Corporations

Question 1

Business Judgment Rule

Answer 1

The business judgment rule creates a rebuttable presumption that, when making a business decision, directors and officers have acted on an informed basis, in good faith, and with an honest belief that their decision was in the corporation’s best interest.

Directors must be informed to the extent that they reasonably believe is appropriate. They are entitled to rely on 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 in rebutting this presumption.

Question 2

Difference Between LLCs and Corporations for Tax Purposes

Answer 2

Limited liability companies are treated like corporations for liability purposes, but may be taxed like partnerships (i.e., are not “double taxed” like corporations). Both limited liability companies and corporations are created by statute, not common law.

Question 3

Member Liability in an LLC

Answer 3

Generally, members of an LLC are only liable for losses up to the amount which a member contributed to the limited liability company.

Members will not be personally liable beyond the scope of their contributions unless the court pierces the company veil.

Question 4

Incorporation

Answer 4

The articles of incorporation are filed with the state and will prevail if in conflict with the bylaws.

A corporation is not generally liable for a contract entered into prior to incorporation unless the contract on

Question 5

Duty of Loyalty

Answer 5

A director must act in good faith and with a reasonable belief that what he does is in the corporation’s best interest.

A duty of loyalty issue will arise in three occasions —

1. If the director competes with the corporation;
2. If the director usurps a corporate opportunity for themselves; or
3. If the director is on both sides of a transaction (when the director has a material financial interest in a contract, as well as knowledge of that interest, yet still votes to approve it);

The BJR presumption does not apply to the duty of loyalty. An LLC operating agreement may waive the duty of loyalty.

Question 6

Defenses to Liability for Breach of Duty of Loyalty

Answer 6

The MBCA includes three safe harbors that may protect a director who breaches their duty of loyalty:

1. Approval by disinterested directors, if all relevant information is disclosed to them;
2. Approval by disinterested shareholders; or
3. If the transaction is judged to be fair to the corporation at the time that it was entered into.

Question 7

Voting Requirements for Shareholders

Answer 7

In order for a resolution to pass, there needs to be a quorum present, and more votes must be cast in favor of the resolution than against it. Only record owners of shares by the record date are eligible to vote.

Question 8

Voting by Proxy

Answer 8

A shareholder may vote by proxy. A shareholder can appoint a proxy in writing by signing an appointment form or making a verifiable electronic transmission.

A proxy is generally revokable, and any action inconsistent with the grant of a proxy will revoke it. Exception: A proxy is not revokable if it explicitly states that it is not + is coupled with an interest. A proxy is valid for 11 months unless otherwise stated.

Question 9

Lawsuits by Shareholder

Answer 9

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 will depend on the injury.

Question 10

Direct Suits

Answer 10

A direct suit is appropriate when the wrong done by the corporation has injured the shareholder personally, for example, the refusal to pay dividends.

Question 11

Derivative Suits

Answer 11

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

A shareholder must meet three requirements to file a DS —
1. Shareholder must have standing (be a contemporaneous owner at the time of the alleged act or omission);
2. Adequacy; Shareholder must represent the interests of the corporation;
3. Shareholder must make a written demand on the board of directors and wait 90 days before filing suit.

Question 12

Piercing the Corporate Veil

Answer 12

Generally, the law will treat a corporation as an entity separate from its shareholders. However, piercing the corporate veil is when the court will disregard the corporate/LLC form and hold a shareholder personally liable for corporation debt.

To do so, a plaintiff must show that the shareholders of the corporation or members of an LLC abused the privilege of incorporating and fairness requires holding them liable.

Person bringing suit must show that there was an undercapitalization of the business, failure to follow corporate formalities, commingling of assets, confusion of business affairs, or deception of creditors.

Question 13

Right to Inspect

Answer 13

Under the MBCA, 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 any purpose that is reasonably related to a person’s interest as a shareholder.

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 14

Dissociation of an LLC Member

Answer 14

A member may leave/dissociate, however, it does not lead to the winding up or dissolution of the LLC unless the other members unanimously agree to dissolve the LLC.

The dissociating member has no right to have the LLC buy out his interest unless the OA provides for reimbursement, a buyout, or dissolution. The dissociating member will be paid when the LLC dissolves, if ever.

Question 15

LLC Liability

Answer 15

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

Question 16

Characteristics of a Corporation

Answer 16

1. Perpetual or continuous existence (survives the death of its owners);
2. Centralized management via a Board of Directors;
3. Limited liability;
4. Free transferability of shares.

Disadvantage — “double taxation”
Advantage — Raises capital

Question 17

Double Taxation

Answer 17

Profits made by the corporation are taxed as corporate income, then, when the profits are distributed to the shareholders as dividends, they are taxed again as personal income.

Question 18

Promoters

Answer 18

Promoters take the necessary preliminary steps for creating a corporation. They are not agents of the corporation and have no power to bind the corporation.

When there is more than one promoter, they is mutual agency among the promoters themselves.

Question 19

Pre-Incorporation Promoter Liability

Answer 19

Promoters are personally liable for the contracts entered into for the benefit of the not-yet-formed corporation, unless agreed to otherwise.

Question 20

Post-Incorporation Promoter Liability

Answer 20

The corporation is not liable for any pre-incorporation agreements made by promoters without an adoption or novation.

Adoption — Corporation can adopt the contract expressly or impliedly, and the promoter will still be liable but will be entitled to indemnification by the corporation.

Novation — The promoter will be fully released from all liability/obligations under the contract; the corporation takes the place of the promoter, with the consent of all parties in the agreement.

Question 21

Incorporation Process

Answer 21

Incorporation requires the execution and filing of articles of incorporation; the articles will control if in conflict with the bylaws.

