Corporations

Question 1

FACT PATTERNS FOR CORPORATE LAW

Answer 1

1. Organization & Formation of a Corporation
2. Issuance of Stock
3. Directors and Officers
4. Shareholders
5. Fundamental Corporate Changes

Question 2

Corporation

Answer 2

A legal entity distinct from its owners and may be created by filing certain documents with the state.

Owned by shareholders.
Board of Directors manages the corporation (as elected by shareholders).
Officers carry out corporation’s policy.

Question 3

Formation of De Jure Corporation

Answer 3

1. Person or entity (“the incorporator”) forms a corporation by filing articles of incorporation with the secretary of state - If applicable laws followed, it is a “de jure” corporation
2. Paper - “The articles of incorporation” contain:
   (1) Corporation Name (corp, co, inc, lmtd);
   (2) Name and address of Incorporator(s)
   (3) Name of registered agent and address of registered office w/in the state of incorporation; and
   (4) Stock information (Authorized stock = max number that corp can sell; if multiple class, then number in each class & voting/rights of them
3. Act - Deliver articles to Secretary of State with required fees.

Question 4

Organize Corporation

Answer 4

1) Directors (or incorporators) hold organization meeting (may pick directors);
2) Complete organization of corporation by: (1) appointing Officers & (2) Adopt Initial Bylaws (the operating manual). Board of shareholders can amend, repeal, adopt bylaws.

Question 5

Internal Affairs Rule

Answer 5

Roles and duties of directors/officers/shareholders are governed by law of state where corporation is incorporated.

Question 6

Entity Status

Answer 6

Corporation is a legal person; can sue, be sued, hold property, be partner in partnership, can invest, can make contributions to charity.

Question 7

Benefit Corporation (B-Corp)

Answer 7

A corporation to make profit, but also formed to pursue some benefit to a greater social policy cause. Articles must specify. Annual Benefit Report to disclose activities.

Question 8

Federal Tax Law

Answer 8

Income tax on profits; and Shareholders taxed on distributions (double taxations).

C-Corporations do pay tax.

S-Corporation (subchapter S in IRC): don’t pay tax at entity level. Requires: Max 100 shareholders (all human), all U.S. Citizens; one class of stock that’s not publicly traded

Limited Liability: Shareholders are generally liable only to pay for stock & not for corporate debts (with 1 exception). Only the corporation entity is liable for business debts.

Question 9

Doctrine of Defective Corporation

Answer 9

Proprietors failed to actually form a corporation, which means they are liable for business debts because they only have partnership.

2 Doctrines to help them escape (MUST BE UNAWARE - ACTING IN GOOD FAITH) - but abolished in many states!!

1. De Facto Corporation: (1) Relevant incorporation statute (generally given); (2) parties made good faith, colorable attempt to comply with statute; and (3) some exercise of corporate privileges (acting as though they were a corp).
   - - - Exception (Action by State does not protect under this doctrine)
2. Corporation by Estoppel: not a de jure corporation, but treated as such for people who treated the business like a corporation. Narrow - only applies to contract cases (not tort)

Question 10

Pre-incorporation Contracts

Answer 10

Everybody knows that a corporation did not exist yet.

Promotor - a person acting on behalf of a corporation that is not yet formed.

Liability:

• – Corporation is only liable if it adopted the contract (express; or implied adoption, which occurs if corporation accepts benefit of the contract)
• — Promotor is liable (unless contract provides otherwise) until there is a novation (even if corp adopts the lease - where both would be liable!!)
• — Foreign Corporations (outside of state where incorporated): must qualify (must register in state) and pay prescribed fees if transacting business here (regular course of intrastate activity) - must maintain agent and office in the state - If fails: cannot assert claim in state and may be liable for civil fee (however, can be sued).

Question 11

Raising Money in a Corporation

Answer 11

Debt Security (Bonds): Corporation borrows money and agrees to repay it with interest. The person holding a bond is a CREDITOR, not an owner.

Equity Securities (Stock): Corporation sells ownership interest to shareholders. Person holding stock is an OWNER.

Issuance: Corporation sells its own stock.

Question 12

Issuance of stock

Answer 12

Rules for issuance of stock (ONLY apply when Corporation is selling its own stock):

Subscriptions: written offers to buy stock from the corporation.
Pre-incorporation subscriptions cannot be revoked for 6 months.
Post-incorporation subscriptions are revocable anytime until the offer is accepted by the corporation (i.e. the board accepts the offer, and ya can’t get out).

Consideration:
Form - any tangible or intangible property or benefit to the corporation (cash/property/services/debt/promissory notes)
Amount - Par = minimum issuance price

Treasury Stock: company issued stock but reacquired it; can re-sell at whatever price it wants.

