Corporations

Question 1

Limited Liability for Owners, Directors, and Officers

Answer 1

The shareholders generally are not personally liable for the obligations of the corporation; neither are the corporation’s directors or officers. Generally, only the corporation itself can be held liable for corporate obligations. The owners risk only the investment that they make in the business to purchase their ownership interests (“shares”).

Question 2

Corporation management

Answer 2

Centralized Management Generally, the right to manage a corporation is not spread out among the shareholders, but rather is centralized in a board of directors, who usually delegate day-to-day management duties to officers

Question 3

Free Transferability of Ownership

Answer 3

Generally, ownership of a corporation is freely transferable— that is, generally, shareholders are free to sell their shares to others unless it is provided otherwise

Question 4

Formation of a De Jure Corporation

Answer 4

need a person, a paper, and an act:

1. Person: To form a corporation, we need one or more persons who undertake to form it, who are known as the incorporators. The incorporators must comply with all applicable statutory requirements to form the corporation. Basically, they must execute and deliver the articles of incorporation to the secretary of state. Incorporators may be a person or an entity. They do not need to be a citizen of the state of incorporation
2. Paper: Articles of Incorporation: The articles of incorporation must include: (1) The name of the corporation. The name must include one of the following words or an abbreviation: “corporation,” “company,” “incorporated,” or “limited,” (2) The name and address of each incorporator, (3) A registered agent and the street address of the registered office. The registered office must be in the state. (4) Information regarding the corporation’s stock - the maximum number of shares the corporation can sell. (5) Optional: business purpose
3. Act: Corporate Existence Begins on Filing - To complete formation of the corporation, the incorporators will have notarized articles delivered to the secretary of state and pay any required fees.

Question 5

Organizational Meeting

Answer 5

The purpose of the meeting is to “complete the organization of the corporation,” which means (1) adopt initial bylaws and (2) appoint officers.

If the initial directors were named in the articles, the board of directors hold the organizational meeting. If they were not named in the articles, the incorporators hold the organizational meeting.

Question 6

Bylaws

Answer 6

Bylaws are an internal document. You can think of them as the corporation’s operating manual; the bylaws might include things like setting record dates (for determining who may vote at shareholder meetings) and methods of giving notice. Bylaws may contain any provision for managing the corporation that is not inconsistent with the articles or law.

Board or shareholders can amend and repeal bylaws or adopt new ones

Question 7

Internal Affairs Doctrine

Answer 7

Under the internal affairs doctrine, the internal affairs of a corporation are governed by the law of the state of incorporation

Question 8

Entity Status

Answer 8

Upon formation, a corporation has entity status, meaning it’s a legal person. The corporation can sue and be sued, hold property, be a partner in a partnership, invest in other companies or commodities, and so on

Question 9

DEFECTIVE INCORPORATION

Answer 9

One of the main reasons to incorporate is to avoid personal liability for obligations that the corporation incurs. If the incorporators thought they formed a corporation, but they failed to do so, they’d be personally liable for business debts. (Basically, the would-be incorporators have formed a partnership instead, and partners are liable for business debts.) But two doctrines may still allow the incorporators to escape liability: (1) de facto corporation and (2) corporation by estoppel. In other words, the veil of protection may be applied where a de jure corporation has not been formed

These doctrines are abolished in many states

Question 10

De Facto Corporation

Answer 10

For a de facto corporation to exist, we must meet the following requirements:

• There must be a relevant incorporation statute. (On the exam, you can address this requirement quickly— it will always be met, because there’s an incorporation statute in every state.)
• The parties made a good faith, colorable attempt to comply with the statute, meaning the parties tried and came close to forming a corporation; and
• There has been some exercise of corporate privileges, meaning the parties were acting as though they thought there was a corporation.

If the de facto corporation doctrine applies, the business is treated as a corporation for all purposes except in an action by the state (called a “quo warranto” action).

Question 11

Corporation by Estoppel

Answer 11

Under the common law doctrine of corporation by estoppel, persons who have dealt with the entity as if it were a corporation will be estopped from denying the corporation’s existence. The doctrine applies in contract to prevent the “corporate” entity, and parties who have dealt with the entity as if it were a corporation, from backing out of their contracts. Correspondingly, it will prevent the improperly formed “corporation” from avoiding liability by saying it was not properly formed. Note well that corporation by estoppel applies only in contract cases. It does not apply to tort victims.

