Corporations

Question 1

What is a corporation?

Answer 1

A distinct legal entity that can conduct business in its

own right by buying, selling, and holding property or by suing or being sued, and by lasting forever.

Question 2

Who are shareholders?

Answer 2

Investors, ultimate owners of a residuary interest in a

corporation

Question 3

Who are directors?

Answer 3

Elected by shareholders, responsible for major corporate decisions, appoint officers

Question 4

Who are officers?

Answer 4

Run the corporation on a daily basis

Question 5

Who is liable for pre-incorporation agreements?

Answer 5

The corporation is not but promoters are liable for any Ks entered into before the corp exists.

Exception: novation where the corp is substituted for the promoter

Question 6

Who is a promoter and what do they do?

Answer 6

• Try to find investors who are willing to invest in the corporation
• Enter into Ks on behalf of the corporation (even before it exists)
• Promoters are fiduciaries of the corporation—they cannot make secret profits.

Question 7

What does an incorporator do and what are they liable for?

Answer 7

Incorporator must sign and file the articles of incorporation and pay a fee, but are not liable for Ks formed by promotors.

Question 8

What are the articles of incorporation?

Answer 8

Like a K between the corp and shareholders which establishes their basic rights. Also like a K between the state and corporation.

Question 9

What must be included in the articles of incorporation?

Answer 9

D-PAINS

• Name of the corp: must include corp, co, inc, ltd (either full or abbrev)
• Names and addresses of incorporators
• Agent of the corporation (name and address wi state of incorporation)
• Duration of the corp (most are perpetual)
• Purpose of the corp
• Authorized shares (must state the maximum no of shares of each class of stock that the corp is authorized to use)

Question 10

What is the doctrine of ultra vires?

Answer 10

Ultra vires = acts beyond the powers of the corp. If the corporation acts outside of its stated purpose, the acts will be held unenforceable. Shareholders can sue to enjoin an ultra vires action. Corporation can take action against ultra vires directors or officers. State can initiate proceedings to enjoin such actions.

• Today the purpose is usually stated as “to engage in any lawful activity”

Question 11

What is the general rule of veil piercing?

Answer 11

Shareholders are NOT personally liable for the debts of a corporation, but only liable for the amount invested into the corporation, except a court may “pierce the veil” of limited liability to avoid fraud or unfairness.

Question 12

What are the factors a court will look to in piercing the corporate veil?

Answer 12

• Alter ego: The investor or shareholder has failed to observe any corporate formalities between the person and the corporation—treated the company just like itself;
• Undercapitalization: Failure to maintain funds sufficient to cover foreseeable liabilities; and
• Fraud: The parties engaged in fraud or fraud-like behavior.

Courts are more likely to pierce the veil in tort situations rather than contractual situations; more likely in small, closely held corporations

Question 13

What are preemptive rights?

Answer 13

Right to acquire stock to maintain the percentage of ownership any time new shares are issue.

Default rule in most jurisdictions: Shareholders don’t have preemptive rights unless negotiated or included in the articles

Question 14

What rights do shareholders have in dividends?

Answer 14

None

Question 15

Can shareholders sell securities?

Answer 15

Shareholders can sell shares to anyone at any time for any price.

Exception: closely held corps and federal restrictions

Question 16

Closely held corps - private restrictions on the sale of securities

Answer 16

Restriction must be conspicuously noted on stock certificate

Question 17

When are private restrictions enforceable?

Answer 17

Enforceable unless a person had no knowledge - but enforceable if the restriction is certified and conspicuous

Question 18

What are the different types of private restrictions?

Answer 18

C O F T

Consent Option First refusal Transfer prohibition

• Outright prohibition on transfers
• Requires company’s consent
• Company has an option to buy
• Company has a right of first refusal

Question 19

Who is bound to a private restriction and how are they challenged?

Answer 19

Almost any shareholder in a closely held corporation agrees to the restrictions. Challenges made on the basis of restraint on alienation with a reasonable test: Is it reasonable to restrict to maintain legal status?

Question 20

What are the different types of shareholder meetings and what happens at them?

Answer 20

• Annual meeting to elect directors and conduct other shareholder business (mandatory)
• Special meetings: May be called to vote upon fundamental changes.

Question 21

How must shareholders be given notice of meetings?

Answer 21

Must be given notice of both annual and special meetings no fewer than 10 days but no more than 60 days before the meeting. Notification must include the time, date, and location. Special meeting notification must include the purpose of the meeting. Insufficient notification can allow a shareholder to challenge any actions taken at the meeting, but attending the meeting w/o notification waives the right to challenge

Question 22

How is it determined which shareholders are eligible to vote?

Answer 22

Record date

• Directors must pick a record date which is no more than 70 days before a meeting.
• Only those who own shares on the record date can vote.

Question 23

What is a shareholder meeting alternative?

Answer 23

Shareholders may take any action without a meeting by unanimous written consent.

Question 24

What is a proxy and how is it legally effective?

Answer 24

Proxy authorizes others to vote share in accordance w the wishes of the shareholder. Only legally effective if:

• In writing
• Signed by the shareholder as of the record date
• Sent to the secretary of the corp
• States that it authorized another to vote the shareholder’s shares; and
• Cannot be valid for more than 11 months unless specified otherwise

Question 25

What issues do shareholders vote on?