The BOARD must put value on the consideration and determine the value of property/services exchanged for stock (their valuation is conclusive IF made in “good faith”).

Watered stock - Directors are liable if knowingly authorized watered stock. Purchaser is also liable - no defense because he had notice of PAR value. If to 3rd party, they’re not liable if acting in good faith.

Question 13

Preemptive Rights of Stockholder

Answer 13

Right of existing shareholder to maintain % of ownership by buying stock if there is a new issuance for money (would not apply if employee getting stock for working).

If articles of incorporation are silent - NO preemptive rights.

Question 14

Requirements for Directors

Answer 14

Must be adult natural persons;

One or More directors (set in articles of bylaws)

Initially either (1) named by articles; (2) elected by incorporators; AND then elected by shareholders - sometimes staggered board.

Shareholders can fire directors prior to term expiration: with or without cause (but some states require with cause for staggered boards). If removing a person, generally must select replacement (otherwise may be the other board members who select replacement for retired one).

Board of directors act as a group; not agents and have no authority to speak/bind corporation. Only act in two ways (1) unanimous agreement in writing; Or (2) at a meeting that satisfies voting and quorum requirements.

No notice for regular board meetings;
Notice required for special meetings (at least 2 days unless bylaws say otherwise) - date/time/place but topic not required.
NO PROXIES OR VOTING AGREEMENTS ALLOWED - non-delegable fiduciary duties.

Question 15

Director Board Meetings

Answer 15

Any meeting must have quorum (majority of ALL directors).
Majority vote of present directors required to pass resolution.

Role of Board:
1) Manages corporation; sets policy; supervises officer; declares distributions; stock issuance; recommends fundamental corporate changes to shareholders.

May create committees with directors but cannot declare distribution, fill board vacancy or recommend fundamental change to share holders. But can recommend for FULL board action.

Question 16

Standard for Director’s Fiduciary Duty

Answer 16

STANDARD FOR A DIRECTOR - ALWAYS START HERE FOR FIDUCIARY DUTIES IF BOARD MEMBER MESSING UP
**
DUTY OF LOYALTY (Burden on D):
Director must discharge duties in good faith and with reasonable belief that her actions are in the best interest of the corporation; AND
**
DUTY OF CARE (Burden on P):
Director must use care that a person in a like position would reasonably believe appropriate under the circumstances.
**

Question 17

Duty of Care

Answer 17

Burden of Proof is on the Plaintiff:

1) Nonfeasance: Director does nothing (breach must cause loss to corp)
2) Misfeasance: Board makes decision that hurts business (not liable if meets business judgment rule).

Question 18

Business Judgment Rule

Answer 18

Courts will not second guess a poor or erroneous decision made by a director or officer if the decision was made:

1. in good faith;
2. informed; and
3. Had a rational basis

• duty of care *

Question 19

Duty of Loyalty

Answer 19

Applies when the fiduciary has a conflict of interest (bus judg rule does NOT APPLY)

Burden is on the Defendant.

Result: (1) Interested director transaction will be set aside; OR (2) director liable for damages; UNLESS D can show fair to corporation when entered, or that her interest and the relevant facts were disclosed or known, and the deal was approved by either (1) a majority of disinterested directors; or (2) a majority of the disinterested shares. ** some courts also require a showing of fairness.

Quorum rule of disinterested directors: must be majority, but at least 2

Types of conflicts that violate duty of loyalty:

1) Self-dealing / interested transaction
2) Competing ventures (remedy: constructive trust to get profits from D)
3) Corporate opportunity (director cannot usurp corp opportunity unless he tells board and waits for them to reject opportunity) - (something the company has an interest or expectancy in; or something that D found on company time or resources) - inability for company to pay is not a defense). Remedy: must sell to corp at cost; or give profit to corp if sold (constructive trust)

Question 20

Loans

Answer 20

A corporation can make a loan to a director if it is reasonably expected to benefit the corporation (e.g. education)

Question 21

Ultra Vires Acts

Answer 21

Where a corporation acts outside of its stated purpose (as stated in the articles of incorporation).

Question 21

Ultra Vires Acts

Answer 21

Where a corporation acts outside of its stated purpose (as stated in the articles of incorporation).

Question 22

When are directors liable

Answer 22

1) improper distributions
2) improper loans
3) ultra vires acts
4) breaches of fiduciary duties

A director is presumed to concur with board action unless dissent/abstention is noted in the writing of corporate records (minutes, in writing during/after meeting), and cannot dissent if voted for resolution at meeting.
—- Exceptions: (1) not liable if not present at meeting; OR (2) good faith reliance on information provided by non-member or professional.

Question 23

Officer Duties

Answer 23

Officer: President, Treasurer, Secretary

Owe same duties of care and loyalty as directors.

