

*a third party can’t get out of a contract due to the corp’s ultra vires act

Question 6

de jure corporation

Answer 6

when the statutory requirements for incorporation are met, a “de jure” corporation has been formed. the corporation is then liable for activities (not the individuals)

Question 7

incorporation: failure to meet requirements

Answer 7

when a person makes a good faith effort to incorporate, but does not meet the requirements, that person may still be able to escape personal liability (but corporation still does not exist until articles are properly filed; until then, likely just a general partnership)

1. de facto corporation: if the owner made a good faith effort to incorporate & operates the business without knowing the requirements weren’t met, the business will be treated as a “de facto” corporation by the court. the individual owner will not be individually liable
2. corporation by estoppel: a party who deals with an entity as if it were a corporation is estopped from denying its existence and is thereby prevented from seeking personal liability against the business owner.
   - this is limited to contractual agreements
   - the owner must have made a good faith effort to incorporate & operated the business without knowing the requirements weren’t met

Question 8

securities overview

Answer 8

in general, the issuance of stock must be authorized by the board of directors

1. authorized shares: max shares directors can sell, in articles of incorp
2. issued shares: numbers of share directors have actually sold
3. outstanding shares: shares that still remain in possession of SHs (not reacquired by corp)
   - only outstanding shares are voted
4. treasury shares: stock previously issued to SHs but then reacquired by corp

• par value stock
• issuance of stock
• federal causes of action for improper sale of securities

Question 9

par value stock

Answer 9

corp may issue stock at par value. if it does, it must sell the shares for at least the minimum par value amount
-usually set at very nominal value

valuation of consideration: corp can receive any valid consideration that board deems adequate

watered stock: if corp sets par value amount and sells stock for less than stated amount, SHs who bought stock are liable to creditors of corp

Question 10

stock subscriptions & preemptive rights

Answer 10

stock subscriptions:

• ask people to agree in advance to buy stock before corp is formed
• prior to incorp, subscription agreements are irrevocable for up to 6 months

preemptive rights:

• right to acquire stock to maintain the percentage of ownership any time new shares are issued
• SHs generally don’t have preemptive rights unless negotiated/included in articles

Question 11

rule 10b-5

Answer 11

fraudulent purchase or sale of stock or other securities

private person must show:

1. P purchased/sold the security
2. transaction involved interstate commerce
3. D engaged in fraudulent or deceptive conduct (untrue statement of material fact)
4. conduct related to material info
5. D acted with scienter
6. P relied on Ds conduct
7. P suffered harm

out of pocket damages (punitive not allowed)

Question 12

16(B) insider trading

Answer 12

corporate insider can be forced to return short-swing profits to corp

applicable companies:

• corps with securities traded on national securities exchange, or
• corps with assets or more than 10 mil and more than 500 SHs

corporate insiders:
-current (or former) directors, officers, or SHs who own more than 10% stock

short-swing profits: during any 6 month period, a corporate insider who both buys & sells corp’s stock is liable to corp for any profit made on those transactions

Question 13

shareholders overview

Answer 13

• meetings & voting
• proxy voting
• SH agreements
• right to inspect
• power to amend bylaws
• SH derivative action
• liability: piercing the corporate veil
• controlling SHs fiduciary duties

Question 14

SH meetings & voting

Answer 14

meeting:

• annual meeting of SH is required, primary purpose to elect directors
• notice, 10-60 days in advance

voting:

• primary issue upon which SH can vote is selection of board of directors
• quorum of corp’s shares (not SHs) must be represented at meeting
• ->majority of corp’s outstanding shares at start of meeting
• then need majority vote
• SH approval also required for fundamental corporate changes (e.g. structural changes to corp - sale/merger)
• must state purpose of special meeting

*notice waived by attending meeting

Question 15

SH proxy voting & cumulative voting

Answer 15

proxy voting:

• a proxy is a written agreement by a SH to allow a person to vote for them
• valid for 11 months unless otherwise stated
• generally revocable (unless state irrevocable & person gives something of value in exchange to SH)

cumulative voting:
-applies only to election of directors, SHs given number of votes equal to number of shares they own, multiplied by number of director positions being voted on

