Corporations Flashcards
When will directors be protected by the business judgement rule?
The business judgement rule is a presumption that a director’s decision may not be challenged if:
(1) The director acted in good faith;
(2) With the care that an ordinarily prudent person would exercise in a like position; and
(3) In a manner that the director reasonably believed to be in the best interest of the corporation.
Note: While corporate law allows directors to rely on the opinions of experts and corporate insiders generally, it is not reasonable to rely solely on a director’s word regarding a transaction that the director has a personal interest in.
Can a transaction be set aside merely because a director had a personal interest in it?
No. A transaction will not be set aside merely b/c a director had a personal interest in the transaction if:
(1) The director disclosed the material facts of the transaction to disinterested members of the board or the shareholders, who approved the transaction; OR
(2) The transaction was fair to the corporation.
What type of protections does an exculpatory clause give a corporation’s board of directors?
A corporation’s articles of incorporation may limit or eliminate directors’ personal liability for money damages to the shareholders or corporation for actions taken; EXCEPT to the extent that the director:
(1) Received a benefit to which he was not entitled;
(2) Intentionally inflicted harm on the corporation or its shareholders;
(3) Approved unlawful distributions; or
(4) Intentionally committed a crime.
De Facto Corporation
For a de facto corporation to exist, the following requirements must be met:
(1) There must be a relevant incorporation statute (this will always be met, b/c there’s an incorporation statute in every state);
(2) The parties made a good faith, colorable attempt to comply w/ the statute (the parties tried and came close to forming a corporation);
(3) There has been some exercise of corporate privileges (meaning the parties were acting as though they thought there was a corporation).
Note: If the de facto corporation doctrine applies, the business is treated as a corporation for all purposes except in an action by the state.
–REMEMBER: This doctrine can be raised as a defense to personal liability only by a person who is unaware that there was no valid incorporation. (otherwise, the person is jointly and severally liable for all liabilities created in so acting)
–Abolished in most states
Defective Incorporation
If the incorporators thought they formed a corporation, but they failed to do so, they’dbe personally liable for business debts. (basically formed a partnership instead)
But two doctrines may still allow the incorporators to escape liability: (1) de facto corporation; and (2) corporation by estoppel.
–One important characteristic of both of these doctrines is that anyone asserting either doctrine must be unaware of the failure to form a de jure corporation.
Corporation by Estoppel
Not a de jure corp, but treated that way for people who treated the business like a corp.
–No requirement of following the statutory provisions
–Applies only in contract cases (doesn’t insulate against personal liability in tort cases)
–Abolished in most states
Liability for Pre-Incorporation Contracts
–Corporation: Liable only if it expressly or impliedly adopts (since the corporate entity does not exist prior to incorporation, it’s not bound on contracts entered into by the promoter in the corporate name)
–Promoter: Liable until novation (under MBCA, anyone who acts on behalf of a corp knowing it’s not in existence is jointly and severally liable for obligations incurred) (promoter’s liability continues after the corp is formed, even if the corp adopts the contract and derives benefit from it – only released upon novation) (unless agreement expressly relieves promoter of liability, then it will be treated as an offer to the corp)
–Novation: An agreement among all 3 parties (the promoter, the corp, and the other contracting party) to release the promoter from liability and substitute the corp for the promoter in the contract.
What is a promoter?
A promoter is a person acting on behalf of the corp not yet formed. Promoters procure commitments for capital and other instrumentalities that will be used by the corp after it’s formed.
–A promoter’s fiduciary duty to the corp is one of fair disclosure and good faith (can’t profit by selling property to the corp unless all material facts are disclosed to an independent board and approved; if board is not completely independent, promoter still not liable for his profits if the subscribers knew of the transaction at the time they subscribed or unanimously ratified it after full disclosure)
–Promoters may always be liable for fraud if Ps can show damage by misrepresentations or failure to disclose material facts
–Absent agreement to contrary, promoters are partners w/ each other and have a fiduciary relationship; this is breached if 1 secretly pursues personal gain at expense of another
Foreign Corporations Transacting Business in a State
Must register w/ secretary of state and pay fees in each state it wishes to transact business.
–Transacting business means the regular course of intrastate business activity. (doesn’t include occasional/sporadic activity nor simply owning property in a state)
Define “Issuance”
Issuance = Corp sells its own stock
Define “authorized shares”
These are shares described in the corp’s articles of incorporation.