Question 12

PRE-INCORPORATION CONTRACTS (WE KNEW THERE WAS NOT A CORPORATION)

Answer 12

A promoter is a person acting on behalf of a corporation not yet formed. Before a corporation is formed, promoters procure commitments for capital and other instrumentalities that will be used by the corporation after its formation

Question 13

Promoters’ Relationship with Third Parties— Preincorporation Agreements

Answer 13

A promoter may enter into contracts on behalf of a corporation not yet formed

• Corporation’s Liability: Since the corporate entity does not exist prior to incorporation, it is not bound on contracts entered into by the promoter in the corporate name prior to incorporation. The corporation may become liable only if it expressly or impliedly adopts the promoter’s contract
• Promoter’s Liability: Under the MBCA, anyone who acts on behalf of a corporation knowing that it is not in existence is jointly and severally liable for the obligations incurred. Thus, if a promoter enters into an agreement with a third party on behalf of a planned but unformed corporation, the promoter is personally liable on the contract. The promoter’s liability continues after the corporation is formed, even if the corporation adopts the contract and benefits from it. The promoter will be released from liability only if there is an express or implied novation

Question 14

FOREIGN CORPORATIONS

Answer 14

Foreign corporations transacting business in a state must register (qualify) and pay fees.

Transacting business means the regular course of intrastate (not interstate) business activity. So, it doesn’t include occasional or sporadic activity in this state, nor does it include simply owning property in this state

Question 15

Issuance of Stock: Generally

Answer 15

To start and operate a corporation, we need money (capital). The corporation can either borrow the money or raise it by selling stock (or both). Either way, the corporation will issue a security to the investor. Security is a fancy word for investment

Question 16

Debt Securities

Answer 16

When the corporation borrows money, it issues a debt security, which is usually called a bond. The bond is a promise that the corporation will repay the loan with interest. If the loan is unsecured by corporate assets, it may be called a debenture. Importantly, the holder of debt securities is a creditor, but not an owner, of the corporation

Question 17

Equity Securities

Answer 17

When the investor buys an ownership interest in the corporation, it issues equity securities, which is stock (the investor holds shares of stock). Importantly, the money invested does not create a debt. The shareholder is an owner, but not a creditor, of the corporation

Question 18

Authorized Shares

Answer 18

shares described in the corporation’s articles of incorporation

Question 19

Issued and Outstanding Shares

Answer 19

shares that have been sold

Question 20

authorized but unissued shares

Answer 20

Shares that have been reacquired by the corporation through repurchase or redemption

Question 21

Common shares

Answer 21

Shares when corporation chooses to issue only one type of share, giving each shareholder an equal ownership right

Question 22

Share Options

Answer 22

A corporation may issue share options. An option is the right to purchase shares in the future under terms predetermined by the board of directors. Options may be offered in exchange for any type of consideration, including future services.

Question 23

Issuance Definition

Answer 23

An issuance of stock is when a corporation sells its own stock.

Question 24

SUBSCRIPTIONS

Answer 24

Subscriptions are written offers to buy stock from a corporation.

Question 25

Preincorporation Subscription

Answer 25

Under the MBCA, preincorporation subscriptions are irrevocable for six months unless otherwise provided in the terms of the subscription agreement or unless all subscribers consent to revocation

Question 26

Postincorporation Subscription

Answer 26

Postincorporation subscriptions are revocable until accepted by the corporation. In other words, the corporation and the subscriber are obligated under a subscription agreement when the board accepts the offer

Question 27

Consideration: What must the corporation receive when it issues stock?

Answer 27

Under the MBCA, stock (or an option to buy stock) may be issued for any tangible or intangible property or benefit to the corporation. This includes money (cash or check), property, services already performed for the corporation, and discharge of a debt. It also includes promissory notes to the corporation and future services to the corporation.

Question 28

Necessary Amount of Consideration for Issuance

Answer 28

Traditional View—Par: Par means minimum issuance price. Traditionally, stock could not be issued by a corporation for less than the stock’s stated par value, and the consideration received for par value stock had to be held in a certain account containing at least the aggregate par value of the outstanding par value shares. 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

MBCA Approach—Board Determines Value: The MBCA generally has eliminated the concept of par and allows corporations to issue shares for whatever consideration the directors deem appropriate. The board’s valuation is conclusive if made in good faith. The stock is considered fully paid and non-assessable as soon as the corporation receives the consideration for which the board authorized the issuance.