Answer 25

SAD MES
E- Election of directors
M- Mergers
S- Share exchanges
A- Amendments to articles of incorporation
S- Sales of all or substantially all of its assets; or
D- Dissolution

Question 26

What is a shareholder quorum and why is it important?

Answer 26

For a vote to be effective, a quorum of the corp’s shares must be represented in a meeting (can be by proxy)
- Quorum is a majority of the corporation’s outstanding shares represented at the start of the meeting

Question 27

What is the necessary vote for a shareholder meeting?

Answer 27

If a quorum is present, a shareholder vote is effective if the votes cast in favor of the proposal exceed the votes cast against the proposal.

Question 28

What is cumulative voting?

Answer 28

Applies only to the election of directors. Protects shareholders’ right to elect directors. Corps can choose to permit cumulative voting in the articles. Shareholders are given a number of votes that is equal to the no of shares, multiplied by the no of director positions being voted on. Then votes can be spread around or put on one director.

Question 29

What are shareholder’s rights to inspection?

Answer 29

A shareholder may inspect the corp’s records in person or through an agent as long as the shareholder states a proper purpose (related to the shareholder’s interest in the corp - NOT to harass corporate officers)

Question 30

What are the two main types of shareholder litigation?

Answer 30

Direct lawsuits and derivative lawsuits

Question 31

What is a direct lawsuit?

Answer 31

• Shareholder is suing in the shareholder’s own name for damages and the damages go directly to the shareholder.
• A shareholder can sue directly if the shareholder has been harmed directly, including:
- Interference in voting rights or dividends, misinformation about important issues, and tort injury.

Question 32

What is a derivative lawsuit?

Answer 32

• Shareholder is suing on behalf of the corporation
• Alleged harm harms the corporation, principally
• Harm to corporation—bad business decisions (e.g., disloyalty)
• Claim must be made in the corp’s name and any recovery belongs to the corp

There are also special rules for standing, demand requirement, and recovery.

Question 33

What is the standing requirement for a derivative lawsuit?

Answer 33

• Must maintain contemporaneous stock ownership
• Requirements:
• –Must have been a stockholder at the time of harm
• • Must hold the shares throughout the litigation; and
• • Must fairly and adequately represent the interests of the corporation

Question 34

What is the demand requirement for a derivative lawsuit?

Answer 34

• The P shareholder is gen required to first demand that the board bring the lawsuit in the corp’s name before the shareholder can bring the suit

Exception: demand futility provision - demand is not required if it would be futile (e.g., the directors have been named as Ds)

Question 35

How is recovery from a derivative lawsuit destributed?

Answer 35

• Any recovery goes to the corp, not the shareholder. Atty’s fees: If the litigation produces a substantial benefit to the corp, the P’s attys are entitled to have their fees paid by the corp

Question 36

What duties do shareholders owe to fellow shareholders?

Answer 36

None

Question 37

What are the duties of a controlling shareholder?

Answer 37

May owe a fiduciary duty to minority shareholders: (1) in selling stock to an outsider/looter intent on destroying the company, and (2) if he receives a special distribution or otherwise conducts major business transactions to his own benefit (owes duty of loyalty)

Question 38

Who is a controlling shareholder?

Answer 38

Those who own 50% +1, or more
But look to the nature of the co (widely held corp with low stock percentage ownership per shareholder - controlling shareholder would need less of a percentage to be considered controlling)

Question 39

What is the job of the board of directors?

Answer 39

Manage and direct the management of the corp’s business and affairs:

• appoint officers
• Oversee officers
• make high-level corp decisions

Usually paid

Question 40

What are the requirements for board?

Answer 40

Must have at least one director and directors must be natural persons. Elected by shareholders and serve for a limited term (norm 1 year)

Question 41

How is a director removed or replaced?

Answer 41

o Shareholders may remove directors with or without cause.
o There is an important exception: Staggered board
  - Classes of directors are elected at different times—
e.g., nine directors: Three elected in year one,
three elected in year two, and three elected in year
three;
  - May only be removed for cause, only if the articles
provide; and
  - Different classes of shareholders may elect different
directors—only directors elected by a particular
class may be removed by that class.
o Vacancy or size of the board has increased—new director(s) can be chosen by the shareholders at a special meeting OR by the board

Question 42

What are the notice requirements for board meetings?

Answer 42

Directors must be given notice for special meetings, but not for regular meetings. Attendance at the meeting waives notice, unless the director promptly objects at the meeting. Dirs CANT vote by proxy or enter into voting agreements.

Question 43

What are the requirements for a legal board vote?

Answer 43

Must have:

• Quorum: maj of the total no of directors unless the bylaws say otherwise
• Affirmative vote: as long as quorum is present, a resolution of the board will pass upon a maj vote of those present at the meeting

Ex: unanimous written consent - may approve a proposal and avoid a meeting, if agreed upon by unanimous written consent

Question 44

What is the effect of a board member dissent?