Officers are agents of the corporation (corporation is the principal).

Corporate President has inherent authority to bind corp to contracts in ordinary course of business.

Officers are selected and removal by the Board.
Shareholders hire/fire Directors

Question 24

Indemnification of Directors and Officers

Answer 24

Facts: Officer or Director sued and now seeks reimbursement from corporation. Articles can limit director's liability in duty of care cases (not loyalty cases). Situations: Category 1: Corporation CANNOT indemnify when D/O held liable to corp or held to have received an improper benefit Category 2: Corporation MUST indemnify if D/O successful in defending either on merits or otherwise. Category 3 (catch all): Corporation MAY indemnify if D/O shows that she acted in good faith with reasonable believe that what she did was in the best interest of the corporation (duty of loyalty). - - - Eligibility Determined by: Disinterested Directors / Shareholders / Indep. Legal Counsel can determine if eligible.

Question 25

Closely Held Corporation

Answer 25

Generally shareholders do not manage corporation, but can in a Closely Held Corporation. - Shareholder Management Agreement (in articles & approved by shareholders or my unanimous shareholder agreement) - Small number of shareholders that manage directly (duty of care/loyalty to other shareholders) - Stock not publicly traded

Question 26

Professional Corporation (Association)

Answer 26

PC, PA Articles must state purpose to practice particular profession Directors, officers, and shareholders must be licensed professionals Liable for own malpractice but shareholders not. Shareholders generally not personally liable for corporation obligations but may be liable if corporate veil pierced.

Question 27

Piercing the Corporate Veil

Answer 27

A doctrine that allows shareholders of a *closely held corporation* to be sued for the debts of the corporation when fairness requires it. Result: Corporate entity is disregarded so that shareholders, officers, directors, etc. can be held liable. PCV TEST: (1) Did a shareholder abuse the corporation? AND (2) Would it be unfair for X to have limited liability? Courts can pierce when: 1. Ignoring Corporate Formalities (alter ego: corp not treated as separate entity). 2. Inadequate Capitalization (undercapitalization: not enough $$ at time of incorp) - shareholders failed to invest enough to cover prospective liabilities. 3. Fraud or Illegality Once pierced, all persons who actively manage the closely held corporation (i.e. all shareholders) may be held personally liable. Can be another corporation. ** COURTS MAY BE MORE WILLING TO PIERCE THE VEIL FOR A TORT VICTIM THAN A CONTRACT BREACH **

Question 28

Derivative Suit

Answer 28

Shareholder (P) sues on behalf of the corporation and against the corporation (BOD) to enforce the corporations rights. Often arises when director or officer breaches duty of care/loyalty owed to corporation but has not taken action. Standing: (1) shareholders bringing suit must have owned stock been so at the time of suit (or by operation of law); (2) must provide adequate representation of corp's interest; (3). Written Demand Required: SH must make written demand on Corp and wait 90 days before filing suit UNLESS (1) Corp has already rejected SH demand; OR (2) irreparable injury to corp will result if waiting full 90 days. Recovery: goes to corporation, but SH may recover legal expenses (unless they lose and then liable to D if no reasonable cause). So - if you see a wrong committed by an D/O, identify the breach, and what shareholder remedies are available. Standard to dismiss - If independent investigation (independent directors or court appointed panel of independent person) concludes that suit is not in the corporation - low chance of success, expense exceeds recovery

Question 29

Direct Suit

Answer 29

RARE Occurs when the corporation, its officer, or director caused harm to, or breached a duty owed to a particular shareholder. Recovery: for shareholder or shareholder class. Examples: issue dividend

Question 30

Shareholder Voting

Answer 30

Authorized stock: max number of shares a corp can sell Issued stock: number of shares corp actually sells Outstanding stock: shares issued and not acquired Record shareholder: person shown as stock owner in the corporate records Record date: the voter eligibility cutoff Exception to record owner rule: 1. if corp reacquires stock, then no one votes on that share. 2. if shareholder dies, executor can vote 3. Proxy: writing authorizes another to vote the shares (good for 11 months - can revoke by writing or attending meeting) Irrevocable proxy - (1) must state it AND (2) proxy has some interest in the shares other than voting (such as option to buy)

Question 31

Shareholder Voting Trusts & Agreements

Answer 31

Voting Trust: written agreement controlling how shares will be voted; copy to corporation; transfer legal title to voting trustee; original shareholder gets trust certificate and retain all rights except to vote Voting (Pooling) agreements requires (1) in writing and (2) signed. Shareholders can call meetings with 10% or more to hold special meeting. Shareholders CANNOT fire officers. Shareholder Meeting notice: must be in writing, delivered 10-60 days before meeting; must state date/time/place. Special Meeting Notice: must also state purpose of meeting because the SH cannot do anything else at the meeting. Failure to give notice: action at meeting is voidable unless SH waived (express / implied is attending mtg without objection to failed notice)

