Corporations Flashcards
In general, what is a corporation?
A corporation is a legal entity distinct from its owners and may be created only by filing certain documents within the state
What are shareholders?
aka stockholders = the owners of the corporation
What is the board of directors?
the group in charge of management of the corporation
What are officers?
the agents of the corporation appointed to carry out the corporation’s policy
Generally, are the shareholders, officers, or directors personally liable for the obligations of the corporation?
Generally no, only the corporation itself can be held liable for corporate obligations
Owners risk only the investment that they make in the business to purchase their ownership interests (shares)
Is ownership of a corporation freely transferable?
Generally yes, shareholders are free to sell their shares to others unless it is provided otherwise
What is a C Corporation?
Generally, a corporation is taxed as an entity distinct from its owners - has its profits and losses stay in the business
corporate tax rate generally is lower than the personal tax rate, so this arrangement can be advantageous to pesrons who want to delay the realization of income
However, this advantage comes at a price - double taxation - bc when the corp does make distributions to shareholders, the distributions are treated as taxable income to the shareholders, even though the corp has already paid taxes on its profits
What is an S Corporation?
Tax laws permit certain corporations to elect to be taxed like partnerships and yet retain the other advantages of the corporate form
No income tax is paid at corporate level; profits/losses of the business are instead “passed-through” to the business and reported on the owners’ personal tax returns. Any tax due is paid at the individual level by the owners.
Partnerships and S corps are not subject to double taxation - profits and losses flow through the entity to the owners
Number of restrictions on S corps (stock can be held by no more than 100 people, shareholders must be individuals, and there can be only one class of stock)
How are corporations created under statute?
Corps are created by complying w state corporate law, which is often based on the Revised Model Business Corporation Act (MBCA)
What is it called if a corporation has or hasn’t complied with all laws?
A corp formed in accordance with law is a de jure corporation
If all corporate laws haven’t been followed, a de facto corporation might result or a corporation might be recognzied through estoppel
To create a de jure corporation, what are the three things we need?
A person, a paper, and an act
Who is the person we need to create a de jure corporation?
We need an incorporator
Incorporator can be a person or an entity
Do not need to be a citizen of the state of incorporation
The incorporators must comply with all applicable statory requirements to form the corporation
Must execute and deliver the articles of incorporation to the secretary of state
What is the paper we need to form a corporation?
The articles of incorporation
Must include: (1) the name of the corporation (including the word/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 agent (agent’s office must be in the state; legal representative); and (4) information regarding the corporation’s stock (info about the authorized stock which is the max number of shares the corp can sell; state the number of shares per class; describe voting rights, etc.)
Articles may also include any other provision that’s not inconsistent with the law
Often include a statement of business purposes - absent a statement, MBCA presumes that a corporation is formed to conduct any lawful business and is allowed to undertake any act that is necessary or convenient for carrying on their business purpose
Thus, unless an exam question restricts a corporation’s purposes, you should usually find corporate acts to be within the corporation’s powers
If corp does include a narrow business purpose in its articles, it may not undertake activities unrelated to achieving the stated business purpose
Activities beyond the scope = ultra vires
Under MBCA, ultra vires acts are generally enforceable, and the ultra vires nature of an act ca nbe raised in only three situations:
(1) a shareholder may sue the corporation to enjoin a proposed ultra vires act;
(2) the corporation may sue an officer or director for damages for approving an ultra vires act; and
(3) the state may bring an action to dissolve a corporation for committing an ultra vires act
Very limited defense - so I shouldn’t allow a corporation to get out of a contract merely because the contract is outside the scope of the corporation’s stated purpose
What must the articles of incorporation include?
In short: name of corp including abbrevation, name/address of incorporator; name/address of registered agent; info about stock
Must include:
(1) the name of the corporation (including the word/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 agent (agent’s office must be in the state; legal representative); and
(4) information regarding the corporation’s stock (info about the authorized stock which is the max number of shares the corp can sell; state the number of shares per class; describe voting rights, etc.)
Absent a narrow business statement in the articles of incorporation, what is presumed about a business’s purposes?
absent a statement, MBCA presumes that a corporation is formed to conduct any lawful business and is allowed to undertake any act that is necessary or convenient for carrying on their business purpose
Thus, unless an exam question restricts a corporation’s purposes, you should usually find corporate acts to be within the corporation’s powers
When a company does have a narrow business purpose and they do something outside that purpose, what are the only three situations where they’ll really be held liable?
In short: usually still enforceable; except with: shareholders wanting to stop the act; corporation suing for damages for approving act; and state dissolving corp for doing act
Under MBCA, ultra vires acts are generally enforceable, and the ultra vires nature of an act can be raised in only three situations:
(1) a shareholder may sue the corporation to enjoin a proposed ultra vires act;
(2) the corporation may sue an officer or director for damages for approving an ultra vires act; and
(3) the state may bring an action to dissolve a corporation for committing an ultra vires act
Very limited defense - so I shouldn’t allow a corporation to get out of a contract merely because the contract is outside the scope of the corporation’s stated purpose
When does corporate existence begin (the act)?
To complete formation of the corp, the incorporators will have notarized articles delivered to the secretary of state and pay any required fees
Corporate existence begins upon this filing by the state
Filing is conclusive proof of corporate existence
What is the organizational meeting step of incorporation?
After filing, you’ll hold an organizational meeting
If initial directors were named in articles, the board of directors hold the org meeting
If they weren’t named, the incorporators hold meeting
Purpose of meeting is to complete the organization of the corporation, which means (1) adopt initial bylaws and (2) appoint officers
What are bylaws?
Bylaws are an internal document
Like an operating manual
May contain any provision for managing the corp that is not inconsistent with the articles or law
Are the bylaws filed with the state?
