Corporations Flashcards
Board approves act of director with personal interest in transaction
Did he fail to disclose all of the material facts?
A transaction cannot be set aside merely because a director had a personal interest in the transaction if the director disclosed the material facts of the transaction to disinterested members of the board or the shareholders, who approved the transaction, or the transaction was fair to the corporation
Board Meeting Requirements
- QUORUM needed for ANY meeting of the board
- Unless bylaws say otherwise, quorum = majority of ALL directors on the board
- Quorum can be LOST if people leave! (Broken quorum)
- Majority of those PRESENT required to pass resolution
Resolutions passed by majority of the quorum
Business Judgment Rule
Court will not second guess business decision if made in good faith, informed, and had rational basis
- Good faith
- With the care that an ordinarily prudent person would exercise in like position
- in a manner generally believed to be in the best interests of the corporation
- Presumption that when the board acts, it did appropriate due diligence
- Did the board do their homework before making their decision? Can rely on experts and corporate insiders where reasonable.
Bylaws
Operating manual for corporation
- Not filed with the state
- ARTICLES govern if conflict
- Board or shareholders can amend, repeal, and adopt
Can shareholders be held liable for corporate debts?
Generally not because the corporation is liable for what it does. But…
PIERCING THE CORP VEIL: doctrine that allows shareholders to be sued for debts of corp
- Available only in CLOSE CORPS
Can shareholders manage the company?
Generally not. But can eliminate the board and manage directly in a CLOSELY HELD corporation:
1. Small number of shareholders
2. Stock not publicly traded
*SHAREHOLDER MANAGEMENT AGREEMENT
Should be conspicuously noted on front and back of stock certificate
MANAGER owes duties of care and loyalty to corp
- Sets up alt management
1. In the articles and approved by all shareholders
2. Unanimous written shareholder agreement
** Generally, management is vested in the board of directors, who are voted by the shareholders
Consideration for issuance
- Form: any tangible or intangible property or benefit to the corp
- Very broad
- Only problematic when there is no consideration - Amount: par = minimum issuance price
- No par = no minimum issuance price
- Up to BOARD, if made in good faith
- Watered stock = sold for under required par. Directors are liable if they knowingly authorized the issuance. Purchaser is liable, no defense, since charged with knowledge of par value
** Corporatate statuses
- De jure: followed all statutory provisions, insulates against personal liability of shareholders
- De facto: colorable compliance wiht most provisions and exercise of corporate privilege, insulates against personal liability, but corporation subject to quo warranto by state
- Estoppel: parties act as if there is a corporation; no requirement of following statutory provisions; insulates against personal liability in contract but not in tort
Corporate Opportunity
A director cannot usurp a corporate opportunity until 1. he tells the board about it, and 2. he waits for the board to reject the opportunity
- Breach of duty of loyalty
- Opportunity: something the company has an interest/expectancy in; defendant found on company time/with company resources
- Corp’s financial inability to pay is not a defense!
- Remedy: must sell to corp at his cost. If he sold for profit, corp will get that profit (constructive trust)
Corporation by Estoppel
Not a de jure corporation, but treated that way for people who treated the business like a corp
- Applies only in CONTRACT, not tort!
** ultra vires is not a good excuse
De Facto Corporation Requirements
De facto; treated as corp for all purposes except in action by the state (quo warranto)
- Relevant incorporation statute (automatically met)
- Good faith attempt to comply with statute
- Act like a corp; exercise of corp
Defective Incorp
Wrongly thought there was a corporation, failed to do so. Merely a partnership.
- Proprietors can nevertheless escape liability if they are UNAWARE of failure to form de jure corporation.
- Equitable, must be in good faith
Abolished in many states but…
1. De facto corporation
2. Corporation by estoppel
Director Voting
Directors cannot give proxies or enter into voting agreements
- Void
- Policy: directors owe the corporation NON-DELEGABLE fiduciary duty
- Cf. SHAREHOLDERS, who can vote by proxy and enter into voting agreements
Dissolution
Triggers the winding up process. Can still sue and be sued, but cannot start new business.
- Voluntary: requires board action and shareholder approval. File notice of intent to dissolve with SoS, and corp exists only to wind up, notify creditors so they can make claims
- Involuntary: requires court order.