Answer 44

To avoid potential liability for a board decision. The director must dissent by:

• Entering dissent in the meeting minutes;
• File written dissent before the meeting is adjourned; or
• Provide written dissent by certified or registered mail to the corp’s secretary immediately following the adjournment of the meeting

Question 45

What are the rules regarding indemnification of officers and directors?

Answer 45

The practice of corporations paying for the costs of a director’s or officer’s defense in litigation, usually by purchasing insurance.

Required or Mandatory Indemnification
• The corporation is ALWAYS required to pay the costs of defense if the director or officer succeeds in the case.

Prohibited Indemnification
• The corporation CANNOT indemnify a director or officer who is liable for receiving an improper benefit from the corporation or otherwise loses a lawsuit.

Permissive Indemnification
• The corporation may, but is NOT required, to indemnify a director or officer for the costs of a suit if the director or officer:
o Acted in good faith with no intent to harm the corporation; or
o Had no reasonable cause to believe the conduct was illegal.

Question 46

What is an LLC?

Answer 46

o The LLC combines the limited liability of corporations with the tax treatment of a partnership.
o Generally no limitations on the number of shareholders, no residency requirements, and no natural person requirements (more flexible than an S Corp).
o An LLC files articles of organization and an operating agreement with the state.
o The owners are called members, rather than shareholders.
o An LLC is presumed to be managed by ALL of its members.

Question 47

What is the difference between an LLC and a corp?

Answer 47

o Legally, LLCs are generally treated like corporations.
o There is a difference in terminology and taxing features, but otherwise, analyze LLCs under general corporate law principles.

Question 48

What is the business judgment rule?

Answer 48

Rebuttable presumption that director reasonably believed his actions were in the best interests of the corp. In the absence of fraud, illegality, or self-dealing, a court will not disturb the good-faith judgment of the directors or officers. Protects from liability. The business judgment rule does not apply in a conflict-of-interest transaction.

Question 49

What duty of care must directors use?

Answer 49

o Directors and officers must use the care a person in a like position would reasonably believe appropriate under similar circumstances. (duty to investigate and ask questions)
o Did the officer or director have special skills? If so, she is obligated to use them.
o An officer or director is entitled to rely on the expertise and the reports of:
- Officers and other employees;
- Outside experts; and
- A committee of the board of directors.

Question 50

What is the is the standard for an officer or director’s duty of loyalty?

Answer 50

o Directors and officers cannot receive unfair benefits to the detriment of the corporation unless they effectively disclose and obtain ratification of those benefits.
o Self-dealing transaction: When the director or officer (or a relative) receives compensation directly from the corporation.
o Corporate opportunity: When the director or officer prevents money from coming into the corporation.

Question 51

What is a distribution?

Answer 51

When a corporation removes profit from the corporation and gives it to the shareholders

Question 52

Who has the power to authorize a dividend?

Answer 52

The power to authorize a dividend lies with the board of directors. A board cannot declare a dividend if:

• The corporation is insolvent; or
• Declaring the dividend would make the corporation insolvent.
• Directors who vote to authorize an unlawful dividend in violation of their fiduciary duties are personally liable, jointly and severally, to the corporation in the amount in excess of the lawful amount.

Question 53

How do you overcome the business judgment rule?

Answer 53

GIOIR

Show that

• The director did not act in good faith
• The director was not informed to the extent reasonably necessary
• Did not show objectivity (had a material interest)
• Failed to timely investigate a significant matter
• Failure to act as a reasonable director

Question 54

Safe harbor for breach of duty of loyalty

Answer 54

Disclosure of all material facts, and:

(i) approval by the maj of disinterested board members;
(ii) approval by the maj of disinterested shareholders; or
(iii) a court concludes the transaction was fair - substantively and procedurally at the time of commencement

Question 55

What are the notice requirements for a director special meeting?

Answer 55

Unless otherwise noted in the articles of incorporation or bylaws, notice must be provided at least two days prior to the meeting and should state the date, time, and place of the meeting

Question 56

Presence at a board meeting

Answer 56

A director must be present at the time that the vote is taken in order to be counted for quorum purposes, but presence includes appearances made through communications equipment that allows all persons participating in the meeting to hear and speak to one another.

Question 57

Corporation by estoppel

Answer 57

person who deals with an entity as if it were a corporation is estopped from denying its existence and is thereby prevented from seeking the personal liability of the business owner (limited to K agreements)

Question 58

De facto corporation

Answer 58

The owner must make a good-faith effort to comply with the incorporation requirements and must operate the business as a corporation without knowing that the requirements have not been met. If the owner has done so, then the business entity is treated as a de facto corporation, and the owner, as a de facto shareholder, is not personally liable for obligations incurred in the purported corporation’s name.

Question 59

Usurping - interest or expectancy test

Answer 59

Under the “interest or expectancy” test, the key is whether the corporation has an existing interest or an expectancy arising from an existing right in the opportunity. An expectancy can also exist when the corporation is actively seeking a similar opportunity.

Question 60

Usurping - line of business test

Answer 60

The key is whether the opportunity is within the corporation’s current or prospective line of business. Whether an opportunity satisfies this test frequently turns on how expansively the corporation’s line of business is characterized.