Corporations Flashcards
Incorporation
Requirements to Form a Corporation: To create a corporation we need:
1. A person
To form a corporation need n one or more persons who undertake to from it, who are know as the incorporators
2. A paper
We also need a particular paper: The Articles of Incorporation
Article of Incorporation must include: (1) The name of the corporation(plus the abbreviation of corporation/company); (2) The name and address of each incorporator; (3) A registered agent and the street address of the registered office(the registered office must be in the state); and (4) Information regarding the corporations stock. (Maximum number of stock, the different classes of stock, or series within a class stock)
Registered Agent: The companies legal representative
Business Purpose: Traditional corporation have included a statement of business purposes in their articles.
3. An act
Deliver articles to Secretary of State with required fees
The articles of incorporation are filed with the state, and, if in conflict with bylaws, the articles control.
A corporation is not generally liable for a contract entered into prior to incorporation unless it expressly or impliedly adopts the contract.
Express Adoption: The board takes an action adopting the contract
Implied Adoption: The corporation accepts a benefit of the contract
Promoter Liability: Under the MCBA, anyone who acts on behalf of the corporation knowing that it is not in existence is jointly and severally liable for the obligations incurred.
Thus promoter will be personally liable for contract on behalf of unformed corporation with third party
Issuance of Stock
Rule: To start and operate a corporation, we need money(capital).
The corporation can either:
1. Borrow the money; or
2. Raise it by selling stock
Either way the corporation will issue a security(investment) to the investor
Debt Securities: When the corporation borrows money, it issues a debt security(bonds)
The bond is a promise to that the corporation will repay the loan with interest.
Holder of Debt: Is a creditor not an owner
Equity Securities: When the investor buys an ownership interest in the corporation, it issues equity securities(stocks)
Holder of Equity: Is an owner not a creditor
Issuance: An issuance of stock is when a corporation sells its own stock. Its important to remember that the rules in this facts pattern apply only when there is an issuance
Subscriptions: Written offers to buy stock from a corporation.
Pre Incorporation Subscriptions: Under the MCBA, pre incorporation subscriptions are irrevocable for six months unless otherwise provided in terms of the subscription agreements or unless all subscribers consent to revocation
Post Incorporation Subscriptions: Are revocable until accepted by the corporation
Form of Consideration: Under the MCBA, stock may be issued for any tangible or intangible property or benefit to the corporation.
Amount of Consideration: Cannot be less than Par Value: Minimum issuance price.
Water Stock: Watch out for this on bar exam, which occurs when stock is issued for less than its par value
Directors are liable for issuing the stock if they knowingly authorized the issuance
Person who bought the stock is also liable and charged for par value
Preemptive Right: Right of existing shareholder to maintain their percentage of ownership by buying stock if there is a new issuance.
Under the MCBA, preemptive right must be stated in articles or shareholders do not have preemptive right
Exceptions: Even if the articles do prove a preemptive right, shareholders generally have no preemptive right in shares issued:
1. For consideration other than cash
2. Within 6 months after incorporation; or
3. Without voting rights but having a distribution preference
If the initial directors were named in the articles, the board of directors holds the organizational meetings,.
If they were not named the incorporators hold the organizational meeting.
Organizational Meeting: The purpose of the meeting is it:
1. Adopt initial bylaws; and
2. Appoint officers
Bylaws are an internal document(operating manual). Bylaws may contain any provision for managing the corporation that is not inconsistent with the articles or law
Directors
Directors manage the corporation and act as a body by voting.
Directors may exercise all corporate powers that are not limited by the articles of incorporation or a shareholders’ agreement, including the power to form contracts and acquire liabilities. Shareholders hire and fire directors.
Board Must Act As Group: The board of directors must act as a group
Thus an individual director is not an agent of a corporation and may not speak for or bind the corporation
Group of directors may act only in the following ways:
1. Unanimous agreement in writing; or
2. At a meeting, which must satisfy the quorum and voting requirements
Quorum: A quorum is a majority of all directors, unless the bylaws say otherwise (can never be less than 1/3rd)
Broken Quorum: A quorum can be broken if people leave. Once a quorum is no longer present, the board cannot take action
Voting Requirements: If a quorum is present at a meeting, passing a result requires only a majority vote of those present.
Board Meeting Notice Requirements: Depends in whether it is regular or special meeting:
1. Regular meeting: Notice is not required
2. Special Meeting: Written notice at least two days in advance disclosing date, time, and place is required. They need not state the purpose of the meeting
Failure To Give Notice: Whatever happened at the meeting is voidable unless the directors who were not notified waive the notice defect.
