Corporations

Question 1

Federal tax treatment for corporations

Answer 1

C corp: double taxation. The corp and the shareholders are tax payers.
Default rule

S corp: pass through entity (not the same rules as partnership though)

Question 2

State tax treatment for corporations

Answer 2

subject to the Texas franchise tax

modified gross revenue tax with a $1M annual gross receipts exemption

Most common cause of involuntary termination for corporations is failing to file franchise tax!

Question 3

To make an S-corp election and maintain S-corp status, the corp must meet these requirements

Answer 3

No more than 100 SHs

SHs must be natural persons and must be US citizen or resident alien

Only 1 class of stock. Voting differences are okay, but no economic differences (must be common stock)

Question 4

Liability of SHs and directors within a corporations

Answer 4

Shareholders, directors, and officers are generally NOT personally liable for debts and obligations of the corporation.

But, remember liability for their own torts, some creditors will require personal guarantees, piercing the veil.

Question 5

General formation of a corporation

Answer 5

Corps cannot inadvertently be formed, unlike partnerships! They must comply with formal steps

Must prepare and submit AOI which is signed by the incorporators and is submitted to the SOS

Question 6

The corporation’s COF/AOI must include

Answer 6

Name (includes corporate designators and must be distinguishable upon the records)

Type of entity - for-profit corporation

Period of duration (perpetual unless stated otherwise)

Purpose (any lawful business)

Registered agent and registered off - NOT a PO box

Initial mailing address - PO box okay here

Shares (# of authorized shares and PV or no PV)

Names and addresses of initial directors (don’t need to update)

Names and addresses of organizers/incorporators (often the attorney helping)

One time filing fee of $300

Question 7

What designators may be used in a corporate name?

Answer 7

“corporation”, “incorporated”, “company”, “limited” or an abbreviation

Question 8

When is the corporation in existence?

Answer 8

The effective filing date is the date of receipt, assuming it is accepted for filing upon handling/review. It is not the day that it was SENT, it is the day of RECEIPT

Once the certificate of formation is received for filing → the corporation is in existence! Acceptance relates back to the date of filing.

Question 9

What is the modern ultra vires doctrine?

Answer 9

An act of a corporation that is beyond the scope of the purpose expressed in the COF or inconsistent with the limitation of an officer or director’s power as that limitation is expressed in the COF (different than general agency authority issues) is not automatically void.

Someone needs to assert in a proceeding that it was beyond the scope or inconsistent with the express limitation on authority to invalidate

See 20.002.

Question 10

What is novation?

Answer 10

party is released from contract because they were substituted for another party. Not automatic, must be in the agreement.

Question 11

What is a promoter?

Answer 11

someone who is engaged in transactions toward corporate formation and organization, before the corporation has technically been formed.

When promoters enter into a contract on behalf of a non-existing corporation, the promoter will be personally liable unless there was an agreement otherwise.

Promotor is personally liable UNLESS corporation by estoppel

Question 12

What is a de jure corporation?

Answer 12

Formed in compliance with law. IDEAL

Question 13

What is a de facto corporation? Generally (see Tx card too)

Answer 13

The filing of the COF but there is something wrong with it EVEN if it is actually accepted.

Law under which incorporation is permitted

Good faith, colorable attempt to comply
Some jurisdictions apply this strictly, but many jurisdictions say that a “colorable attempt” is the compliance and is the submission for filing (NOT just drafting of COF)

Use of corporate privileges

Question 14

What is a de facto corporation under TX law?

Answer 14

3.001(c)

acceptance of the COF is conclusive evidence to the rest of the world (apart from the SOS, because they can still terminate the corp if something is incorrect) that the corporation is properly formed.

In TX: little difference between de jure and de facto because both require acceptance.

Question 15

What is corporation by estoppel?

Answer 15

NOT de facto because no acceptance of the COF, but the court stops the creditor from holding the promotor personally liable even though the creditor is the one being misled. When the contract was made, the creditor did not expect to hold the promotor personally liable, so now when the corporation is actually formed, not an injustice to say they must hold the corporation liable.

(Look for fact patters where then the corporation is insolvent and need to pierce the veil)

Question 16

How does the corporation get property?

Answer 16

Consideration paid for shares; and/or
Borrow money; and/or
Revenue from operation.

Question 17

Corporations creating classes and series of shares

Answer 17

They can give the BOD a “blank check” or they can define the shares in the COF
Shares must be issued for consideration, but the BOD determines what the consideration is

All shares for this class have one vote unless the facts say otherwise.

Question 18

Vote required to amend the COF of corporations

Answer 18

Tx requires shareholder vote of 2/3

Question 19

What are authorized shares?

Answer 19

Number of share determined by the corporation when creating the COF.

The number of shares listed is maximum number of shares allowed, not the required amount.

21.901 - the corporation can correct an overissuance of shares by amending the articles of incorporation.

Question 20

What are issued shares?

Answer 20

the number that the BOD has authorized to go out

Still need the board to authorize the number to be actually issued even if COF has a maximum set.