–It’s the max number of shares a corp can sell
Subscriptions
Subscriptions are written offers to buy stock from a corp
–Note: Under the MBCA, pre-incorporation subscriptions are irrevocable for 6 months unless otherwise provided in the terms of the subscription agreement or unless all subscribers consent to revocation. (payment due upon demand by board; demand can’t be discriminatory; failure to pay = penalty or forfeiture)
–Post-incorporation subscriptions are revocable until accepted by the corp (i.e., the corp and the subscriber are obligated under a subscription agreement when the board accepts the offer)
What must the corp receive when it issues stock?
Form: Any tangible or intangible benefit to corp (includes money, property, services, past services already performed, discharge of debt, and promises to convey property)
–The MBCA greatly expanded what’s acceptable consideration; older statutes did not authorize shares to be issued for promissory notes or promises of future work
Amount: Consideration for Par Only = minimum issuance price, must be placed in special account (traditional view); now, the MBCA generally allows corps to issue shares for whatever consideration the directors deem appropriate (the board determines the value of the property or services; board’s valuation is conclusive if made in good faith)
–Note: While the concept of par value is mostly dead under the MBCA, a corp’s articles of incorporation can still specify a par value for stock. Then, if the board authorizes a sale of stock for less than the stated par value, the shares will prob be treated as validly issued, but the directors who authorized the issuance can be held liable for breach of their fiduciary duty.
Watered Stock
On the bar exam, if you’re given par stock, watch for watered stock, which can occur when par value stock is issued for less than its par value.
Preemptive Rights of Shareholders
This is the right of an existing shareholder to maintain their % of ownership in the company by buying stock if there is a new issuance of stock for money (meaning cash or its equivalent, e.g., a check).
–Under the MBCA, shareholders do not have this preemptive right unless the articles of incorporation provide it. If silent, then no preemptive rights.
Limitations of Preemptive Rights of Shareholders
Even if the articles do provide a preemptive right, shareholders generally have no preemptive right in shares issued:
(1) for consideration other than cash (e.g., for services of an employee);
(2) Within 6 months after incorporation; or
(3) Without voting rights but having a distribution preference.
–Remember: Preemptive rights will only attach if the issuance is for money)
Requirements for Directors
(1) Must be natural persons (i.e., human beings w/ legal capacity);
(2) Must have one or more directors (can be set in articles or bylaws);
(3) Initial directors named in articles or elected by incorporators at the organizational meeting;
(4) Thereafter, shareholders elect the directors at each annual shareholders’ meeting.
Removal of Directors
Shareholders can remove directors before their terms expire. Directors are removable w/ or w/o cause.
–Exception: In some states, Staggered board = only w/ cause
–A director elected by cumulative voting cannot be removed if the votes cast against removal would be sufficient to elect her if cumulatively voted at an election of directors
–A director elected by a voting group of shares can be removed only by that class
Staggered Board
The entire board is elected each year unless there is a “staggered” (or “classified”) board. This is usually set in the articles. A staggered board is divided into half or thirds, w/ one-half or one-third elected each year.
When vacancies arise (e.g., director resigns before term is up), who selects the person who will serve as director for the rest of the term?
It’s the board or the shareholders. But if the shareholders created the vacancy by removing a director, the shareholders generally must select the replacement.
Is an individual director an agent of the corp?
No. Individual directors have no authority to speak for or bind the corp. The directors MUST act as a group (even if there is only one director).
In what ways may the board act?
The board of directors must act as a group. They may act in the following ways:
–(1) Unanimous agreement in writing (email is OK, and separate documents are also OK); or
–(2) At a meeting, which must satisfy the quorum and voting requirements.
Notice for Board Meetings
If there is a board meeting, the method for giving notice is set in the bylaws. Directors may act in regular or special meetings:
–Regular: No notice required.
–Special Meetings: Must give at least 2 days written notice of date, time, place (purpose not required).
Note: Failure to give required notice means that whatever happened at the meeting is voidable – maybe even void – unless the directors who were notified waive the notice defect. They can do this (1) in writing anytime, or (2) by attending the meeting w/o objecting at the outset of the meeting.
Directors’ Voting Restrictions
Directors cannot give proxies or enter voting agreements for how they will vote as directors. Any efforts to do so are void b/c directors owe the corp non-delegable fiduciary duties.
–Note that this is different from shareholders, who can vote by proxy and enter into voting agreements.
Board Meeting Requirements
–Quorum: Majority of all directors (otherwise the board cannot act).
–If a quorum is present at a meeting, passing a resolution (which is how the board takes action at a meeting) requires only a majority vote of those directors present.
Remember: Any action required to be taken by the directors at a formal meeting may be taken by unanimous consent, in writing, w/o a meeting.