Question 29

Preemptive Rights: Right to Maintain Percentage of Ownership

Answer 29

A preemptive right is the right of an existing shareholder of common stock to maintain her percentage of ownership in the company by buying stock whenever there is a new issuance of stock for money (meaning cash or its equivalent, like a check).

Right Must Be Stated in Articles: if the articles are silent on this issue, we do not have preemptive rights

Limitation: Even if the articles do provide a preemptive right, shareholders generally have no preemptive right in shares issued: (1) for consideration other than cash (for example, for services of an employee), (2) within six months after incorporation, or (3) without voting rights but having a distribution preference

Question 30

Board of Directors - Generally

Answer 30

The directors are responsible for the management of the business and affairs of the corporation.

The board manages the corporation, meaning it sets policy, supervises officers, declares distributions, determines when stock will be issued, recommends fundamental corporation changes to shareholders, and so on.

Unless the articles or bylaws provide otherwise, the board may create one or more committees, with one or more members, and appoint members of the board of directors to serve on them. The committees may act for the board, but the board remains responsible for supervision of the committees. The committees may not: Declare a distribution • Fill a board vacancy • Recommend a fundamental change to shareholders

The board may also delegate authority to officers.

Question 31

Directors Qualifications

Answer 31

Directors must be adult natural persons, meaning they must be human beings with legal capacity. Absent a provision otherwise in the articles or bylaws, the directors need not be shareholders in the corporation or residents of any particular state. Any qualifications for directors prescribed by the articles or bylaws must be reasonable and lawful; no qualification may limit the ability of a director to discharge her duties

Question 32

Required Number of Directors

Answer 32

There must be one or more directors. The number can be set in the articles or bylaws, which may require as many directors as desired.

Question 33

Election of Directors

Answer 33

Initial directors may be named in the articles. If not, they are elected by the incorporator(s) at the organizational meeting. After that, the shareholders elect the directors. The directors are elected at each annual shareholders’ meeting, subject to contrary provisions in the articles.

Question 34

Staggered Boards

Answer 34

The entire board is elected each year unless there is a “staggered” (or “classified”) board. Whether there is a staggered board is usually set in the articles. A staggered board is divided into half or thirds, with one-half or one-third elected each year.

Question 35

Removal of Directors

Answer 35

Shareholders can remove directors before their terms expire. Shareholders may remove a director with or without cause. In some states, if there is a staggered board, shareholders can remove a director only with 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. Similarly, a director elected by a voting group of shares can be removed only by that class

Question 36

Board Action

Answer 36

Board Must Act As Group: They may act in the following ways:

• Unanimous agreement in writing (email is OK, and separate documents are also OK); or
• At a meeting, which must satisfy the quorum and voting requirements

Question 37

Ratification of Defective Corporate Actions

Answer 37

Directors, incorporators, and officers may ratify defective corporate actions (that is, actions that are void or voidable due to a failure of authorization, such as those taken in the absence of the requisite board resolution or shareholder approval). To ratify such an action, the board of directors must state the action to be ratified and the nature of the failure of authorization, approve the ratification, and seek shareholder approval if necessary

Question 38

Board Meetings: Notice

Answer 38

If there is a board meeting, the method for giving notice is set in the bylaws. Directors may act in regular or special meetings:

• For regular meetings notice is not required;
• For special meetings at least two days’ written notice of date, time, and place is required. The notice need not state the purpose of the meeting

Question 39

Failure to Give Notice

Answer 39

Failure to give required notice means that whatever happened at the meeting is voidable—maybe even void—unless the directors who were not notified waive the notice defect. They can do this (1) in writing any time, or (2) by attending the meeting without objecting at the outset of the meeting.

Question 40

Directors - Proxies

Answer 40

Directors cannot give proxies or enter voting agreements for how they will vote as directors. Any efforts to do so are void. Why? Because directors owe the corporation non-delegable fiduciary duties. Note that this is different from shareholders, who can vote by proxy and enter into voting agreements

Question 41

Board Meetings - Quorum

Answer 41

For any meeting of the board, we must have a quorum. A quorum is a majority of all directors, unless the bylaws say otherwise (but a quorum can be no fewer than one-third of the board members). Without a quorum, the board cannot act.

Approval of Action: 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 present. So, if there are nine directors, at least five directors must attend the meeting to constitute a quorum. If five directors attend, at least three must vote for a resolution for it to pass

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

Question 42

Director Authority to Bind Corporation

Answer 42

A director does not have the power to bind the corporation in 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 approved the action, or (2) there was unanimous written consent of the directors.