- Shareholder: for director abuse, waste of assets, misconduct, harmful director deadlock, failure at consecutive meetings to fill board vacancy. Court may just order buyout of objecting shareholder, e.g., in closely held corp
- Creditor: insolvent and creditor has unsatisfied judgment or corp admits debt in writing
Duty of Care
Burden on PLAINTIFF
- Nonfeasance: director does NOTHING
- Liable only if breach causes loss to corporation - Misfeasance: board makes decision that hurts business
- Causation is never a problem
- Director is not liable if she meets the BUSINESS JUDGMENT RULE
Duty of Loyalty
Burden on DEFENDANT. Business Judgement Rule never applies! Cases about conflict of interest
- Self dealing (i.e. between director/close relative and corp) / interested director transaction
- Competing ventures
- Corporate opportunity
Exculpatory provision
A corp’s articles may limit or eliminate directors’ personal liability for damages to shareholders or corporation for actions taken UNLESS
1. Received a benefit to which he/it is not entitled
2. Intentional harm to corporation
3. Approved unlawful distributions
4. Intentionally committed a crime
* Negligence okay
Fiduciary duties in closely held corps
Vertical: manager owes duties to corp
Horizontal: shareholders in close corporations owe a fiduciary duty of utmost good faith to OTHER SHAREHOLDERS
- Close corp looks a lot like a partnership…
- If there is oppression of minority shareholder, courts will sometimes allow suit because minority shareholder cannot sell/no way out
Fiduciary Duty Owed by DIRECTORS
Non-delegable!
- “A director must discharge her duties in good faith and with reasonable belief that actions are in the best interest of the corp.”
- Duty of LOYALTY - “She must also use the care that a prudent person in like position would reasonably believe appropriate under circumstances.”
- Duty of CARE
Formation
- Person: incorporator
- One or more
- Executes the articles and delivers to SoS
- Could be entity
- Need not be citizen of state of incorp - Paper: articles of incorp
- Name (must include corporation, company, incorporated, or limited)
- Name or address of incorporator(s)
- Name of the registered agent and address of the registered office in state of incorporation
- Information re: stock; authorized stock (max shares), number of shares in each class, voting rights and preferences of each class
- Option: initial directors - Act: incorporator delivers notarized articles to SoS and pays fees
- ACCEPTANCE for filing = de jure corporation
Fundamental Corp Change requirements
- Board action
- Written notice to shareholders
- Shareholder approval
- Generally, majority of shares entitled to vote
- Modern, only majority of actual voting shares - Deliver document to SoS
Fundamental Corp Changes
- Amending articles
- Mergers and consolidations
- Transfer of all or substantially all assets
- Voluntary dissolution
- Conversion into another form of business
Kinds of shareholder meetings
- Annual
- Required
- If none held within 15 mos, shareholder can ask court to require one
- Elect directors - Special
- Called by the board, president, the holders of at least 10% of the outstanding shares, or anyone else as authorized in the bylaws
- Can fire directors (not officers)
- Limited to purpose
Notice for meeting
Set in bylaws
- Regular meeting: no notice
- Special meeting: notice required
- Unless bylaws say otheriwise; at least 2 days’ notice of date, time, and place…need not state purpose
- Remedy: anything at the meeting is void/voidable unless the directors who were not notified waive the notice defect - In writing, any time
- Attending meeting without objecting at outset
Organizational meeting
After formation, next step
- If directors named in arts, will hold. If not, incorporators can hold and elect the initial directors
- Must COMPLETE the organization of the org
1. Appoint officers
2. Adopt initial bylaws
Perfecting Right of Appraisal
Shareholder dissents from fundamental corporate change; forces corp to buy shares at fair price
Before vote, shareholder must -
1. File with corp written notice of objection and intent to demand pay
2. At shareholder vote, must abstain or vote against
3. After vote goes through, make written demand to be bought out and deposit stock with company
- If cannot agree on fair value of shares, corp will sue and court may appoint appraiser
** Generally only remedy unless there is fraud
Piercing the Corp Veil
Imposition of liability on shareholder…could be human or another corporation, e.g. parent/subsidiary
1. Shareholders have abused the privilege of incorporating
2. Fairness requires holding them liable
Common situation
- Fraud,
- Alter ego: commingles corp and personal funds, corp funds and resources for personal use…court may allow creditor to collect from shareholder. Other shareholder would not be liable!