No, only the articles are (that’s what starts the corporation)
If a corporation’s bylaws and articles conflict, which governs?
The articles
the bylaws need to not be in conflict with either the articles or the law
Who can amend or repeal the bylaws or adopt new ones?
The board of directors or shareholders
The internal affairs of a corporation are governed by what state?
Under internal affairs doctrine, internal affairs of the corporation are governed by the law of the state of incorporation
Even if they do business only in another state, they’re still governed by the law of the state of incorporation
so the roles and duties of directors, officers, and shareholders are governed by the state of incorporation
What does entity status mean?
Upon formation, a corporation has entity status, meaning it’s a legal person
Corp can sue and be sued, hold property, be a partner in a partnership, invest in other companies or commodities, donate to charity, etc.
What generally is limited liability?
It’s one of the most important consequences of forming a corp - they get limited liability
Generally, shareholders are liable only to pay for their stock, not for corporate debts
so if corporation gets debts, commits a tort, etc., the shareholders are not personally liable
Directors and officers are also not vicariously liable for corporate debts - just the corporation is liable for its debts
Normally, if incorporators thought they formed a corporation but failed to do so, they’d be personally liable for business debts as partners. But what two doctrines may still allow the incorporators to escape liability?
(1) de facto corporation and (2) corporation by estoppel
But note: anyone asserting either doctrine must be unaware of the failure to form a de jure corporation
AND NOTE: these have been abolished in many states - so on exam, raise the possibility of de facto or estoppel but then note caveat that doctrine likely doesn’t apply, but if it does, here’s how
what are the requirements for a de facto corporation to exist?
In short: incorporation statute; good faith, colorable attempt; exercise of corporate privileges
(1) must be a relevant incorporation statute (on exam, can address this quickly because there’s always a statute in every state)
(2) parties made a good faith, colorable attempt to comply with the statute; meaning they tried and came close
(3) there has been some exercise of corporate privileges, meaning parties were acting as though they thought there was a corporation
If they meet these rquirements, the de facto corporation doctrine applies, and the business is treated as a corporation for all purposes except in an action by the state
What is corporation by estoppel?
Under CL doctrine of corporation by estoppel, persons who have dealt w the entity as if it were a corporation will be estopped from denying the corporation’s existence
Can’t back out of contracts
And will also prevent improperly formed “corporation” from avoiding liability by saying it was not properly formed
ONLY applies in contract cases
What is a promoter?
A person acting on behalf of a corporation not yet formed
Before a corporation is formed, promoters procure commitments for capital that will be used when it is formed
What are promoter’s relationships with each other?
Promoters are joint venturers (partners) who have a fiduciary relationship with each other
Will breach duty if they secretly pursue personal gain at the expense of their fellow promoters
What is a promoter’s relationship with the corporation?
Fiduciary duty is one of fair disclosure and good faith
Promoter who profits by selling property to the corp may be liable for his profit unless all material facts of the transaction were disclosed
If transaction is disclosed to an independent board of directors and approved, promoter has met his duty and will not be liable for his profits
If the board is not completely independent, the promoter still will not be liable for his profits if the subscribers knew of the transaction at the time they subscribed or unanimously ratified the transaction after full disclosure
Disclosure must be to all who are contemplated to be part of the initial financing scheme
If the promoters purchase all the stock and subsequently sell their individual shares to outsiders, the promoters cannot be held liable for the profits from the sale of property to the corporation
Promoters may always be liable if Ps can show that they were damaged by the promoters’ fraudulent misrepresentations or fraudulent failure to disclose all material facts
What is a promoter’s relationship with third parties?
A promoter may enter into contracts on behalf of a corporation not yet formed
Since the corporate entity doesn’t exist prior to incorporation, it is not bound on contracts entered into by the promoter in the corporate name prior to incorporation
Corporation may become liable only if it expressly or impliedly adopts the promoter’s contract
On January 10, P, acting as a promoter for a corporation not yet formed, leases a building from Don Draper and signs the lease, “Oscar de la Rental Cars, Inc.” On February 20, Oscar de la Rental Cars, Inc. is formed. Is the corporation liable on the contract?
Yes, if it adopted the contract
Express adoption: board takes an action adopting the contract
Implied adoption: corporation accepts a benefit of the contract
How can adoption happen (like when a promoter makes a contract on behalf of a not yet incorporated corporation)?
Express adoption: board takes an action adopting the contract
Implied adoption: corporation accepts a benefit of the contract
How can adoption happen?
What is a promoter’s liability to third parties?
Anyone who acts on behalf of a corp knowing that it is not in existence is jointly and severally liable for the obligations incurred
thus, if a promoter enters into an agreement w a third party on behalf of a planned but unformed corporation, the promoter is personally liable on the contract
Promoter’s liability continues even after corporation is formed, even if the corporation adopts the contract and benefits from it
Promoter will be released from liabiltiy only if there is an express or implied novation (substituting corporation for promoter)
On January 10, P, acting as a promoter for a corporation not yet formed, leases a building from Don Draper and signs the lease, “Oscar de la Rental Cars, Inc.” Will P be liable on the lease if Oscar de la Rental Cars, Inc. is never formed?
yes, he is personally liable for contracts formed when corporation is not yet formed
On January 10, P, acting as a promoter for a corporation not yet formed, leases a building from Don Draper and signs the lease, “Oscar de la Rental Cars, Inc.” Will P be liable on the lease if Oscar de la Rental Cars, Inc. is formed and adopts the lease?
Yes, he remains personally liable until there’s a novation
The corporation will be on the hook too since they’ve adopted the lease, but the promoter remains liable until he’s substituted out
How to handle promoter preincorporation liability questions?
If you keep in mind that promoters are forming a corporation, these questions should be fairly easy to answer.
