Corporations Flashcards
A corporation is _____
a legal entity distinct from its owners and may be created only by filing certain documents with the state.
There are several key players we need to remember in the context of corporations:
- Shareholders, or stockholders, are the owners of the corporation;
- The board of directors is the group in charge of management of the corporation; and
- Officers are agents of the corporation appointed to carry out the corporation’s policy
Key Characteristics of a Corporation
- Limited Liability for Owners, Directors, and Officers
- Centralized Management
- Free Transferability of Ownership
- Continuity of Life
- Taxation (lower corporate tax rate but double tax, but see also S Corp)
On the exam, Corporations questions fall into five main fact patterns or topic areas:
- Organization of a corporation
- Issuance of stock
- Directors and officers
- Shareholders
- Fundamental corporate changes
Comparison of Corporation with Sole Proprietorship
- In a sole proprietorship, one person owns all of the assets of the business.
- There is no business entity distinct from the owner.
- The owner is personally liable for the business’s obligations, and the business “entity” cannot continue beyond the life of the owner.
- Ownership is freely transferable, and all profits and losses from the business flow through directly to the owner.
Comparison of Corporation with Partnership
- A partnership is similar to a sole proprietorship except that there are at least two owners of a partnership.
- Little formality is required to form a partnership (just an intention to carry on as co-owners a business for profit).
- Partnerships generally are not treated as legal entities apart from their owners.
- Partners are personally liable for obligations of the partnership, and management rights generally are spread among the partners.
- Ownership interests of partners cannot be transferred without the consent of the other partners.
- A partnership generally does not continue beyond the lives of its owners.
- Finally, profits and losses of a partnership flow through directly to the
partners unless the partners have elected to be taxed as a corporation.
Comparison of Corporation with Limited Partnership
- A limited partnership is a partnership that provides for limited liability of some investors (called “limited partners”), but otherwise is similar to other partnerships.
- A limited partnership can be formed only by compliance with the limited partnership statute.
- There must be at least one general partner, who has full personal liability for partnership debts and has most management rights.
Comparison of Corporation with Limited Liability Company
- The limited liability company (“LLC”) is designed to offer the limited liability of a corporation and the flow through tax advantages of a partnership (unless the parties elect to be taxed as a corporation).
- Like a corporation, it may be formed only by filing appropriate documents with the state, but otherwise it is a very flexible business form: owners may choose between centralized management and owner management, free transferability of ownership or restricted transferability, etc
Comparison of Corporation with Benefit Corporation
- A benefit corporation (“B corporation”) intends to benefit the public and the environment, in addition to its shareholders.
- B corporations are treated the same as C corporations for tax purposes.
- A benefit corporation’s articles of incorporation must state that it is a benefit corporation.
- Directors and officers of benefit corporations operate with the same limited liability and fiduciary duties as their traditional counterparts in C corporations, but they are also required to consider the impact of their decisions on the B corporation’s employees, customers, communities, and the environment, not just its share-
holders. - B corporations must also prepare an annual benefit report, which is delivered to all the shareholders and posted online and/or filed with the secretary of state.
Corporations are created by ____
complying with state corporate law, which in a majority of states is based on the Revised Model Business Corporation Act (“MBCA”).
A corporation formed in accordance with law is a ____ corporation. If all corporate laws have not been followed, a ____ corporation might result or a corporation might be recognized through _____.
de jure; de facto; estoppel
To create a de jure corporation, we need _______
a person, a paper, and an act
To form a corporation, we need one or more persons who undertake to form it, who are known as ____
the incorporators.
The incorporators must comply with _____ to form the corporation.
all applicable statutory requirements
Incorporators may be a ____. They do not need to be a citizen of _____
person or an entity; the state of incorporation.
To form a corporation, we also need a particular paper—the ____
articles of incorporation.
The articles of incorporation must include:
- The name of the corporation: must include one of the following words or an abbreviation: “corporation,” “company,” “incorporated,” or “limited.”
- The name and address of each incorporator
- A registered agent and the street address of the registered office. The registered office must be in the state. The registered agent is the company’s legal representative, meaning
they could, for example, receive service of process for the corporation. - Information regarding the corporation’s stock.
–> The articles must give details about the corporation’s authorized stock,
which is the maximum number of shares the corporation can sell.
–> If the company has different classes of stock or series within a class of stock, many states require that the articles
state the number of shares per class; provide a distinguishing designation for each class (for example, “Class A preferred,” “Class B preferred,” and so on); and describe the voting rights,
preferences, and limitations of each class of stock.
Optional Contents of Articles of Incorporation
The articles may also include any other provision regarding operation of the corporation that’s not inconsistent with law.
-> For example, the articles might include the names and addresses of the initial directors.
-> The articles may also require that any internal corporate claims be brought exclusively at a court within the corporation’s state of incorporation.
Traditionally, corporations have included a statement of business purposes in their articles. Absent such a statement, the 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, including making charitable donations and lending money to employees, officers, and directors.
Ultra Vires Acts
If a corporation includes a narrow business purpose in its articles, it may not undertake activities unrelated to achieving the stated business purpose
-> Activities beyond the scope of the stated business purposes are said to be “ultra vires.
Under common law, ultra vires acts were _____.
Under the MBCA, ultra vires acts generally are enforceable, and the ultra vires nature of an act can be raised in only three situations:
void and unenforceable
a) A shareholder may sue the corporation to enjoin a proposed ultra vires act;
b) The corporation may sue an officer or director for damages for approving an ultra vires act; and
c) The state may bring an action to dissolve a corporation for committing an ultra vires act
To complete formation of the corporation, 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 (the filing is conclusive proof of corporate existence)
If the initial directors were named in the articles, the _____ hold the organizational meeting. If they were not named in the articles, the ____ hold the organizational meeting.
board of directors; incorporators
The purpose of the organizational meeting is to “complete the organization of the corporation,” which means
(1) adopt initial bylaws and
(2) appoint officers.
Bylaws
- Bylaws are an internal document (not filed with the sec. state)
- You can think of them as the corporation’s operating manual; the bylaws might include things like
setting record dates (for determining who may vote at shareholder meetings) and methods of giving notice. - Bylaws may contain any provision for managing the corporation that is not inconsistent with the articles or law.
If a corporation’s bylaws and articles conflict, which governs?
Articles
Who can amend or repeal the bylaws or adopt new ones?
Board of Directors
Internal Affairs Doctrine
Under the internal affairs doctrine, the internal affairs of a corporation are governed by the law of the state of incorporation.
Upon formation, a corporation has ____ status, meaning it’s a legal person. The corporation can ____
entity; sue and be sued, hold property, be a partner in a partnership, invest in other companies or commodities, and so on.
This is the essence of limited liability—generally, shareholders are liable only to pay for _____
their stock, not for corporate debts
If the incorporators thought they formed a corporation, but they failed to do so, they’d be personally liable for business debts. (Basically, the would-be incorporators have formed a partnership instead, and partners are liable for business debts.) But two doctrines may still allow the incorporators to escape liability:
(1) de facto corporation and
(2) corporation by estoppel.
One important characteristic of both of these doctrines is that anyone asserting either doctrines (de fact corp and by estoppel) must be _____
unaware of the failure to form a de jure corporation
For a de facto corporation to exist, we must meet the following requirements:
- There must be a relevant incorporation statute. (There’s an incorporation statute in every state.)