- Undercapitalization: corporation did not have enough money WHEN FORMED if shareholders failed to invest enough to cover prospective liabilities, e.g., take out appropriate insurance
* Courts may be more likely to pierce for tort victim than contract claimant
** Powers of the president
Agent of the corp, can enter into contracts for day to day operations
- Extraordinary actions if authorized by the board
Pre-incorporation contracts
Know there’s no corp…requires PROMOTER: person who procures commitments for capital and instrumentalities on behalf of a corporation that will be formed in the future
- Unless CLEARLY says otherwise, e.g., that the promoter is not to be bound (contract is treated as an offer to the proposed corporation), PROMOTER is PERSONALLY liable until there is a NOVATION (agreement of promoter, corp, contracting party that corp replaces promoter under contract)
- Corporation is liable only if it ADOPTS, and adoption makes corp liable but does NOT relieve promoter!
- Express, e.g., by board resolution
- Implied (acquiescence, conduct normally constituting estoppel)
Requirements to Bring Derivative Suit
- Stock ownership when claim AROSE and throughout the suit
- Can also bring if received by operation of law (inheritance/divorce decree) by someone who owned stock when claim arose - Must provide adequate representation of the corp’s interest
- Written demand on corp (usually board) that corp bring suit
- May not have to make demand if it would be futile, e.g., directors themselves would be the defendant…demanding that they sue themselves…
Revocation of a Proxy
Proxies are generally revocable unless they say the are irrevocable and are coupled with an interest (situations in which the proxy holder essentially pays for the right to be a proxy, e.g., purchasing underlying shares)
- May be revoked by a SUBSEQUENT INSTRUMENT or by Shareholder of record SHOWING UP and voting the shares himself
Revocation of Proxy
REVOCATION:
1. Writing to the corporate secretary
2. Attending meeting and voting
IRREVOCABLE PROXY:
1. Must state that it is irrevocable
2. Must be combined with an interest in shares other than voting, e.g. proxy-holder has option
Right to Inspect
Shareholder’s right to review corp’s books and records on written demand
- Any shareholder can do so
Non-controversial request: merely makes written request 5 business days in advance. Need not state a proper purpose.
- Articles, bylaws, minutes of shareholder meetings, names/addresses of current directors/officers
Controversial request: same but demand must state a proper purpose, i.e., related to interest as shareholder
- Minutes of board meetings, accounting records, record of shareholders
* IF corp fails, s/h will seek court order. If wins, can recover fees and costs in making motion.
* C.f. directors, who have unfettered access to these materials
Self Dealing
Violates the duty of loyalty
** An interested director transaction will be set aside or the director will be liable in damages unless the director shows that 1) deal was fair to corp when it was entered or 2) her interest and the relevant facts were disclosed/know and the deal was approved by MAJORITY (min 2) of disinterested directors or a MAJORITY of disinterested shares
- Quorum = majority of disinterested directors (min 2)
- Even if deal gets approved…some courts also require showing of fairness
Shareholder as Plaintiff
Derivative Suit: shareholder sues to enforce CORP’s claim
- Could the corp have brought suit itself? If so, derivative
- Breach of duty of care / loyalty are always derivative suits b/c owned from d/o to corp (vertical fiduciary duty)
C.f., DIRECT suit, where SHAREHOLDER herself is hurt
Shareholder meeting notice
Must be in writing and delivered 10-60 days before meeting
- To every shareholder entitled to vote
- Must state date, time, place of meeting
- For SPECIAL MEETINGS: must state purpose b/c shareholders cannot do anything else at that meeting
- Remedy: actions void/voidable unless those who were not sent notice waive the notice defect by
1. express: in writing, signed anytime
2. implied: attend the meeting without objecting at the outset
Shareholder Meeting Quorum
Majority of VOTING shares, not shareholders!