For there to be a valid contract, someone must be bound with the third party. It can’t be the corporation since it does not exist; therefore, the promoter is liable even though she was acting on behalf of the corporation to be formed.
(If the agreement expressly relieves the promoter of liability, it will be treated as an offer to the corporation.)
Can a promoter have a right to reimbursement on contracts?
Yes, a promoter who is held personally liable on a preincorporation contract may have a right to reimbursement from the corporation to the extent of any benefits received by the corporation
What is a “foreign” corporation?
Anything outside of your state is foreign - doesn’t mean just outside of the country
What must foreign corporations transacting business in a state do?
Register and pay fees
Must register with secretary of state in each state in which it wishes to transact business
Corp has to provide info about its articles and prove good standing in its home state
What does “transacting business” mean in regards to foreign corporations?
Means the regular course of intrastate (within the state) business activity
So doesn’t include occasional or sporadic business in the state
What does “transacting business” mean in regards to foreign corporations?
Means the regular course of intrastate (within the state) business activity
So doesn’t include occasional or sporadic business in the state
What happens if a foreign corporation transacts business without registering?
There can be a civil fine and the corp can’t assert a claim in this state
It can defend, but can’t assert
Once the foreign corporation registers and pays back-fees and fines, can it then assert a claim here?
Yes, then it can assert a claim in this state
Once the foreign corporation registers and pays back-fees and fines, can it then assert a claim here?
What is the exception to the general rule that a promoter will be liable on a preincorporation contract?
Promoter will not be liable on a preincorporation contract if the agreemetn bt the parties expressly indicates that the promoter is not to be bound. In such a case, the “contract” is considered to be an offer to the proposed corporation.
If the exception is applying, something would indicate that the third party would look to the corporation only for payment
What is the exception to the general rule that a promoter will be liable on a preincorporation contract?
Promoter will not be liable on a preincorporation contract if the agreemetn bt the parties expressly indicates that the promoter is not to be bound. In such a case, the “contract” is considered to be an offer to the proposed corporation.
If the exception is applying, something would indicate that the third party would look to the corporation only for payment
SECOND FACT PATTERN: ISSUANCE OF STOCK
SECOND FACT PATTERN: ISSUANCE OF STOCK
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
What does security basically mean?
Corporation will issue a security to an investor, whether the corp is borrowing money or raising it by selling stock
Security is basically an investment
What are debt securities?
When the corporation borrows money, it issues a debt security, which is usually called a bond
Bond is a promise that the corp will repay the loan with interest
If loan is unsecured by corporate assets, it may be called a debenture
The holder of a debt securities is a creditor, but NOT an owner, of the corporation
Debt obligations may be payable to either the holder of the bond (a bearer or coupon bond) or to the owner registered on the corporation’s records (a registered bond)
May also have special features, like that it’s convertible to equity securities at the option of the holder, or that the corp may redeem the obligation at a specified price before the obligation matures
Who may debt obligations be payable to?
Debt obligations may be payable to either the holder of the bond (a bearer or coupon bond) or to the owner registered on the corporation’s records (a registered bond)
What are equity securities?
When the investor buys an ownership interest in the corporation, it issues equity securities, which is stock (the investor holds shares of stock)
Money invested does NOT create a debt
Shareholder is an OWNER, but NOT a creditor, of the corporation
Remember: the shares described in the corp’s articles are authorized shares
The shares that have been sold are issued and outstanding
Shares that have been reacquired by the corp through repurchase or redemption are authorized but unissued (treasury shares)
What are the shares described in the corp’s articles?
the shares described in the corp’s articles are authorized shares
What are the shares that have been sold?
The shares that have been sold are issued and outstanding
What are the shares that have been reacquired by the corp through repurchase or redemption?
Shares that have been reacquired by the corp through repurchase or redemption are authorized but unissued (treasury shares)
Can corporations choose to issue different classes of shares?
Yes, a corporation may choose to issue only one type of share, giving each shareholder an equal ownership right (shares are sometimes called common shares)
Or ownership rights may be varied if the articles provide that the corp’s stock is to be divided into classes or series within a class (if this is the case, then the articles must include info such as the number of shares in each class)
What are share options?
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
What is an issuance of stock?
An issuance of stock is when a corp sells its own stock
Rule in this fact pattern apply ONLY when there is an issuance
What are subscriptions?
Subscriptions are written offers to buy stock from a corporation
One potential issue is whether they may be revoked
Are preincorporation subscriptions revocable?
Under MBCA, preincorporation subscriptions are irreovcable for six months unless otherwise provided, or unless all subscribers consent to revocation
On January 10, S signs a subscription, offering to buy 100 shares of C Corp., a corporation not yet formed. A week later, S changes his mind. Can S revoke?
No, irrevocable for 6 months
When is payment due for a preincorporation subscription?
Unless otherwise provided, payment is due upon demand of the board
Demand may not be done in a discriminatory manner
Subscriber who fails to pay may be penalized by sale of the shares or forfeiture of the subscription and any amounts paid on the subscription, at the corporation’s option
Are postincorporation subscriptions revocable?
Revocable until accepted by the corporation
The corporation and the subscriber are obligated under a subscription agreement when the board accepts the offer
What form of consideration must the corporation receive when it issues stock?
Under MBCA, stock or stock options may be issued for any tangible or intangible property or benefit to the corporation
Includes money, property, services already performed for the corporation, and discharge of a debt
Also includes promissory notes to the corp and future services to the corp
Can X Corp. give employees options to buy stock as payment for services?
Yes
What is the traditional view to the amount of consideration needed (what stock can be sold for)?
