Corporations

Question 1

Pre-Incorporation Transactions

Answer 1

o Promoter—enters into contracts securing capital to bring the corporation into existence
 Personally liable for a contract entered into pre-incorporation, even after the
corporation comes into existence
 Exceptions:
a) Novation—the corporation and the third party contract agree to substitute the
corporation for the promoter
b) Adoption—the corporation takes the benefits of the contract

Question 2

Incorporation

Answer 2

Must file articles of incorporation with the state

o Ultra Vires Act—occurs when a corporation has a narrow purpose and acts outside the
scope of that purpose

 A shareholder can file a suit to enjoin the action or take action against the officer,
director, or employee who engaged in the act.

Question 3

De Jure Corporation—

Answer 3

De Jure Corporation—exists when the statutory requirements for incorporation are met
o A good faith attempt to incorporate can still invoke corporate protections if:

1) De Facto Corporation—attempted to incorporate and ran business believing it was
incorporated

2) Corporation by Estoppel—a third party entered into a contract with the corporation as
though it was properly incorporated; the third party is estopped from asserting that the
corporation was not formed appropriately
Example 1: Based on a past bar essay: L and M i

Question 4

Securities (Stock), Valuation, and Federal Causes of Actions

Answer 4

1. Valuation
   o Board of directors must determine whether the value paid for the stock is adequate
   o Par Value Stock—corporation assigns a minimum value to its stock
    If sold for less than the par value, the board is liable
    Shareholder may also be liable if had knowledge of par value
2. Federal Causes of Action for Improper Sale of Securities (Stock)
   o Rule 10b-5; and
   o Section 16(b)
   Exam Tip 1: These causes of action are not frequently tested issues. See the
   outline for more information.

Question 5

Shareholders: Meetings

Answer 5

1. Meetings
   o Required to hold an annual shareholders meeting
   o The primary purpose is to elect directors.

Question 6

Shareholders: Right to inspect Corporate Records

Answer 6

o Restricted to normal business hours
o Requires five days’ notice
o Must state a proper purpose

Question 7

Shareholders: right to vote

Answer 7

o To select the board of directors
o To approve fundamental corporate changes (e.g., merger, sale of corporation)
a. Proxy Voting
 Proxy—written agreement to allow a person to vote on behalf of the shareholder
 Revocable unless otherwise stated (irrevocable proxy is allowed)

Question 8

Shareholders: Power to amend Corporate Bylaws

Answer 8

o Can amend or repeal existing bylaws
o Can pass new bylaws
o Can limit the board of director’s ability to change the bylaws

Question 9

Shareholder Agreements

Answer 9

May enter into an agreement to vote their shares together

Question 10

Right to Sue the Corporation

Answer 10

If the prompt simply asks whether a shareholder can sue the corporation, discuss the possibility of a direct action AND a derivative action.

a. Direct Action
 Suing the corporation for their own benefit (i.e., to remedy a wrong personal to the
shareholder)
 Usually arises when the shareholder is denied voting rights, the board failed to declare a
dividend, or the board failed to approve or deny a merger

b. Derivative Action
 Suing on behalf of the corporation
 Usually against a director or officer
 Any recovery goes to the corporation
 Standing—any person who is a shareholder at the time of the bad act or omission (and
at the time the action is filed)
 Demand upon the board—required to demand action by the board
• Board has 90 days to act before filing derivative action (unless demand is rejected,
or irreparable harm would occur)
• Futility exception—no demand is required if it would be futile
Example 2: If the shareholder is accusing the board of directors of
wrongdoing, it would be futile to demand that the board bring a suit against
itself.
 Board dismissal—can bring motion if the action is not in the corporation’s best interest
• Can be challenged if board was not disinterested or not acting in good faith

Question 11

Shareholder Liability—Piercing the Corporate Veil

Answer 11

Generally, not personally liable for corporate acts
o Court may “pierce the veil” and hold shareholders personally liable
o Based on totality of circumstances, including the following factors:
 Undercapitalization of the corporation at the time of formation
 Disregard of corporate formalities (not holding annual meetings or holding votes)
 Use of corporate assets as a shareholder’s own assets
 Self-dealing with the corporation
 Siphoning corporate funds or stripping assets
Exam Tip 3: On the exam, discuss each fact that supports or negates the
contention that the shareholder is abusing the protections of the corporation.