- The parties made a good faith, colorable attempt to comply with the statute, meaning the parties tried and came close to forming a corporation; and
- There has been some exercise of corporate privileges, meaning the parties were acting as though they thought there was a corporation.
If the de facto corporation doctrine applies, the business is treated as a corporation for ____ purposes except ____
all; in an action by the state (called
a “quo warranto” action).
It’s important to remember that the de facto doctrine can be raised as a defense to personal liability only by a person who is _____.
unaware that there was no valid incorporation
-> Persons who act on behalf of a corporation knowing that there was no incorporation are jointly and severally liable for all liabilities created in so acting.
Corporation by Estoppel
Under the common law doctrine of corporation by estoppel, persons who have dealt with the entity as if it were a corporation will be estopped from denying the corporation’s existence.
-> The doctrine applies in contract to prevent the “corporate” entity, and parties who have dealt with the entity as if it were a corporation, from backing out of their contracts.
-> Correspondingly, it will prevent the improperly formed “corporation” from avoiding liability by saying it was not properly formed.
Corporation by estoppel applies only in ____ cases.
contract (It does not apply to tort victims).
Estoppel applies only on a ____
case-by-case basis.
The de facto doctrine applies equally in contract and tort situations, but estoppel generally is applied only in ____
contract cases (on the rationale that a tort victim does not allow himself to be
injured in reliance on the business’s status as a corporation).
If there is no valid incorporation and the facts do not support a de facto or estoppel argument, generally, the courts will hold only the ____ and their liability is _____.
active business members personally liable; joint and several
Caveat to raise in de facto corporation and corporation by estoppel questions
These doctrines are abolished in many states.
Promoter
A person acting on behalf of a corporation not yet formed (and they know that). Before a corporation is formed, promoters procure commitments for capital and other instrumentalities that will be used by the corporation after its formation.
Promoters’ Relationship with Each Other
- Absent an agreement to the contrary, promoters are joint venturers (partners) who have a fiduciary relationship with each other.
- They will breach their fiduciary duty if they secretly pursue personal gain at the expense of their fellow promoters.
Promoters’ Relationship with Corporation
A promoter’s fiduciary duty to the corporation is one of fair disclosure and good faith.
Promoters: Breach of Fiduciary Duty Arising from Sales to the Corporation
- A promoter who profits by selling property to the corporation may be liable for his profit unless all material facts of the transaction were disclosed.
- If the transaction is disclosed to an independent board of directors and approved, the 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’ Relationship with Corporation: Fraud
Promoters may always be liable if plaintiffs can show that they were damaged by the promoters’ fraudulent misrepresentations or fraudulent failure to disclose all material facts.
Preincorporation Agreements: Corporation’s Liability
- Since the corporate entity does not exist prior to incorporation, it is not bound on contracts entered into by the promoter in the corporate name prior to incorporation.
- The corporation may become liable only if it expressly or impliedly adopts the promoter’s contract.
Preincorporation Agreements: Promoter’s Liability
- Under the MBCA, anyone who acts on behalf of a corporation knowing that it is not in existence is personally, jointly and severally liable for the obligations incurred.
If the agreement expressly relieves the promoter of liability, there is _____; such an arrangement may be construed as a ____ to the proposed corporation, and the promoter has no rights or liabilities under the agreement.
no contract (for there to be a
valid contract, someone must be bound with the third party); revocable offer
The promoter’s liability for incorporation contracts continues ____, even if the corporation adopts the contract and benefits from it.
The promoter will be released from liability only if _____
after the corporation is formed
there is an express or implied novation (that is, an agreement among all three parties—the promoter, the corporation, and the other contracting party—to release the promoter from liability and substitute the corporation for the promoter in the contract).
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.
Foreign corporations (including out of state and foreign businesses) transacting business in a state must ____
register and pay fees.
For a foreign corporation to be transacting business means _____.
So, it doesn’t include ____
the regular course of intrastate (not interstate) business activity.
occasional or sporadic activity in this state, nor does it include simply owning property in this state.
A foreign corporation must register with the secretary of state in each state in which it wishes to transact business. The corporation has to provide information about ____
its articles and prove good standing in its home state.
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 ____ to the
investor.
security
The ____ is a promise that the corporation will repay the loan with interest.
The holder of debt securities is a creditor, but not _____.
bond
an owner; of the corporation.
When the investor buys an ownership interest in the corporation, it issues equity securities, which is ____
Importantly, the money invested does not create a debt. The shareholder is an owner, but not a ____, of the corporation.
stock (the investor holds shares of stock)
creditor
Define authorized, issued,outstanding and treasury stock
Authorized shares: shares described in the corporation’s articles of incorporation
Issued: number of shares that have been sold
Outstanding: It’s the shares the company issued but has not reacquired.
Treasury (authorized but unissued): have been reacquired by the corporation through repurchase or redemption
A corporation may choose to issue only one type of share, giving each shareholder an equal ownership right (in which case the shares are generally called ____). Alternatively, ownership rights may be varied if the articles provide that the corporation’s stock is to be divided into ____
“common shares”; classes or series within a class.
An issuance of stock is ___
when a corporation sells its own stock.
-> It’s important to remember that the rules in this fact pattern apply only when there is an issuance, meaning, when the corporation is selling its own stock.
Subscriptions are ____
written offers to buy stock from a corporation.
Under the MBCA, preincorporation subscriptions are ____
irrevocable for six months unless otherwise provided in the terms of the subscription agreement or unless all subscribers consent to revocation.
Payment Rules of Preincorporation Subscription
- Unless otherwise provided, payment is due upon demand of the board.
- Demand may not be made in a discriminatory manner.
- A 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.
Postincorporation subscriptions are ___
revocable until accepted by the corporation. In other words, the corporation and the subscriber are obligated under a subscription agreement when the board accepts the offer.
CONSIDERATION for stock issuance: Form of Consideration
Under the MBCA, stock (or an option to buy stock) may be issued for any tangible or intangible property or benefit to the corporation.
-> This includes money (cash or check), property, services already performed for the corporation, and discharge of a debt.
-> It also includes promissory notes to the corporation and future services to
the corporation.
Note: The MBCA greatly expanded what is acceptable consideration for the issuance of shares. Older statutes did not allow shares to be issued for promissory notes or promises of future work.
Stock Issuance: Amount of Consideration = Traditional View
Par means minimum issuance price. Traditionally, stock could not be issued by a corporation for less than the stock’s stated par value, and the consideration received 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.
Correspondingly, no par means ____ issuance price.
no minimum
-> That means the board can have the stock issued for any price it sets.
Watered Stock
Can occur when par value stock is issued for less than its par value.
Stock Issuance: Amount of Consideration = Traditional View
- The MBCA generally has eliminated the concept of par and allows corporations to issue shares for whatever consideration the directors deem appropriate.
- Consideration received for the issuance of stock need not be placed in any special account.
- If the corporation issues stock in exchange for consideration other than cash, such as for property or past services, the board determines the value of the property or services.
- The stock is considered fully paid and nonassessable as soon as the corporation receives the consideration for which the board authorized the issuance.
Under the MCBA the board’s valuation is conclusive if ____
made in good faith.