Traditional view = par
Par = minimum issuance price
Traditionally, stock could not be issued by a corporation for less than the stock’s stated par value
And the consideration rec’d 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
No par = no minimum issuance price = board can have the stock issued for any price it sets
C Corp. is issuing 10,000 shares of $3 par stock. What is the minimum amount it must receive for these shares?
Could C Corp. receive more than this amount for the shares?
must receive at least $30,000
can receive more; par is just the minimum
What is watered stock?
Watch for this on exam - occurs when par value stock is issued for less than its par value
If sold for less than what it should be, directors would be liable if they knowingly authorized; buyer would be liable no matter what; if X transfers stock to third party, third party is not liable if she acted in good faith
C Corp. issues 10,000 shares of $3 par to X for $22,000. The corporation wants to recover the $8,000 of “water.” Who is liable?
The directors?
X (the person who bought the stock)?
What if X transfers the stock to a third party—is the third party liable?
Trick question: I own 10 shares of $3 par stock of X Corp. I sell it to you for less than $3 per share. Why is there no problem here?
Yes, the directors are liable if they knowingly authorized issuance
Yes X is liable no matter what
Third party is not liable if she acted in good faith, if she didn’t know
this is not an issuance; only applies when the corp is selling its own stock; doesn’t apply to you or me
What is the MBCA view to what stock can be issued for?
Traditional view = par
MBCA = whatever the directors deem appropriate as long as it’s in good faith
MBCA generally has eliminated the concept of par and allows corporations to issue shares for whatever consideration the directors deem appropriate
Consideration rec’d need not be placed in any special account
Board’s valuation is conclusive if made in good faith
But watch: a corporation’s articles can still specify a par value for stock; in which case, if the directors authorize a sale of stock for less than the stated par value, the shares will probably be treated as validly issued, but the authorizing directors can be held liable for breach of their fiduciary duty
What are preemptive rights?
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
Preemptive rights don’t exist unless stated in the articles
Even if they are stated in the articles, shareholders generally have no preemptive right in the shares issued:
(1) for consideration other than money,
(2) within 6 months after incorporation, or
(3) without voting rights but having a distribution preference
S owns 1,000 shares of C Corp. There are 5,000 shares outstanding. C Corp. is planning to issue an additional 3,000 shares. If S has preemptive rights, then how many shares does S have the right to buy?
as many as 600 shares; doesn’t have to, but can; 20%
Even if preemptive rights are included in the articles, when do shareholders generally not have preemptive rights?
Even if they are stated in the articles, shareholders generally have no preemptive right in the shares issued:
(1) for consideration other than money,
(2) within 6 months after incorporation, or
(3) without voting rights but having a distribution preference
Suppose the C Corp. articles provide for preemptive rights. You own 20 percent of the stock of C Corp. C Corp. issues stock to Susie to purchase property from Susie (or to pay Susie for services performed for the corporation). Do you have preemptive rights?
no, bc this was not an issuance for money; only attaches if issuance is for money; this one isn’t for money
FACT PATTERN THREE: DIRECTORS AND OFFICERS
FACT PATTERN THREE: DIRECTORS AND OFFICERS
What are the necessary qualifications for a director?
Must be adult natural persons, meaning they must be human beings w legal capacity
Absent a provision to the contrary, directors need not be shareholders in the corp or residents of any particular state
Any qualifications for directors in articles or bylaws must be rsble and lawful
No qualification may limit the ability of a director to discharge her duties
how many directors are necessary?
One or more
Number can be set in articles or bylaws
How are directors elected?
Initial directors may be named in the articles
If not, they’re elected by the incorporator(s) at the organizational meeting
After that, sharehodlers elect the directors
Directors are elected at each annual shareholders’ meeting, subject to contrary provisions in articles
Entire board is selected each year unless there’s a staggered board
Whether there is a staggered board is usually set in the articles
Staggered board is divided into 1/2 or 1/3s, with 1/2 or 1/3 elected each year
How can a director be removed?
Shareholders can remove directors before their terms expire
Shareholders may remove a director with or without 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
Who fills vacancies in the board of directors (like if someone resigns or is removed)?
Board or the shareholders fill the vacancies
But if the shareholders created the vacancy by removing a director, the shareholders generally must select the replacement
Can board members act individually or do they have to act as a group?
Board of directors must act as a group
Individual directors have no authority to speak for or bind the corporation
May act in the following ways:
(1) unanimous agreement in writing (email, conference call, or separate documents, are ok); or
(2) at a meeting, which must satisfy the quorum and voting requirements discussed below
Can the board 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)?
Yes, may ratify.
To ratify such an action, the board must state the action to be ratified and the nature of the failure of authorization, approve the ratification, and seek shareholder approval if necessary
If there is a board meeting, the method for giving notice is set in…
the bylaws
What kind of notice is required for regular and 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 - purpose need not be disclosed
What happens if required notice was not given?
Means that whatever happened at the meeting is voidable - maybe even void - unless the directors who were not notified waive the notice defect
Can do this (1) in writing any time, or (2) by attending the meeting without objecting at the outset of the meeting
Can directors give proxies or enter voting agreements for how they will vote as directors?
No - any efforts to do so are void
Because directors owe the corporation non-delegable fiduciary duties
Note: this is different from shareholders who can vote by proxy and enter into voting agreements
What are the similarities and differences between shareholder and director meetings?
WHEN?
Shareholders:
Annual = as board of directors or president directs, but must be within 18 months of prior annual meeting
Special = as board of directors or president directs
Directors:
Regular = as board of directors or president directs
Special = as board of directors or president directs
NOTICE REQUIREMENTS
Shareholders
Annual = can be by mail bt 10 and 60 days before meeting; must include time and place
Special = can be by mail bt 10 and 60 days before meeting; must include time, place and purpose
Directors
Regular = none needed
Special = at least two days written notice; must include time and place but NOT purpose
PROXY VOTING ALLOWED?