- Number of people is irrelevant
- Not LOST if people leave (c.f. board quorum)
Shareholder Vote Requirements
- Elect a director: plurality (more votes than anyone else)
- Remove a director: traditionally, majority of all voting shares. Now, majority of shares that ACTUALLY vote on the issue
Shareholder voting (pooling) agreement
Must be in writing and signed.
- Usually specifically enforceable
- Can be perpetual
- Shareholders retain both legal and beneficial ownership
Shareholder voting trust
Requires –
- Written agreement controlling how the shares will be voted
- Copy given to corp
- Transfer legal title to voting trustee
- Give original shareholders trust certificates. Retain all rights but the right to vote.
- Usually max out at 10 years
Standard to Dismiss Derivative Suit
After filing, corp may move to dismiss based on independant investigation that concluded that suit is not in the corp’s best interest
- E.g., low chance of success, too expensive
- Finding made by independant directors or court appointed panel of independant persons (e.g., special litigation committee)
- If those recommending dismissal were independant and made a reasonable recommendation, court will usual dismiss suit
Transfer of all or substantially all assets / share exchange
Substantially all is generally at least 75%
- Fundamental for SELLING corp only! Not for buyer!
- Notice to SELLING corp / approval from SELLING corp’s shareholders
- BUYING corp shareholders do not have to approve / cannot vote
- Rights of appraisal to shareholders of SELLING CORP
- Deliver articles of exchange to SoS, but no filing
- NO successor liability! Selling corporation still exists…Company that buys another’s assets not liable for its debt, unless buyer is mere continuation of seller, i.e., same management/shareholders, etc. Will be if just a disguised / de factor merger
Treasury stock
Company issued, but reacquired
- Authorized. Corp can re-sell at any issuance price.
- Not considered “outstanding”
Votes needed for fundamental corp changes
Requires majority of shares entitled to vote
- May be changed by state law
Voting provisions in Articles of Incorp or Bylaws prevail?
If there is a conflict…
Vote required for approval may be set in AOI or Bylaws, but when the two conflict the AOI CONTROL!
What if shareholder dissents from fundamental corp change?
Dissenting Shareholder’s Right of Appraisal: right to force corp to buy stock at fair value. Triggered ONLY by…
- Merging or consolidating
- Transferring substantially all assets
- Stock being acquired in share exchange
- Conversion to another form of business
LIMIT: even if company is doing one of these, there is no appraisal if company’s stock is listed on national exchange or company has 2000 or more shareholders
- Exists in close corporations
- In public corp, just sell stock
Which shareholders can vote?
Unless otherwise stated, each outstanding share has one vote
- Must be the RECORD SHAREHOLDER (shown as stock owner in corp records) as of the RECORD DATE (eligibility cutoff date) to vote, NOT as of the meeting
Who may vote at a shareholder meeting?
Shareholders of record ON THE RECORD DATE may vote at a shareholder meeting
- If purchased AFTER the record date, not entitled to vote. Would have to obtain a proxy from seller.
Adoption
- Express adoption: board takes express act adopting contract
- Implied: corp accepts a BENEFIT of the contract
Authorized stock
Max number of shares a corp can sell
Benefit corporation
B-Corp; formed for profit but to pursue some benefit to a broader social policy cause
- Must say so in articles
- Files annual benefit report
- Decision makers can think beyond the bottom line
Board of directors
In charge of management
- Elected by the shareholders
- Appoints officers
C-Corp
Do pay income tax at the entity level
Can one person hold multiple offices?
Yes, one person can be all officers at once
Competing Ventures
A director cannot compete directly with her corporation
- Breach of duty of loyalty
- Remedy: corporation gets constructive trust over profits from competing venture
Consequences of forming a corp
- Internal affairs rule: governed by the laws of state of the state of incorporation
- Entity status: is a legal person; can sue, hold property, be a partner, invest, contribute to charity etc.
- Double taxation: corporation pays income tax, and shareholders pay income tax on distributions to them
- Limited liability: corporation’s debt/tort/contract…shareholders are not personally liable. Directors/officers not liable. Corporation itself is liable (cf. partnership, partners liable)
Conversion
Corp converts into another business entity
Corporation Loans
Corp can make loan to direct if reasonably expected to benefit the corp
- E.g., so director could take business courses
Cumulative Voting
Method to give small shareholders a better chance of electing someone to the board
- Do NOT vote for each seat individually; one at-large election, and top finishers are elected to the board.