While the concept of par value is mostly dead under the MBCA, 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 directors who authorized the
issuance can be held liable for breach of their fiduciary duty (though the
MBCA itself provides no clear guidelines on this issue)
A preemptive right is _____
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 (meaning cash or its equivalent, like a check).
Under the MBCA, shareholders do not have a preemptive right to purchase newly issued shares to maintain their proportional ownership interest unless ____
the articles of incorporation provide the right.
-> So if the articles are silent on this issue, we do not have preemptive rights.
Even if the articles do provide a preemptive right, shareholders generally have no preemptive right in shares issued:
(1) for consideration other than cash (for example, for services of an employee), (2) within six months after incorporation, or
(3) without voting rights but having a distribution preference.
The directors are responsible for _____
the management of the business and affairs of the corporation.
Qualifications to be a director
- Directors must be adult natural persons, meaning they must be human beings with legal capacity.
- Absent a provision otherwise in the articles or bylaws, the directors need not be shareholders in the corporation
or residents of any particular state.
Any qualifications for directors prescribed by the articles or bylaws must be _____; no qualification may _____
reasonable and lawful; limit the ability of a director to discharge her duties.
Number of Directors
- We must have one or more directors.
- The number can be set in the articles or bylaws, which may require as many directors as desired.
Initial directors may be _____. If not, they are elected by ____
named in the articles; the incorporator(s) at the organizational meeting
The directors are elected at _____, subject to contrary provisions in the articles
each annual shareholders’ meeting
Staggered Board
A staggered board is divided into half or thirds, with one-half or one-third elected each year.
Ex: say there are nine directors. Instead of electing all nine each year, we could divide the board into three classes of three directors each, and they would serve three-year terms.
The entire board is elected each year unless there is a _____.
“staggered” (or “classified”) board
-> Whether there is a staggered board is usually set in the articles.
Removal of Directors
- Shareholders can remove directors before their terms expire.
- Shareholders may remove a director with or without cause.
In some states, if there is a staggered board, shareholders can remove a
director _____. A director elected by cumulative voting cannot be removed if ____. A director elected by a voting group of shares can be removed only by ____.
only with cause; the votes cast against removal would be sufficient to elect her if cumulatively voted at an election of directors; that class.
Where there is a board vacancy who selects the person who will serve as director for the rest of the term?
It’s the board or the shareholders. But if the shareholders created the vacancy by removing a director, the shareholders generally must select the replacement.
The board of directors must act as ___
a group (individual directors have
no authority to speak for or bind the corporation)
The board of directors may act in the
following ways:
- Unanimous agreement in writing (email is OK, and separate documents are also OK); or
- At a meeting, which must satisfy the quorum and voting requirements discussed below..
Directors, incorporators, and officers may ____ 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). To do so, the board of directors must _____
ratify; state the action to be ratified and the nature of the failure of authorization, approve the ratification, and seek shareholder approval if necessary.
Board Meetings: Types of Meetings and Notice
If there is a board meeting, the method for giving notice is set in the bylaws. Directors may act in regular or 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 (The notice need not state the purpose of the meeting)
Board meetings: Failure to give required notice means that whatever happened at the meeting is voidable—maybe even void—unless ____. They can do this by:
the directors who were not notified waive the notice defect;
(1) in writing any time, or
(2) by attending the meeting without objecting at the outset of the meeting.
Board of Directors: Proxies
Directors cannot give proxies or enter voting agreements for how they will vote as directors (Any efforts to do so are void)
Board of Directors: Quorum
For any meeting of the board, we must have a quorum. A quorum is a majority of all directors, unless the bylaws say otherwise (but a quorum can be no fewer than one-third of the board members).
-> Without a quorum, the board cannot act.
Board of Directors: Approval of Action
If a 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.
Board of Directors: Broken Quorum
- A quorum of the board can be lost (“broken”) if people leave.
- Once a quorum is no longer present, the board cannot take an act at that meeting.
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 director
Unless the articles or bylaws provide otherwise, the board may create ____. The committees may act for the board, but the board _____
one or more committees, with one or more members, and appoint members of the board of directors to serve on them; remains responsible for supervision of the committees.
The board may also delegate authority to ____
officers.
While the board can delegate actions to a committee, a committee may not take the following actions:
- Declare a distribution
- Fill a board vacancy
- Recommend a fundamental change to shareholders
+ Note, however, that a committee can recommend such actions to the full board for its action.
Director FIDUCIARY DUTIES OWED TO THE CORPORATION: The Standard
(1) 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. (2) She must also use the care that a person in like position would reasonably believe appropriate under the circumstances.
-> The first sentence of this standard is the duty of loyalty.
-> The second sentence of this standard is the duty of care.
____ the directors’ action on the basis of a breach of the duty of care has the burden of proving that the statutory standard above was not met.
The person challenging
Breach of Director Duty of Care: Two Common Scenarios
(1) nonfeasance: a director basically does nothing. In other words, we have a lazy director.
-> But, the key here is that he is liable only if his breach causes a loss to the corporation (difficult to show in these cases)
(2) misfeasance: when the board makes a decision that hurts the business. Here, in contrast to cases of nonfeasance, causation is clear.
Business judgment rule
Directors who meet the standard will not be liable for corporate decisions that in hindsight turn out to be poor or erroneous.
-> We expect a person in a like position to do appropriate homework. If she did, she is not liable for bad results = Think of the business judgment rule as a presumption that when the board took an act, it did appropriate homework.
Under the BJR the court will not second-guess a business decision if ____
it was made in good faith, was informed, and had a rational basis.
In discharging her duties, a director is entitled to rely on information, opinions, reports, or statements (including financial statements), if prepared or presented by:
(1) corporate officers or employees whom the director reasonably believes to be reliable and competent;
(2) legal counsel, accountants, or other persons as to matters the director reasonably 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 reasonably believes the committee merits confidence.
Duty of loyalty cases are about ____. The ____ does not apply in duty of loyalty cases.
conflicts of interest; business judgment rule
Common scenarios of breach of director duty of loyalty
- Self-dealing
- Competing Ventures
- Corporate Opportunity Doctrine
- Common Law Insider Trading—Special Circumstances Rule
What Constitutes a Conflicting Transaction?
This is any transaction between the corporation (on one side) and (1) one of its directors, or (2) that director’s close relative, or (3) another business of the director’s (on the other side).
Standards for Upholding Conflicting Interest Transactions
A conflicting interest transaction will not be enjoined, set aside, or give rise to an award of damages because of the director’s interest if:
(1) It was approved by a majority (but at least two) of the disinterested directors (those without a conflicting
interest). It is imperative, however, either that the director disclosed all material facts to the board or that 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 (those without a
conflicting interest)—again, after disclosure or the facts were known. Notice of the shareholders’ meeting must describe the transaction. OR
(3) Judged by the circumstances at the time the corporation entered into the transaction, it was fair to the corporation.
The presence of ____ at the meeting at which the directors or shareholders voted to approve the conflicting interest
transaction does not affect the action.
the interested director(s)
Quorum: voting on conflicting interest transaction
- For purposes of the vote on a conflicting interest transaction, at a directors’ meeting, a quorum is a majority (at least two) of disinterested directors.
Note that at a shareholders’ meeting, a quorum consists of a majority of the votes entitled to be cast, not including shares owned or controlled directly or beneficially by the director with the conflicting interest.