Shareholders = yes at both annual and special
Directors = no at both regular and special
What do we need for the board to act?
For any meeting of the board, we need a quorum
A majority of all directors (unless bylaws say otherwise, but can’t be fewer than 1/3 of all members)
Without quorum, board can’t act
If quorum is present, passing a resolution requires what?
If 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 9 directors, at least 5 directors must attend the meeting to constitute a quorum. If 5 directors attend, then at least 3 must vote for a resolution for it to pass.
What is a broken quorum?
A quorum of the board can be lost (broken) if people leave
Once a quorum is no longer present, the board can’t take an act at that meeting
(Different from shareholder meetings)
If there was no meeting, how can the board act?
If there was unanimous written consent of the directors
Ex: the facts tell you that a director has entered into an extraordinary contract with another entity on the corporation’s behalf, either on his own accord or with the approval of some of the directors, or with the approval of all of the directors, who were called individually.
You must recognize that 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
What is the role of the board of directors?
Manages corporation
Sets policy, supervises officers, declares distributions, determines when stock will be issued, recommends fundamental corporation changes to shareholders, etc.
Unless provided otherwise, board may create one or more committs, with one or more members, and appoint members of the board of directors to serve on them
Committees may act for the board, but the board remains responsible for supervision of the committees
Board may also delegate authority to officers
While the board can delegate actions to a committee, a committee may not take the following actions:
(1) declare a distribution
(2) fill a board vacancy
(2) recommend a fundamental change to shareholders
However, a committee can recommend such actions to the full board for its action
What fiduciary duties does a director owe to a corporation?
Duty of loyalty = A director must discharge her duties in good faith and with the rsble belief that her actions are in the best interest of the corporation
Duty of care = She must also use the care that a person in like position would rsbly believe appropriate under the circumstances - BUT only liable if his breach causes a loss to the corporation - BUT even if there is causation, look at business judgment rule
Always go into both on exam when I see a potential breach
Who has the burden of proving that a director breached her duty of care?
The person challenging the directors’ action on the basis of a breach of the DOC has burden of proving that the standard was not met
What are the two main situations for breach of duty of care?
Nonfeasance or misfeasance
Nonfeasance = occurs when a director basically does nothing; they are lazy
Misfeasance = occurs when the board makes a decision that hurts the business
Doofus, a director of C Corp., fails to attend any of the board of directors’ meetings or to keep abreast of the company business in any way. Will Doofus be held liable for breach of the duty of care?
state the standard in full; then focus on second sentence; a person in like condition would do some work, here he did nothing; so he’s liable only if his behavior causes a loss to the corporation
Doofus, a director of C Corp., fails to attend any of the board of directors’ meetings or to keep abreast of the company business in any way. Will Doofus be held liable for breach of the duty of care?
state the standard in full; then focus on second sentence; a person in like condition would do some work, here he did nothing; so he’s liable only if his behavior causes a loss to the corporation
The directors of Hedonists’ Hot Tubs, Inc. vote to start a new line of hot tubs with built-in wine coolers and video cameras. The directors engaged consultants to consider the issue and robustly debated before making the decision. The idea turned out to be a disaster. The company lost money. Are the directors liable for a breach of the duty of care?
To answer this question, first state the standard in full, then focus on the duty of care portion. Here, the directors’ action caused a loss to the corporation, so causation is clear. But remember, a director is not liable if she meets the business judgment rule.
Business judgment rule = court will not second guess business decision if made in good faith, informed, and had rational basis
What is the business judgment rule?
court will not second guess business decision if made in good faith, informed, and had rational basis
After I evaluate duty of care, see that there’s causation (directors made a decision that then hurt the company), then go into business judgment rule - if they made a bad decision but it was in good faith, informed, and had rational basis, the director won’t be found liable
A director is entitled to rely on info, etc. if prepared or presented by:
(1) corporate officers or employees whom the director rsbly believes to be reliable and competent;
(2) legal counsel, accountants, or other persons as to matters the director rsbly 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 rsbly believes the committee merits confidence
Who has the burden of proof in duty of loyalty cases?
Duty of loyalty cases are about conflicts of interest
Business judgment rule doesn’t apply
Burden is on the defendant to prove they were loyal and did not have or violate a conflict of interest
What constitutes a conflicting transaction (self-dealing - duty of loyalty issue)?
Any transaction between the corporation and: (1) one of its directors, or (2) that director’s close relative, or (3) another business of the director’s
Ex: XYZ Corp enters into a contract with LMN Corp, which is owned or run by one of XYZ Corp’s directors - we worry that the director has divided loyalties
A conflicting interest transaction will not be enjoined, set aside, or give rise to an award of damages because of the director’s interest (it’ll be fine) if:
(1) it was approved by a majority of the disinterested directors - imperative that either the director disclosed all material facts to the board or they were known when the board approved the transaction; or
(2) it was approved by a majority of votes entitled to be cast by disinterested shareholders - again, after disclosure or the facts were known - notice of the shareholders’ meeting must describe the transaction; or
(3) judged by the circum at the time the corp entered into the transaction, it was fair to the corp
Martha is a director of XYZ, Inc. If she sells wreaths to XYZ, Inc., this is an interested transaction. How should you address it on the exam?
State standard in full: A director must discharge her duties in good faith and with the rsble 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 rsbly believe appropriate under the circumstances
Then focus on duty of loyalty portion.
Interested director transactions will be set aside (or the director will be liable in damages) unless the director shows that either:
(1) the deal was fair to the corporation when entered; or
(2) her interest and the relevant facts were disclosed or known, and the deal was approved by either (1) a majority of the disinterested directors or (2) a majority of the disinterested shares
AND NOTE: even if the deal is approved by an appropriate group, some courts also require a showing of fairness - in determining whether a transaction is fair, courts look to factors such as adequacy of the consideration, corporate need to enter into the transaction, financial position of the corporation, and available alternatives
Does the interested director have to have been at the meeting where they approved the conflicting interest?
