Corporations Flashcards
Corporation Characteristics
A corporation (“corp”) is a legal entity that is separate from its owners
>Corps have the following general characteristics:
Centralized management - management rights are centralized in a board of directors (“BoD”) who delegate day-to-day management to corporate officers
>Unlike general partnerships, management is generally not spread among owners
Limited liability - only the corp itself can be liable for its obligations
>Shareholders, board members, and officers are generally not liable for corp’s obligations, although note exceptions
Transferability of ownership - shareholders can freely trnasfer their ownership interest unless prohibited by articles or bylaws
Continuity - corps can exist in perpetutity; changes in ownership do not affect the corp’s existence
Personhood - corps are considered “people” for most intents and purposes and are entitled to certain constitutional protections
Formation
A corp is formed when articles of incorpoation are filed with the state
>Corp formed in accordance with applicable laws = “de jure” corp
Articles of incorporation - must include:
1) Name - corp name
2) Shares - max number of shares the corp is authorized to issue
3) Incorporators - names and addresses of each incorporator (i.e., people who are forming the corp)
4) Registered office and agent - name and address of initial registered agent and office
>Optional provisions - articles can include any other provisions regarding management, as long as they are legal
>Statement of purpose - some states require a statement regarding the corp’s purpose; most corps use boilerplate language allowing it to engage in any lawful purpose
»A corp that includes a narrow purpose cannot take action unrealted to that purpose
Bylaws - written rules for managing the corp, which provide for ordinary business conduct
>Must be adopted by incorporators or BoD
>Shareholders can amend intitial bylaws
>Can contain any provision for managing and regulating the corp’s affiars as long as it is legal
>Conflicts with articles of incorporation - articles control
Pre-Incorporation Transactions & Liability
Promoter - acts on behalf of a not-yet formed corp to get capital commitments, usually by forming Ks with parties interested in becoming shareholders upon corp formation
>Promoters may also work on corp planning and formation and usually become incorporators
Promoter liability - promoter is personally liable for Ks he enters into on behalf of the not-yet-formed corp and remains liable after formation
>Exceptions - promoter is not personally liable where:
»a) Novation - agreement between parties releasing promoter and substituting the corp (i.e., third party releases promoter), or
»b) Indemnification - promoter may be indemnified by the corp if he is held liable on the K after formation
Corp liability - corp generally has no liability based on pre-incorporation Ks entered into by promoters
>Exception - corp will be liable if it adopts the K
Subscription agreement - agreement whereby one agrees to buy a specified number of shares from a corp at a given price
Ultra Vires Acts & De Facto Corporations
Ultra vires acts - where a corp acts outside of its stated purpose (as stated in articles of incorporation), it takes ultra vires acts
>Consequences of ultra vires acts - three possibilities:
»1) Shareholder suit - shareholders may sue corp to enjoin the ultra vires act
»2) Corp suit - corp may sue an officer or director responsible for the ultra vires act for resulting damages
»3) State action - state may bring action to dissolve the corp
De facto corp - where a corp’s formation fails to adhere to proper formalities but it carries itself on as a corp, it may still be treated as a properly formed corp
>Requirements:
»1) A corporate law exists under which the entity could have become legally incorporated;
»2) A good faith effort to comply with the state’s incorporation laws; and
»3) The business acted like a corp (e.g., conducting business in its corp name)
Corp by estoppel - persons who treat the business as a corp are estopped from denying the entity is a corp, particularly in order to avoid liability
Piercing the Corporate Veil
Generally shareholders, directors, and officers are not personally liable for corp obligations, but they can be held liable under the doctrine of piercing the corp veil
>Consequence - when the corp veil is pierced, the corp entity is disregarded in order to hold shareholders, officers, directors, etc liable
Acts justifying piercing the veil - courts will pierce the corp veil where:
1) Ignoring corp formalities - where a shareholder dominates the corp to the extent that the corp is not being treated as a separate entitiy