In approving a conflicting interest transaction despite the statute’s absolute terms, a transaction approved by the board or shareholders might still be set aside if the party challenging the transaction can prove that ____.
So, even if the deal is approved by an appropriate group, remember on the exam to say this: some courts also require a showing of ____. In determining this courts look to factors such as ____
it constitutes a waste of corporate assets
fairness; adequacy of the consideration, corporate need to enter into the transaction, financial position of the corporation, and available alternatives.
Possible remedies for an improper conflicting interest transaction include:
enjoining the transaction, setting the transaction aside, damages, and similar remedies.
Directors and Director Compensation
- Despite the apparent conflict of interest, unless the articles or bylaws provide otherwise, the board can set director compensation.
- However, it must be reasonable and in good faith.
-> If it’s excessive, the board is wasting corporate assets and breaching the duty of loyalty
Directors may engage in unrelated businesses, but engaging in ____
a directly competing business raises serious duty of loyalty problems.
Remedy for director competing ventures
The company can get a constructive trust on profits made from the competing venture.
Corporate Opportunity Doctrine
The directors’ fiduciary duties prohibit them from diverting a business opportunity from their corporation to themselves without first giving their corporation an opportunity to act.
-> This is known as “usurpation of a corporate opportunity.”
For the Corporate Opportunity Doctrine to apply the Corporation Must Have ____
Interest or Expectancy
A corporation’s interest does not extend to every conceivable business opportunity, but neither are opportunities limited to those necessary to the corporation’s current business. The closer the opportunity is to the
corporation’s _____, the more likely a court will find it to be a corporate opportunity.
line of business
Under the corporate opportunity doctrine the corporation’s lack of _____ probably is not a defense.
financial ability to take advantage of
the opportunity
-> The director should still present the opportunity to the corporation and allow it to decide whether it can take advantage of the opportunity.
Under the corporate opportunity doctrine because the board generally makes decisions concerning management of the corporation, it is ___ that must decide whether to accept an opportunity or to reject it.
the board
Remedies for usurping a corporate opportunity
- The corporation can sue to recover under a constructive trust theory.
- If she still owns the property, she can be compelled to transfer it to the corporation at the price she paid.
- If she has sold the property at a profit, the corporation may recover that profit.
Common Law Insider Trading—Special Circumstances Rule
- A director has no common law duty to disclose all facts relevant to a securities transaction between the director and the other party to the transaction.
- However, courts have found a duty to disclose where a director knows of special circumstances (for example, an
upcoming extraordinary dividend or a planned merger).
Director Duty to Disclose
The directors also have a duty to disclose material corporate information to other members of the board.
Director Loans
A corporation can make a loan to a director if it is reasonably expected to benefit the corporation.
The articles may limit or eliminate directors’ personal liability for ____. However, the articles may not limit or
eliminate liability for ______
money damages to the corporation or shareholders for actions taken or for failure to take action
financial benefits received by the director to which she is not entitled, an intentionally inflicted harm on the corporation or its shareholders, unlawful corporate distributions, or an
intentional violation of criminal law.
Directors may be liable to the corporation for ____
improper distributions, improper loans, “ultra vires” acts (that is, making the company do things it has no power to do), and for breaches of fiduciary duties.
But how do we know exactly which
directors are liable for these actions? A director is presumed to concur with
board action unless her dissent or abstention is noted in writing in the corporate records.
Abstention noted 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.
-> So an oral dissent, by itself, is not effective.
-> Note also that a director cannot dissent if she voted for the resolution at the meeting
A director is not subject to the liability of a director decisions (and need to abstain) if ____
she was absent from the board meeting (for example, she was sick that day).
Officers are ____ of the corporation.
agents
____ law determines the authority and powers of officers.
Agency
-> The corporation is the principal and the officer is the agent.
-> Whether the officer can bind the corporation is determined by whether she has agency authority to do so (as in,
actual or apparent authority + ratification)
Traditionally, corporations were required to have a ____. Now, the corporation ____ have any particular officers.
president, a secretary, and a treasurer
need not
One officer may appoint ____ if permitted in or by the bylaws.
May one person simultaneously serve in more than one office? ____
assistant officers
Yes.
Officer Duties
- Officers’ general duties are determined by the bylaws or, to the extent consistent with the bylaws, by the board or an officer so authorized by the board.
- Officers owe the same duties of care and loyalty to the corporation as directors
Selection and Removal of Officers
Officers are selected and removed by the board, which also sets officer compensation.
Despite any contractual term to the contrary, an officer has the power to resign____ by delivering notice to the corporation, and the corporation has the power to remove an officer at any time, ____ cause. If the resignation or removal is a breach of contract, the nonbreaching party may have a right to ____
at any time; with or without
damages (but note that mere appointment to office itself does
not create any contractual right to remain in office)
A corporation cannot indemnify a director who is:
(1) held liable to the corporation or
(2) held to have received an improper benefit
Unless limited by the articles, a corporation must indemnify a director
or officer who ____
was successful in defending a proceeding on the merits or otherwise against the officer or director for reasonable expenses, including attorneys’ fees, incurred in connection with the proceeding.
-> In some states, the director or officer must win the entire case; in others, they are entitled to indemnification “to the extent” that they win the case.
A corporation may indemnify a director for reasonable litigation expenses incurred in
unsuccessfully defending a suit brought
against the director on account of the director’s position if the director: (1) acted in good faith; and (2) believed that her conduct was in the best interests of the corporation (when the conduct at issue was within the director’s official capacity).
Who Makes Determination to indemnify or not
- Generally, the determination whether to indemnify is to be made by a disinterested majority of the board, or if there is not a disinterested quorum, by a majority of a disinterested committee or by independent legal counsel.
- The shareholders may also make the determination (the shares of the director seeking indemnification are not counted).
Officers generally may be indemnified to the _____
same extent as a director.
Notwithstanding the above rules, a court in which a director or officer was sued may order indemnification if ____. If the director/officer was held liable to the corporation, reimbursement is limited to ____
it is justified in view of all circumstances
costs and attorneys’ fees (it cannot include the judgment).
A corporation may advance expenses to a director defending an action as long as _____
the director furnishes the corporation a statement that the director believes he met the appropriate standard of conduct and that he will repay the advance if he is later found to have not met the appropriate standard.
A corporation may purchase liability insurance to indemnify directors or officers for actions against them even if ____
the directors or officers would not have been entitled to indemnification under the above standards.
The MBCA DOES NOT limit a corporation’s power to indemnify, advance expenses to, or maintain insurance on ____.
agents and employees
DO SHAREHOLDERS GET TO MANAGE THE CORPORATION?
- The power to manage the corporation generally is vested in the board of directors.
- Generally, the shareholders have no direct control in management of the corporation’s business.
- They may act in their own personal interests and generally have no fiduciary duty to the corporation or their fellow shareholders.
Close Corporations
- Shareholders can run the corporation directly in a close corporation.
- The characteristics of a close corporation are that there are few shareholders, and the stock is not publicly traded
Options for managment in a close corporation
- In a close corporation, we can set up management with a board of directors and run it like a regular corporation.
Or we can set up management differently, such as by eliminating the board and having shareholders run the business, or appointing a manager, and so on.
Special Fiduciary Duty in Close Corporations
In many states, courts impose a fiduciary duty on shareholders owed to other shareholders.