They can do this:
1. In writing any time; or
2. By attending the meeting without objecting at the outset of the meeting
Requirement For Directors:
1. Qualifications: Adult Natural Persons
2. Number: Must have one or more
Duty of Care: Business Judgement Rule
Duty of Care: A director must use the care that a person in like position would reasonably believe appropriate under the circumstances
A director owes this duty to the incorporation
On the exam you’ll see the duty of care come up in two scenarios:
1. Nonfeasance: Occurs when a director basically does nothing(is lazy)
Director is only liable if his breach of duty causes a loss to the corporation
2. Misfeasance: Occurs when the board make a decision that hurts the business. Thus causation is clear
Exception: The business judgement rule is a presumption that in making a business decision, the directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.
Directors must be informed to an extent that they reasonably believe is appropriate. They are entitled to rely upon information, opinions, reports, or statements of corporate officers, legal counsel, public accountants, etc., in making a decision.
A party claiming that the directors breached their duty of care has the burden of proof.
Courts will not second guess business decisions if made in good faith, was informed, and had a rational basis
Duty of Loyalty
A director must act in good faith and with a reasonable belief that what he does is in the corporation’s best interest. The business-judgment rule presumption does not apply if there is a duty of loyalty issue.
A duty of loyalty issue arises if
1. Interested Director Transaction: A director has a material financial interest in a contract, as well as knowledge of that interest, yet still votes to approve the contract.
Interested director transaction will be set aside(or the director liable in damages) unless the director shows either:
1. The deal was fair to the corporation when entered; or
2. Their interest and the relevant facts were disclosed or known and the deal was approved by either (1) a majority of the disinterested directors; or (2) a majority of the disinterested shareholders
- Competing Ventures: A director may not compete with his corporation
3.Corporate Opportunity Doctrine: A corporate officer may not usurp a corporate opportunity.
The directors fiduciary duties prohibit them from diverting business opportunity from their corporation to themselves without first giving their corporation an opportunity to act
This means the director can’t take until he (1) Tells the board about it and (2) waits for the board to reject the opportunity
A qualified director is a director without a conflicting material interest.
Qualified shares are those not held by a conflicted director or related person.
An LLC operating agreement may waive the duty of loyalty (e.g., allow members to open competing businesses) so long as it is not “manifestly unreasonable.”
Officers
Officers: Agents of the corporation
Fiduciary Duties: Officers owe the same duties of care and loyalty as directors
Authority to Bind Corporation: Whether an officer can bind the corporation is determined by whether they have agency authority to do so.
The president of a corporation generally has apparent authority to bind the corporation to contracts in the ordinary course of business
Apparent Authority is that authority which a third party reasonably believes an agent possesses based on the principles holding out the agent as having such authority
Selection and Removal of Officers: Officers are selected and removed by the board of directors, which also sets officer compensation
An officer may resign at any time by delivering notice to the corporation
Corporation has power to remove officer at any time with or without cause
If removal is breach of contract, removal is still effective but officer may sue for breach of contract damages.
Exam Tip: Shareholders hire and fire directors, not officers
Indemnification
There are three categories of indemnification for when an officer or director has been sued and are trying to indemnify the corporation:
- No Indemnification: A corporation cannot indemnify a director who is (1) held liable to the corporation or (2) held to have received an improper benefit
- Mandatory Indemnification: 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 attorney fees, incurred in connection with the proceeding
- Permissive indemnification: A corporation may indemnify a director for reasonable litigation expenses incurred in unsuccessfully defending a suit brought against the directors on account of the directors position if the director: (1) acted in good faith; and (2) believed that her conduct was in the best interests of the corporation
Cases that settle go into category 3
Shareholders
General Rule: Generally shareholders have no direct control in management of the corporations business.
Exception: They do have control in close corporations
Close Corporations: Shareholder can run the corporation directly.
The characteristics of a close corporation are:
1. Small number of shareholders
2. Stock not publicly traded
3. Shareholders can manage directly
Shareholder Management Agreement: Sets up alternative management for a close corporation
The MCBA allows shareholder to enter into agreements to dispense with the board and vest management power in the shareholders
There are two ways to set up a shareholder management agreement:
1. In the articles and approved by all shareholders; or
2. By unanimous written shareholder agreement
Exam Tip: Whoever manages the corporation owes the duties of care and loyalty to the corporation
Thus managing shareholders will have the liabilities that a director ordinarily would have with respect to that power
Shareholder Duty To Other Shareholders: Controlling shareholder cannot use their power to benefit at the expense of minority shareholders.
Lawsuits Against Shareholders-Piercing The Corporate Veil
General Rule: Shareholders generally cannot be held liable for corporate debts.
Exception: A shareholder might be liable for what the corporation did if the court pierces the corporate veil
This happens in close corporations only
Piercing the Corporate Veil: To pierce the corporate veil and hold shareholders personally liable:
1. The shareholders must have abused the privilege of incorporating; and
2. Fairness must require holding them liable
There are three common scenarios in which the corporate veil is pierced
1. Alter Ego: If the shareholders ignore corporate formalities such that the corporation may be considered the “alter ego” of the shareholders or another corporation, and some basic injustice results, a court might pierce the corporate veil.