Question 43

FIDUCIARY DUTIES OWED TO THE CORPORATION

Answer 43

The Standard: A director must discharge her duties in good faith and with the reasonable belief that her actions are in the best interest of the corporation. She must also use the care that a person in like position would reasonably believe appropriate under the circumstances.

• The first sentence of this standard is the duty of loyalty.
• The second sentence of this standard is the duty of care.

Question 44

Duty of Care

Answer 44

A director must use the care that a person in like position would reasonably believe appropriate under the circumstances. (Owed to the corporation)

Burden is on the challenger/plaintiff

Business Judgment Rule: The court will not second-guess a business decision if it was made in good faith, was informed, and had a rational basis. A director is not a guarantor of success

In discharging her duties, a director is entitled to rely on information, 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.

Question 45

Duty of Loyalty

Answer 45

A director must discharge her duties in good faith and with the reasonable belief that her actions are in the best interest of the corporation. Burden on the defendant

Question 46

Duty of Loyalty: Conflicting Transactions (Self-Dealing)

Answer 46

any transaction between the corporation (on one side) and (1) one of its directors, or (2) that director’s close relative, or (3) another business of the director’s (on the other side)

A conflicting interest transaction will not be enjoined, set aside, or give rise to an award of damages because of the director’s interest if, after the disclosure of all material facts:

1. (1) It was approved by a majority (but at least two) of the disinterested directors (those without a conflicting interest).
2. It was approved by a majority of votes entitled to be cast by disinterested shareholders, or
3. Judged by the circumstances at the time the corporation entered into the transaction, it was fair to the corporation.

some courts also require a showing of fairness

Question 47

Duty of Loyalty: Conflicting Transactions Remedies

Answer 47

Possible remedies for an improper conflicting interest transaction include enjoining the transaction, setting the transaction aside, damages, and similar remedies.

Question 48

Duty of Loyalty: Setting of Director Compensation

Answer 48

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

Question 49

Duty of Loyalty: Competing Ventures

Answer 49

Directors may engage in unrelated businesses, but engaging in a directly competing business raises serious duty of loyalty problems

Question 50

Duty of Loyalty: Corporate Opportunity Doctrine

Answer 50

The directors’ fiduciary duties prohibit them from diverting a business opportunity from their corporation to themselves without first giving their corporation an opportunity to act. This is known as “usurpation of a corporate opportunity.”

a usurpation problem arises only if a director takes advantage of a business opportunity in which the corporation would have an interest or expectancy.

Question 51

Duty to Disclose

Answer 51

The directors also have a duty to disclose material corporate information to other members of the board

Question 52

Director Liability

Answer 52

Directors may be liable to the corporation for improper distributions, improper loans, “ultra vires” acts, and for breaches of fiduciary duties

A director is presumed to concur with board action unless her dissent or abstention is noted in writing in the corporate 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 corporation immediately after the meeting

Question 53

Corporate Officers

Answer 53

Officers are agents of the corporation. Agency law determines the authority and powers of officers. The corporation is the principal and the officer is the agent. Whether the officer can bind the corporation is determined by whether she has agency authority to do so (as in, actual or apparent authority). Unauthorized actions may become binding on the corporation because of ratification, adoption, or estoppel.

Question 54

Officer Duties

Answer 54

Officers’ general duties are determined by the bylaws or, to the extent consistent with the bylaws, by the board or an officer so authorized by the board. Officers owe the same duties of care and loyalty to the corporation as directors

Question 55

Selection and Removal of Officers

Answer 55

Officers are selected and removed by the board, which also sets officer compensation. Despite any contractual term to the contrary, an officer has the power to resign at any time by delivering notice to the corporation, and the corporation has the power to remove an officer at any time, with or without cause. If the resignation or removal is a breach of contract, the nonbreaching party may have a right to damages, but note that mere appointment to office itself does not create any contractual right to remain in office

Question 56

When is there no indemnification of Directors, Officers, and Employees?

Answer 56

A corporation cannot indemnify a director who is (1) held liable to the corporation or (2) held to have received an improper benefit

Question 57

When is there Mandatory Indemnification?

Answer 57

Unless limited by the articles, a corporation must indemnify a director or officer who was successful in defending a proceeding on the merits or otherwise against the officer or director for reasonable expenses, including attorneys’ fees, incurred in connection with the proceeding. In some states, the director or officer must win the entire case; in others, they are entitled to indemnification “to the extent” that they win the case.