Have to look at the records of the corporation. Can’t exceed authorized shares.

Question 21

What are outstanding shares

Answer 21

the shares that are actually out there with shareholders.

Usually the same number as issued, but the corp could have bought back shares so they are no longer outstanding (see treasury shares)

Question 22

What are treasury shares?

Answer 22

shares that the corp has bought back/redeemed

They are issued, but are not outstanding
Can be sold again or canceled.
The resell of treasury shares don’t have to be above PV

Question 23

What is par value?

Answer 23

the value stated in the COF
The minimum issue price
Can be $0

Shares without par value → stated capital reflects the entire consideration paid for the shares.

Question 24

Shares with or without PV may be issued for the following types of consideration

Answer 24

21.159
(1) a tangible or intangible benefit to the corp ;
(2) cash;
(3) a promissory note;
(4) services performed or a contract for services to be performed
(5) a security of the corp or any other organization; and
(6) any other property of any kind or nature

Question 25

Process to determine what consideration should be paid for shares

Answer 25

21.160
Consideration to be recieved for shares must be determined by the BOD.

A corp may dispose of treasury shares for consideration that may be determined by the BOD

Question 26

Amount of consideration for issuance of certain shares

Answer 26

21.161
consideration to be received by a corp for the issuance of shares with PV may not be less than the PV of the shares

Question 27

Who determines consideration received for shares during a merger or conversion?

Answer 27

21.162
In the absence of fraud in the transaction, the judgment of the BOD, the SH, or the party approving the plan of conversion or the plan of merger, as appropriate, is conclusive in determining the value and sufficiency of the consideration received for the shares

Question 28

What are preemptive rights?

Answer 28

A SH has the right to purchase a proportional number of shares first if the corp issues more shares in order to maintain their percentage ownership interest

SHs may or may not have, depends on the COF.
1. If the COF explicitly states they do or don’t, that controls.
2. If silent, then have to see when incorporated. 21.208
If incorporated before 9/1/03 → Silence means preemptive rights
If incorporated after 9/1/03 → silence means no pre-emptive rights

Pre-emptive rights only applies to the sale of shares by the corporation, not a transfer of shares by a SH

There are certain situations where there are no pre-emptive rights. See 21.204. COF can expressly override these situations.

Question 29

What is the SOL for preemptive rights claims?

Answer 29

21.206
Claim must be brought the earlier of

One year of written notice to the SH whose rights were violated; or

Four years after:
(A) the date the corporation issued the shares, securities, or rights;
(B) the date the corporation sold the shares, securities, or rights; or
(C) the date the corporation otherwise distributed the shares, securities, or rights.

Question 30

Does a transferee have pre-emptive rights?

Answer 30

If the transferor had preemptive rights, those rights likely transfer to the transferee. BUT, the transferee cannot assert a violation of the transferor’s preemptive rights.

Question 31

What is a distribution?

Answer 31

specific transfer from corp to SH
Payment of money or property in respect to the shares owned.

Not every payment to a SH is a distribution.

Question 32

What is stated captial?

Answer 32

The total par value of all issued shares. The sum of:

1. The PV of all shares of the corp with PV that have been issued.
2. The consideration for all shares without PV that have been issued EXCEPT that part of the consideration that has been actually received and the part the board has allocated to surplus within 60 days of issuing those shares. (The entire thing cannot be surplus – something has to be in SC.)

Question 33

What is surplus?

Answer 33

net assets (assets-liabilities) - Stated Capital.

21.002(12) “Surplus” means the amount by which the net assets of a corp exceed the Stated Captial of the corp

Question 34

What are net assets?

Answer 34

Assets-liabilities

Question 35

What is the distribution limit of a corporation?

Answer 35

Either when the corp would be insolvent after distribution (cannot pay its liabilities) OR that exceeds the surplus.
21.303

Question 36

When a corporation cancels treasury shares

Answer 36

SC goes down by PV of the treasury shares, which causes surplus to goes up that same amount. It doesn’t affect the overall value of the corp. Either by canceling the shares or redemption.
21.252(b)

Question 37

When a corporation redeems redeemable shares

Answer 37

When a corp redeems redeemable shares, the shares are cancelled and are restored to authorized but unissued shares. Corporation can force buy back.

21.251(a)

Question 38

What happens when distribution is improper?

Answer 38

Corporate directions may be personally jointly & severely liable for an inappropriate or impermissible distribution. Not strict liability.

Shareholders may also be liable if they know it is an impermissible distribution.
Innocent shareholders may have to pay under the Fraudulent Transfer Act in order to pay creditors if the corporation is insolvent.

Question 39

Basic concepts when piercing the corporate veil.

Answer 39

It is NOT a cause of action. Instead, it is a theory of recovery based on some other, underlying cause of action (means to a result!)

Usually used when the SH is using the corporation as a mere instrumentality to be shielded from personal liability.

Extreme remedy and to be used reluctantly and cautiously. But it is an equitable remedy and will be employed where circumstances require it.

Question 40

What are the traditional piercing the veil factors?