-> Because partners owe each other a fiduciary duty of utmost good faith, these courts apply the same duty in the close corporation.
Close Corp: Duties of Controlling Shareholders to Minority Shareholders
- Controlling shareholders cannot use their power to benefit at the expense of minority shareholders.
- There is also a duty to disclose material information to the minority share-
holders.
In a close corp. if there is oppression of minority shareholders, they can ____
sue the controlling shareholders who oppress them for breach of this fiduciary duty.
Licensed professionals, including lawyers, medical professionals, and CPAs, may incorporate as a ____
The name must include one of those phrases or ____The articles must state that the purpose is ____.
“professional corporation” or “professional association.”
“P.C.” or “P.A.”; to practice
Employees of a Professional Corp
Directors, officers, and shareholders usually must be licensed professionals. But may the professional corporation employ non-professionals? Yes, but not to practice the profession
Professional Corp: Liability
- The professionals are personally liable for their malpractice.
- However, shareholders are generally not liable for corporate obligations or for other professionals’ malpractice.
CAN SHAREHOLDERS BE HELD LIABLE FOR CORPORATE DEBTS?
Shareholders generally cannot be held liable for corporate debts.
-> Why? Because the corporation is liable for what it does.
But a shareholder might be personally liable for what the corporation did if the
court pierces the corporate veil.
Piercing the veil can happen in ____ only.
close corporations
To pierce the corporate veil and hold shareholders personally liable:
- The shareholders must have abused the privilege of incorporating; and
- Fairness must require holding them liable.
So courts may pierce the corporate veil to avoid fraud or unfairness by shareholders in a close corporation. But something like ____ is not enough.
sloppy administration
Common Scenarios—Elements Justifying Piercing
- Alter Ego (Identity of Interests)
- Undercapitalization
- Fraud, Avoidance of Existing Obligations, or Evasion of Statutory Provision
Piercing the Veil: Alter Ego (Identity of Interests)
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 corporate veil.
-> These situations may arise where shareholders treat corporate assets as their own, commingle their money with corporate money, and so on.
Piercing the Veil: 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.
Piercing the Veil: 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 pierce the corporate veil.
Piercing the Veil: Who Is Liable
- Normally, only shareholders who are active in the operation of the business will be personally liable.
- Liability is joint and several.
- May pierce to get to corp = the court might pierce the corporate veil and hold the parent corporation liable just as it could if the shareholder were a human.
Piercing the Veil: 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.
- Where the corporation is insolvent, claims of shareholder-creditors may be subordinated to outside creditors’ claims if equity so requires (for example, because of fraud).
Piercing the Veil: Who May Pierce
- Generally, creditors may be allowed to pierce the corporate veil.
- Courts almost never pierce the veil at the request of a shareholder.
Derivate SH Lawsuit
- In a derivative suit, a shareholder is suing to enforce the corporation’s claim, not her own personal claim.
- It’s a case in which the corporation is not pursuing its own claim, so a shareholder steps in to prosecute it for the corporation.
Direct SH Lawsuit
A direct action may be brought for a breach of a 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.
If a shareholder-plaintiff wins a derivative suit, who gets the money from the judgment?
The corporation. Remember, it is the corporation’s claim.
In a derivate suit the shareholder-plaintiff may recover costs and attorneys’ fees, usually from _____.
If the shareholder-plaintiff loses the derivative suit, she ____. If the court finds that the action was commenced or maintained without reasonable cause or for an improper purpose, it may order ____
the judgment won for the corporation (after all, the shareholder did a favor for the corporation by suing and winning)
cannot recover costs and attorneys’ fees
the plaintiff to pay reasonable
expenses of the defendant.
Suppose a shareholder brings a derivative suit and loses. Can other shareholders later sue the same defendants on the same transaction?
Nope!
REQUIREMENTS FOR DERIVATIVE SUITS
- Standing: Stock Ownership at Time of Wrong and Adequate Representation
- Demand Requirements
- Corporation Joined as Defendant
Standing for derivative suits
To commence and maintain a derivative proceeding, a shareholder must have been a shareholder at the time the claim arose or must have become a shareholder through transfer by operation of law from someone who did own stock at the time the claim arose.
-> Examples of “transfer by operation of law” include getting stock through inheritance or by divorce decree
Adequate Representation for derivative suits
The shareholder must also fairly and adequately represent the corporation’s interest.
Demand Requirements
Under the MBCA, the shareholder must make a written demand on the corporation (usually, that means the board) to take suitable action.
- In some states, this demand must always be made, and the 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, shareholders are not required to make this demand if the demand would be futile.
The parties can settle or dismiss a derivative suit only ____. The court may give notice to ____ on whether to settle or dismiss. After the derivative suit is filed, the corporation may ____
with court approval; shareholders and get their input
move to dismiss.
Dismissal of a derivative action must be based upon ____
an independent investigation that concluded that the suit is not in the corporation’s best interest (for example, it has a low chance of success or the expense of the case would exceed the recovery the corporation would win).
-> The investigation must be made by independent directors or a court-appointed panel of one or more independent persons.
In ruling on the motion to dismiss a derivative action, if the court finds that ____ in most states, the court will dismiss.
(1) those recommending dismissal were truly independent and (2) they made a reasonable investigation
Burden of proof - motion ti dismiss derivative claim
- To avoid dismissal, in most cases the shareholder bringing the suit has the burden of proving to the court that the decision was not made in good faith after reasonable inquiry.
- However, if a majority of the directors had a personal interest in the controversy, the corporation will have the burden of showing that the decision was made in good faith after reasonable inquiry.
What SH may vote?
- Shareholders of record on the record date may vote at the meeting.
- The record date is fixed by the board of directors but may not be more than 70 days before the meeting.
Unless the articles provide otherwise, each outstanding share is entitled to ____
one vote.
There are a few exceptions to the general rule that the record owner on the record date is who votes:
- Treasury Stock: Corp can’t vote shares for themselves
- Death of Shareholder: Executor can vote
- Voting By Proxy: A shareholder may vote her shares 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 corporation,
(4) authorizing another to vote the shares.
Revocation of Proxy
A proxy is generally revocable by the shareholder and may be revoked by the shareholder attending the meeting to vote themselves, in writing to the corporate secretary, or by subsequent appointment of another proxy.
A proxy will be irrevocable only if it states that it is irrevocable and ____
is coupled with an interest or given as security
The rules governing proxy solicitation provide that
(1) there must be full and fair disclosure of all material facts with regard to any management-submitted proposal upon which the shareholders are to vote;
(2) material misstatements, omissions, and fraud in connection with the solicitation of proxies are prohibited; and
(3) management must include certain shareholder proposals on issues other than election of directors, and
allow proponents to explain their position.
An exam question might ask you for your opinion as to how they might pool
their voting power. They may do so ____
in a voting trust or a voting agreement.
Voting Trust
A voting trust is a written agreement of shareholders under which all of the shares owned by the parties to the agreement are transferred to a trustee, who votes the shares and distributes the dividends in accordance with the provisions of the voting trust agreement
Requirements for Voting Trust
- A written trust agreement, controlling how the shares will be voted;
- A copy of the agreement (including names and addresses of the beneficial owners of the trust) is given to the corporation;
- Legal title to the shares is transferred to the voting trustee;
and - The original shareholders receive trust certificates and retain all shareholder rights except for voting.
