Corporations

Question 1

Basics:

Answer 1

Know: incorporation, shareholders, directors, and officers

Question 2

Incorporation

Answer 2

The articles of incorporation are filed with the state, and, if in conflict with bylaws; the articles control.

A corporation is not generally liable for a contract entered into prior to incorporation unless it expressly or impliedly adopts (ratifies) the contract.

The promoter (the person entering the contract on behalf of the prospective corporation) is liable.

Question 3

Shareholders

Answer 3

Shareholders are owners and do not manage the corporation. Thus, they generally just have annual meetings. Written notice of meetings is required 10-60 days prior and must state the time, place, and purpose of the meeting.

Shareholders can vote by proxy (have someone vote their shares for them) or by voting agreement. Generally, a quorum (majority of all outstanding shares required to vote) must be present to hold a vote.

Question 4

Directors

Answer 4

Directors manage the corporation and (like shareholders) act as a body by voting.

Shareholders hire and fire directors. Directors cannot vote by proxy or agreement. A quorum (majority of directors) needs to be present for a vote to take place, but unlike shareholders, directors can “break quorum” by leaving.

Notice is only required for a special meeting.

Question 5

Key duties

Answer 5

The duty of loyalty and duty of care are heavily tested. Whether a director of a corporation (or member of an LLC) breached a duty of care or loyalty is very fact based. However, usually when a duty of loyalty is an issue, the director or member HAS breached the duty.

Question 6

Duty of care

Answer 6

Business judgment rule:
There is a presumption that “in making a business decision, the directors acted in an “informed basis, in good faith, and in the honest belief that the action taken was in the best interest of the company”

Directors must be informed to an extent that they reasonably believe is appropriate. They are entitled to rely upon information, opinions, reports, or statements of corporate officers, legal counsel, public accountants, etc, in making a decision.

A party claiming that the directors breached their duty of care has the burden of proof.

Question 7

Duty of loyalty

Answer 7

A director must act in good faith and with a reasonable belief that what he does is in the corporation’s best interest. The business-judgment rule presumption does not apply if there is a duty of loyalty issue.

A duty of loyalty issue arises in three ways: (BCC)

• director is on both sides of a transaction
• director competes with the corporation
• director usurps a corporate opportunity

Question 8

Director is on both sides of a transaction

Answer 8

This occurs when a director has a material financial interest in a contract, as well as knowledge of that interest, yet still votes to approve the contract.

Question 9

Director competes with corporation

Answer 9

A director may not compete with his corporation

Question 10

Director usurps a corporate opportunity

Answer 10

A director may not usurp a corporate opportunity

Question 11

Defenses to liability for a breach of loyalty

Answer 11

The Revised Model Business Corporation Act (MBCA) includes three safe harbors that may protect a director who breaches his duty of loyalty:

1) approval by disinterested directors (if all relevant information is disclosed),
2) approval by disinterested shareholders, or
3) if the transaction is judged to be fair at the time it was entered into

Question 12

Waiver of duty in a LLC

Answer 12

An LLC operating agreement may waive the duty of loyalty (e.g. allow members to open competing businesses) so long as it is not “manifestly unreasonable).

Question 13

Voting

Answer 13

In order for a resolution to pass, there needs to be a quorum present, and more votes must be case in favor of the resolution than against it.

Question 14

Who votes

Answer 14

The record owner on the record date. The record date determines who is entitled to vote at a particular meeting–namely, those persons who were registered as shareholders “of record” on that date.

Exceptions are made if the shareholder died (then the shareholder’s executor may vote) or executed a valid proxy (then the proxy may vote).

Unless the articles of incorporation provide otherwise, each outstanding share (regardless of class) is entitled to one vote on each.

Question 15

Voting by proxy

Answer 15

A shareholder may vote by proxy. A shareholder can appoint a proxy by signing an appointment form or making a verifiable electronic transmission. A shareholder may not orally ask someone to serve as a proxy.

A proxy is generally revocable (even if it states it is irrevocable), and any action inconsistent with the grant of a proxy works to revoke it. Thus, when two or more revocable proxies are given, the last given proxy revokes all previous proxies.

Exception: a proxy is not revocable if it explicitly states it is irrevocable and is coupled with an interest (e.g. a sale of shares). Many states say that a proxy is valid for 11 months unless otherwise stated.

Question 16

Lawsuits by shareholders against the corporation

Answer 16

A shareholder may file an action to establish that the acts of the directors are illegal, fraudulent, or willfully unfair and oppressive to either the corporation or the shareholder.

Whether a suit is appropriately brought as a direct or derivative action depends on the injury.

Question 17

Direct suits

Answer 17

A direct suit is appropriate when the wrong done amounts to a breach of duty owed to the individual personally (e.g. when a shareholder sues for denial of preemptive rights, payment of a dividend, or oppression in a close corporation.)

Question 18

Derivative Suits

Answer 18

A derivative suit is appropriate when the injury is caused to the corporation and a shareholder is trying to enforce the corporation’s rights. (This also applies to LLCs).

Filing a derivative lawsuit has extra requirements. A shareholder may not commence or maintain a derivative suit unless three requirements are met (SAD)

1) standing to bring a lawsuit,
2) adequate representation of the interests of the corporation,
3) demand (generally, the shareholder should file a written demand and wait 90 days before filing a suit unless irreparable injury would result or a demand would be futile).

Any recovery goes to the corporation. A derivative lawsuit can be dismissed with court approval if it is not in the best interest of the corporation to continue it.

Question 19

Lawsuits against shareholders–piercing the corporate veil

Answer 19

As a general rule, the law treats a corporation as an entity separate from its shareholders, even where one individual owns all the corporate stock. In some (very limited) circumstances, courts will disregard the LLC form and hold a shareholder personally liable for corporate debt. To do so is called piercing the corporate veil.

It is only allowed in close corporations and LLCs. Generally, a plaintiff must show that shareholders of the corporation or members of an LLC abused the privilege of incorporating and fairness requires holding them liable. One generally needs to show undercapitalization of the business, failing to follow formalities, comingling of assets, confusion of business affairs, or deception of creditors.

Note that only the shareholders or members who participated in the wrong are personally liable.

Question 20

Right to inspect books and records

Answer 20

A shareholder has a right to inspect corporate books and records as long as his demand is made in good faith and for a proper purpose.

A proper purpose is a purpose reasonably related to a person’s interest as a shareholder (ex. when a shareholder articulates a purpose to address economic risks to the corporation)

A shareholder must state:

1) ) his purpose,
2) the records he desires to inspect, and
3) that the records are directly connected to his purpose

Question 21

Formation, rights, and duties of LLCs

Answer 21

Articles or organization must be filed to create an LLC. Since LLCs are a relatively new form of business association, courts tend to analyze them in the context of corporate partnership law.

Members of an LLC have fiduciary duties.

Members of an LLC in a member-managed LLC are treated as agents of the LLC (with actual and apparent authority to bind the LLC in ordinary–but not extraordinary–affairs).

Question 22

Dissociation of an LLC

Answer 22

If a member leaves, then it leads to dissociation of that member, but it does not lead to winding up or dissolution unless the other members unanimously agree to dissolve the LLC.

Question 23

Liability of an LLC

Answer 23

Generally, individual members are not liable for losses. They are liable if the court decides to pierce the LLC veil or if proper procedures for dissolution and winding up have not been followed.

Creditors may enforce claims against each of the LLC members. However, a member’s total liability may not exceed the total value of assets distributed to dissolution.