No, the presence of the interested director at the meeting at which the directors or shareholders voted to approve the conflicting interest transaction doesn’t affect the action
Do some courts also require a showing of fairness even if the deal was approved by the appropriate groups?
Yes, even if the deal is approved by an appropriate group, some courts also require a showing of fairness
In determining whether a transaction is fair, courts look to factors such as adequacy of the consideration, corporate need to enter into the transaction, financial position of the corporation, and available alternatives
What are the possible remedies for an improper conflicting interest transaction?
Enjoining the transaction, setting the transaction aside, damages, and similar remedies
Can directors set their own compensation?
Yes but it must be rsble and in good faith
Otherwise, they’re wasting corporate assets and breaching duty of loyalty
What is the corporate opportunity doctrine?
Directors’ fiduciary duties prohibit them from diverting a business opportunity from their corporation to themselves without first giving their corporation an opportunity to act
What counts as a business opportunity? Ex: something in business line; something the corp has an interest or expectation in; closer to the business’s line of business, more likely a court will find it to be a corp opportunity
Cheatem is a director of C Realty Corp., which develops condo projects. Cheatem learns of land that has been zoned for condos and buys it for himself as an investment. What are C’s rights, if any, against Cheatem?
Start with standard in full: duty of loyalty which is director needs to discharge her duties in good faith with the rsble belief that her actions are in the best interest of the company; and she must take the care that a rsble person would believe appropriate in her position
Then focus on duty of loyalty
A director can’t usurp a coporoate oporutnity. This means a director can’t take it until he (1) tells the board about it and (2) waits for the board to reject the opp
Is the corp’s lack of financial ability to take the corporate opportunity a defense?
No
Director should still present opp to corp and allow it to decide whether it can take advantage of it or not
What are remedies for usurping a corp opp?
if director usurps a corp opp, the corp can sue to recover under a constructive trust theory
Can be compelled to transfer property to the corp at the price she paid
If she sold property at a profit, corp may recover that profit
Which directors may be held liable for something (how do we know who to blame)?
A director is presumed to concur with a board action unless her dissent or abstention is noted in writing in the corp 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
Exception: a director is not liable if she was absent from the board meeting
Exception: good faith reliance on someone or some information presented
Who are officers?
Officers are agents of the corporation
Corporation is the principal and officers are the agents
Can officers’ actions bind the corporation?
Whether officer can bind the corp is determined by whether she has agency authority to do so (actual or apparent authority)
Unauthorized actions may become binding on corp because of ratification, adoption, or estoppel
Corp is liable for actions by its officers within the scope of their authority, even if the particular act in question was not specifically authorized
What authority does the president of a corporation have?
President of a corp generally has apparent authority to bind the corporation to contracts in the ordinary course of business
Does a corporation need to have any particular officers?
Traditionally, had to have a president, secretary, and treasurer
Now, doesn’t need to have anything in particular and one person can serve in more than one office
What duties do officers owe?
Same care and loyalty as directors
And anything determined by the bylaws or authorized by the board
How are officers selected and removed?
By the board, which also sets officer compensation
Unless contrary provision, an officer has the power to resign at any time by delivering notice to the corp, and the corp has the power to remove an officer at any time, with or without cause
If resignation or removal is a breach of contract, can have damages - but mere appointment to office doesn’t in itself create a contract
Shareholders fire and hire directors
Shareholders DO NOT fire and hire officers - the board of directors does
Let’s say someone has been sued by (or on behalf of) the corporation in her capacity as an officer or director. She has incurred costs, attor- neys’ fees, maybe even fines, and a judgment or settlement in that litigation. Now, she seeks indemnification (reimbursement) from the corporation. What are the three categories of indemnification?
No indemnification (I think only directors)
Mandatory indemnification
Permissive indemnification
When can a corp NOT indemnify a director (category 1)?
A corp cannot indemnify (reimburse) a director who is:
(1) held liable to the corp or
(2) held to have rec’d an improper benefit
When is indemnification of a director or officer mandatory (category 2)?
Unless contrary provision, a corp MUST indemnify a director or officer who was successful in defending a proceeding on the merits or otherwise for rsble expenses, including atty fees, incurred in connection with the proceeding
When is indemnification of a director or officer permissive (category 3)?
A corp MAY indemnify a director or officer for rsble litigation expenses incurred in unsuccessfully defending a suit brought against the director or officer on account of the person’s position if the person:
(1) acted in good faith; and
(2) believed that her conduct was in the best interests of the corporation
That’s the duty of loyalty standard
Generally, determination whether to indemnify is to be made by a disinterested majority of the board, or if not enough people, by a majority of a disinterested committee or independent legal counsel
Shareholders may also make the determination
Suppose D is sued for breaching duties to the corporation. She then settles that case. Does this case fall into Category 1, Category 2, or Category 3?
Didn’t win or lose - goes to category 3, permissive
Can a court order indemnification?
Notwithstanding the above rules, a court in which a D or O was sued may order indemnification if it is justified in view of all circum
If D or O was held liable to the corp, reimbursement is limited to costs and atty’s fees
Can the articles of incorporation eliminate director (and sometimes officer) liability to the corp for damages?
Can for damages but not for intentional misconduct, usurping corporate opportunities, unlawful distributions, or improper personal benefit
So can eliminate liability only for duty of care cases
Can a corporation advance expesnes to a director defending an action?
