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.”