Question 12

Shareholders’ Fiduciary Duty

Answer 12

o “Controlling” shareholders have a duty to not abuse their power to disadvantage minority
shareholders.
o Controlling shareholder—someone who owns more than 50% of a corporation or otherwise
controls voting power

Question 13

Board of Directors

Answer 13

• Manage and direct the corporation’s business and affairs

* Selected by the shareholders at the annual shareholder’s meeting

Question 14

Board of Directors: Removal

Answer 14

o Shareholders may remove for breach of fiduciary duty (common law); or
o Without cause (modern trend)

Question 15

Board of Directors: Voting

Answer 15

o Must have a quorum of directors present to hold a vote (generally a majority)
Example 3: If there are 10 directors on the board, must have 6 directors
present to have a valid vote.
o Presence—can include phone call so long as the director can hear and participate

Question 16

Board of Directors: Special Meetings

Answer 16

o Requires notice at least two days before meeting
o Notice must include the date, time, and place of meeting
o A director who did not receive proper notice can object
 But, if the director attends the meeting and fails to object to lack of notice, the
objection is waived

Question 17

Board of Directors: Fiduciary Duties : Duty of Care

Answer 17

a. Duty of Care
 Must act as an ordinarily prudent person
 Includes the duty to investigate and ask questions
 Can rely on reports and outside experts
Exam Tip 5: After discussing whether the director met the duty of care, discuss
the business judgment rule.

Question 18

Board of Directors: Fiduciary Duties : Business Judgement Rule

Answer 18

1) Business Judgment Rule
• A rebuttable presumption that a director reasonably believed his actions were in the
best interest of the corporation.
• Protects a director from liability for breaching the duty of care if he acted in good
faith
• To overcome the presumption, one of the following must be shown:
o The director did not act in good faith;
o The director was not informed to the extent reasonably necessary;
o The director did not show objectivity and had a material interest in the decision;
o The director failed to timely investigate after being alerted to a significant
matter; or
o Any other failure to act as a reasonable director

Question 19

Board of Directors: Fiduciary Duties : Duty of Loyalty

Answer 19

 Must act in the best interest of the corporation
 Violated if the director engages in:
• Self-dealing; or
• Usurping a corporate opportunity

Question 20

Board of Directors: Fiduciary Duties : Duty of Loyalty: Self Dealing

Answer 20

1) Self-Dealing
• Engaging in a transaction with the corporation that benefits the director or a close
family member
• Includes transactions with another business entity that the director is associated
with
a) Safe Harbor Rules—Transaction can be protected if:
o The interested director discloses all material facts to the board of directors and
receives approval by a majority of disinterested board of directors;
o The interested director discloses all material facts to shareholders and receives
approval by a majority of disinterested shareholders; or
o The transaction is fair to the corporation substantively and procedurally
b) Remedies—Transaction can be enjoined or rescinded and the corporation can seek
damages from the interested director

Question 21

Board of Directors: Fiduciary Duties : Duty of Loyalty: Usurping a Corporate Opportunity

Answer 21

• Taking an opportunity that the corporation would be interested in without offering
it to the corporation first
• Director must present the opportunity to the corporation first
• If the corporation declines the opportunity, the director may take it without
violating the duty of loyalty.

Question 22

Officers

Answer 22

• Elected by the board of directors to run day-to-day operations
• Typical officers—president, secretary, and treasurer
• Act as agents of the corporation
Exam Tip 6: Can raise Agency issues regarding whether the officer (as an
agent) had authority to bind the corporation (the principal) to a contract with a
third party
• An officer can act with actual express authority, actual implied authority, and apparent
authority.

Question 23

Dissolution and Winding Up-corp

Answer 23

• A corporation may voluntarily terminate its status.
• Winding Up—corporation exists for the limited purpose of winding up its affairs and liquidating
its business
• Order of distribution:
1) Creditors of the corporation
2) Shareholders of stock with preferences in liquidation
3) Other remaining shareholders of stock

Question 24

Limited Liability Companies (LLCs)

Answer 24

• Has the tax advantages of a partnership and the limited liability of a corporation
• Formation—requires filing articles of organization
• Members can be individuals or corporations
• Management—can be member-managed or manager-managed
• Authority—members of a member-managed LLC have authority to bind the LLC

Question 25

LLC- Liability

Answer 25

o Members are generally not liable for LLC obligations

o Piercing the veil—members can be liable for LLC obligations

Question 26

LLC - Duties

Answer 26

Members owe fiduciary duties to each other and to the LLC

a. Duty of loyalty (member-managed LLC)

 Must account to the LLC for any profit or benefit
 Must refrain from dealing with the LLC on behalf of an adverse interest
 Must refrain from competing with the LLC

Note 1: From a recent question: An LLC had two corporate members. The
question was whether a corporate member had a duty to bring a derivative
action on behalf of the LLC against itself.

b. Duty of care
 Must act reasonably
 Actions are subject to the business judgment rule

Question 27

LLC- Member Actions

Answer 27

a. Direct Action
May bring suit against LLC or other members to enforce the member’s rights
b. Derivative Action
May bring a derivative action on behalf of the LLC against other members (or even against
themselves)

Question 28

LLC- Dissociation

Answer 28

o A member can withdraw at any time and for any reason

o Must provide notice (not necessarily written)

Question 29

LLC-Dissolution

Answer 29

o Can occur if all members agree, if there are not enough members remaining, or any other
reason stated in the operating agreement
o Involuntary dissolution—a member can ask for a court order to dissolve the LLC
 Must show that a controlling member has acted oppressively and harmed the member
seeking dissolution
o Winding up—must pay off debts to creditors before distributing assets to members