Yes as long as the director furnishes the corp a statement that the director believes he met the appropriate standard of conduct and that he’ll repay the advance if he’s later found to have not met the standard
Can a corporation purchase liability insurance to indemnify directors or officers for actions against them?
Yes even if the D or O would not have been entitled to indemnification in the situations above
FACT PATTERN FOUR: SHAREHOLDERS
FACT PATTERN FOUR: SHAREHOLDERS
Do shareholders generally have a duty to their corporation or fellow shareholders?
Generally, no fiduciary duties
They usually have no direct control in management of the corporation’s business
Can act in their own personal interests and don’t have the duty of care or loyalty
Liability is therefore usually limited to liabilities for unpaid stock, a pierced corporate veil, or the absence of a de facto corporation
What is a close corporation?
Small number of shareholders
Stock not publicly traded
Shareholders can manage directly
They run the corporation - can set up a board of directors to run it like normal, or can forgo the board and run it themselves, or just appoint a manager
What are shareholder management agreements?
These agreements set up alternative management for a close corporation
MBCA allows shareholders to enter into agreements to dispense w the board and vest management power in the shareholders
If the articles don’t 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
Two ways to set up a shareholder management agreement:
(1) in the articles and approved by all shareholders OR
(2) by unanimous written shareholder agreement
Either way, agreement should be conspicuously noted on the front and back of stock certificates
If shareholders do this and set up management by shareholder or by a manager, now the shareholders owe the duty of care and loyalty like directors normally would
What are the two ways to set up a shareholder management agreement?
Two ways to set up a shareholder management agreement:
(1) in the articles and approved by all shareholders OR
(2) by unanimous written shareholder agreement
If the examiners question you about the power of the shareholders to run the day-to-day affairs of their corporation, how should you respond?
unless the corporation’s articles or a shareholder agreement provides otherwise, you should generally respond that the shareholders have no such power; that power is vested in the board of directors, and the shareholders have the power to elect the board.
Who owes the duties of care and loyalty to a corp?
Whoever is managing the corp
So normally it’s the board of directors
But if the shareholders are managing, they have the liabilities
What is the special fiduciary duty in close corporations?
So if shareholders are managing, they’ll have duty of care and loyalty
Whether or not they’re managing, in close corporations, they’ll also have a duty to the other shareholders because this is like a partnership
So they owe a duty of utmost good faith
What are the duties of controlling shareholders to minority shareholders?
Controlling shareholders can’t use their power to benefit at the expense of minority shareholders
Controlling shareholder could be a corporation
For ex: a parent corporation should not use its domination of a subsidiary corporation to receive something to the detriment of the subsidiary’s minority shareholders
Would breach the duty of not hurting the minority shareholders
Also a duty to disclose material information to the minority shareholders
If there is oppression of minority shareholders, what can they do?
they can sue the controlling shareholders who oppress them for breach of this fiduciary duty
For ex: controlling S might deny the minority any voice in corp affairs, fire them from employment, refuse to declare dividends, and refuse to buy the minority’s stock (so the minority is getting no return on investment)
Why do courts let minority shareholder sue?
Because oppression thwarts their legitimate goals for investing and they have no way out
Can shareholders generally be held liable for corporate debts?
No, bc the corp is liable for what it does
Can a shareholder be personally liable for what the corp does?
Yes, a shareholder might be personally liable for what the corp did if the court pierces the corporate veil
Can happen in close corporations only
What is piercing the corporate veil?
Doctrine that allows shareholders to be sued for debts of corp
Avail only in close corporations
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
So courts may pierce corporate veil to avoid fraud or unfairness by sharheolders in a close corporation
But something like sloppy admin isn’t enough
What are the three scenarios justifying piercing the corporate veil?
Alter ego (identity of interests)
Undercapitalization
Fraud, avoidance of existing obligations, or evasion of statutory provisions
What is the alter ego situation that could justify piercing the corporate veil?
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, a court might pierce the CV
May arise where shareholders treat corporate assets liek their own, commingle their money w corporate money, etc.
X and Y are the only shareholders of Close Corp. X commingles personal and corporate funds, uses the corporate car as his own, and uses the corporate credit card to pay for personal purchases. Close Corp. fails to pay its bills. Can a creditor of the corporation who has been unable to collect its claim from the corporation collect from either X or Y?
To answer this question, we start with the general rule: shareholders are not liable for the acts or debts of the corporation.
Then, give the piercing the corporate veil standard: A court may pierce the corporate veil and hold shareholders personally liable where the shareholders have abused the privilege of incorporating and fairness requires holding them liable.
Here, a court might pierce the corporate veil. Why?
First, did a shareholder abuse the corporation? YES - abused corp by using card for its own purchases, commingling funds, using car as his own, etc.
Second, would it be unfair for X to have limited liability? YES because then creditors aren’t getting paid
If the court does pierce the corporate veil, only X would be liable. Y did nothing wrong. Only X treated corporate assets as his own.
What is the undercapitalization situation for piercing the corporate veil?
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 rsbly cover prospective liabilities
S is a shareholder of Glowco, Inc., a close corporation that hauls and disposes of nuclear waste. Glowco does not carry insurance. Glowco has an initial capitalization of $1,000. Shortly after Glowco is incorporated, V is injured when one of Glowco’s trucks melts down. Glowco does not have anywhere near enough money to compensate V. Can V sue S?
Start w general rule: shareholders are not liable for corporate obligations.
But a shareholder may be personally liable for corporate obligations where they abused the privilege of incorporating and fairness requires it.
Here, a court may pierce the CV because the corporation was undercapitalized when formed. The shareholders failed to invest enough to cover prosepctive liabilities.
Additionally, courts may be more willing to pierce the corporate veil for a tort victim than a contract claimant. Fairness requires holding the shareholder personally liable because otherwise the injured party won’t see justice because of the shareholders’ failings.
