Corporations

Question 1

What is the primary purpose of forming a corporation?

Answer 1

Shareholders are not liable for debts of a corporation if validly formed (with limited exception for piercing the corporate veil). Also: promoting investment

Question 2

What is a promotor and when are they liable?

Answer 2

• Before formation, a promoter is one who works on behalf of the corporation to create and fund the entity, with knowledge the entity is not yet formed
• A promoter is personally liable for a breach of contract, even after the corporation (C) is formed, unless there is a novation or the third party (3P) knew of the pre-formation status and agreed to look only to the C for performance
• A promoter owes a fiduciary duty to the corporation even before it is formed. A secret profit (e.g., undisclosed commission) on a pre-incorporation transaction is a breach.

Question 3

When is a corporation liable for pre-formation transactions?

Answer 3

The corporation is not liable for pre-formation transactions unless there is a novation or an express (by the board) or implied (accepts benefits) adoption of the contract.

Question 4

What is required in the articles of incorporation?

Answer 4

◦ Name of the corporation (must include Corporation, Company, Limited, etc.);
◦ Name and address of local agent for service of process;
◦ Names and addresses of incorporators; and
◦ Number of authorized shares in each class of stock.
◦ Unless stated in the articles, RMBCA presumes “any lawful business” purpose

Question 5

What are ultra vires actions?

Answer 5

Corporate acts that are beyond what is permitted in the articles
◦ Ultra vires acts were void at C/L, but are enforceable under the RMBCA
◦ Shareholders or the state can enjoin the acts if equitable; the corporation can sue the directors/officers who committed the acts
◦ A 3P cannot assert ultra vires acts as a defense to escape liability

Question 6

When is a corporation considered formed (what date)?

Answer 6

If the state accepts the articles, the entity is formed on the date when the articles are filed, or a later (not earlier) date set out in the articles; filing by the state is conclusive proof the entity is formed.

Question 7

What are the two theories for a defectively formed corporation?

Answer 7

• De Facto—(not recognized by RMBCA) corporation not formed in spite of good faith effort to comply and acted without knowledge of defects
• Corporation by estoppel—applies in a contract dispute (not in a tort case) to prevent a 3P from denying the existence of the corporation when a de facto corporation exists

Question 8

What is piercing the corporate veil? When can you?

Answer 8

A plaintiff can “pierce the corporate veil” of limited liability to recover directly from the investor or shareholder on the basis of fraud or unfairness
* Commonly sought in a contract dispute, but more likely to be granted in tort case
* Grounds:
◦ Alter ego—failed to observe corporate formalities; C is just the SH’s alter ego
◦ Undercapitalization—failure to maintain sufficient funds to cover liabilities
◦ Fraud—the parties engaged in fraud or fraud-like behavior

Question 9

What consideration is necessary in exchange for stock?

Answer 9

RMBCA: Can be money, tangible or intangible property or future services so long as the value is determined as adequate by the board acting in good faith

Question 10

What is a stock subscription and how long is it irrevocable for?

Answer 10

Agreement to buy stock before formation, irrevocable for 6 months

Question 11

What are preemptive rights and when are they authorized?

Answer 11

If the board issues new shares, the rights of shareholders to purchase additional shares to maintain proportional ownership; must be authorized in the articles (majority rule)

Question 12

When can a shareholder compel a dividend?

Answer 12

In its discretion, the board may authorize payment of a dividend; a SH cannot compel the board to authorize a distribution unless it acts in bad faith and abuses its discretion

Question 13

When can a corporation not issue a distribution (dividend or share buyback)?

Answer 13

A corporation may not make a distribution if it is insolvent or would cause such, determined under either the equity test or balance sheet test at the time a dividend is declared

Question 14

What is required in a notice of a shareholder meeting? When is it required?

Answer 14

Notice required no fewer than 10 days and no more than 60 days before the meeting
* Content of the notice must include where and when it will be held
* Special meeting notice must include the purpose for the meeting
* Failure to provide proper notice allows SH to challenge actions, absent a waiver
* Waiver—SH will be held to waive defects in notice by a signed writing or by attending the meeting without objecting to the defective notice

Question 15

When can shareholders act without meeting?

Answer 15

Unanimous consent of SH to act without a meeting is allowed if it is in writing

Question 16

What shareholders are entitled to vote and how is this determined?

Answer 16

Only a SH who own shares on the record date is entitled to vote
Record date—fixed by directors and can be no more than 70 days before the meeting; a SH who acquires after the record date cannot vote without a proxy from the record owner

Question 17

What is a proxy and how long is it valid for?

Answer 17

Proxy—a third party may be appointed to vote if in a signed writing sent to the corporation
* Valid for 11 months unless otherwise stated
* Revocable unless otherwise specified and is coupled with an interest

Question 18

What is a quorum for a shareholder meeting?

Answer 18

To hold a vote requires a quorum of the eligible shares to be present at the meeting
* A quorum is a majority of votes representing the eligible outstanding shares (excludes shares corp itself owns)
Then, majority wins unless otherwise specified.

Question 19

What are the rights of shareholders?

Answer 19

1. To inspect records—SH may inspect and copy records with five days’ notice stating a proper purpose (related to financial interest of SH and not to harass or acquire corporate secrets)
2. To sue the corporation—SH may bring a direct or derivative action against the corporation

Question 20

What is required for a shareholder to bring a derivative action?