These situations often arise when shareholder treat corporate assets as their own, commingle their money with corporate money, etc.
- Undercapitalization: The corporation is inadequately capitalized, so that at the time of formation there is not enough encumbered capital to reasonably cover prospective liabilities
Courts are more willing to pierce the corporate veil for a tort victim than for a contract claimant - Fraud, Avoidance of Existing Obligation’s, or Evasions 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
Who is liable: Normally only only the shareholders who are active in the operation of the business will be personally liable
Lawsuits By Shareholders Against the Corporation
A shareholder may file an action to establish
that the acts of the directors are illegal, fraudulent, or willfully unfair and oppressive to either the corporation or the shareholder.Whether a suit is appropriately brought as a direct or derivative action depends on the injury.
A direct suit is appropriate when the wrong done amounts to a breach of duty owed to the individual personally. (E.g., shareholder sues for denial of preemptive rights, payment of a dividend, or oppression in a close corporation.)
A derivative suit is appropriate when the injury is caused to the corporation and a shareholder is trying to enforce the corporation’s rights. (This also applies to LLCs.)
Always ask: Could the corporation have brought this suit? If so its a derivative suit
Shareholders suing for director breach of duty of care is always a derivative suit. This is because fiduciary duties are owed to corporation
A shareholder may not commence or maintain a derivative suit unless three requirements are met(SAD):
1. Standing to bring a lawsuit: Standing requires the shareholder to be a contemporaneous owner at the time of the alleged act or omission
2. Adequate Representation: The shareholder must fairly and adequately represent the corporations interest
3. Demand Requirement’s: Under The MBCA, the shareholder must make a written demand on the corporation(usually that means the board) to take suitable action
Shareholder must always make this demand and cannot sue until 90 days after making the demand.
- Corporation must be joined as defendant
Recovery of Derivative Suits: The corporation wins the money from the judgement since its their claim. Shareholder recovers court costs and attorney fees if shareholder wins
However if shareholder loses they do not recover fees and costs.
If shareholder brings a suit and loses, other shareholders are barred from suing on the same transaction again
Voting
Authorized Stock: Max number of shares a corporation can sell (set in articles)
Issued Stock: Number of shares corporation actually sells
Outstanding Stock: Shares issued and not reacquired
Record Shareholder: Person shown as stock owner in corporate records
Record Date: Voter eligibility cutoff date.
General Rule: Shareholder of record on the record date may vote at the meeting
The voter date is fixed by the board of director but may not be more than 70 days before the meeting
Each outstanding share is entitled to one vote
Exceptions: There are a few exception to the general rule that the record owner on the record date is who votes:
1. Treasury Stock: Corporation reacquires stock before the record date, so the corporation is the owner of this treasury stock as of the record date. Corporation does not vote on it because it was not outstanding on record date
2. Death of shareholder
3. Voting by Proxy: A shareholder may vote her shares in person or by proxy executed in writing
A proxy is a writing signed by the record shareholder directed to the secretary of the corporation, authorizing another to vote the shares
Revocable Proxies: A proxy is generally revocable by the shareholder and may be revoked by:
1. Writing to the corporate secretary or
2. Attending meeting and voting
Irrevocable Proxies: A proxy will be irrevocable only if it states that it is irrevocable and is coupled with an interest or given as a security. This requires (1) the proxy says its irrevocable and (2) the proxy holder has some interest in the shares other than voting
Rule: Shareholder usually take action:
1. At a meeting; or
2. They can act by unanimous written consent signed by the holders of all voting shares.
There are two types of shareholder meetings:
1. Annual Meeting: Corporations must hold annual meetings.
If the annual meeting is not held within 15 months of its last annual meeting, a shareholder can petition the court to order one be held
2. Special Meetings: May be call by: (1) the board of directors, (2) The president, (3) the holder of at least 10 percent of the outstanding shares; or (4) anyone else authorized to do so in the articles or bylaws
Shareholder Meeting Notice: Must be in writing and delivered 10-60 days before meeting
Notice must be in writing to every shareholder entitled to vote
Contents: Must state date, time and place of meeting. For special meeting must contain purpose
Consequences of No Notice: If proper notice is not given to all shareholder, whatever action was taken at the meeting is voidable.
Shareholders generally get to vote on these things:
1. To elect directors
2. To remove directors
3. On fundamental corporate changes
Quorum: Every time the shareholders vote, we must have a quorum represented at the meeting.
Determination of quorum is determined by the majority number outstanding of shares, not shareholders.