Question 16

SH agreements

Answer 16

SHs may enter into a binding agreement which governs how they’ll vote their shares

it’s a contract and may be enforced

no time limit

Question 17

right to inspect

Answer 17

a SH may inspect the corp’s records in person or through an agent as long as the SH states a proper purpose (related to SHs financial interest in the corp)

improper purpose: designed to harass corporate officers

Question 18

power to amend corporate bylaws

Answer 18

Shareholders:
- Can amend or repeal existing bylaws
- Can pass new bylaws
- Can limit the board of director’s ability to change the bylaws

*Shareholders have the power to amend a corporation’s bylaws under state law. A corporation’s bylaws for the management of the corporation’s business or regulation of its affairs are enforceable, so long as the bylaws do not conflict with state law or the articles of incorporation. The nomination of directors and the procedure for nominating directors are common provisions in the bylaws and are consistent with regular corporate practice. Therefore, the investor’s proposed amendment to the bylaws is not inconsistent with state law.

Question 19

direct vs. derivative lawsuits

Answer 19

direct lawsuits:

• SH suing in SHs own name for damages that go directly to SH
• only if SH has been harmed directly (interference in voting rights/dividends, misinformation about important issues, and tort injury)

derivative lawsuits:

• SH suing on behalf of corp for harm suffered by corp
• recovery goes to corp

1. standing:
   a. must have been SH at time of harm
   b. must hold shares throughout litigation, and
   c. must fairly & adequately represent the interests of the corp
2. demand requirement:
   - P SH is must first demand the board bring the lawsuit in corp’s name before SH can bring suit
   - demand futility: demand not required if would be futile
3. recovery goes to corp, attorney’s fees recoverable if litigation produces a substantial benefit to corp

Question 20

piercing the corporate veil

Answer 20

generally, SHs are not personally liable for corporate acts. however, courts may allow a P to “pierce the veil” of limited liability and sue a SH individually to avoid fraud or unfairness

to determine whether to pierce the corporate veil, court will look at the totality of the circumstances, including:

1. alter ego: disregard of corporate formalities
   - not holding annual meeting or holding votes
   - use of corporate assets as SHs own assets,
   - self-dealing
2. undercapitalization of the corp: failure to maintain funds sufficient to cover foreseeable liabilities
3. fraud

• this issue is likely to arise when there is a closely held corporation with only a few SHs
• Usually a shareholder that is uninvolved with the daily operations of the company will not be held liable as a result of veil piercing

*Courts rely on various theories to pierce the corporate veil, including the “mere instrumentality” test, wherein a member would have to show that (i) the members dominated the entity in such a way that the LLC had no will of its own, (ii) the members used that domination to commit a fraud or wrong, and (iii) the control and wrongful action proximately caused the injury. Under the “unity of interest and ownership” test, a petitioner must demonstrate that there was such a unity of interest and ownership between the entity and the members that, in fact, the LLC did not have an existence independent of the members and that failure to pierce the veil through to the members would be unjust or inequitable.

Question 21

controlling SH fiduciary duties

Answer 21

SHs don’t owe a duty to fellow SHs in the corp, except for controlling SHs

controlling SH:

• anyone with more than 50% of a corporation’s shares is a controlling SH
• or holds enough shares to enact changes through the voting process

fiduciary duty:

• a controlling SH owes a fiduciary duty to minority SHs to not use his power in a way to disadvantage them
• can’t sell stock to outsider with intent on looting/destroying company

Question 22

board of directors overview

Answer 22

the board of directors manages and directs the corporation’s business and affairs

• selection
• removal
• voting
• fiduciary duties

Question 23

board of directors selection, removal & voting, special meetings

Answer 23

selection: directors are selected by SHs at the annual SH meeting (need at least 1 director)
removal: SHs may remove a director for breach of fiduciary duty (common law) or without cause (modern trend)

exception: staggered board: classes of directors elected at diff times
- can only be removed for cause, only if articles provide
- only directors elected by particular class may be removed by that class

voting: for board of directors’ acts at a meeting to be valid, a quorum of directors must be present at the meeting (majority), then majority vote
*present includes calling on phone, but such presence must allow all persons participating to hear each other

to avoid liability, director must dissent:

• entering dissent in meeting minutes
• file written dissent before meeting ends, or
• provide written dissent by registered mail to corp’s secretary immediately following meeting

Special Meetings
- Requires notice at least two days before meeting
- Notice must include the date, time, and place of meeting
- A director who did not receive proper notice can object
- But, if the director attends the meeting and fails to object to lack of notice, the objection is waived