Question 58

When is there Permissive Indemnification?

Answer 58

A corporation may indemnify a director for reasonable litigation expenses incurred in unsuccessfully defending a suit brought against the director on account of the director’s position if the director: (1) acted in good faith; and (2) believed that her conduct was in the best interests of the corporation (when the conduct at issue was within the director’s official capacity).

Question 59

Shareholder Management Agreements

Answer 59

Shareholder management agreements set up alternative management for a close corporation. The MBCA allows shareholders to enter into agreements to dispense with the board and vest management power in the shareholders. If the articles do not include such a special provision, shareholders exercise only indirect control of the corporation through their voting power, by which they elect and remove directors, adopt and modify bylaws, and approve fundamental changes in the corporate structure. There are two ways to set up a shareholder management agreement:

• In the articles and approved by all shareholders OR
• By unanimous written shareholder agreement

Question 60

Special Fiduciary Duty in Close Corporations

Answer 60

In many states, courts impose a fiduciary duty on shareholders owed to other shareholders.

Question 61

Duties of Controlling Shareholders to Minority Shareholders

Answer 61

Controlling shareholders cannot use their power to benefit at the expense of minority shareholders.

For example, a parent corporation should not use its domination of a subsidiary corporation to receive something to the detriment of the subsidiary’s minority shareholders

Question 62

Oppression of Minority Shareholders

Answer 62

If there is oppression of minority shareholders, they can sue the controlling shareholders who oppress them for breach of this fiduciary duty.

Question 63

CAN SHAREHOLDERS BE HELD LIABLE FOR CORPORATE DEBTS?

Answer 63

Shareholders generally cannot be held liable for corporate.

But a shareholder might be personally liable for what the corporation did if the court pierces the corporate veil. This can happen in close corporations only.

Question 64

Piercing the Corporate Veil

Answer 64

To pierce the corporate veil and hold shareholders personally liable:

• The shareholders must have abused the privilege of incorporating; and
• Fairness must require holding them liable.

So courts may pierce the corporate veil to avoid fraud or unfairness by shareholders in a close corporation. But something like sloppy administration is not enough.

Question 65

Common Scenarios—Elements Justifying Piercing

Answer 65

1. Alter Ego (Identity of Interests) If the shareholders ignore corporate formalities such that the corporation may be considered the “alter ego” or a “mere instrumentality” of the shareholders or another corporation, and some basic injustice results. These situations may arise where shareholders treat corporate assets as their own, commingle their money with corporate money, and so on.
2. Undercapitalization The corporate veil may be pierced where the corporation is inadequately capitalized, so that at the time of formation there is not enough unencumbered capital to reasonably cover prospective liabilities
3. Fraud, Avoidance of Existing Obligations, or Evasion of Statutory Provisions: The corporate veil may be pierced where necessary to prevent fraud or to prevent an individual shareholder from using the entity to avoid his existing personal obligations.

Question 66

Shareholder Derivative Suits

Answer 66

In a derivative suit, a shareholder is suing to enforce the corporation’s claim, not her own personal claim. In other words, if a shareholder believes the corporation has been wronged but the directors have not done anything to enforce its rights with respect to the wrong, the shareholder may be able to bring a shareholder derivative suit to enforce the corporation’s rights

ask: could the corporation have brought this suit? If so, it’s a derivative suit.

Question 67

Direct Shareholder Actions

Answer 67

A direct action may be brought for a breach of a fiduciary duty owed to the shareholder by an officer or director.

To distinguish breaches of duty owed to the corporation and duties owed to the shareholder, ask:

1. 1) who suffers the most immediate and direct damage, the corporation or the shareholder; and
2. (2) to whom did the defendant’s duty run, the corporation or the shareholder? In a shareholder direct action, any recovery is for the benefit of the individual shareholder.

Question 68

REQUIREMENTS FOR DERIVATIVE SUITS

Answer 68

1. Standing: a shareholder must have been a shareholder at the time the claim arose or must have become a shareholder through transfer by operation of law from someone who did own stock at the time the claim arose
2. Adequate Representation: The shareholder must fairly and adequately represent the corporation’s interest.
3. Demand Requirements: the shareholder must make a written demand on the corporation (usually, that means the board) to take suitable action. In some states, this demand must always be made, and the shareholder cannot sue until 90 days after making this demand, unless: (1) the shareholder has earlier been notified that the corporation has rejected the demand; or (2) irreparable injury to the corporation would result by waiting for the 90 days to pass. In other states, shareholders are not required to make this demand if the demand would be futile.
4. The corporation must be joined to the suit as a defendant

Question 69

Dismissal or Settlement of Derivative SUits

Answer 69

The parties can settle or dismiss a derivative suit only with court approval.