- Voting power = number of shares x number of directors to be elected
- Can allocate votes however
- Usually only comes up in closely held
- ONLY for director elections
- C.f., straight voting
- Must by in the articles
Derivative Suit Outcomes
- Plaintiff shareholder WINS: $ from judgement goes to CORP. Plaintiff recovers costs and fees only (usually from judgement)
- Plaintiff shareholder LOSES: cannot recover costs/atty fees, and is liable for defendant’s fees if he sued without reasonable cause; other shareholders are barred from suing on the same transaction again
Director compensation
Can set their own compensation in good faith
- If excessive, corporate assets, breach of duty of loyalty
Distributions
Payments from corp to shareholders
- Dividend
- Repurchase
- Redemption: forced sale to corp at price set in articles
** In the board’s discretion! No right until board declares it. To win, plaintiff must show abuse of discretion (direct, not derivative suit)
Elimination of Liability
The articles can eliminate director (and sometimes officer) liability to the corporation for damages only for DUTY OF CARE
- Will not cover intentional misconduct, usurping, unlawful distribution, improper personal benefit
Exceptions to Record Owner Rule
- Corp reacquires stock before the record date, so corp is owner of treasury stock as of date. Not outstanding, no vote.
- Shareholder dies AFTER record date, executor CAN vote
- Proxy: writing directed to secretary of corp and signed by record shareholder authorizing another to vote the shares
- Only good for 11 months, unless it says otherwise
Foreign Corporations
Corporation formed outside of the STATE, not just another country!
- Transacting business = regular course of INTRAstate business activity. Not merely owning property, occasionally doing business.
- If transacting business in state, must qualify and pay prescribed fees
- Register, gets certificate of authority with SoS
- Give info from articles, prove you’re in good standing in home state
- Provide registered agent and registered office in state
- Penalty: civil fine, and corp cannot assert claim in state. Can be sued and defend.
- Once back in good standing, can assert claim
Indemnification of Directors and Officers
Someone is sued in her capacity as an officer/director…now seeing reimbursement.
- Category 1: corp CANNOT indemnify
- D/O held liable to corp
- Improper benefit
- Requires holding (not mere settlement) - Category 2: corp MUST indemnify
- D/O successful in defending on merits or otherwise (not settlement) - Category 3: corp MAY indemnify (permissive)
- D/O shows acted in good faith w/ reasonable belief that what she did was in the corp’s best interest (duty of loyalty)
- Eligibility determined by disinterested directors/disinterested shares/independant legal counsel
- Catch-all…if doesn’t fall into to category 1/2, automatically category 3
** The court can order reimbursement if it is justified in view of all of the circumstances. If held liable to the corporation, cannot cover judgment itself, but can for attorney fees and costs
Issued stock
Number of shares corp actually sells
Mergers and consolidations
Merger: one corp is absorbed into another
Consolidation: two corps become one new corp
- Requires board actions for both companies, shareholder approval from both corporations
- No approval required for a SHORT FORM MERGER: owning a 90% or more owned subsidiary into the parent
- Surviving corp delivers papers to SoS
- Triggers right of appraisal for shareholders entitled to vote, shareholders of subsidiary in short form
- Absorbs all assets and liabilities
- Successor liability: creditor can sue surviving company
Methods of board action
Must act as a group
- Individual directors are not an agent for the corporation
1. Unanimous agreement in writing (sep documents okay) - Need to decide together, not individually
2. At a meeting that satisfies quorum and voting requirements - Conference call is okay
Officer duties of care
Officers owe same duties of care and loyalty as directors
- Officers are AGENTS of the corporation
- President usually has inherent authority to bind corp to contracts in the ordinary course of business
Officers
Agents who carry out corporation’s policy
Outstanding stock
Shares issued and not reacquired (out of authorized stock)
Preemptive right
Right of existing shareholder to maintain % ownership by buying stock if there is a new issuance for MONEY
- If articles are silent, no preemptive rights
Preferred stock
Pay first (not more!)