Answer 40

1. Whether the corporation was grossly undercapitalized for the purposes of the corporate undertaking
2. Failure to observe corporate formalities
3. Non-payment of dividends
4. The insolvency of the debtor corporation at the time
5. Siphoning of funds of the corporation by the dominant stockholder
6. Non-functioning of other officers or directors
7. Absence of corporate records
8. The fact that the corporation is merely a facade for the operations of the dominant stockholder or stockholders

PLUS an element of injustice or fundamental unfairness

No one factor is enough, but some may have more weight and some may overlap.

Question 41

What are the current Alter Ego elements when there is a contract? TX

Answer 41

Unity/lack of separateness

Injustice/actual fraud (dishonest of purpose or intent to deceive) for direct personal benefit

Total dealings minus corporate formalities
Courts have held that corporate formalities are no longer a factor!

Question 42

What are the current Alter Ego elements when there is NOT a contract? TX

Answer 42

Unity/lack of separateness

Injustice

Total dealings minus corporate formalities

Question 43

What are the current elements for Sham to perpetrate fraud when there is a contract in TX?

Answer 43

Actual fraud (constructive fraud is not sufficient, there must be dishonesty or purpose to decieve) for direct personal benefit

Question 44

What are the current elements for Sham to perpetrate fraud when there is NOT a contract in TX?

Answer 44

Actual or constructive fraud
The BOC doesn’t address so Castleberry controls

Question 45

Reverse veil piercing

Answer 45

Generally restricted by courts.

Looking to impose liability of SH onto the corporation OR insider reverse piercing: SH trying to disregard the corporate entity to protect their personal assets

Question 46

Single Business Enterprise Theory

Answer 46

No longer applicable in TX

Originally used to impose a corporation’s liability on an affiliated entity (or occasionally individual) where the entities had “integrated their resources to achieve a common business purpose”

Question 47

SOL when piercing the veil applies

Answer 47

RULE: if plaintiff can show alter ego, tolling applies (NOT the same as not accruing like in partnerships). Here, stopping the clock after the claim has already accrued and suspends until the final judgment is issued. Does not restart the clock! Just starts where it left off.

Question 48

What is the analysis for SH voting?

Answer 48

1. Was a quorum present?
2. Did the action receive the requisite vote? Action can be
   Matter where the BOC specifices portion of (all) shares entitled to vote. I.e. Fundamental business transactions
   Electing directors
   Other (catch-all)
3. Other issues to spot:
   Was there a written consent in lieu of meeting?
   Proxies?
   Telephone or electronic participation?

Question 49

Who can a director of a corporation be?

Answer 49

Must be a natural person, but doesn’t have to be a SH

Question 50

What requires SH approval?

Answer 50

Election of directors on an annual basis

Voting on fundamental business transaction

The BOC specifies a few matters that may be determined by directors or SHs (dual authority). Bylaws (because either SH or BOD can approve)

Question 51

What is a SH quorum?

Answer 51

21.358
Default rule: need the majority of shares issued and outstanding (so treasury shares don’t count) and each share gets one vote.
Statute says that COF can change, but no less than ⅓
We are concerned about counting the majority of SHARES not the majority of shareholders.

Once a quorum is present, business may be conducted (Even if SHs leave meeting and the number present drops below!) Unlike directors.

Question 52

SH voting rules for fundamental business transcations

Answer 52

21.364(b) and 365(a)
2/3 of all outstanding shares entitled to vote
Statute says that COF can change, but no less than majority of all shares entitled to vote

Fundamental business transactions include: merger, sale exchange, conversion, sale of substantially all assets outside ordinary course of business
Fundamental actions include (§21.364): amendment of COF, voluntary w/u (dissolution), revocation/cancellation of w/u, reinstatement

Question 53

SH voting for catchall other matters

Answer 53

Anything that is not electing directors or FBT/FA: Majority (voted, expressly abstained in Texas) but there are 4 variations of the majority rule.
1. Shares entitled to vote (all shares)
2. Shares present (Delaware/old default rule)
3. Shares voted (Model Act default)
4. Shares voted, expressly abstained (TX)

Question 54

SH voting rules for election of directors

Answer 54

Default: plurality (whoever gets the most votes, NOT the majoirty)
COF or bylaws can change this, but no less than majority if using alternative methods (and if using alternative methods, no longer cumulative votes)

Question 55

What is cumulative voting?

Answer 55

Can pool SHs votes and put the total on one candidate for director (rather than having to vote the number of shares owned by the SH for as many candidates as there are directors to be elected)

Question 56

Assuming cumulative voting is allowed, how does one know if one has enough shares to assure election of a director if all votes are cast on 1 candidate?

Answer 56

S/(D+1) +1

S: Outstanding shares (that are present at the election)

D: number of directors being elected

Question 57

How do you know if cumulative voting is permitted?

Answer 57

Must check the certificate of formation!

Cumulative voting rights MUST be expressly granted UNLESS the corporation was incorporated prior to 9/1/03, then cumulative is the default unless denied by the certificate of formation! See §21.362

Question 58

Do you have to give notice if using cumulative voting?