Question 24

fiduciary duties overview

Answer 24

• duty of care
• duty of loyalty
• self-dealing
• usurpation of corporate opportunity

Question 25

duty of care

Answer 25

directors have a duty to act with the care of an ordinarily prudent person in a like position and similar circumstances (objective standard)

1. reliance: a director is entitled to rely on the performance of other officers, employees, and outside experts. this includes reliance on info, reports, and opinions provided by these people
2. business judgment rule: the BJR is a rebuttable presumption that a director reasonably believed his actions were in the best interest of the corp. the BJR will protect a director from liability for breaching the duty of care if he acted in good faith

a. to overcome the BJR, one of the following must be shown:
- the director did not act in good faith
- the director was not informed to the extent reasonably necessary before making a decision
- the director did not show objectivity & had a material interest in the decision
- the director failed to timely investigate after being alerted to a significant matter
- any other failure to act as a reasonable director

Question 26

duty of loyalty

Answer 26

requires a director to act in a manner that the director reasonably believes is in the best interest of the corporation

self-dealing and usurping corporate opportunities are violations of the duty of loyalty

*The duty of loyalty includes the duties to refrain from dealing with the company on behalf of one with an adverse interest in the company, and to refrain from competing with the company. The operating agreement may amend this duty so long as the amendment is not manifestly unreasonable.

Question 27

self-dealing

Answer 27

a director that engages in a transaction with a corp that benefits himself, or a closely related family member will be considered to have engaged in self-dealing. if the transaction benefits another corp/partnership that the director is associated with or his closely related family member is associated with, this will also be self-dealing.

self-dealing violates the duty of loyalty unless the transaction is protected by the safe harbor rule

the BJR does not apply to self-dealing transactions

safe harbor rules: there are 3 ways that a self-dealing transaction can be protected and avoid violating the duty of loyalty:

1. the interested director discloses all material facts to the board of directors & receives approval by a majority of disinterested directors,
2. the interested director discloses all material facts to SHs & receives approval by majority of disinterested SH vote, or
3. the transaction is fair to the corp at the time of the deal

*The fairness test looks at the substance and procedure of the transaction. Substantively, the test asks whether the corporation received something of comparable value in exchange for what it gave to the director. Procedurally, it looks at whether the process followed by the directors in reaching their decision was appropriate.

remedies: self-dealing transaction not protected by safe harbor provisions can be enjoined or rescinded and the corp can seek damages from the interested director

Question 28

usurping of corporate opportunity

Answer 28

a director may violate the duty of loyalty by “usurping” a corporate opportunity for business and taking the opportunity for himself rather than offering it to the corp first

corporate opportunity: courts ask if the corp is seeking the opportunity or if the opportunity is within the corp’s current/prospective line of business

if opportunity is a corporate opportunity, the director must present it to the corp first & it must be declined by the corp.
-at that time, the director can take the opportunity for himself without violating the duty of loyalty

Question 29

corporation: officers

Answer 29

a typical corp’s officers are president, secretary and treasurer. they are elected by the board of directors

authority: officer’s authority to act on behalf of corp is governed by agency law. the corp is the principal and the officer is the agent
- express actual
- implied actual
- apparent authority

Question 30

corporation: dissolution & winding up

Answer 30

dissolution: a corporation may voluntarily terminate its status

involuntary dissolution:

• by creditors if they show corp isn’t paying its debts
• by SHs if they can show:
  1. corporate assets are being wasted
  2. directors are acting fraudulently, or
  3. directors & SHs are deadlocked

process for voluntary: board must adopt resolution proposing the change, notice to SHs of special meeting, majority of SHs must vote in favor

winding up: a dissolved corp may continue to exist for the limited purpose of winding up its affairs and liquidating its business

• distribution: upon dissolution, corporate assets must be distributed in the following order:
  1. creditors of the corp
  2. SHs of stock with preferences in liquidation
  3. other remaining SHs of stock

Question 31

getting money out of the corp

Answer 31

1. board can buy back shares of corp
2. board can declare a dividend (usually cash)
   - SHs have no rights to dividends
   - boards can’t declare dividends if corp is insolvent or would become insolvent by issuing dividend (if do, directors personally liable unless relied in good faith on financial records)

priority of distribution:

• first preferred, then common
• preferred participating: receive again with common
• cumulative preferred: for this year and last year