Broken Quorum
A quorum of the board can be lost (“broken”) if people leave. Once a quorum is no longer present, the board cannot take an act at that meeting.
–Note that this rule is different for shareholder voting.
When does a director have the power to bind the corp into a contract?
A director does not have the power to bind a corp into a contract unless there is actual authority to act. Actual authority generally can arise only if:
(1) Proper notice was given for a directors’ meeting, a quorum was present, and a majority of the directors present approved the action; or
(2) There was unanimous written consent of the directors.
Committees Cannot Take Certain Actions
While the board can delegate actions to a committee, a committee may not take the following actions:
(1) Declare a distribution;
(2) Fill a board vacancy
(3) Recommend a fundamental change to shareholders.
Note, however, that a committee can recommend such actions to the full board for its action.
Role of the Board of Directors
The board manages the corp, meaning it sets policy, supervises officers, declares distributions, determines when stock will be issued, recommends fundamental corp changes to shareholders, etc.
Unless the articles or bylaws state otherwise, the board may create one or more committees, w/ one or more members, and appoint members of the board to serve on them. The committees may act for the board, but the board remains responsible for the supervision of the committees. The board may also delegate authority to officers.
Fiduciary Duties of Directors to Corp (The Standard)
A director must discharge her duties in good faith and w/ the reasonable belief that her actions are in the best interest of the corp. (duty of loyalty)
She must also use the care that a person in like position would reasonably believe appropriate under the circumstances. (duty of care)
–Every time you see a director arguably in breach of either duty, state the entire standard.
The directors also have a duty to disclose material corporate info to other members of the board.
Director’s Duty of Care
A director must use the care that a person in a like position would reasonably believe appropriate under the circumstances. The person challenging the director’s action has the burden of proof.
The duty of care typically comes up in two ways:
(1) Nonfeasance - Director does nothing.
- -Liable only if breach causes a loss to the corp (in many nonfeasance cases, it’s difficult to show causation - b/c the company would have lost money anyway, even if this person had been paying attention)
(2) Misfeasance - Board makes a decision that hurts business.
- -Here, the directors’ action caused a loss to the corp, so causation is clear.
- -But remember, a director is not liable if she meets the business judgment rule. (This means that directors who meet this standard will not be liable for corp decisions that in hindsight turn out to be poor or erroneous. We expect a person in like position to do the appropriate homework. If she did, she is not liable for bad results.)
Business Judgment Rule
Court will not second-guess a business decision if made in good faith, informed, and had a rational basis. (a director is NOT a guarantor of success)
–Applies only in duty of care cases
What types of reports and information may a director properly rely on?
In discharging her duties, a director is entitled to rely on info, opinions, reports, or statements (including financial statements), if prepared or presented by:
(1) Corporate officers or employees whom the director reasonably believes to be reliable and competent;
(2) Legal counsel, accountants, or other persons as to matters the director reasonably believes are within such person’s professional competence; or
(3) A committee of the board of which the director is not a member, if the director reasonably believes the committee merits confidence.
Director’s Duty of Loyalty
A director must discharge her duties in good faith and w/ the reasonable belief that her actions are in the best interest of the corp. The burden is on Defendant b/c the fiduciary has a conflict of interest.
Most common scenarios include:
–Self-dealing / interested director transactions
–Competing Ventures
–Corporate Opportunity
What Constitutes a Conflicting Transaction?
This is any transaction between the Corp vs. either:
(1) one of its directors; or
(2) that the director’s close relative; or
(3) another business of the director’s.
Standards for Upholding Conflicting Transactions
Interested director transactions will be set aside (or the director liable in damages) unless the director shows either:
(1) The deal was fair to the corporation when entered; or
(2) Her interest and the relevant facts were disclosed or known, and the deal was approved by either: (i) a majority (at least two) of the disinterested directors, or (ii) a majority of the disinterested shares.
Note: Despite the statute’s absolute terms, a transaction approved by the board or shareholders might still be set aside if the party challenging the transaction can prove that it constitutes a waste of corporate assets. So, even if the deal is approved by an appropriate group, remember to say this on the exam: “Some courts also require a showing of fairness.”
–Notice of the shareholders’ meeting must describe the transaction
–The presence of the interested director(s) at the meeting at which the directors or shareholders voted to approve the conflicting interest transaction is irrelevant
Factors to Be Considered in Determining Fairness of a Conflicted Transaction
In determining whether a transaction is fair, courts look to factors such as adequacy of the consideration, the corporate need to enter into the transaction, the financial position of the corp, and available alternatives
Directors May Set Own Compensation
Despite the apparent conflict of interest, unless the articles or bylaws provide otherwise, the board can set director compensation. However, it must be reasonable and in good faith.
