Corporations Flashcards
What are the characteristics of a CHC?
In a CHC-
- There is no market for the shares of the corporation. - Owned by a private group of people.
- Often there is an Agreement that limits a shareholder’s ability to transfer the stock.
- Operates day to day more like a partnership because there is a close group of owners.
There is no separation between ownership and control
What should you have in a CHC in the event one person eventually wants out?
Want to have a buyback or stock sale agreement among the corporation holders
what do the board of directors do in a public corporation?
directors
- Set corporate policy
- Make fundamental business decisions
- Hire the officers who run the business on a day to day basis.
what is the Nexus of Contracts theory?
NoC theory takes the approach that the state shouldn’t be regulating operation, but facilitating the creation of these contracts that correspond to the types of provisions people would like to make. Should enable people to enter into arms length bargains and lower transaction costs by adopting provisions people would otherwise negotiate if left to their own devices- laissez faire
What was Brandeis’ dissent in Liggett v. Lee?
Says corporations make a modern feudal system where we are all serfs to a few corporate board directors.
Calls states beginning to drop restrictions on purposes for which corporations can be formed a “race for laxity”
What are th agency costs associated with having a board of direcotrs?
Costs:
Monitoring- ensuring the agent is doing a good job and making sure the agent is not putting his interests above the interests of the principal. Agents are fiduciaries.
Bonding- Costs Initially incurred by the agent if they do not serve the sharehodlers. It’s like posting bond. These costs are designed to provide the principal with peace of mind. E.g. insurance.
What is the internal affairs rule?
when the Q of law has to deal with purely internal affairs of the corp, then you use the law of the state in which the corporation is incorporated. Not true in CA.
should a CHC incorporate at home or in Delaware?
- If closely held and locally operated local incorporation is almost always preferred
- DE may be higher cost due to income taxes and you may have to defend a suit there if you are incorporated there.
- DE laws may give more flexibility in management
when does a corporation become incorporated?
Corporation begins when docs are FILED BY SECRETARY OF STATE
How much info must be included in the articles to incorporate under the MBCA?
Very little
- A corporate name that is linguistically distinct
- An authorized number of shares (max the corporation can issue, they can do fewer).
- mailing address of initial registered agent and office. - does not have to be PPB
- Name and address of each incorporator.
What are some things you MUST opt into for the corporation to have those characteristics?
E.g. cumulative voting rights, creating classes of shares, preemptive shareholder rights.
Under MBCA, what makes a name valid?
Under MBCA, Names are allowed if linguistically distinct to other corps.
Sec of state depending on state has power to determine if name is “deceptively similar,” to another. Texas did this until 2019.
What is a reserve name?
reserving a name prior to incorporting
What does it mean to Register your name?
Registered name- you must register your name in every state you are going to “do business” to “qualify” the corporation to do business there.
If you are incorporated in DE, where are subject to taxation?
You are subject to taxation in states in which you do business.
Explain the spectrum that courts use to determine how they will treat a director conflict of interest
~good~ if court believes the transaction is fair to the corp, it will be upheld
• Marciano v. Nakash – it was inherently fair, so not voidable
~in between~ court looks & sees if transaction was approved by a majority of disinterested directors or shares (not shareholders) after they knew all material facts
~bad~ if court believes the transaction involves fraud, undue overreaching, or wastes corporate assets, they will void it
Where can you look to find the maximum authorized number of shares of a corporation?
must a corporation issue all the shares it has authorized?
Must register maximum number (authorized number) of shares in the articles. Can issue fewer but the amount in the articles is a maximum.
T/F: Registered office address has to be the PPB of the corp.
False! Can make it a lawyer or independent person or company’s address.
T/F: When the registered agent resigns or dies, you don’t need to update the secretary of state.
TRUE: If the registered agent resigns or dies, you don’t need to update the secretary of state, can substitute with the corp secretary and the corp principal office.
Do you face personal risk for serving as the incorporator of another’s corporation?
Generally no. This is different than being a promoter.
What do you have to state when incorporating in TX?
In TX you have to specify corporations purpose or purposes, but that can be the purpose to “engage in any lawful business”. This general right is the default in the MBCA
How long do corporations exist by default under the MBCA?
Corporations have perpetual existence by default under MBCA.
In TX when incorporating, what do you need to specify about directors?
you need to specify who the initial directors are, but do not have to update the secretary of state if there is a change.
Under MBCA 2.05 after incorporation, there is what is called an “organizational meeting.”