Answer 58

Yes! Assuming cumulative voting is permitted by the COF, notice must be given by at least one SH who intends to cumulate votes at least one day before the date of the election.

Question 59

Is cumulative voting usually used in publicly held corporations?

Answer 59

No, this is usually an issue in closely held corporations.

Most publicly held companies have adopted some form of majority vote standard for electing directors and have procedures for advance nomination of candidates.

Question 60

SH meeting

Answer 60

can be in person or telephonic or other electronic or combination where all SHs have reasonable opportunity to vote and read or hear the proceedings as they are occurring

6.002 requires SH to be able to “communicate with all other persons participating”;

§21.351 – Annual meeting
Written notice of meeting must be given to SHs between 10 and 60 days before meeting
SH may waive notice in writing or by attending or participating without objecting that the meeting is improperly convened

Question 61

What is SH Unanimous written consent in lieu of meeting

Answer 61

not suspicious, specially when there is only 2 or 3 shareholders. Doesn’t have to be the same piece of paper! Can all sign a seperate identical document.

Signing an agreement instead of having an annual meeting

Question 62

What is SH Non-unanimous written consent

Answer 62

signed by SHs with enough shares to authorize action at meeting where all SHs present) if authorized by COF

Question 63

What is proxy voting for SHs?

Answer 63

(proxy holder could vote at meeting or sign written consent).

Agreement to act as a proxy must be:
1. Written (including electronic transmission)
2. Expires in 11 months, unless stated otherwise (§21.368)
3. Revocable unless conspicuously states irrevocable and coupled with an interest. Coupled with an interest means the proxy must have an interest in the shares. See 21.369.

Question 64

What is a record date?

Answer 64

The date that determines who the SHs are and how many shares they own that is used for the annual meeting.

BOD can close share transfer records or set “record date” to determine who will have right to vote at SH meeting
If no record date set, the default rule is the date the notice of meeting is given
The record owner on the record date gets to vote.

Question 65

Director voting quorum

Answer 65

Quorum is majority of number of directors set by COF or bylaws unless increased or decreased
Can’t be below 1/3

Question 66

Director voting on matters requires

Answer 66

require a vote of a majority of directors present at a meeting with a quorum (remember 2/4 is not a majority)

Quorum must be present at time of vote (different than SHs)

BOD can delegate decision making on most non-fundamental changes to a committee of the BOD if bylaws provide

Question 67

What if the director is present and fails to vote?

Answer 67

A director who is present at the meeting is presumed to be in favor/ascent unless they expressly object and that objection is in the minutes.

Question 68

Director voting non-unanimous written consent and proxies

Answer 68

not options provided by statute, but could be provided under non-traditional SH agreement

Why not provided by statute? They were elected by SHs and we want them to make a decision as a group and have appropriate debates.

Question 69

How many directors are required to be on the BOD?

Answer 69

Can be as few as 1
Directors do not have to be SH
Directors must be individuals (not an entity)

Question 70

Election of directors

Answer 70

Directors are elected annually by SHs unless they die or resign
Even though they are elected annually, they serve until successor elected or qualified
Vacancies do not automatically arise if annual meeting is not held

Question 71

How can directors be removed

Answer 71

Directors can be removed with or without cause by SHs by a majority of all voting shares

If SHs voting against removal have enough votes to elect at election with cumulative voting, no removal. If cumulative voting using the formula, and the minority has enough to have approved a direct, there will be no removal if the minority is voting against it.

Vacancies can be filled by directors or SHs
No more than 2 vacancies may be filled by directors if due to increase in size of board
If remaining directors are less than quorum, majority of remaining can fill vacancies

Question 72

Officers of a corporation

Answer 72

Corps are required to have a president and a secretary, but they can be the same person

Officers are appointed and removed by BOD

An officer’s power and authority to bind the corp are determined by agency principles. Officers are agents of the corporation, unlike SHs and directors.

Question 73

Agency principles as applicable to officers of a corporation

Answer 73

Actual authority - How does corp manifest actual authority to the officer? - bylaws, BOD resolution, course of dealing, acquiesced in by BOD or other informal

Apparent authority - How does corp manifest apparent authority to a third party? – title (making someone VP of marketing likely gives them aparent authority when buying an advertisement), course of dealing or other holding out

Ratification – formal ratification by the board or informal like “SHs ratify everything the BOD did for the last year” in the annual meeting minutes.

Estoppel - A corporation is estopped to deny the representations of its officers and agents made within the scope of their authority.

Question 74

What is a super majority provision?

Answer 74

If the minority wants any sort of power, the default rules need to be altered. Coud insists that there is an 80% voting requirement (ex. to amend the COF) so that would give a ⅓ shareholder veto powers.

Can increase quorum or voting requirements

Question 75

Can SHs contract on how to vote their shares?

Answer 75

Yes, SHs can contract on how to vote their shares (voting agreements) but directors cannot contract how they will vote as a director because that violates their fiduciary duties to the corporation. SHs do not owe fiduciary duties to the corporation.
But directors can alter the voting requirements to require a unanimous vote, etc.