Question 22

Filing the Articles of Incorporation

Answer 22

Must be delivered and filed by the Secretary of State’s office; effective date of incorporation is the date of filing, unless the articles set a separate date that is no more than 90 days after the filing date.

Question 23

Organization of a Corporation

Answer 23

Requires naming of directors, appointing of officers, and adopting of bylaws.

Question 24

Bylaws

Answer 24

Internal rules and regulations to govern actions and relations to its shareholders, directors, and officers.

May include any provisions for regulation and management that are not inconsistent with the law or the articles of incorporation.

Question 25

De Facto Corporation

Answer 25

If statutory compliance is insufficient for de jure status, a de facto corporation may still have been formed if:
- There was a good faith, colorable attempt to comply with incorporation formalities, and
- Corporation principals acted as if there were a corporation.

De facto status will insulate directors from liability.

Question 26

Corporation by Estoppel

Answer 26

Absent de jure or de facto status, a corporation may still exist by estoppel. If a creditor always dealt with the principals as if they were a corporation, he will be estopped from later alleging that the corporation is defective, if that would unjustly harm the principals.

The inverse is also true — if a corporation has always dealt with a third party as if they were a corporation, they cannot later allege that they were not a corporation.

May be both a sword and a shield.

Question 27

Powers of Directors

Answer 27

All exercises of corporate power must be by or under the Board of Directors. Individual directors do not have the power to act or act as a corporate agent.

All board action must be done with a quorum, unless a greater number is required. Unless otherwise specific, a quorum is the majority.

Question 28

Dividends

Answer 28

The Board of Directors has the option to decide to retain corporate earnings to expand the business.

Shareholders must prove that refusal to declare a dividend amounted to fraud, bad faith, or an abuse of discretion.

Question 29

Ultra Vires Doctrine

Answer 29

The statement of corporate purpose in the articles of incorporation authorize the Board of Directors powers while also limiting the authority of the corporation’s representatives.

Under the Ultra Vires Doctrine, a corporation cannot be obliged to undertake a contract entered into by a director or officer that is beyond the scope of their powers described in the articles of incorporation or bylaws.

Question 30

Duty of Care

Answer 30

Directors/officers must perform their duties in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, in a manner that they reasonably believe to be in the best interests of the corporation.

Directors are entitled to rely on the information, reports, records, financial data prepared in a reliable and competent manner.

Question 31

Self-Dealing

Answer 31

A transaction between director and the corporation of which the director had knowledge and a material financial interest.

Not per se voidable. When a director is involved in a “conflict of interest transaction”, they director must notify the Board of Directors.

Question 32

Shareholder Powers/Duties

Answer 32

Shareholders generally have the duty to elect directors, remove directors with or without cause, amend the bylaws, and approve fundamental changes.

Powers generally performed at shareholder meetings, in which a quorum must be present and shareholders must have 10-60 days notice minimum.

Question 33

Cumulative Voting

Answer 33

Shareholders may allocate all of their votes to any candidate. Strengthens the minority. Combining all votes onto one candidate.

The default is a straight vote — 1 share, 1 vote.

Question 34

Voting Rights of Shareholders

Answer 34

Generally, one share = one vote.

Only shareholders of record by the “record date” are eligible to vote.

Shareholders are entitled to vote by proxy.

Question 35

Proxy Voting

Answer 35

Shareholder must provide the proxy holder with a written, signed, or electronically transmitted authorization. Proxies are generally valid for 11 months.

Question 36

Piercing the Corporate Veil Factors

Answer 36

1. Undercapitalization;
2. Disregarding corporate formalities;
3. Commingling of funds;
4. The extent to which the corporate entity is no more than an alter ego of its shareholder(s).

Question 37

Demand

Answer 37

Required for derivative suits, but not for direct suits.

A shareholder bringing a derivative suit must first attempt to persuade the board of directors to enforce the corporation’s rights by making a written demand within 90 days of bringing suit.

Question 38

Amending the Bylaws

Answer 38

Shareholders may amend bylaws.

Question 39

Acting as an Agent of a Nonexistent Corporation

Answer 39

A creditor of a corporation may seek to enforce a contract against someone who knowingly purported to act as shareholders or as agents of the corporation when the corporation did not, in fact, exist.

In such cases, the shareholders or agents are jointly and severally liable for all liability created while so acting.

(If you pretend to act on behalf of a corporation and you know that one doesn’t actually exist, you are jointly and severally personally liable).

Question 40

Dismissing a Derivative Suit

Answer 40

Directors can seek dismissal of a derivative suit when —

(1) a majority of disinterested directors determine, in good faith and after conducting a reasonable inquiry, that

(2) continuance of the suit would be detrimental to the corporation’s best interests.

Question 41

Proper Purpose for Inspecting Records

Answer 41

Under the MBCA, a proper purpose is any purpose reasonably related to a shareholder’s interest as a shareholder.

A proper purpose includes a desire to investigate potentially illegal transactions or any other activities posing an economic risk to the corporation, where there is some credible evidence of a potential issue.

Question 42

Member-Managed vs. Manager-Managed LLC

Answer 42

Member-Managed: LLCs with more than one member ordinarily enter into an operating agreement that may include how all operations will be run. The agreement also sets how to share profits and losses. If neither the articles of organization nor the operating agreement contain a provision to appoint managers, then the LLC is member-managed, by default.

Manager-Managed: In a manager-managed LLC, the owners elect a manager to handle day-to-day business decisions. Members still retain authority over some things, such as dissolving. That said, the manager is the main legal agent of the LLC. Appropriate when an LLC has passive investors or “silent partners”.