Answer 20

Derivative (SH sues on behalf of the C to vindicate rights of the C)
◦ Standing—must be a SH at the time of the wrong (or acquire shares from SH who was) and maintain ownership throughout litigation; SH must fairly and adequately represent the interests of the corporation
◦ Demand—must make written demand to the board, and wait 90 days before commencing action unless board rejects it earlier (tested against business judgment rule) or waiting would cause irreparable injury; some states excuse if demand futile
◦ Recovery—any recovery goes to the corporation; SH can seek reimbursement for attorney’s fees if the action produced a substantial benefit to the corporation

Question 21

What is a controlling SH and what are their duties?

Answer 21

SH—owns greater than 50% or enough of the shares to enact major changes
* Cannot use the position of control to cause C to take action that prejudices the minority
* May owe a fiduciary duty to minority SH for selling stock to a looter without reasonable investigation, seeking to eliminate other SH, receiving a distribution denied to other SH or failing to disclose material information

Question 22

How much notice is required for a board meeting?

Answer 22

Two days’ notice is required for a special meeting unless waived in writing or by D attending; no notice is required for a regular meeting; directors cannot vote by proxy

Question 23

What is required for a valid board meeting vote?

Answer 23

• Quorum—requires a majority of all directors unless articles or bylaws specify otherwise
• Presence—a D can “attend” a meeting by electronic means that allow hearing/speaking
• Required number—if a quorum is present, a majority vote of the directors in attendance can approve a resolution, provided they are present when the vote is taken
• No Voting Agreements are allowed among directors

Question 24

What is the duty of care and the business judgment rule?

Answer 24

DOC: Must act as a prudent person in like circumstances; must use any special skills
Business Judgment Rule: In the absence of fraud, illegality, or self-dealing, the good faith actions of a director or officer will not be disturbed.

Question 25

What is the duty of loyalty and how is it violated?

Answer 25

A director/officer must act in good faith and in the best interest of the corporation.
* Corporate Opportunity
* Competing Venture
* Self-Dealing

Question 26

What is self-dealing and how is it sanitized?

Answer 26

Rule: A transaction between the corporation and a director (or her relatives) or a business in which the director has an interest that would normally require approval of the board (e.g., salary) is a breach of duty of loyalty unless:
◦ Ratification—disclosure of material facts and approval by either a majority of all disinterested directors or majority of all disinterested SH; or
◦ Fair—transaction was fair to the corporation at the time of the transaction.
◦ Some states treat as a partial defense and shift burden to plaintiff to prove unfair
* Remedy—damages to C; transaction may be subject to injunctive relief or rescission

Question 27

What are the corporate opportunity and competing venture doctrines?

Answer 27

Corporate Opportunity
* Rule: A director/officer cannot usurp a corporate opportunity unless she first notifies the board and waits for the board to accept or reject before seizing the opportunity.
* Corporate opportunity is measured by “interest or expectancy” or “line of business” test
* Remedy—damages, constructive trust or corporation gets the opportunity at cost
Competing Venture
* Rule: A director/officer that engages in a business that competes with the C is in breach of his duty of loyalty.
* Remedy—constructive trust on the profits or injunctive relief

Question 28

What is the right of indemnification?

Answer 28

A D may seek indemnification for expenses resulting from litigation
1. Mandatory—required if D successfully defends an action against him for his role as a D
2. Prohibited—not if D is liable for receiving an improper personal benefit
3. Permissive—if the D acted in good faith or had no cause to know his acts were unlawful

Question 29

When is a stock sale restriction permitted?

Answer 29

Reasonable restrictions on selling stock are allowed but not enforceable against a transferee unless the stock certificate includes a conspicuous statement or transferee has actual knowledge; controlling SH has a fiduciary duty when selling to outsiders.

Question 30

What are the two federal causes of action in corporate law?

Answer 30

Rule 10b-5—a buyer or seller using interstate commerce may allege a violation against a defendant who intentionally engaged in fraud or deception causing plaintiff to suffer harm
Section 16(b)—a corporate insider can be forced to return short-swing profits to the C

Question 31

How are fundamental changes approved?

Answer 31

Majority of both BoD and shareholders. Includes mergers, sale of assets, stock acquisition.

Question 32

When can a corporation be involuntarily dissolved?

Answer 32

By creditors—allowed only if the corporation is insolvent
* By shareholders—allowed if one of the grounds is shown:
◦ Waste of corporate assets (e.g., board paying itself excessive salaries)
◦ Illegal, oppressive or fraudulent conduct (e.g., blocking dividends to raise salaries)
◦ Director deadlock and irreparable injury to C is likely (e.g., C is losing value)
◦ Shareholder deadlock over election of new directors

Question 33

When does shareholder have appraisal rights?

Answer 33

Forces the C to buy his stock at a fair (appraised) value within 30 days of the demand for payment
1. Qualifying SH—a SH entitled to vote on a fundamental change
2. Trigger—there must be a merger, acquisition, sale of assets or amendment of the articles
3. Procedure:
* Notice—written notice delivered before SH vote on the action
* Disapproval—SH must not vote in favor but must abstain or vote against
* Demand—SH must submit written demand for payment
* Payment—C pays agreed upon fair market value or the court can appoint an appraiser

Question 34

What is an LLC and when can it be dissolved? What are the fiduciary duties?

Answer 34

A limited liability company (LLC) provides its investors (called members) with limited liability (like a corporation) yet flexible management and pass-through taxation (like a partnership).

Fiduciary Duties are owed by members to each other (as in a partnership) and to the entity itself (as in a corporation); apply the rules above when analyzing the duties of a member.

Dissolution—requires consent of all members or can occur for lack of any members or the grounds for involuntary dissolution; upon dissolution and winding up, the creditors must be notified and instructed how to resolve any outstanding claims.