Question 76

SH agreements

Answer 76

Any number of SHs (with or without the corp as a party) may enter into a written voting agreement to provide manner that shares will be voted

Question 77

Is a subsequent owner of the SHs ownership interest subject to the voting agreement?

Answer 77

A subsequent owner of the ownership interest subject to the voting agreement is bound by the agreement if they have notice of actual knowledge of the voting agreement or they acknowledge in writing.
Notice of the SH agreement if conspicuously noted on the certificate.

Question 78

SH voting trusts

Answer 78

Any number of SHs may enter into voting trust to confer on trustee the right to vote their shares
Different than a SH agreement because here there is a transfer of legal title to the voting trustee and the owner retains the equitable title.
Record ownership is actually transferred to voting trustee, and voting trustee votes shares as determined under the agreement; voting trustee could have authority to determine how to vote shares or other means

Question 79

Non-traditional SHs agreements

Answer 79

21.101
SHS of a corp may enter into an agreement that provides for unconventional governance and economic provisions not otherwise authorized by the statute, such as:
restrict the discretion or powers of BOD;
Eliminate the BOD and vest management in SHs;
Specify who will be directors and officers;
Provide for selection, term, removal or directors, officers, and employees;
Authorize director proxies

Question 80

What is a statutory close corporation?

Answer 80

A statutory close corp MUST include the sentence “This corporation is a close corporation” in the COF!

The term “close corp” or “closely held corp” is commonly used to refer to a corp with a small number of SHs. Most corps with small number are not statutory close corps within the meaning of chapter 21

Question 81

Can SHs of a statutory close corporation enter into an unconventional SH agreement?

Answer 81

21.714
Yes, but requires ALL to enter and much more cumbersome and difficult.

Question 82

Share Transfer Restrictions

Answer 82

21.211(a) authorizes reasonable share transfer restrictions of the following types:
1. Right of first refusal (ROFR) or first option to purchase
2. Put right
3. Call right
4. Buy-sell
5. Tag-along, drag-along
6. Consent requirement
7. Prohibition
8. Restriction to Maintain S Election or other Tax Advantage
9. Triggers Automatic Sale or Transfer

Question 83

What is a buy-sell transfer restriction?

Answer 83

A two-way obligation where one party is obligated to sell and the other is obligated to buy on circumstances agreed to trigger such an obligation
Such as divorce, death, or other circumstances

Question 84

Where are transfer restrictions found?

Answer 84

COF/AOI
Bylaws
Written Agreement

Question 85

If the corporation agrees or places a restriction on transfer, what must they do?

Answer 85

restriction must be conspicuously referred or described on the front and/or back of the certificate as specified in §3.202

Share transfer restrictions are specifically enforceable if reasonable and noted conspicuously on certificate 21.231(a)(1)
Noted conspicuously means in bold, underlined, capitalized, etc. 3.202

Unless noted conspicuously, a bona fide purchaser for value takes free of the restriction §21.213(b) unless they have actual knowledge of the restriction at the time of the transaction.

Question 86

Inspection/Information rights of directors

Answer 86

Directors have a very broad statutory right of access to books and records reasonably related to service as director (§3.152)

Question 87

Inspection/Information rights of SHs

Answer 87

A 5% SH or person who has been a SH for 6 months has right of access to books, records of account, minutes, and share transfer records relating to the SH’s stated purpose §21.218(b)
On written demand
For a proper purpose (not just curiosity, but could be a suspicion of mismanagement.)
Can only get access to what relates to the purpose)

Attorney’s fees are recoverable by SH if improperly denied access §21.222(a)

Statute automatically entitles SHs to financial statements and voting lists if it is a publicly held corporation!

Question 88

Director’s Fiduciary Duties

Answer 88

Duty of care
Duty of loyalty
Duty of obedience (rarely an issue)

SHs do not owe fiduciary duties to the corporation.
Directors do not owe fiduciary duties to individual SHs!

See specific facts duty (insider SH trying to get passive SH to buy/sell has duty to disclose material facts)

Question 89

What is the standard for the director’s duty of care?

Answer 89

Business judgment rule:
presumes that in making a business decision the directors acted:
on an informed basis,
in good faith, and
in the honest belief that the action was in the best interests of the company

We focus on the decision making PROCESS, not the outcome of the decision.

Question 90

What is the standard for breaching the business judgment rule?

Answer 90

DE: gross negligence

TX: Little case law, but
allegations of “mere mismanagement, neglect, or abuse of discretion” not sufficient;
Weight of authority right now: Standard is probably gross negligence OR even further where it is anything short of fraud (so even if grossly negligent, still not liable.)

Question 91

What if a director relies on an expert’s advice

Answer 91

3.102
Protects a governing officer who relies in good faith, with ordinary care on info, report, etc. from officer, employee, legal counsel, CPA, investment banker or other reasonable source of information or board committee of which director is not a member
SAFE HARBOR! If they rely on information from experts, they are NOT liable.
Applies to directors and other “governing officers” like a manager of an LLC!