• Dismissal must be based upon an independent investigation that concluded that the suit is not in the corporation’s best interest
• The investigation must be made by independent directors or a court-appointed panel
• In ruling on the motion to dismiss, if the court finds that (1) those recommending dismissal were truly independent and (2) they made a reasonable investigation, in most states, the court will dismiss
• Burden of Proof: To avoid dismissal, in most cases the shareholder bringing the suit has the burden of proving to the court that the decision was not made in good faith after reasonable inquiry. However, if a majority of the directors had a personal interest in the controversy, the corporation will have the burden of showing that the decision was made in good faith after reasonable inquiry

Question 70

Who Votes at Shareholder Meetings?

Answer 70

Shareholders of record on the record date may vote at the meeting.

The record date is fixed by the board of directors but may not be more than 70 days before the meeting. Unless the articles provide otherwise, each outstanding share is entitled to one vote.

Question 71

Shareholder Voting by Proxy

Answer 71

A shareholder may vote her shares in person or by proxy executed in writing. A proxy is (1) a writing (fax and email are fine), (2) signed by the record shareholder (email is fine if the sender can be identified), (3) directed to the secretary of the corporation, (4) authorizing another to vote the shares.

Question 72

Shareholder Voting: Trusts and Voting Agreements

Answer 72

Let’s say X, Y, and Z own relatively few shares of C Corp. An exam question might ask you for your opinion as to how they might pool their voting power. They may do so in a voting trust or a voting agreement.

Question 73

Requirements for Voting Trust

Answer 73

A voting trust is a written agreement of shareholders under which all of the shares owned by the parties to the agreement are transferred to a trustee, who votes the shares and distributes the dividends in accordance with the provisions of the voting trust agreement.

The requirements are:

1. A written trust agreement, controlling how the shares will be voted;
2. A copy of the agreement (including names and addresses of the beneficial owners of the trust) is given to the corporation;
3. Legal title to the shares is transferred to the voting trustee; and
4. The original shareholders receive trust certificates and retain all shareholder rights except for voting.

Question 74

Requirements for Voting Agreement

Answer 74

Rather than creating a trust, shareholders can enter into voting (or “pooling”) agreements providing for how they’ll vote their shares.

The requirements are that the agreement be in writing and signed. It need not be filed with the corporation and is not subject to any time limit. These agreements are increasingly specifically enforceable.

Question 75

Annual Shareholder Meetings

Answer 75

Corporations must hold annual shareholders’ meetings. If the annual meeting is not held within the earlier of six months after the end of the corporation’s fiscal year or 15 months after its last annual meeting, a shareholder can petition the court to order one to be held

Question 76

Special Shareholder Meetings

Answer 76

Special meetings may be called by (1) the board of directors, (2) the president, (3) the holders of at least 10 percent of the outstanding shares, or (4) anyone else authorized to do so in the articles or bylaws

Question 77

Notice of Shareholder Meetings

Answer 77

Shareholders must be notified of meetings not fewer than 10 or more than 60 days before the meeting. Notice must be in writing (fax or email is fine) to every shareholder entitled to vote. Notice may be waived in writing or by attendance

Contents: The notice must state the date, time, and place of the meeting. For special meetings, the notice must also state the purpose of the meeting. The shareholders cannot do anything else at that meeting

Question 78

Consequences of Failure to Give Proper Notice for Shareholder Meetings

Answer 78

If proper notice is not given to all shareholders, whatever action was taken at the meeting is voidable (maybe void), unless those who were not sent notice waive the notice defect.

Waiver can be:

1. Express waiver, meaning in writing and signed any time (fax or email are fine) OR
2. Implied waiver, meaning the shareholder(s) attend the meeting without objecting at the outset

Question 79

Shareholder Voting: Quorum

Answer 79

The general rule is that a quorum is a majority of outstanding shares entitled to vote, unless the articles or bylaws require a greater number.

Every time the shareholders vote, we must have a quorum represented at the meeting. Determination of a quorum focuses on the number of shares represented, not the number of shareholders.

Note that a shareholder quorum will not be lost if people leave the meeting.