- What do directors do at this meeting? and
- what happens if there are no direcotrs yet?
If the initial directors are named in the articles, they meet to appoint officers and adopt bylaws, etc.
If the initial directors are not named in the articles, it is up to the incorporator to appoint the directors who can then hold that organizational meeting.
Do corporations have the same powers an individual has?
Yes, but idk exactly what this means.
According to Sullivan v. Hammer, if directors or a Special Committee gave due consideration to the transaction, what is the presumption?
The court must review the claims of Plaintiffs against the presumption that the acts of the directors are valid
What are promoters?
people who enter contracts on corporations behalf before the corp is founded.
What is a common reason for promoter liability?
if you send articles of incorporation via snail mail and assume the articles have been filed when they have not. Very similar to agency principles.
does Texas have a piercing the corporate veil statute?
Yah
If a promoter and 3rd party enter contracts prior to incorporation, is the promoter personally liable?
Yes. corp does not exist to be liable. It cannot be liable since it does not have actual or apparent authority, doesn’t yet exist.
After it incorporates, can a corporation become liable for a promoter contract through ratification or adoption?
It cannot be ratified because the corp did not exist at time of contract formation. Ratification is not retroactive when the corp did not exist. Adoption of the contract would make the corp liable because adoption is retroactive.
If the corporation is liable, is the promoter released from liability on the contract?
No. Agency question. The promoter remains liable even if incorporation occurs and the corp adopts the contracts
Why are Courts hard on promoters?
Courts are hard on promoters because they could have easily incorporated first and in theory the corp may or may not form after promotion.
Promoters could have also contracted out their personally liability for the contract.
What are the 2 ways for a promoter to get released from liability?
The ONLY way a promoter gets released is if there is a novation. The promoter, corp, and 3rd party must agree that only the corporation will be liable. This is very rare because the 3rd party has little incentive to do this.
Promoters can weasel out if liability of 3rd party pushed the promoter to make a deal before incorporation.
when are foreign corporations considered to be “doing business” within another state?
Foreign corporations are only doing business when regularly carrying on intrastate transactions within another state.
What is a defective corporation?
defective corp is one that is de facto but not de jure
When does a de facto corporation exist?
A de facto corporation exists if there is:
- A valid law under which a corp can be organized
- An act on corp’s behalf
- Good faith attempt to form a corporation
What was the district courts solution to solving the de facto vs de jure problem in Robertson v. Levy?
only the date the corporation was filed mattered. The corp was filed after the agreements were entered so the individual, not the corp was liable.
can shareholders be liable in a defective incorporation?
Yes, depending on state law and only until the defective corporation incorporates.
What is the test for if a De Facto corporation exists?
- Is the equitable doctrine available in the state at all? If so,
- check for a good faith attempt to form a de jure corporation under the relevant state law .
How does corporation by estoppel apply in the context of defective incorporation? (opposite of partnership by estoppel)
when someone deals with a business as if it were a corporation, they are later estopped from arguing that it wasn’t a corporation at all and the owners should be personally liable. Not based on reasonable reliance because if you rely on the fact that a business is a corporation, you are barred from later arguing it wasn’t.
If there has NOT been a good faith attempt to follow a statute and form a corp, are 3rd parties estopped from arguing it wasn’t a corp?
possibly yes, depending on the state.
It is possible that the promoter could persuade the court that there was an implied agreement that the 3rd party would solely look to the corporation for performance?
This is very unlikely because the promoter has burden of proving an implied agreement exists. Vast majority of cases hold promoters accountable.
What promoters do the MBCA rules favor?
MBCA is more sympathetic to promoters who don’t KNOW the business is not incorporated
or when promoters are pushed to enter contracts by 3rd parties to prevent the failure of the deal.
What happens in the vast majority of peircing the corporate veil cases.
shareholders immune to personal liability.
what states law do courts choose in piercing the corporate veil?
Court may apply the law of the state where the tort occurred or where the majority of business occurred. these often conflict.
How do academics feel about most state approaches to piercing the corporate veil?
heavily criticized by academics. Called “Rare, unprincipled, and arbitrary”
When do economists thing PCV should occur?
Say it should only apply where
- 3rd party creditor was misled to believe they were dealing with a shareholder, not the corp. OR
- where the shareholder commingled or siphoned funds.
other tests create uncertainty, which is bad for business
What are the 2 most significant PCV considerations?