If it’s excessive, the board is wasting corporate assets and breaching the duty of loyalty.
Director’s Competing Ventures
Directors may engage in unrelated businesses, but engaging in a directly competing business raises serious duty of loyalty problems.
–In such a case, the corp may be awarded a constructive trust on profits the director made from the competing venture.
Corporate Opportunity Doctrine
The directors’ fiduciary duties prohibit them from diverting a business opportunity from their corp to themselves w/o first giving their corp an opportunity to act. This is known as the “usurpation of a corporate opportunity.”
–On the exam, start by stating the standard in full, then focus on the duty of loyalty portion. A director cannot usurp a corporate opportunity. That means the director can’t take it until he (1) tells the board about it and (2) waits for the board to reject the opportunity.
–Remember, a usurpation problem arises only if the director takes advantage of a business opportunity in which the corp would have an interest or expectancy.
-A corp’s interest does not extend to every conceivable business opportunity, but neither are opportunities limited to those necessary to the corp’s current business. The closer the opportunity is to the corp’s line of business, the more likely the court will find it to be a corporate opportunity.
–The corp’s lack of financial ability to take advantage of the opportunity is not a defense.
–It is the board that must decide whether to accept an opportunity or to reject it.
–If a director usurps a corp opportunity, the corp can sue to recover under a constructive trust theory. If she still owns the property, she can be compelled to transfer it to the corp at the price she paid. If she has sold the property at a profit, the corp may recover the profit.
Common Law Insider Trading – Special Circumstances Rule
A director has no common law duty to disclose all facts relevant to a securities transaction between the director and the other party to the transaction. However, courts have found a duty to disclose where a director knows of special circumstances (e.g., an upcoming extraordinary dividend or a planned merger)
Corporate Loans to Directors
A corp can make a loan to a director if it is reasonably expected to benefit the corp.
Personal Liability of Directors May Be Limited
The articles may limit or eliminate directors’ (and, in some states, officers’) personal liability for money damages to the corp or shareholders for actions taken or for failure to take action.
However, the articles may NOT limit or eliminate liability for financial benefits received by the director to which she is not entitled, an intentionally inflicted harm on the corp or its shareholders, unlawful corp distributions, or an intentional violation of criminal law. Thus, these provisions can eliminate liability only for DUTY OF CARE cases.
–Note: A corp may advance expenses to a director defending an action as long as the director furnishes the corp a statement that the director believes he met the appropriate standard of conduct and that he will repay the advance if he is later found to have not met the appropriate standard.
–A corp may purchase liability insurance to indemnify D/Os for actions against them even if the D/Os would not have been entitled to indemnification under the above standards.
Which Directors May Be Liable?
A director is presumed to concur w/ board action unless her dissent or abstention is noted in writing in the corp records.
–In writing means: (1) in the minutes, (2) delivered in writing to the presiding officer at the meeting, or (3) written dissent to the corp immediately after the meeting.
–An oral dissent, by itself, is NOT effective.
–A director cannot dissent if she voted for the resolution at the meeting.
Exception: A director is not liable under the rule above is she was absent from the board meeting (e.g., due to illness).
–Another defense is good faith reliance on info presented by an officer, employee, or a committee of which the director relying upon was not a member or her reliance on a professional reasonably believed to be competent.
Power and Status of Officers
Officers are agents of the corp. The corp is the principal and the officer is the agent. Whether the officer can bind the corp is determined by whether she has agency authority to do so (actual or apparent). Unauthorized actions may become binding on the corp b/c of ratification, adoption, or estoppel.
The corp is liable for actions by its officers within the scope of their authority, even if the particularized act in question was not specifically authorized.
–Officers owe the same duties of care and loyalty as directors
–The corp need not have any particular officers, it may have those specified in or permitted by the bylaws, and one person may simultaneously serve in more than one office.
Selection and Removal of Officers
Officers are selected and removed by the Board, which also sets officer compensation. Despite any contract term to the contrary, an officer has the power to resign at any time by delivering notice to the corp, and the corp has the power to remove an officer at any time, w/ or w/o cause.
If the resignation or removal is a breach of contract, the non-breaching party may have a right to damages, but note that mere appointment to office itself doe snot create any contractual right to remain in office.
**Remember that directors hire and fire officers (whereas shareholder hire/fire directors)