Question 80

Specific Votes Required to Elect Directors

Answer 80

Plurality: meaning, the person who gets more votes for the seat on the board than anyone else is elected

Question 81

Specific Votes Required to Approve Fundamental Corporate Changes

Answer 81

traditionally, we needed a majority of the shares entitled to vote. Increasingly, though, this is treated as “other matters.”

Question 82

Specific Votes Required to Remove Directors

Answer 82

Traditionally, we needed a majority of the shares entitled to vote. Increasingly, though, this is treated the same as “other matters.”

Question 83

Specific Votes Required for “Other Matters”

Answer 83

Majority of the shares that actually vote on the issue.

Question 84

Class Voting on Article Amendments

Answer 84

Whenever an amendment to the articles of incorporation will affect only a particular class of stock, that class has a right to vote on the action even if the class otherwise does not have voting rights

Question 85

Shareholder Resolutions

Answer 85

As a general matter, shareholders are permitted to submit resolutions or proposals for action at shareholder meetings. For example, shareholders may express views on corporate matters through nonbinding resolutions. Generally, shareholder resolutions that seek to bind the corporation or the board should involve a proper subject for shareholder action, such as seeking an amendment to the bylaws.

Question 86

STOCK TRANSFER RESTRICTIONS

Answer 86

Restrictions Are Fine If Reasonable: Restrictions are valid if they are not an undue restraint on alienation. The Right of First Refusal is valid. It does not restrict the ability to transfer, but only requires the shareholder to offer the stock first to the corporation

Enforcing Restriction Against Transferee fine if (1) the restriction is conspicuously noted on the stock certificate (or is contained in the information statement required for uncertificated shares) or (2) the transferee had actual knowledge of the restriction at the time of the purchase.

Question 87

Distributions Definition

Answer 87

Distributions are payments by the corporation to shareholders

Question 88

Types of Distributions

Answer 88

Distributions can take the form of dividends, redemptions (meaning, a forced sale to the corporation at a price set in the articles) of shares, repurchases of shares, distribution of assets upon liquidation, and so on.

Question 89

Rights to Distributions

Answer 89

At least one class of stock must have a right to receive the corporation’s net assets on dissolution. Beyond this rule, distributions generally are discretionary

Question 90

Declaration of Distributions

Answer 90

the decision whether to declare distributions generally is solely within the directors’ discretion, subject to solvency limitations and any provisions to the contrary in a shareholders’ agreement or the articles. A shareholder has a “right” to a dividend or other distribution only when the board declares it.

Question 91

Compelling Distributions

Answer 91

The shareholders have no general right to compel a distribution. Because the decision about distributions is the board’s, it is difficult to win a case to force the declaration of a distribution. To win, the plaintiff must make a very strong showing of abuse of discretion.

Question 92

Rights After Declaration—Same as a General Creditor

Answer 92

Once a distribution is lawfully declared, the shareholders generally are treated as creditors of the corporation and their claim for the distribution is equal in priority to claims of other unsecured creditors. However, a distribution can be enjoined or revoked if it was declared in violation of the solvency limitations, the articles, or a superior preference right.

Question 93

Limitations on Distributions

Answer 93

Restrictions in the Articles: The articles may restrict the board’s right to declare dividends (for example, a creditor might insist that the corporation include in its articles a provision prohibiting payment of any distributions unless the corporation earns a certain amount of profits).

Question 94

When can a Corporation not make a Distribution?

Answer 94

Under the modern view, a corporation cannot make a distribution if it’s insolvent or if the distribution would render it insolvent.

Question 95

Director Liability for Unlawful Distributions

Answer 95

Directors are jointly and severally liable for improper distributions. A director who votes for or assents to a distribution that violates the above rules is personally liable to the corporation for the amount of the distribution that exceeds what could have been properly distributed

BUT directors have a good faith reliance defense (BJR)

A director who is held liable for an unlawful distribution is entitled to contribution from (1) every other director who could be held liable for the distribution, that is, those who voted in favor of the distribution) and (2) each shareholder, for the amount she accepted while knowing that the distribution was improper.

Question 96

Shareholder Liability for Unlawful Distributions

Answer 96

Shareholders are personally liable only if they knew the distribution was improper when they received it.