Quorum cannot be lost if people leave the meeting
Votes Required: Unless the articles or bylaws provide otherwise, the specific required of votes for certain matters are:
1. To elect a director: Plurality(meaning the person who gets more votes for the seat on the board then anyone else is elected)
2. To approve a fundamental corporate change: Majority of shares entitled to vote (increasingly becoming “other matters” rule though)
3. To remove a director: Majority of shares entitled to vote(increasingly becoming “other matters” rule though)
Other Matters: Majority of the shares that actually vote on the issue
Cumulative Voting: Method to give small shareholder better chance of electing someone to the board of directors. (Available only when shareholders elect directors
With cumulative voting, we don’t vote for each seat individually. We have one at large election. The top two finishers are elected to the board.
To determine your voting power take your number of shares X number of directors to be elected
Shareholders Right To Inspect Corporate Books and Records
Right To Inspect: A shareholder has the right to inspect and copy the books and records of the corporation
Standing: Any shareholder can demand access
Procedure: Under the MBCA, the procedure followed depends on the material sought: Generally for non controversial things, shareholder have an unqualified right of access; for more controversial things their right of access is qualified.
Unqualified Right of Acts: Any shareholder may inspect the following records regardless of purpose:
1. The corporations articles and bylaws
2. Board resolutions regarding classifications of shares
3. Minutes of shareholders meetings from the past three years
4. Communications sent by the corporation to shareholder over the past three years
5. A list of the names and business addresses of the corporations current directors and officers; and
6. A copy of the corporations most recent annual report.
The shareholder must make a written demand at least five business days in advance
Qualified Right: For more controversial things the shareholder must state a proper purpose for the demand. These types of things include:
1. Excerpts of the minutes of board meetings,
2. The corporations books, papers, and accounting records; and
3. Shareholder records
Proper Purpose: One that’s reasonably related to the persons interest as a shareholder
Failure To Allow Proper Inspection: The shareholder can seek court order
Directors have unfetter access to such materials
Stock Transfer Restrictions
General Rule: Restriction’s on the transferability of stocks are valid if they are not an absolute restraint on alienation.
The right of first refusal is valid because it does not restrict the ability to transfer, but only requires the shareholder to offer the stock first to the corporation
If restriction is valid, it can be imposed against the transferee if:
1. The restriction is conspicuously noted on the stock certificate; or
2. The transferee had actual knowledge of the restriction at the time of the purchase
Fundamental Corporate Changes
Procedure for Fundamental Corporate Change: Generally to do any fundamental corporate change, we need:
1. Board action adopting a resolution of a fundamental change
2. The board submits the proposal to the shareholders with written notice; and
3.. Shareholders approval
The shareholder vote that’s required to approve a fundamental change is the majority of the shares entitled to vote.
Dissenting Shareholders Right of Appraisal: Right to force corporation to buy stock at fair value
Applies only to these fundamental changes:
1. Merging or consolidating
2. Transferring substantially all assets
3. Stock being acquired in a share exchange
4. Converting to another form of business
Exists only In close corporations
Exclusive Remedy: Absent fraud, the right of appraisal is the shareholder exclusive remedy if they do not like a fundamental change
Amending Articles: Requires majority of shares entitled to vote
Merger and Consolidations:
Merger: One corporation is absorbed into another
Consolidation: Two corporations become one new corporation
Requirements: For both mergers and consolidations, board of directors action is required, as well as notice to the shareholders and shareholder approval, generally by both corporations.
There is a right of appraisal
Dissolution is not the end of the corporation but is the beginning of a process that will end the corporations existence.
The corporation may still sue and be sued.
The corporation cannot start new business but must wind up(liquidate)
Steps for winding up: The following steps must be taken to wind up the corporation:
1. Give written notice to known creditors and publish notice of dissolution in newspaper in the county of its principal place of business
2. Gather all assets
3. Convert assets to cash
4. Pay creditors; and
5. Distribute remaining sums to shareholder, pro rata by share, unless there is a liquidate preference
LLC Rules
Formation, rights, and duties: Articles of organization must be filed to create an LLC. Since LLCs are a relatively new form of business association, courts tend to analyze them in the context of corporate or partnership law. Members of an LLC have fiduciary duties. Members of an LLC in a member-managed LLC are treated as agents of the LCC (with actual and apparent authority to bind the LLC in ordinary—but not extraordinary—affairs).
Dissociation: if a member leaves, then it leads to dissociation of that member, but it does not lead to winding up or dissolution unless the other members unanimously agree to dissolve the LLC.
Liability: Generally, individual members are not liable for losses. They are liable if the court decides to pierce the LLC veil discussed above or if proper procedures for dissolution and winding up have not been followed. Creditors may enforce claims against each of the LLC members. However, a member’s total liability may not exceed the total value of assets distributed to the member in dissolution