Question 32

Shareholder Votes

Answer 32

``` Elect (requires PLURALITY - more seats than others) Remove directors (MAJORITY) Vote on fundamental corporate changes Other things if board asks Amend bylaws. ``` MUST HAVE A QUORUM - which is measured by number of shares held (not people) - usually requires a majority of outstanding shares. If people leave mtg, cannot lose quorum (different than BOD). Generally - just need majority of shares that vote on the issue. Cumulative Voting (only electing directors): Method to give small shareholders better chance of electing someone to the board - one at large election & top finishers are elected. Voting power = # of shares X number of directors to be elected. Does not exist unless Articles say so. Straight Voting: series of individual elections for each seat.

Question 33

Stock Transfer Restrictions

Answer 33

Usually in close corporation to keep outsiders out. Transfer restriction are allowed if they're not absolute restraints on alienation. Right of First Refusal to company (valid restriction). Restriction must be noted on stock certificate & transferee must have knowledge to be enforceable.

Question 34

Shareholder Right to Inspect

Answer 34

Shareholder's right to review corporations books and records on written demand. No proper purpose needed. Uncontroversial things include: minutes / bylaws / name & addresses of current directors & officers / recent annual report Procedure for Controversial Information? Demand must state a proper purpose! Include: excerpts from board mtgs / accounting records / records of shareholders.

Question 35

Distributions

Answer 35

Payments by corporations to the shareholders at the board's discretion. 1) Dividend 2) Repurchase of Stock 3) Redemption: forced sale to corp at set price in articles Courts defer to board, but P may win if strong showing of abuse of discretion (e.g. show consistent profits, board refuses dividend but pays themselves a bonus).

Question 36

Dividends

Answer 36

BOD declares. Preferred means pay FIRST. Then Common stock gets paid. Corporation cannot make any distribution if it is insolvent or if the distribution would render it insolvent. Insolvent: Corp is unable to pay debts as they become due or their total assets are less than their total liabilities (including preferential liquidation rights). Directors are jointly and severally liable for improper distribution UNLESS GOOD FAITH RELIANCE DEFENSE on financial professionals. Shareholders can be personally liable for improper distributions if they knew when they received it.

Question 37

Fundamental Corporate Changes

Answer 37

Board generally cannot act alone. Things like: amending articles, merging/consolidating, transferring all assets, voluntary dissolution, conversion into another form of business. Requirements: 1. Board Action to adopt fundamental change; 2. Submits written notice to SHs 3. Shareholder Approval (typically majority of eligible voting shares) 4. Deliver change information to Secretary of state Dissenting Shareholders right of appraisal: right to force corp to buy stock at fair market value. Can only be triggered by merge/consolidate, transfer substantially all assets, stock being acquired in stock exchange, or conversion to another form of business... BUT: even if corp doing this, no appraisal if their stock is listed on a national exchange or 2,000+ share HOLDERS (number of people) - so only in close-corps. Shareholder must: file written notice of objection and intent to demand payment; vote against change; and after vote, make written demand to be bought out and deposit stock with company. If no FMV, then corp will sue and appraiser hired. Absent Fraud, right of appraisal is the remedy for dissenting SH.

Question 38

How to make fundamental changes

Answer 38

Amending articles Merger: one corp is absorbed into another (no SH approval required if 90% owned subsidiary "short form merger") Consolidation: two corps become one new corp Transfer of all or substantially all assets - one company gobbles up (at least 75%) assets or gobbles up stocks. A fundamental change for SELLING corp only, so only notice/approval to selling corp & rights for dissenting SH (buying co doesn't need anything). Conversion: A business converts into another form (Corp to LLC) Dissolution: voluntary vs. involuntary (court order) 1. BOD action; 2. notice to SH; 3. SH approval (majority of shares entitled to vote) 4. Deliver to secretary of state (not for share of assets) Surviving corporation: Corporations can sue survivor (NOT for xfer of assets unless a "mere continuation of seller" or de facto merger)

Question 39

Right to involuntary dissolution

Answer 39

Requires Court Order Shareholders / Creditors can petition for when BOD: 1. Director Abuse; Waste of assets; Misconduct 2. Deadlock 3. Directors failed to fill board vacancy Court may just require buy-out in close corp. Does not end corporation, but starts wind-up ("liquidation") process and will continue to exist.

Question 40

Liquidation Process

Answer 40

Requires: 1. Written notice to known creditors & publish notice of dissolution in newspaper in PPB; 2. Gather all assets; 3. Converts assets to cash; 4. Pay creditors; 5. Distribute remaining sums to shareholders, pro rata, unless liquidation preference (articles).