Voting Agreement
Rather than creating a trust, shareholders can enter into voting (or
“pooling”) agreements providing for how they’ll vote their shares.
Requirements for Voting Agreement
- The requirements are that the agreement be in writing and signed.
- It need not be filed with the corporation and is not subject to any time limit.
In some states, the trust is not valid for more than ____ unless it is extended by the agreement of the parties.
10 years
Voting agreements are increasingly specifically enforceable.__
specifically enforceable
-> In states that will grant specific performance of a voting agreement, there is no need to use a voting trust
How do SH act:
- Shareholders usually take action at a meeting (need not be held in state of incorporation).
- Or, they can act by unanimous written (email is fine) consent signed by the holders of all voting shares.
There are two kinds of shareholder meetings:
- Annual Meeting
- Special Meeting
If the annual meeting is not held within the earlier of ____, a shareholder can petition the court to order one to be held.
six months after the end of the corporation’s fiscal year or 15 months after its last annual meeting
And what do shareholders do at the annual meeting?
Primarily, they elect directors.
Special meetings may be called by
(1) the board of directors,
(2) the president,
(3) the holders of at least 10 percent of the outstanding shares, or
(4) anyone else authorized to do so in the articles or bylaw
Notice for SH meetings
- Shareholders must be notified of meetings not fewer than 10 or
more than 60 days before the meeting. - Notice must be in writing (fax or email is fine) to every shareholder entitled to vote (Notice may be waived in writing or by attendance)
Contents of the Notice of SH Meeting
- The notice must state the date, time, and place of the meeting.
- For special meetings, the notice must also state the purpose of the meeting (and the meeting can only be about that)
Consequences of Failure to Give Proper Notice of SH meeting
If proper notice is not given to all shareholders, whatever action was
taken at the meeting is voidable (maybe void), unless those who were not sent notice waive the notice defect
How SH can waive notice of meeting:
- Express waiver, meaning in writing and signed any time (fax or email are fine) OR
- Implied waiver, meaning the shareholder(s) attend the meeting without objecting at the outset
Shareholders generally get to vote on these things:
- To elect directors
- To remove directors
- On fundamental corporate changes
- They may also vote on other things if the board asks for a shareholder vote on those things.
SH Meeting: Quorum
- Every time the shareholders vote, we must have a quorum represented at the meeting.
- Determination of a quorum focuses on the number of shares represented, not the number of shareholders.
- The general rule is that a quorum is a majority of outstanding shares entitled to vote, unless the articles or bylaws require a greater number.
A ____ quorum will not be lost if people leave the meeting.
shareholder
SH Voting—In General
- Absent a contrary provision in the articles, each share is entitled to one vote.
- The articles may provide for weighted voting or contingent voting.
- If a quorum is present, generally, shareholders will be deemed to have approved a matter if the votes cast in favor of the matter exceed the votes cast against the matter, unless the articles or bylaws require a greater proportion.
Unless the articles or bylaws provide otherwise, the specific votes required for certain matters are:
- To elect a director: Plurality (meaning, the person who gets more votes for the seat on the board than anyone else is
elected). - To approve a fundamental corporate change: traditionally, we needed a majority of the shares entitled to vote. Increasingly, though, this is treated as “other matters.”
- To remove a director: Traditionally, we needed a majority of the shares entitled to vote. Increasingly, though, this is treated the same as “other matters.”
- Other matters: Majority of the shares that actually vote on the issue
Cumulative voting usually comes up only in ____
close corporations.
Cumulative voting gives smaller shareholders a ____
better chance of electing someone to the board of directors.
Note that cumulative voting is available only when ____. If the articles are silent about cumulative voting, ____
shareholders elect directors; it does not exist.
Straight Voting
- With straight voting, we have a separate election for each seat on the board being elected.
- Each outstanding share gets one vote for each seat.
- The candidate who gets more votes than another is elected to that seat.
Mechanics of Cumulative Voting
- With cumulative voting, we don’t vote for each seat individually.
- We have one at-large election. The top two (or however many) finishers
are elected to the board. - To determine your voting power when cumulative voting exists, multiply the shareholder’s number of voting shares times the number of directors to be elected.
- The total number may be divided among the candidates in any manner that the shareholder desires, including casting all for the same candidate.
Class Voting on Article Amendments
Whenever an amendment to the articles of incorporation will affect only a particular class of stock, that class has a right to vote on the action even if the class otherwise does not have voting rights.
Shareholder Resolutions
- As a general matter, shareholders are permitted to submit resolutions or proposals for action at shareholder meetings.
- Generally, shareholder resolutions that seek to bind the corporation or the board should involve a proper subject for shareholder action, such as seeking an amendment to the bylaws.
STOCK TRANSFER RESTRICTIONS - validity
Restrictions are valid if they are not an undue restraint on alienation.
A ___ is valid. It does not restrict the ability to transfer, but only requires the shareholder to offer the stock first to the corporation.
right of first refusal
Enforcing Stock Restriction Against Transferee
Enforceable 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.
SHAREHOLDERS’ INSPECTION RIGHTS
A shareholder has the right, personally or by an agent, to inspect (and copy) the books and records of the corporation.
Standing: SHAREHOLDERS’ INSPECTION RIGHTS
Any shareholder can demand access.
Procedure: SHAREHOLDERS’ INSPECTION RIGHTS
Under the MBCA, the procedure followed depends on the material sought.
- Generally, for non-controversial things, shareholders have an unqualified right of access; for more controversial things, their right of access is qualified.
Any shareholder may inspect the following records regardless of purpose:
(1) the corporation’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, and
(6) a copy of the corporation’s most recent annual
report.
Unqualified and Qualified Right for Certain Records: The shareholder must make a written demand at least ___ in advance.
five business days
Qualified inspection rights: For more controversial things, such as _____, the shareholder must ____.
(1) excerpts of the minutes of board (in contrast to shareholder, referenced above) meetings,
(2) the corporation’s books, papers, and accounting records, and
(3) shareholder records
state a proper purpose for the demand
What’s a proper purpose? for SH demanding qualified documents
It’s one that’s reasonably related to the person’s interest as a shareholder.
If the corporation fails to allow proper inspection, the shareholder can ____. If they win, they can ____
seek a court order; recover their costs and attorney’s fees incurred in making the motion.
The shareholder need not personally conduct the inspection; they may ____
send an attorney, accountant, or other agent.
Compare—Directors’ and SH Inspection Rights
- Directors need not go through this procedure to get access to corporate books and records.
- Directors have unfettered access to such materials.
Types of Distributions
Distributions can take the form of dividends, redemptions (meaning, a forced sale to the corporation at a price set in the articles) of shares, repurchases of shares, distribution of assets upon liquidation, and so on.
Rights to Distributions
- At least one class of stock must have a right to receive the corporation’s net assets on dissolution.
- Beyond this rule, distributions generally are discretionary.
Even if the articles authorize distributions, the decision whether to
declare distributions generally is
solely within the directors’ discretion, subject to solvency limitations (below) and any provisions to the contrary in a shareholders’ agreement or the articles.
A shareholder has a “right” to a dividend or other distribution only when ____
the board declares it.
SH Compelling Distribution
- The shareholders have no general right to compel a distribution.