What is the fraud, avoidance of existing obligations, or evasion of stat provisions sitatuation of piercing the corporate veil?
Corporate veil may be pierced where necesary to prevent fraud or to prevent an individual shareholder from using the entity to avoid his existing personal obligations
But mere fact that an individual chooses to adopt the corporate form of business to avoid future personal liability is not in itself a reason to pierce the CV
Who is liable when piercing the corporate veil?
normally, only shareholders who are active in the operation of the business will be held liable
Liability is joint and several
Doesn’t matter if the shareholder at fault is a corporation; can hold them “personally” liable
What are the requirements for a shareholder to bring a derivative suit on behalf of a corporation?
Stock ownership when claim arose
Adequate representation of corp’s interest
Written demand on corp to take action
What is authorized, issued, and outstanding stock?
Authorized stock: maximum number of shares a corp can sell
Issued stock: number of shares the corp actually sells
Outstanding stock: shares issued but not reacquired
how can a shareholder vote by proxy?
Can vote her shares either 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 corp,
(4) authorizing another to vote the shares
When will a proxy be irrevocable?
Only if it states that it is irrevocable and is coupled with an interest or given as security
(1) the proxy says it’s irrevocable and
(2) the proxy holder has some interest in the shares other than voting
What are the requirements for a voting trust (where you pool your shares together in a trust so the trustee votes and then distributes the dividends in accordance)?
(1) a written trust agreement
(2) copy of the agreement is given to corp
(3) legal title to the shares is transferred to voting trustee
(4) original shareholders receive trust certificates and retain all shareholder rights except for voting
What are the requirements for a voting agreement (used in lieu of a trust, seems simpler)
the agreement has to be in writing and signed
Unless otherwise specified, what are the specific votes needed in shareholder meetings to elect/remove directors or vote on fundamental corporate change?
Elect director: plurality (person gets more votes than anyone else)
Approve fundamental change: traditionally, we needed a majority of the shares entitled to vote. But now increasingly just need the majority of the shares that actually vote on the issue.
Remove a direct: Traditionally, needed a majority of the shares entitled to vote. Now, need majority of the shares that actually vote on the issue.
Other matters: majority of shares that actually vote on the issue.
If there is a restriction on stock transfers (like a right of first refusal), and the restriction is valid, can it be enforced against the transferee, a third party purchaser?
Valid they are not an undue restraint on alienation
Can be enforced against third party 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
A shareholder may inspect what types of records regardless of purpose?
(1) the corp’s articles and bylaws
(2) board resolutions regarding classification of shares
(3) minutes of shareholders’ meetings from the past three years
(4) communications sent by the corporation to shareholders over the past three years
(5) a list of the names and business addresses of the corporation’s current directors and officers
(6) a copy of the corporation’s most recent annual report
What are more controversial things where the shareholder has a qualified right to inspect them?
(1) excerpts of the minutes of the board meetings
(2) the corp’s books, papers, and accounting records
(3) shareholder records
Must state a proper purpose for demand - one that’s rsbly related to the person’s interest as a shareholder
Generally, to do any fundamental corporate change, we need what three things?
(1) board action adopting a resolution of fundamental change;
(2) board submits the proposal to the shareholders w written notice; and
(3) shareholder approval (trad: majority of shares entitled to vote; modern: majority of shares that actually voted)
Most of the time, we also need to deliver a doc to the secretary of state
What are the steps for a shareholder to perfect a right of appraisal?
(1) notice of shareholders’ meeting at which vote will take place must state that the shareholders will be entitled to exercise their dissenting rights
(2) before vote, shareholder must file w the corporation a written notice of objection and intent to demand payment
(3) at vote, shareholder must abstain or vote against
(4) if action is approved, corp must notify shareholders who filed an intent to demand payment - must into T and P to submit her shares - within 10 days
(5) within time set by corp, shareholder must make written demand to be bought out and deposit her stock with corp
(6) corp must pay dissenters the amount the corp estimates as the fair value of the shares plus accrued interest
Then
(7) if shareholder is dissatisfied with valuation, he has 30 days in which to send the corp her own estimate and demand payment
(8) if shareholder and corp can’t agree, corp must file action in court wihtin 60 days of receiving demand
(9) if corp doesn’t file, the corp must pay the demand
Approval of a plan of merger by shareholders of the surviving corporation is not required if the following conditions exist:
(1) the articles of incorporation of the surviving corporation will not differ from the articles before the merger
(2) each shareholder of the survivor whose shares were oustanding immediately prior to the effective date of hte merger will hold the same number of shares, w identical preferences, limitations, and rights; and
(3) the voting power of the shares issued as a result of the merger will comprise no more than 20% of the voting power of the shares of the surviving corporation that were outstanding immediately prior to the merger
What are the grounds on which the attorney general can seek dissolution of a corp?
Grounds that corp fraudulently obtained its articles of incorporation
or that corp is exceeding or abusing its authority
What are the grounds on which shareholders can seek involuntary dissolution of corporation?
(1) director abuse, waste or assets, or misconduct
(2) directors are deadlocked in management of affairs, shareholders are unable to break deadlock, and irreparable injury to the corp 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) corp has abandoned its business and failed to dissolve wihtin rsble time
On what grounds can creditors seek involuntary dissolution of a corp?
(1) the creditor’s claim has been reduced to judgment, execution of the judgment has been returned unsatisfied, and the corp is insolvent; or
(2) the corp has admitted in writing that the creditor’s claim is due and owing and the corp is insolvent
What are the steps to wind up the corporation?
Give written notice to creditors and publish notice of dissolution in newspaper in PPB
Gather all assets
Convert assets to cash
Pay creditors
Distribute any remaining sums to shareholders pro rata