- Was the corproation being used to perpetuate fraud?
a. constructive fraud may be enough
b. in TX, you need actual fraud to PCV on a contract claim. - Commingling/syphining funds (courts ALWAYS PCV)
what are the lesser, but not insiginficant factors considered for PCV?
- Were corporate formalities observed?
a. not suffucuent to PCV in TX - Does the suit involve a contract or a tort claim?
- was the corporation grossly undercapitalized for it business purpose?
- will an individual or corporation be liable?
- What public policies are implicated?
What is unique about TX and PCV?
TEXAS IS THE ONLY STATE WITH A STATUTE GOVERNING PIERCING THE CORPORATE VEIL.
What types of corporations does PCV almost exclusively apply to?
PCV is almost exclusively applied to closely held corporations. Corps with low number of shareholders, where those shareholders are a close-knit group of family or friends.
T/F: If a court decides to PCV, all shareholders are liable.
False:
If the court decides to pierce it does not hold ALL shareholders liable, examined on a shareholder by shareholder basis, and applies on a creditor by creditor basis.
How did Fletcher v. Atex impact how PCV work between parent corporations and subsidiaries?
Court aks if:
Is there overlap of board of director between subsidiaries?
Did parent dominate the subsidiary?
If CHCs don’t have to follow many formalities under statute, how important should corp formalities be?
Not very. Just used to support the courts argument after PCV is already decided on.
Are courts more likely to pierce the corporate veil on contract or tort claims?
For whatever reason, courts are MORE likely to pierce the corporate veil on contract claims.
Unintuitive because victims can protect themselves in advance in contract claims.
What are the current considerations for whether a corporation was grossly undercapitalized for the purposes of its business? (PCV)
Capital must go to the purpose of the corporation (e.g. insurance company can’t be without money to pay out claims)
o Courts ask whether grossly undercapitalized
· Ex: significant chance of injury => greater amount of capital required
§ disposing of nuclear waste, hazardous substances
Must be capitalized enough to serve this purpose
If legislatures dispensed with minimum capital requirements, then why should Courts look at undercapitalization at all?
Because in some instances corporations might be so grossly undercapitalized that it warrants granting PCV.
what counts as captial for thinking about PCV undercapitalization?
Not just capital that SH contribute as part of investment.
- Courts also look at whether Corp had liability insurance (In Radaszewski
§ Court said important factor was that Corp had purchased insurance for this type of event)
- Money infusions even if they are loans (O’Hazza)
- personal guarantees (Baatz)
When is undercapitalization considered for PCV?
POINT WHEN THE CORP IS FORMED.
adequacy of capital is also determined during initial capitalization (Woodrow)
According to empirical research, do courts make distinct considerations for undercaptialization in tort vs. contract claims?
Not in practice.
What are the exceptional cirecumastances when courts will look at undercaptialization over time vs. at the time of formation?
When SH has been siphoning funds off Corp and treating Corp’s assets as their own
According to empirical research, do courts PCV at a higher rate when a corp has 1 shareholder or a couple of shareholders?
Courts PCV in more than 50% of cases where Corp has 1 SH.
Why are courts more likely to PCV when there is only 1 SH?
where there’s only 1 SH, there’s going to be tendency to blur distinction between Corp and personal assets
what are the 3 circumstances where you would try to PCV?
(1) PCV to get at assets of individual SH of a Corp
o Woodruff
(2) Parent Corp and subsidiary
o Fletcher v. Atex
3) Brother and sister Corps
o π tries to hold brother/sister corp liable for the debts and obligations of its sibling Corp
What is DE alter ego liability?
SH is the alter ego of the Corp.
Goal is to hold the alter ego liable for the debts/obligations of a Corp
Can you PCV in other limited liabiity BAs?
Yes. PCV can be relevant for other business forms with limited liability
In states where statute is silent, do courts PCV of LLCs?
Even in states where statute is silent on whether PCV applies to LLC, courts have consistently applied PCV principles to LLC context
Did TX decide to PCV to get access to limited partners?
In TX LP, court wouldn’t PCV to hold limited partners liable when the general partners were already liable
§ Rationale: No reason to PCV because someone is already generally liable
Can public policy concerns affect a courts decsion to PCV?
Of course. Ex: Question of whether or not PCV was appropriate in a Corp that was obligated to clean up toxic waste. Implicated lots of public policy concerns
In what state is PCV not a judicial phenomenon? Why?
Texas. There is a PCV statute
How much do shareholders usually get after bankruptcy
Usually nothing, since their claims are below the claims of creditors
What happened in Pepper v. Litton?
court subordinated the Litton’s SH claim against the Corp to the claims of the other creditors since he tried to jump ahead of creditors by acting as if he was a secured creditor.