- Because the decision about distributions is the board’s, it is difficult to win a case to force the declaration of a distribution.
- To win, the plaintiff must make a very strong showing of abuse of discretion.
–> For example, maybe the corporation consistently makes profits and the board refuses to declare a dividend while paying themselves a bonus.
Contractual Rights in Regard to Distributions: Limitations and Preferences
Shares may be divided into classes with varying rights (for example, some classes may be redeemable, others not; some may have no right to receive distributions, others could have preferences; etc.).
____ stock is paid before common stock is paid.
The right to the preferred dividend may or may not _____ if unpaid in a particular year (that is, “cumulative” vs. “noncumulative” preferred shares), or may accumulate only if ____ (that is, “cumulative if earned” preferred
shares).
Preferred
accumulate; there are sufficient current earnings
Preferred shares have no right to a share of the distributions made on common shares unless ____
the preferred shares provide that they are “participating.”
Once a distribution is lawfully declared, the shareholders generally are treated as ____ and their claim for the distribution is equal in priority to claims of ____. However, a distribution can be enjoined or revoked if it was declared in violation of ____
creditors of the corporation; other unsecured creditors
the solvency limitations, the articles, or a superior preference right.
Limitations on distributions: Restrictions in the Articles
The articles may restrict the board’s right to declare dividends (for example, a creditor might insist that the corporation include in its articles a provision prohibiting payment of any distributions unless the corporation earns a certain amount of profits).
Limitations on distributions: Share Dividends
Distributions of a corporation’s own shares (that is, “share dividends” or “stock dividends”) to its shareholders are
excluded from the definition of “distribution.”
-> Therefore, the above restrictions are inapplicable.
Shares of one class or series may not be issued as a share dividend in respect of shares of another class or series unless one of the following occurs:
(1) the articles so authorize;
(2) a majority of the votes entitled to be cast by the class or series to be issued approves the issue; or
(3) there are no outstanding shares of the class or series to be issued.
Which Shareholders Get Dividends?
The record shareholder of the stock as of the record date will receive the dividend
Which Funds Can Be Used for a distribution?
- The modern view doesn’t look at funds that can be used for distributions.
- Under the modern view, a corporation cannot make a distribution if it’s insolvent or if the distribution would render it insolvent.
A distribution is not permitted if, after giving it effect, either:
a. The corporation would not be able to pay its debts as they become due in the usual course of business (that is, the corporation is insolvent in the bankruptcy sense); or
b. The corporation’s total assets would be less than the sum of its total liabilities plus (unless the articles permit otherwise) the amount that would be needed, if the corporation were to be
dissolved at the time of the distribution, to satisfy the preferential rights on dissolution of shareholders whose preferential rights are superior to those receiving the distribution (that is, the
corporation is insolvent in the balance sheet sense).
Director Liability for Unlawful Distributions
- Directors are jointly and severally liable for improper distributions.
- A director who votes for or assents to a distribution that violates the above rules is personally liable to the corporation for the amount of the distribution that exceeds what could have been properly distributed.
+ But remember, directors have a good faith reliance defense
A director is not liable for distributions approved in good faith:
(1) based on financial statements prepared according to reasonable accounting practices, or on a fair valuation or other method that is reasonable under the circumstances; or (2) by relying on information from officers, employees, legal counsel, accountants, etc., or a committee of the board of which the director is not a member.
A director who is held liable for an unlawful distribution is entitled to contribution from
(1) every other director who could be held liable for the distribution, that is, those who voted in favor of the distribution and
(2) each shareholder, for the amount she accepted while knowing that the
distribution was improper.
Shareholder Liability for Unlawful Distributions
Shareholders are personally liable only if they knew the distribution was improper when they received it.
Fundamental corporate changes are ____, so the board generally cannot do them alone.
extraordinary
Fundamental corporate changes include the following types of
changes:
- Amending the articles
- Merging or consolidating into another company
- Transferring substantially all assets (or having stock acquired in a “share exchange”)
- Converting to another form of business
- Dissolving
Procedure for Fundamental Corporate Changes
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 the shareholders with written notice; and (3) shareholder approval.
The shareholder vote that’s required to approve a fundamental corporate change is ___
a majority of the shares entitled to vote
-> But this is changing; an increasing number of states require only a majority of the shares that actually vote on the proposed fundamental change.
–> **Generally, though, we’ll apply the traditional rule.
If a corporation approves certain fundamental corporate changes, the shareholders who did not vote in favor of the change may have ___
appraisal rights
-> The dissenting shareholder right of appraisal is the right of a shareholder to force the corporation to buy their stock for fair value.
For a shareholder to perfect a right of appraisal:
- If a proposed corporate action will create dissenters’ rights, the notice of the shareholders’ meeting at which a vote on the action will be taken must state that the shareholders will be entitled to exercise their dissenting rights;
- Before the shareholders vote, the shareholder must file with the corporation a written notice of objection and intent to demand payment;
- At the shareholder vote, the shareholder must abstain or vote against the proposed change (they cannot vote in favor of the proposed action);
- If the action is approved, the corporation must notify, within
10 days after approval, all shareholders who filed an intent to demand payment. –> The notice must include the time and place to submit her shares and the other terms of the repurchase; - Within the time set by the corporation, the shareholder must make written demand to be bought out and deposit her stock with the corporation; and
- The corporation must pay the dissenters the amount the corporation estimates as the fair value of the shares, plus accrued interest.
Only certain fundamental corporate changes will trigger the right of appraisal:
- Merging or consolidating
- Transferring substantially all assets
- Stock being acquired in a share exchange
- Converting to another form of business
“Market-out exception” to appraisal rights
Even if the company is doing one of these changes, there is no appraisal right if the company’s stock is listed on a national exchange (that is, it’s a publicly traded corporation) or if the company
has 2,000 or more shareholders (not shares, shareholders) and the shares involved have a value of at least $20 million (exclusive of the shares held by senior executives, directors, and share- holders owning more than 10% of the shares).
-> What it means is that the right of appraisal exists in close corporations.
Appraisal: If the shareholder is dissatisfied with the corporation’s determination of value, the shareholder has _____.
If the shareholder and the corporation cannot agree on the fair value of the shares, the _____.
If the corporation does not so file, the
corporation must ____
30 days in which to send the corporation her own estimate of value and demand payment of that amount (or the difference between her estimate and the amount sent by the corporation)
corporation must file an action in court within 60 days of receiving the shareholder’s demand,
requesting the court to determine the fair value of the shares, and the
court may appoint an appraiser
pay what the shareholder demanded
Absent ___, the right of appraisal is the shareholder’s exclusive remedy if ____
fraud; they do not like a fundamental change.
The corporation can amend its articles by following the procedure for fundamental corporate changes. Certain ____ amendments (for example,
deleting the names of initial directors named in the articles or changing the number of authorized shares after a stock split) can be made without shareholder approval, but most require approval by the shareholders.
“housekeeping”
If approved, the amended articles must be ____. Shareholders generally do not have ____ for amendments of the articles.
delivered to the secretary of state; dissenting rights of appraisal
A merger involves ____
A consolidation involves ____
the blending of one or more corporations into another corporation, and the latter corporation survives while the merging corporations cease to exist following the merger
two corporations combining to form a new entity
A domestic corporation can merge with a foreign corporation into a new domestic corporation, but only if ____
the merger is permitted in the foreign corporation’s state of incorporation.
