Corporations

Question 1

Piercing the Corporate Veil

% out of exams tested: 35%

Answer 1

Issue: The issue is whether [Molly] can be held liable if [Ted] is able to pierce the corporate veil.

Rule: Generally, shareholders in a properly formed corporation are not personally liable for the obligations of their corporation. However, a court will pierce the corporate veil to hold shareholders personally liable for the corporation’s obligations if: (i) corporate formalities have been ignored and injustice has resulted (alter ego); (ii) the corporation was inadequately capitalized at the time of formation; or (iii) the corporate form is being used to perpetuate a fraud.

• Alter Ego: Where shareholders treat the corporation as their alter ego, such as where they take corporate funds for personal use, and the corporation does not have sufficient funds to pay its creditors as a result, the courts often will pierce.
• Fraud: Fraud requires a mistake of fact.

Question 2

Duty of Care and Business Judgment Rule

% out of exams tested: 71%

Answer 2

Issue: Whether [Ted, Molly, or Luna] have violated any fiduciary duties to [Leah Plunkett] with regard to [the Harvard merger].

Rules: Directors are fiduciaries of the corporation, and they owe the corporation a duty of care and a duty of loyalty.

• The duty of care requires the directors to act in good faith and in the best interests of the corporation, using the care that would be exercised by an ordinarily prudent person in a like position.
• Under the business judgment rule, directors who meet this standard are protected against lawsuits challenging their decisions.
  
  • [In making decisions, directors are entitled to rely on the opinions and reports of other directors, corporate officers, corporate employees, and outside experts if the reports are within their competence.]

Question 3

Rule 10b-5

(“Insider” Trading)

% out of exams tested: 14.3%

Answer 3

Issue: Whether [Ted’s] actions violated rule 10b-5.

Rule: Rule 10b-5 makes frauds in connection with the purchase and sale of a security unlawful. A prima facie case for breach of the rule requires proof of: (i) fraudulent conduct, (ii) in connection with the purchase or sale of a security, (iii) use of a means of interstate commerce, and, in some cases, (iv) reliance, and (v) damages.

A fact will be considered material under rule 10b-5 if a reasonable investor would consider it important when making an investment decision. Conduct will be fraudulent only on proof of scienter (i.e., intent to deceive). Typical securities insiders, such as directors, officers, controlling shareholders, and employees of the issuer, are deemed to owe a duty of trust and confidence to their corporation that is breached by trading on inside information. [Reliance will be presumed in a nondisclosure case. In a misrepresentation case involving publicly traded securities, reliance will be presumed based on a fraud on the market theory.]

Question 4

Section 16(b)

(Short swing stock sales)

% out of exams tested: 14.3%

Answer 4

Issue: Whether [Luna] purchase and sale of [DogCo’s stock] are in violation of section 16(b).

Rule: Section 16(b) of the Securities Exchange Act of 1934 provides that any profit realized by a director, officer, or shareholder owning more than 10% of the outstanding shares of the corporation from any purchase and sale, or sale and purchase, of any equity security of her corporation, within a period of less than six months must be returned to the corporation.

The section applies to publicly held corporations whose shares are traded on a national exchange or that have: (i) at least 2,000 shareholders (or 500 nonaccredited shareholders) and (ii) more than $10 million in assets. Section 16(b) imposes strict liability for covered transactions whether or not there is any material fact that should or could have been disclosed–no proof of use of inside information is required.

Question 5

Duty of Loyalty:

Usurping a Corporate Opportunity

% out of exams tested: 36%

Answer 5

Issue: Whether [the opportunity to buy the discounted marijuana] was a corporate opportunity.

Rule: A director ows the corporation the duty of loyalty, which prohbits the director from competing with the corporation, and bars the director from usurping corporate opportunities.

Question 6

Preincorporation Contracts:

Promoter Liability

Answer 6

Issue: Whether [Ted and Molly] can be held liable as promoters for the contract with [DropDeuce Co].

Rule: A promoter is a person who undertakes to procure commitments for a corporation before it is formed. A promoter who enters into a contract knowing that there has been no valid incorporation is personally liable on the contract. This is true even if, as here, the third party with whom the promoter dealt knew that the corporation had not yet been formed.

A promoter is liable on a preincorporation contract unless the contract expressly indicates that the promoter is not to be bound. In which case the agreement is construed as a revocable offer to the proposed corporation, or all parties have agreed to a novation. Generally, promoters are jointly and severally liable for preincorporation contracts.

Question 7

Corporate Purpose and Ultra Vires

% out of exams tested: 14.3%

Answer 7

A corporation has the power to engage in any lawful business. A corporation may limit the business in which it may engage by having a narrow purpose provision in its articles of incorporation. A corporation may not carry on a business outside the scope of its stated purpose. Business outside the scope of the stated purpose is said to be ultra vires.

• Effect of Ultra Vires: At common law, an ultra vires contract was said to be illegal and unenforceable. Today, ultra vires may be raised only if: (i) a shareholder seeking to enjoin a proposed ultra vires action, (ii) the corporation seeking damages against the officers or directors who authorized the ultra vires act, or (iii) the state, seeking to dissolve the corporation for engaging in the ultra vires act.