Question 92

Can a director’s fiduciary duties be exculpated?

Answer 92

COF may include provisions limiting or eliminating liability for monetary damages to corp or SHs ONLY for liability for good faith breach of duty of care.

Courts still have equitable remedies, even if the director isn’t liable for monetary damages!

A lot of COFs will exclupate “to the maximum extent permitted by law.”

Question 93

Director’s duty of loyalty

Answer 93

Not statutorily defined for corporate directors.

Common law: usually usurpation of business opportunity, self-dealing, or conflict of interest.

BJR doesn’t apply to duty of loyalty! Courts scruitinize heavily in duty of loyalty situations, unlike duty of care!

Question 94

If a Director engages in a self-dealing transaction, how can they show the transaction is valid and enforceable?

Answer 94

1. Material facts disclosed to or known by BOD, and BOD in good faith authorizes transaction by majority of disinterested directors;
2. Material facts disclosed to or known by SHs, and SHs in good faith specifically approve of transaction;
   Doesn’t say disinterested SHs but still must be done in good faith so can’t deceive the other SHs in order to make the transaction happen.
3. Transaction is fair to the corp when it is approved
   Affirmatively have to prove fairness.

If one of the 3 conditions are met, there is no DoL claim because it “removes the taint” of self-dealing. Put it back within the DoC argument and the BJR if applicable.

Question 95

If a director engages in a usurpation of business opportunity:

Answer 95

Corp opportunity doctrine – misappropriation or usurpation of business opportunity that properly belongs to corp is breach of duty of loyalty

How do we know if it is a corp opportunity? – in the line of business, or would the corporation have an interest or expectancy

Person with the DoL has the burden to prove that they acted properly. Defenses
Financial incapability
Declined or abandoned by corp (hindsight finding that the corporation would have decline is not allowed)

Question 96

What is the difference between a SH derivative suit and a direct suit?

Answer 96

If the breach is a duty owed to the corporation → it is unlikely that the corporation would bring suit against the corporation for their own activities → likely a derivative suit

If the breach was a duty owed to the individual shareholder or if the individual shareholder is the one injured (directly) → direct suit

Question 97

What are the requirements for a SH derivative suit when NOT a closely held corporation?

Answer 97

1. Ownership requirement (Contemporaneous and continuous)
2. Fair Representation
3. Written demand (demand must be made on BOD to take action and derivative suit cannot be filed for 90 days unless irreparable injury is being suffered or BOD rejects demand before 90 days)
   Some jurisdictions (NOT TX) will waive the demand requirement if the plaintiff can show that it would have been futile or a waste of time.

Question 98

If disinterested, independent directors or court-appointed persons conclude in good faith after a reasonable inquiry that continuation of the suit is not in the best interests of the corp

Answer 98

the court must dismiss

If a disinterested, independent review is underway, the court must stay the suit (so plaintiff will not be able to conduct discovery at this stage.)

The statute basically employs the business judgment rule in requiring the court to defer to decision of disinterested, independent directors if they made a good faith, informed decision

Question 99

Procedural safe guards for derivative suits

Answer 99

Court approval of settlement or discontinuation

Court can award fees as sanction against either side

Plaintiff recovers fees from corporation (not defendants) if substantial benefit conferred on corporation

Court may order plaintiff to pay corporation’s and defendant’s fees if the suit was without reasonable cause or for an improper purpose.

Question 100

What is the closely held carveout for derivative suits in TX?

Answer 100

“closely held corporation” is not the same as a statutory “close corporation” (here 35 SHs or fewer and not listed on the stock exchange)

The statutory requirements regarding demand, standing, dismissal, and court approval of settlements/discontinuation do not apply to a derivative suit by a SH of a closely held corporation against a director, officer, or another SH of the corporation.

suit will proceed on the merits.

Question 101

Can a SH directly recover?

Answer 101

ONLY if closely held.

“If justice requires,” court may order recovery in a derivative action to be paid to the SH – court will consider impact on corp creditors and other SH in determining whether should be paid to corp or SH

Question 102

What if a shareholder derivative suit is filed by a SH of a Delaware corporation in Texas where the SH and all of the director defendants live and where the corporation is headquartered and does business?

Answer 102

Most of the matters addressed in the Texas statute on derivative suits (standing, demand, and independent investigation/dismissal as well as suits on behalf of closely held corporations) would be governed by the law of the state of formation, i.e., Delaware law.

No special rules for closely held corps!

Question 103

When is dissolution appropriate?

Answer 103

Dissolution in event of a deadlock is available, but is not required if petitioned.

Dissolution is an extreme measure

Question 104

What is a liquidating receivership

Answer 104

someone that oversees the process of dissolution and liquidation.

Question 105

What is a rehabilitative receivership?

Answer 105

someone is overseeing the rehabilitative process of the corporation

Question 106

When is a liquidated receivership used?