Procedural Considerations for Derivative Suit
- Corp is joined as a defendant
- Court APPROVAL is required to settle or dismiss derivative suit. Court may give notice to shareholders to get input on whether to approve
Professionals
Licensed professionals may incorporate as a professional corp or professional association
- Directors, Officers and Shareholders must be licensed professionals
- Name must contain these phrases / abbreviations
- Articles must state that the purpose is to practice a particular profession
- Professionals are all liable for their own malpractice, but shareholders are generally not liable for the corporate obligation or the other professionals’ malpractice (advantage over partnership)
Raising Money in a Corporation
- Debt securities: corp borrows money and agrees to repay with interest (bonds). Person holding bond is CREDITOR, not owner.
- Equity securities: corp sells ownership interest (stock). Holder is OWNER, not creditor.
- Issuance: corp sells its own stock
Removal of directors
Shareholders can remove directors before their terms expire
- Directors are removable with or without cause
- EXCEPTION: same states, staggered board = only with cause
Requirements for directors
- Adult natural persons
- One or more
- Set in articles or bylaws - Initial directors may be named in articles or elected by incorporators at organizational meeting
- Shareholders elect thereafter
- Entire board elected each year unless staggered/classified; usually set in articles
Responsibilities reserved for the full board
Fundamental decisions; approve distributions, fill board seats
- Committees can recommend things for full board action
S-Corp
Do not pay income tax at the entity level
- Max 100 human shareholders. All must be humans, US citizen. - Stock not publicly traded
Selection and removal of officers
Officers are selected and removed by the board
- Board sets the officer compensation
- Corp may be liable for breach of contract damages
Selection of interim directors
board, shareholders
- If the shareholders created the vacancy, then they generally must select replacement
Shareholders/stockholders
Owners of the corporation
Stock transfer restrictions
No absolute restraints on alienation. Must be reasonable.
- E.g., right of first refusal is valid
- To enforce against buyer, must be conspicuously noted on stock certificate or transferee had actual knowledge of restriction
Straight Voting
Separate election is held for each seat on the board
- Each share gets one vote per seat
- Candidate who gets more votes than another elected to that seat
- Default if articles are silent
Subscriptions
Written offers to buy stock from the corporation. Revocable?
- Pre-incorporation subscription: NO. Irrevocable for 6 months.
- Post-incorporation subscription: YES> Revocable until accepted by corp, i.e., when the BOARD accepts the offer
Voting matters
Shareholders may
- Elect/remove DIRECTORS
- Fundamental corp changes
- Something board asks, e.g., amend bylaws
When can a corp make a distribution?
Corp cannot make any distribution if insolvent or distribution would render it insolvent
- Insolvent: corp is unable to pay debts as they come due, or total assets < total liabilities (include preferential liquidation rights)
- Directors are jointly and severally liable for improper distribution
- Exception: good faith reliance
- Shareholders are personally liable only if they knew the distribution was improper when they received it
Where do shareholders vote?
- At meeting (can be held anywhere)
- Unanimous written consent signed by holders of all voting share
Which directors are liable?
Director is presumed to concur with board action unless dissent/abstention is noted in writing in the corp records
- In writing: in the minutes or delivered in writing to the presiding officer at the meeting or written to corp immediately after meeting. ORAL dissent is not effective by itself!
- Director cannot dissent if she voted for resolution at the meeting
- You are not liable if you were absent from the meeting
- Good Faith Reliance: on information presented by officer, employee, or committee of which director relying was not a member or on professional reasonably believed competent.
Which shareholders get dividends?
- Only common stock: divid eevenly amongst common stock
- Mix of common and preferred stock: number of preferred shares x preference amount; pay that out to them. Then, remainder is paid out to common shares equally.
Winding up
- Provide written notice
- To known creditors
- In newspaper in county of PPB - Gather assets
- Liquidate assets (cash)
- Pay creditors
- Distribute remaining sums to shareholders
- Pro rata by shares unless there is a liquidation preference (pay first)
- Preference will be in articles
- Preferences may be relevant to INSOLVENCY…since liabilities include liquidation preferences
