Corporations Flashcards
Fiduciary Duties 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 (DOL). She must also use the care that a person in like position would reasonably believe appropriate under the circumstances (DOC).
Duty of Care - BOP on plaintiff
- if nonfeasance (director does nothing), plaintiff must show causation - that the director’s breach causes a loss to the corporation
- if misfeasance (board makes a decision that hurts the business) - causation is clear - but a director is not liable if she meets the business judgment rule (plaintiff has the rebut presumption)
Business Judgment Rule
- Court will not second guess a business decision if it was made in good faith, was informed, and had a rational basis
- this means that directors who meet the standard will not be liable for corporate decisions that in hindsight turn out to be poor or erroneous
- burden on plaintiff to show that the board either did not do appropriate homework or did something galactically stupid
Duty of Loyalty - BOP on defendant
- DOL cases are about conflicts of interest
- BJR does not apply because it can never apply when the fiduciary has a conflict of interest
Close Corporation Characteristics
(1) Small number of shareholders
(2) Stock not publicly traded
(3) shareholders can manage directly
Piercing Corporate Veil
Always start with general rule: shareholders are not liable for the acts or debts of the corporation
To pierce the corporate veil and hold shareholders personally liable:
(1) the shareholders must have abused the privilege of incorporating; and
(2) fairness must require holding them liable
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
3 common scenarios
(1) Alter Ego (identity of interests)
- if the shareholders ignore corporate formalities such that the corporation may be considered an alter ego of the shareholders or another corporation, AND some basic injustice results, a court might pierce the corporate veil
- 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
- but the mere fact that an individual chooses to adopt the corporate form of business to avoid future personal liability is not itself a reason to PCV
Who is liable?
- generally, only shareholders who are active in the operation of the business will be personally liable
Types of Liability
- the corporate veil is easily pierced in tort cases, but not in contract cases since parties who contracted with the corporation had an opportunity to investigate its stability.
Direct Suits
A direction action may be brought for a breach of 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) who suffers the most immediate and direct damage, the corporation or the shareholder?; and
(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
*breach of duty of loyalty and breach of duty of care - always DERIVATIVE!!!!
- because the corporation could sue (these duties are owed to the corporation!!
Examples of Direct Suits
(1) SH sues BOD for issuing new stock without honoring her preemptive rights
(2) SH sues to force the company to declare dividends
(3) SH sues another SH for oppression in a close corporation
Derivative Suits
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
Recovery to Corporation
- because the shareholder is asserting the corporation’s rights rather than her own, if a shareholder-plaintiff wins, the corporation gets the money from the judgment
- shareholder-plaintiff may recover costs and attorney’s fees
- BUT, if the shareholder-plaintiff loses, she cannot recover costs and fees - and if the court finds that the action was commenced or maintained without reasonable cause or for an improper purpose, it may order the plaintiff to pay reasonable expenses of the defendant
Requirements for Derivative Suits - Standing
(1) stock ownership when claim arose and throughout the suit
- or must have become a shareholder through transfer by operation of law from someone who did own stock at the time the claim arose (ex: inheritance or divorce)
(2) SH must fairly and adequately represent the corporation’s interests
(3) written demand to BOD to take suitable action
- 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, SHs are not required to make this demand if the demand would be futile (ex: directors whom the demand is being made would be the defendant)
**Corporation must be joined to the suit as a defendant
- even though the suit asserts the corporation’s claim, since the corporation did not do so, it is joined as a defendant
Dismissal or Settlement Requires Court Approval
- the parties can settle or dismiss only with court approval
- after the derivative suit is filed, the corporation may move to dismiss
Dismissed if found not in the corporation’s best interests
- dismissal must be based upon an independent investigation that concluded that the suit is not in the corporation’s best interests
- The investigation must be made by independent directors or a court-appointed panel of one or more independent persons (usually it’s a “special litigation committee” of independent directors)
- Court determination - 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
Shareholders’ Inspection Rights
Any shareholder has the right, personally or by an agent, to inspect (and copy) the books and records of the corporation
Unqualified Right for Certain Records
- any shareholder may inspect the following records regardless of purpose:
(1) the corporation’s articles and bylaws
(2) board resolutions regarding classifications of shares
(3) minutes of shareholder meetings from the past 3 years
(4) communications sent by the corporation to shareholders over the past 3 years
(5) a list of the names and business addresses of the corporation’s current directors and officers, and
(6) a copy of the corporation’s most recent annual report
- the shareholder must make a written demand at least five business days in advance
Qualified Right
- For more controversial things, such as
(1) excerpts of the minutes of board meetings
(2) the corporations’s books, papers, and accounting records, and
(3) shareholders records
- the shareholder must state a proper purpose for the demand
- a proper purpose is one that’s reasonably related to the person’s interest as a shareholder
- the shareholder must also provide 5 business days’ advance written notice
Failure to Allow Proper Inspection
- if the corporation fails to allow proper inspection, the shareholder can seek a court order
- if they win, they can recover their costs and attorney’s fees incurred in making the motion
Fundamental Corporate Changes
Fundamental corporate changes are extraordinary, so the board generally cannot do them alone. They include the following types of changes:
(1) amending the articles
(2) merging or consolidating into another company
(3) transferring substantially all assets (or having stock acquired in a “share exchange”)
(4) converting to another form of business
(5) dissolving
Procedure for Fundamental Corporate Change
- Generally, to do any fundamental corporate change, we need
(1) board action adopting a resolution of fundamental change;
(2) the board submits the proposal to shareholders with written notice; and
(3) shareholder approval (majority of shares entitled to vote)
Business Judgment Rule
The business judgment rule is a presumption that a director’s decision may not be challenged if the director acted in good faith, with the care that a person would exercise in a like position, and in a manner that the director reasonably believed to be in the best interest of the corporation
Conflicting Transactions
A conflicting transactions is any transaction between the corporation (on one side) and
(1) of its directors,
(2) that director’s close relative, or
(3) another business of the director’s
A conflicting interest transaction can be set aside if
(1) it was approved by a majority (but at least 2) of the disinterested directors
- but interested director must disclose all material facts to the board or they must be known to the board when they approve the transaction
(2) it was approved by a majority of votes entitled to be cast by disinterested shareholders (need to know material facts), or
(3) judged by the circumstances at the time the corporation entered into the contract, it was fair to the corporation
Limitations of Liability for Directors
The articles can eliminate director liability to the corporation for damages, but not for:
(1) intentional misconduct
(2) usurping a corporate opportunity
(3) unlawful distributions, or
(4) improper personal benefit
*So these provisions can eliminate liability only for duty of care cases