Question 97

Types of Fundamental Corporate Changes

Answer 97

Fundamental corporate changes are extraordinary, so the board generally cannot do them alone. They include the following types of changes:

• Amending the articles
• Merging or consolidating into another company
• Transferring substantially all assets (or having stock acquired in a “share exchange”)
• Converting to another form of business
• Dissolving

Question 98

Procedure for Fundamental Corporate Changes

Answer 98

Generally, to do any fundamental corporate change, we need:

1. (1) board action adopting a resolution of fundamental change;
2. (2) the board submits the proposal to the shareholders with written notice; and
3. (3) shareholder approval: The shareholder vote that’s required to approve a fundamental corporate change is a majority of the shares entitled to vote

For most of these changes, we also need to deliver a document to the secretary of state.

Question 99

Dissenting Shareholder Right of Appraisal

Answer 99

If a corporation approves certain fundamental corporate changes, the shareholders who did not vote in favor of the change may have appraisal rights. The dissenting shareholder right of appraisal is the right of a shareholder to force the corporation to buy their stock for fair value

there is no appraisal right if the company’s stock is listed on a national exchange (that is, it’s a publicly traded corporation) or if the company has 2,000 or more shareholders (not shares, shareholders) and the shares involved have a value of at least $20 million

Question 100

Effect of Merger or Consolidation

Answer 100

The surviving corporation succeeds to all rights and liabilities of the constituents. This makes sense because the constituent corporation disappeared. So a creditor of that corporation can sue the survivor. This is known as successor liability

Question 101

Procedure for Merger or Transfer of all or substantially all assets

Answer 101

Board action by both corporations is required, as well as notice to the selling company’s shareholders.

We also need approval by the selling company’s shareholders only. There are dissenting shareholder rights of appraisal for shareholders of the selling corporation (but not for shareholders of the buying corporation).

Question 102

Voluntary Dissolution by Incorporators or Initial Directors

Answer 102

If shares have not yet been issued or business has not yet been commenced, a majority of the incorporators or initial directors may dissolve the corporation by delivering articles of dissolution to the state. All corporate debts must be paid before dissolution, and if shares have been issued, any assets remaining after winding up must be distributed to the shareholders.

Question 103

Voluntary Dissolution by Corporate Act

Answer 103

The corporation may dissolve by a corporate act approved under the fundamental change procedure. This means that we need board of director action, shareholder approval, and we’ll file notice of intent to dissolve with the secretary of state.

Question 104

Effect of Dissolution

Answer 104

A corporation that has been dissolved continues its corporate existence but is not allowed to carry on any business except as appropriate to wind up and liquidate its affairs. We also need to notify creditors so that they can make any claims.

Question 105

Involuntary Dissolution

Answer 105

• Action by Attorney General: The attorney general may seek judicial dissolution of a corporation on the ground that the corporation fraudulently obtained its articles of incorporation or that the corporation is exceeding or abusing its authority
• Action by Shareholders: Shareholders may petition for involuntary dissolution on any of the following grounds: (1) Director abuse, waste or assets, or misconduct; (2) The directors are deadlocked in the management of corporate affairs, the shareholders are unable to break the deadlock, and irreparable injury to the corporation is threatened; (3) Shareholders are deadlocked in voting power and have failed to elect one or more directors for a period that includes at least two consecutive annual meeting dates; (4) The corporation has abandoned its business and failed to dissolve within a reasonable time.
• Action by Creditors: Creditors may seek judicial dissolution if: (1) the creditor’s claim has been reduced to judgment, execution of the judgment has been returned unsatisfied, and the corporation is insolvent; or (2) the corporation has admitted in writing that the creditor’s claim is due and owing and the corporation is insolvent.

Question 106

Administrative Dissolution

Answer 106

The state may bring an action to administratively dissolve a corporation for reasons such as the failure to pay fees or penalties, failure to file an annual report, and failure to maintain a registered agent in the state.

The state must serve the corporation with written notice of the failure. If the corporation does not correct the grounds for dissolution or show that the grounds do not exist within 60 days after service of notice, the state effectuates the dissolution by signing a certificate of dissolution.

A corporation that is administratively dissolved may apply for reinstatement within two years after the effective date of dissolution.

Question 107

Winding Up

Answer 107

Dissolution is not the end of the corporation. It is the beginning of a process that will end the corporate existence. The corporation continues to exist, so it can sue and be sued. It cannot start new business but must wind up (liquidate).

Question 108

Steps for Winding Up

Answer 108

• Give written notice to known creditors and publish notice of dissolution in a newspaper in the county of its principal place of business;
• Gather all assets;
• Convert assets to cash;
• Pay creditors; and
• Distribute any remaining sums to shareholders, pro rata by share, unless there is a liquidation preference.

Question 109

Liquidation Preferences