Question 32

SH dissenters or appraisal rights

Answer 32

if SH doesn’t want to participate in merger, sale, or amendment to articles, can have shares purchased from them by corp at fair value

1. SH must send written notice to corp before vote of intent to dissent,
2. at meeting SH must abstain or vote no; and
3. SH must make prompt written demand for fair market value after action approved (if disagree to fair market value, court can appoint expert appraiser)

Question 33

close corporation and S-Corp

Answer 33

close corp:

• corp with few SHs (also directors & officers)
• typically not publicly traded
• can form voting agreements
• can have preemptive rights

S corp:

• corporation for corporate law, but special treatment re tax
• only taxed once like partnership
• allowed pass-through taxation (not taxed at entity level)

Question 34

LLC
-liability
-duties
-member actions
-dissociation
-dissolution

Answer 34

Has the tax advantages of a partnership and the limited liability of a corporation
-limited liability so only liable for amount of contributions made to LLC

Formation: requires filing articles of organization

Members can be individuals or corporations

Management: can be member-managed or manager-managed. Unless the operating agreement or certificate of incorporation provide otherwise, the default management arrangement is member-management.

If member-managed, it is presumed to be managed by all of its members.
If manager-managed, LLC’s daily busines operations are managed by selected managers, not members.

Authority: members of a member-managed LLC have authority to bind the LLC. (However, an act outside the ordinary course of the activities of the company may be undertaken only with the consent of all members)

1. Liability
   - Members are generally not liable for LLC obligations
   - Piercing the veil: members can be liable for LLC obligations
2. Duties: Members owe fiduciary duties to each other and to the LLC
   (a) Duty of loyalty (member-managed LLC)
   - Must account to the LLC for any profit or benefit
   - Must refrain from dealing with the LLC on behalf of an adverse interest
   - Must refrain from competing with the LLC
   *Courts have found that individual members of LLCs have a duty of loyalty to bring a derivative action on behalf of the LLC against the LLC itself.
   (b) Duty of care
   - Must act reasonably
   - Actions are subject to the business judgment rule
3. Member Actions
   (a) Direct Action: May bring suit against LLC or other members to enforce the member’s rights
   (b) Derivative Action: May bring a derivative action on behalf of the LLC against other members (or even against themselves)
4. Dissociation
   - A member can withdraw at any time and for any reason
   - Must provide notice (not necessarily written)
   - *A dissociated member is not entitled to receive payment for the member’s pro rata share of the LLC’s net assets. Instead, the dissociated member remains entitled to receive distributions authorized by the LLC, but otherwise cannot force the LLC to make payments to him.
5. Dissolution
   - Can occur if all members agree, if there are not enough members remaining, or any other reason stated in the operating agreement
   - Involuntary dissolution: a member can ask for a court order to dissolve the LLC: Must show that a controlling member has acted oppressively and harmed the member seeking dissolution
   - Winding up: must pay off debts to creditors before distributing assets to members

Question 35

personal liability for improper dissolution

Answer 35

When members agree to voluntarily dissolve an entity, the entity must wind up its affairs and liquidate its business. Only after the entity’s debts and obligations to creditors have been paid may the members receive a portion of the liquidated value of the LLC. Those responsible for winding up can be liable for improper distributions.

Question 36

whether board-approved bylaws on a particular subject preempt subsequent conflicting bylaw amendments by shareholders

Answer 36

shareholders have the power to amend the bylaws. The board of directors can also amend the bylaws unless the articles of incorporation or a vote by the shareholders limits this power. Shareholder-approved bylaws can amend or repeal existing bylaw provisions, regardless of whether the bylaw was initially approved by the shareholders or the board of directors. However, a shareholder-approved bylaw dealing with director nominations may not limit the board’s power to amend, add, or repeal to ensure an orderly process. Thus, if shareholders approve a bylaw amendment that limits further board changes, the board could only amend or add to the bylaw to safeguard the voting process; it could not repeal the shareholder-approved bylaw.

Question 37

dismissing derivative action

Answer 37

The board can seek to dismiss a shareholder’s derivative action if a majority of the board’s qualified (disinterested) directors determine in good faith after reasonable inquiry that maintaining the action is not in corporation’s best interests.

*A board’s failure to investigate credible allegations of corporate illegality shows a lack of good faith.