What is the purpose of a trustee in bankruptcy?
represents interests of the Corp’s creditors. appointed to marshal (maximize) assets of Corp for benefit of creditors (pay more than they would otherwise get)
Under MBCA 14, what order to parties get paid back upon dissolution?
- Creditors with security interests in corporate assets
- unsecured creditors pro rata
- shareholders pro rata
How are assets distributed to unsecured creditors?
pro rata. (according to their % stake of the corporation’s total debt). If X is owed $1 million and Y is owed $100k, and the corp has $100k, X will get $90k and Y will get $10k.
If you have a $50k secured claim on the corporation’s assets, and the corporation has a foreclosure sale for $30k, what is your interest in the $20k they still owe you?
Corp has a balance of $30k. After you get the $30k of the secured interest they are able to give, you get an unsecured interest on the remaining $20k.
If you have a $50k secured interest on the corporation’s assets, and the corporation has a foreclosure sale for $55k, what happens to the other $5k after you have gotten your secured $50k back?
Corp has a balance of $55k. Unsecured creditors split the $5k pro rata after you get paid $50k.
Why did Litton fail to meet his burden as a director when trying to grab his salary claims during bankruptcy ahead of the unsecured creditors?
As a director he was a fiduciary
Burden was on the director/ shareholder to show the inherent fairness to the corps shareholders and creditors and good faith for their transaction to control the assets.
what is a squeeze out or freeze out?
abuse by the controlling shareholder to abuse their power to the detriment of other shareholders.
What is an example of a freeze out maneuver?
not declaring dividends in a CHC to the detriment of minority, there is no public market to sell the shares on so will often just sell to the majority holders at a below market price.
What is the test for whether equity will apply to a freeze out according to Pepper v. Litton?
“The question is whether the challenge transaction carries all the earmarks of an arms-length bargain. If not, equity will set it aside.“
What was another approach the court could have taken to avoid Litton’s claim that would have resulted in a bad policy?
Could likely have just “pierced the corporate veil” since he was the sole SH and avoided Litton’s claim on the grounds he as the sole corporate shareholder cannot owe himself a debt. In that case he may have become personally liable for the corporation’s debt, so subordination of his debts here was the preferable method.
What are the 3 principle differences of debt capital vs. equity?
- Debt must be repaid at some point 2. Interest on the principal borrowed must be paid periodically 3. The repayment of principal and interest is not contingent on the success of the business
What is equity capital?
Equity is an ownership interest after the firm’s debts are paid Assets = liabilities + equity
Equity capital is a combination of: contribution by the original entrepreneurs of the firm, capital by subsequent investors, and retained earnings of the business.
Equity claims are residual
T/F: Rights and characteristics of different classes of shares must be similar among their class.
True. Ex: preferred stock vs common stock share same attributes within their class.
Under MBCA 6.01 (e), what are the fundamental rights of holders of common shares?
- they are entitled to vote for the election of directors and other matters coming before shareholders and 2. they are entitled to the net assets of the corporation upon dissolution (residually, after debts paid).
These characteristics can be placed in different classes of shares but each must be present somewhere in the total pool of shares, and must always be outstanding aka issued to a person or persons.
what are some additional rights of common shareholders? (aside from voting and residual interest).
common shareholders also have the right to inspect books and Records the right to sue on behalf of the corporation and the right to financial information Etc.
according to SCOTUS, what are the characteristics of common stock?
- the right to receive dividends contingent upon in a portion of profits 2. negotiability and transferability 3. the ability to be pledged 4. the conferring of voting rights and proportion to shares owned and the the capacity to increase in value. 5. The residual ownership interest
What is typical of prefferred shares?
typically classes of shares with rights preferential to those assigned to common shares but limited in some way. (typically a cap on earnings). For example, a class of preferred stock might have the right to distribution of $5 per share before the common shares become entitled to any distributions. Usually non-voting however voting power is assigned to Preferred shares if the company misses scheduled dividend payments on the preferred stock or if it fails to meet other Financial tests
T/F: preferred shares have caps on their earning.
False. Not always. Depends on the preferred shareholder contract in the articles.
If the corporation retains earnings for a year, what happens to the value of common and preferred stock?
the common stock value will go up, but capped preferred shares will not.