Answer 106

Only used in very specific circumstances: 11.405

when an action has been filed by the attorney general

on application of the entity to have its liquidation continued under the supervision of the court

if the entity is in receivership and the court does not find that any plan presented before the first anniversary of the date the receiver was appointed is feasible for remedying the condition requiring appointment of the receiver

on application of a creditor of the entity if it is established that irreparable damage will ensue

Question 107

When is a rehabilitative receivership used?

Answer 107

Corp is insolvent or in imminent danger of insolvency

BOD deadlocked and SH unable to break deadlock and irreparable injury

BOD acts in illegal, oppressive, or fraudulent manner

Misapplication or waste of corp property

SH deadlocked and SH unable to elect directors for at least 2 years

Question 108

Modern trend for fiduciary duties in a closely held corporation:

Answer 108

NOT TX

SHs of a closely held corp owe each other fiduciary duties! The majority owes the “utmost good faith and loyalty” to the minority. Have to give them the same opportunity.

Question 109

TX common law rule for fiduciary duties in a closely held corporation:

Answer 109

There must be oppression of the minority and then the court may award ONLY the equitable remedy of a rehabilitative receivership.

Oppression defined as: When directors
(1) abuse their authority over the corp
(2) with the intent to harm the interest of one or more of the SHs,
(3) in a manner that does not comport with the honest exercise of their business judgment
(4) and by doing so create a serious risk of harm to the corp

Question 110

Can a plaintiff in TX win on a claim that the director breached informal fiduciary duties?

Answer 110

No. In TX, as a matter of law, a corporation’s director cannot owe an informal duty for the benefit of an individual SH.
Duty of the director is to the corp, so a duty to an individual SH could conflict.

Question 111

Why would directors be concerned with indemnification? If there is an exculpation clause in the COF, doe they still need indemnification?

Answer 111

Proceedings by third parties other than shareholders or corporation
Prevail or settle in a proceeding brought by shareholder or corporation

Question 112

When is Indemnification required:

Answer 112

Director has absolute right to indemnification if “wholly successful on the merits or otherwise” - §8.051(a)
Otherwise, like SOL has run but a case was still brought, still incurred defnese costs so required to get indemnity.

This entitlement can be limited in the COF or bylaws - §8.003

Question 113

When is Indemnification prohibited

Answer 113

Director completely precluded from indemnification if found liable to the corp or found liable because directly improperly received a personal benefit, and found liable for:
Willful or intentional misconduct in the performance of the director’s duty to the corp;
Breach of the director’s duty of loyalty owed to the corp; or
An act or omission not committed in good faith that constitutes a breach of a duty owed by the director to the corp

Not prohibited if there is a settlement!

Question 114

When is indemnification permitted

Answer 114

Director may be indemnified for judgments, penalties, fines, settlements, and other expenses if meets permissive indemnification criteria, but limited to reasonable expenses other than judgment if found liable to corp or on basis received improper personal benefit - §8.102

This permissive indemnification can be made mandatory in COF, bylaws, resolution of SHs or board, or contract (§8.103(c)) or limited in COF or bylaws (§8.003)

Question 115

What is the criteria the director must meet for permissive indemnification?

Answer 115

Acted in good faith; and
Reasonably believed
in the case of conduct in official capacity as director, that the conduct was in the corp’s best interest,
in all other cases, that the conduct was at least not opposed to the corp’s best interest, and
in the case of any criminal proceeding, had no reasonable cause to believe conduct was unlawful

Question 116

Who determines if the director acted in good faith for permissive indemnification? Factfinders

Answer 116

Disinterested, independent directors:
Majority vote of disinterested directors; or
Majority vote of a committee of the directors if the committee is:
Designated by the majority of disinterested directors; and
Composed solely of one or more directors who are disinterested

Special legal counsel, or

Disinterested SHs

Unanimous SH vote

Question 117

When may a corporation advance expenses to a director?

Answer 117

Permissive upon receipt of written affirmation by director of good faith belief meets standards for indemnification and promise to repay if ultimately determined not permitted to be indemnified - §8.104(a)(1), (2)

Permissive advancement can be made mandatory in COF, bylaws, SH or BOD resolution, or contract - §8.104(b)
Mandatory advancement is very common for directors!
If mandated in documents, the corporation is forced to advance even if the corporation is the one suing the bad acting director!

Question 118

When may a corporation indemnify and advance expenses to an officer, employee, or agent?

Answer 118

Officers – required and permitted to same extent as directors - §8.105(b)

Non-director officers, employees, agents, and persons serving another entity at corp’s request – permitted to such further extent “consistent with other law” as provided in COF, bylaws, BOD or SH action, contract, or common law - §8.105(a)
No specific prohibition for non-directors.

Question 119

What notice must be given if the corporation indemnified or advances a director?

Answer 119

SHs must be notified of any indemnification of or advance of expenses to director with or before notice of next annual meeting and within 12 months of indemnification or advance

Question 120

What is the extent of corp’s power to indemnify and advance to directors

Answer 120

Limited to provisions of statute - §8.004

Corp permitted to purchase and maintain insurance for director, officer, employee, agent, etc. and coverage may exceed indemnifiable areas - §8.151(a), (b)

SH approval required if insurance covers unindemnifiable areas and insurer not regularly engaged in business of insurance - §8.151(c)

Corp can self-insure, etc. - §8.151(a)-(c), (d), (e)

Question 121

What are considered fundamental changes to a corporation?