For both mergers and consolidations, ____ is required, as well as _____, generally by both corporations (the required vote is the same as with amending the articles)
board of director action (by both corporations); notice to shareholders and shareholder approval
If approved, the surviving corporation must deliver articles of merger or consolidation to ____. There is a right of ____, generally, for shareholders entitled to vote on the merger or consolidation and also for shareholders of the subsidiary in a short form merger.
the secretary of state; appraisal
Approval of a plan of merger by shareholders of the surviving corporation is not required if all 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 outstanding immediately prior to the effective date of the merger will hold the same number of shares, with 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.
Short Form Merger of Subsidiary
- No shareholder approval is required for a short form merger.
- With short form mergers, a parent corporation owning at least 90% of the outstanding shares of each class of a subsidiary corporation may merge the subsidiary into itself without the approval of the shareholders or directors of the subsidiary.
Effect of Merger or Consolidation
- The surviving corporation succeeds to all rights and liabilities of the constituents.
- So a creditor of that corporation can sue the survivor = this is known as successor liability.
Another fundamental corporate change involves the transfer of ____ of a corporation not in the ordinary course of business.
all or substantially all of the assets
What constitutes “substantially all of the assets” varies from state to state.
A good rule of thumb is that it requires the transfer of at least 75 percent of the corporation’s assets.
Both the transfer of all or substantially all assets and the share exchange are fundamental corporate changes for ____
the selling corporation only—not for the buyer.
-> So the corporation disposing of the property must follow the fundamental change procedure.
TRANSFER OF ALL OR SUBSTANTIALLY ALL ASSETS AND SHARE EXCHANGE: Procedure
- Board action by both corporations is required, as well as notice to the selling company’s shareholders.
- We also need approval by the selling company’s shareholders only.
- There are dissenting shareholder
rights of appraisal for shareholders of
he selling corporation (but not
for shareholders of the buying corporation). - For a share exchange,
articles of exchange must be delivered to the secretary of state.
–> Usually, there is no filing in a transfer of assets.
For the sale of substantially all assets, we do not expect ____ liability. However, there is an exception if the buyer is a _____ of the seller, that is, it has the same management, shareholders, and so on. Also, there will be successor liability if a court concludes that the deal was really a disguised ____
successor; “mere continuation”; (de facto) merger.
CONVERSION
involves one business entity changing its form to another business form, such as a corporation converting itself into an LLC.
CONVERSION: Procedure
- We need board approval and notice to shareholders, as well as shareholder approval.
- We also need to deliver a document to the secretary of state.
- For conversion, shareholders also have a dissenting right of appraisal
DISSOLUTION - Types
Dissolution of a corporation may be voluntary or involuntary (by court order).
Voluntary Dissolution - Ways it can occur
- Dissolution by Incorporators or Initial Directors
- Dissolution by Corporate Act
Dissolution by Incorporators or Initial Directors
- If shares have not yet been issued or business has not yet been commenced, a majority of the incorporators or initial directors may dissolve the corporation by delivering articles of dissolution to the state.
- All corporate debts must be paid before dissolution, and if shares have been issued, any assets remaining after winding up must be distributed to the shareholders.
Dissolution by Corporate Act
- The corporation may dissolve by a corporate act approved under the fundamental change procedure.
- This means that we need board of director action, shareholder approval, and we’ll file notice of intent to dissolve with the secretary of state.
Effect of Dissolution
- A corporation that has been dissolved continues its corporate existence but is not allowed to carry on any business except as appropriate to wind up and liquidate its affairs.
- We also need to notify creditors so that they can make any claims.
A claim can be asserted against a dissolved corporation, even if _____
the claim does not arise until after dissolution, to the extent of the corporation’s undistributed assets
Claims during winding up: If the assets have been distributed to the shareholders, a claim can be asserted against each shareholder for ____.
his pro rata share of the claim, to the extent of the assets distributed to him.
However, a corporation can cut short the time for bringing known claims ____.
The time for filing unknown claims can be limited to ___ by ____.
by notifying claimants in writing of the dissolution and giving them a deadline of not less than 120 days in which to file their claim
three years; publishing notice of the dissolution in a newspaper in the county where the corporation’s known place of business is located
Revocation of Voluntary Dissolution
The corporation may revoke a voluntary dissolution by using the same procedure that was used to approve the dissolution.
Involuntary Dissolution
Involuntary dissolution is also known as “judicial dissolution” because, as mentioned, it happens by court order. Different players can ask for this
Who can ask for involuntary disclosure
- Attorney General
- Shareholders
- Creditors
- Court Supervision
The attorney general may seek judicial dissolution of a corporation on the ground that ____
the corporation fraudulently obtained its articles of incorporation or that the corporation is exceeding or abusing its authority.
Shareholders may petition for involuntary dissolution on any of the
following grounds:
- Director abuse, waste of assets, or misconduct
- The directors are deadlocked in the management of corporate affairs, the shareholders are unable to break
the deadlock, and irreparable injury to the corporation is threatened, or corporate affairs cannot be conducted to the advantage of the shareholders because of the deadlock; - 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; or
- The corporation has abandoned its business and failed to dissolve within a reasonable time.
As an alternative to ordering involuntary dissolution, a court might order ____. This might be especially likely in ____.
a buy-out of the objecting shareholder; a close corporation.
–> This alternative involves the corporation (or one or more shareholders) electing to purchase the shares owned by the petitioning shareholder at their fair value.
Creditors may seek judicial dissolution if:
(1) the creditor’s claim has been reduced to judgment, execution of the judgment has been returned unsatisfied, and the corporation is insolvent; or
(2) the corporation has admitted in writing that the creditor’s claim is due and owing and the corporation is insolvent.
A court may dissolve a corporation in an action by ____
the corporation to have its voluntary dissolution continued under court supervision.
The state may bring an action to administratively dissolve a corporation for reasons such as ____
the failure to pay fees or penalties, failure to file an annual report, and failure to maintain a registered agent in the state.
For an administrative dissolution the state must serve the corporation with ____ of the failure. If the corporation does not correct the grounds for dissolution or show that the grounds do not exist within ____ after service of notice, the state effectuates the dissolution by signing a certificate of dissolution.
written notice; 60 days
A corporation that is administratively dissolved may apply for reinstatement within ___ after the effective date of dissolution. The application must ____.
Reinstatement ____, and the corporation may resume carrying on business as if the dissolution had never occurred
two years; state that the grounds for dissolution either did not exist or have been eliminated
relates back to the date of dissolution
Winding Up
Dissolution is not the end of the corporation. It is the beginning of a process that will end the corporate existence. The corporation continues to exist, so it can sue and be sued. It cannot start new business but must wind up (liquidate).
The following steps must be taken to wind up the corporation:
- Give written notice to known creditors and publish notice of dissolution in a newspaper in the county of its principal place of business;
- Gather all assets;
- Convert assets to cash;
- Pay creditors; and
- Distribute any remaining sums to shareholders, pro rata by share, unless there is a liquidation preference
Liquidation Preferences
- Liquidation preferences mean, in short, “pay first.”
- They work like a dividend preference.
- The articles may set out a dividend preference or liquidation preference, if any.
Remember, liquidation preferences may be relevant to ____
insolvency.