What is a “Preferred shareholder contract” and how is it amended?
outlined in the Articles of Incorporation and cannot be amended without consent of holders of some statutorily designated fraction of the preferred shareholders
Who decides whether to make a distribution to common shareholders?
directors usually.
What is a Cumulative dividend right for a preferred share?
when the dividend is not paid in a given year it accumulates and must be paid before any common shares in a later year. For example if a preferred cumulative dividend is not paid any given year then no common shares may be paid in that year. Then the following year no common shares may be paid until the preferred cumulative dividend holder receives the accumulated amount of their preferred shares. $5 preference becomes a $10 preference the next year.
What happens to a noncumulative dividend right for a preferred share if it is not distributed in a given year?
A non-cumulative dividend that is not paid during the year simply disappears and does not carry over to the next year.
What is a partially cumulative dividend right for a preferred share?
A partially cumulative dividend is typically cumulative in any particular year only if there are sufficient earnings to cover that Year’s dividend. If the earnings are insufficient a preferred dividend for that year disappears just as if the dividend were non-cumulative.
what happens if you have a cumulative dividend right for $5 on your preferred share in year 1, the corporation does not pay a dividend, and then in year 2 the corporation goes bankrupt? What does the coroporation owe you?
Probably nothing. Unpaid Dividends are not debts of the corporation but are a right of priority on future distributions.
why do publically traded preferred shares usually have cumulative dividend rights?
publicly traded preferred dividend shares have cumulative dividend rights because they are allowed in many states to be paid out from various capital accounts.
when do preferred shares get voting rights?
if preferred dividends have been omitted for a specified period of time or if their rights are being changed- known as contingent voting rights.
T/F: preferred shareholders usually do not share in any general depreciation in the value of the corporation’s assets upon dissolution.
True. preferred shares usually have a liquidation preference as well as a dividend preference. The liquidation preference is often fixed at a specified price per share payable upon dissolution before anything may be paid to the common shares.
what are redeemable shares?
Redeemable shares just means that the corporation has the power to buy back the redeemable shares at any time at a fixed price and the shareholder has no choice but to accept that price.
during a stock redemption, where would the price of the preferred shares usually be set out?
In the articles.
what is a stock conversion right?
preferred shares may be made convertible at the option of the holder into Common shares at a fixed ratio specified in the Articles of Incorporation.
How can you avoid the corporation redeeming your preferred stock if you want to stay invested?
Convert to common shares within the paeriod after redemption has been called. The conversion ratio is in the articles.
What are participating preferred shares?
participating preferred shares can get the specified dividend and after the common shares receive a certain amount they can share with the common in additional distributions on some predetermined basis. This is a combo of common and preferred attributes. They are sometimes called class A common.
What are blank shares?
Shares created with financial terms that are not filled out until directors issue them.
T/F: MBCA 6.01 focuses on the difference between preferred and common shares
False.
MBCA 6.01 does not Directly use the terms preferred or common shares and instead establishes a scheme of generality to accommodate any creation of new classes or types of shares that may come in the future.
Are classes of common shares set out in the articles or bylaws?
In the articles.
How is a buyback different from a redemption?
buybacks are the corp going to the market and buying the shares back. redemptions are calling in shares from SHs as set out in the articles.
what is the interrelationship between: Authorized shares Issued Shares Outstanding shares Treasury shares
In descending order by quantity (generally):
Authorized shares- total amount authorized in the articles
Issued Shares- shares actually sold out of the authorized shares
Outstanding shares- Issued shares actually in the hands of shareholdes (voting shares)
Treasury shares- shares the firm has issued then bought back/ reacquired (par value concept)
T/F: “upstream conversion” (common → preferred) is not possible under the MBCA, but in most states it is allowed.
False.
remember that MBCA is an enabling statute.
Upstream conversion is allowed under MBCA even though most states only allow downstream.
In theory, can 3rd parties call in shares?
Yes
What is a sinking fund?
A fund that is set aside in case the corporation wants to buy back shares.
What is a forced stock conversion?
corp calls in a shareholder’s convertible debt security, but the shareholder has the ability to convert the shares into stock or a different class instead of cash out.
What is par value?
the value of a single common share as set by a corporation’s charter. It is not typically related to the actual value of the shares. In fact it is often lower. Any stock certificate issued for shares purchased shows the par value.
How is par value generally used today?
Usually is just a nominal value
What is stated capital?
represents the capital that was raised that corresponded to the shares’ par value. anything more is the capital surplus
What is capital surplus?
surplus generated with the sale of shares that had a par value, showing the amount earned from the sale above the par value.