Answer 121

1. Amendment of COF
2. Merger
3. Interest (share) exchange
4. Sale of all or substantially all assets
5. Conversion
6. Winding up and Termination

Question 122

What is the process required to amend the COF? ON THE EXAM

Answer 122

BOD approves, and submits to SHs
SHs approve by vote of 2/3 outstanding shares entitled to vote
File certificate of amendment with filing fee with SOS

SHs do not have dissenters’ rights (right to be bought out for fair value) with respect to amendment of COF other than with respect to election or termination of election to be “public benefit corp”

Question 123

What is a merger?

Answer 123

all rights and property of the merging entities are “vested” in the surviving entity “without any transfer or assignment,” and all liabilities are owed by the surviving entity. (Surviving entity is the one whos identity remains)

Question 124

What is the process required for a merger?

Answer 124

1. Merger plan: BOD (for both companies) approves and submits plan to SHs and give at least 20 days notice of SH meeting
2. SH (for both companies) must approve plan by 2/3 outstanding shares entitled to vote (bc fundamental change)
3. Must file certificate of merger with SOS

SHs entitled to vote on merger have dissenters rights!

Question 125

Dissenters rights:

Answer 125

Shareholders must:
(1) File written objection prior to meeting
(2) Vote against merger
(3) Demand payment of fair value of shares, tender share certificate
If no agreement receives fair value, after an appraisal proceeding

If you dissent, you lose your shares, but you receive cash for fair value of those shares.

Question 126

What is a triangular merger?

Answer 126

If the parent corporation does not want to be subject to the other corporation’s liabilities, they can arrange a triangular merger.

To do this, they set up a subsidiary corporation and arrange a merger between the subsidiary corporation and the other corporation.
I
t requires the same procedural steps as a merger.
The only difference is that, absent veil piercing, the parent corporation would not be liable for the other corporation’s liabilities, which now belongs to the subsidiary.

Question 127

What is an interest (share) exchange?

Answer 127

Share exchange is like a merger but will result in the acquiring company owning all the stock in the acquired company. A “fake” TLC subsidiary is set up and then will disappear after the merger.

Question 128

What is the process for an interest (share) merger?

Answer 128

BOD of corp whose outstanding shares to be acquired approves and submits plan of exchange to SHs, either recommending or withholding recommendation with explanation
For acquiring corp, only approval of BOD required

SHs whose shares to be acquired approve plan of exchange by vote of 2/3 outstanding shares

File certificate of exchange with filing fee with SOS

SHs whose shares to be acquired have dissenters’ rights

Question 129

What is the sale of all or substantially all assets?

Answer 129

The acquiring company may not want the liabilities of the other company. That is not possible in a merger. However, the acquiring corporation can purchase all of the other corporation’s assets not in the ordinary course of business.

The acquiring corporation will only take on the liabilities that they contractually agree to

CATCH: the acquired corporation must go completely out of business after the sale or else it is not a sale of all assets

Question 130

What is the process for the sale of all or substantially all assets?

Answer 130

BOD of selling corp approves and submits proposed sale to SHs, either recommending or withholding recommendation with explanation
For acquiring corp, only approval of BOD required

SHs of selling corp approve sale of assets by vote of 2/3 of outstanding shares entitled to vote
DE is just majority

No filing with SOS required
Ordinarily, the selling corp will wind up and terminate after sale, pursuant to which a certificate of termination will be filed

SHs of selling corp have dissenters’ rights

Question 131

What is conversion?

Answer 131

If a corporation wanted to change forms of entity into another form
Ex: TLC, Inc. to TLC, LLC

Takes one step instead of two steps like a merger (where would have to create the new entity and then merge)

Converted entity continues to exist in the form of the converted entity; rights and property of converted entity continue to be owned by converted entity, and liabilities continue to be owed

Question 132

What is the process for conversion?

Answer 132

BOD of corp approves and submits plan of conversion to SHs, either recommending or withholding recommendation with explanation

SHs approve plan of conversion by vote of 2/3 outstanding shares entitled to vote

File certificate of conversion (certificate of formation of converted entity attached) with filing fee with SOS

SHs entitled to vote on conversion have dissenters’ rights

Question 133

Fundamental Business Transactions in which SHs have dissenters rights

Answer 133

Merger
Triangular Merger
Sale of All or Substantially All of the Assets
Conversion

Question 134

What is the process for winding up and termination?

Answer 134

1. BOD Approval
   At least 10 days notice of SH meeting
2. SH Approval by vote of 2/3 outstanding shares entitled to vote
3. Corporation ceases to carry on business except as necessary to wind up
   Must give notice to claimants, make payments to claimants, and distribute remaining assets to SHs
4. File Certificate of Termination with filling fee with SOS, thereby ending corporate existence
   The corporation continues its corporate existence for 3 years after filing certificate of termination for limited purposes