>I.e., the corp entity is being used as an alter ego or “mere instrumentality” of the shareholder(s), resulting in some basic injustice
2) Inadequate capitalization - corp was undercapitalized (i.e., underfunded) at the time of incorporation
>Not established by virtue of insolvency alone, but insolvency that occurs shortly after formation is a prime indicator of inadequate capitalization
3) Fraud or illegality - corp entity may be disregarded if there is fruad or other illegality, to prevent fruad or other illegality, or to prevent a shareholder from using the corp to avoid existing personal liabilities
Liability - once the corp veil is pierced, all persons composing the corp may be held personally liable, but only those involved in active management will be held liable
Corporate Securities & Classes of Shares
Corps get funding through issuing securities, of which there are two main types: debt and equity
Debt securities (bonds) - corp borrows funds from an outside creditor and promises to repay creditor
>Holders of debt securities have no ownership interest
Equity securities (stocks) - instrument that represents investment in the corp; holders (i.e., shareholders) become part owners of the corp
>Authorized shares - max number of shares the corp may issue, as prescribed in the articles of incorporation
>Issued/outstanding shares - shares that have been sold to investors
>Reacquired shares (i.e., those that the corp buys back) revert from being issued/outstanding to authorized
Classes of shares - corps may choose to issue different classes of shares; each class of shares can have different series within a class
>Articles must authorize each class and set forth:
»1) Number of shares of each class;
»2) Name or distinguishing designation for each class; and
»3) Describe the rights, preferences, and/or limitations afforded to each class of shares
Varying Rights in Shares & Consideration for Shares
Shares authorized by a corp can have different rights, preferences, and limitations depending on the class of shares
>Articles can define almost any kind of differentation between share classes; differences between share classes often involve:
»Rights to distributions and/or dividens
»Nature of voting rights
»Preference with regard to distributions
Distribution rights - corp can distribute assets in the form of dividens, redemption of shares, or liquidating distributions upon dissolution
>At least one class of shares must be entitled to receive the corp’s net assets upon dissolution
>Board discretion - decision as to whether or not to declare a distribution is within the BoD’s sole discretion, even where the articles authorize distributions
»Shareholders have no general right to demand a distribution
Consideration for shares - shares can be issued by the corp in exchange for any tangible or intangible property or benefit to the corp
>E.g., in some states, corp can issues shares in exchange for anything of value, whehter payment or services
Shareholder Authority & Inspection Rights
Shareholder authority - shareholders exert control over the corp through their power to elect directors, amend bylaws, and approve fundamental changes
>Directors - shareholders can remove and elect directors
>Bylaws - shareholders can amend or repeal bylaws
>Fundamental changes - shareholders must approve of fundamental changes to the corp structure, which includes:
»Mergers
»Sale of assets outside ordinary business
»Dissolution
Inspection rights - shareholders may inspect the corp’s books and records for any proper purpose upon written notice
>Proper purpose - purpose is proper if reasonably related to a person’s interest as a shareholder
>Notice - five days’ written notice must be provided to the corp
»Notice must state the proper purpose
>Inspection without proper purpose - certain records may be inspected by shareholders regardless of proper purpose, including
»Articles and bylaws
»Annual reports and meeting minutes
»BoD resolutions regarding share classifications
»Corp communications to shareholders
Shareholder Meetings & Voting
Meetings - annual and special meetings
>Annual - corp must hold annual meeting for electing directors and other special matters
>Special meetings - may be called to conduct business requiring shareholder approval
>Notice required - notice of a meeting must be sent to shareholders eligible to vote
Voting - unless the articles provide otherwise, each issued share is entitled to one vote
>Quorum required - quorum must be present for a vote to be cast (at least a majority of the shares entitled to vote are present)
>Votes - if votes cast within the voting group favoring the action exceed votes cast opposing the action, then action approved
>BoD elections - directors are elected by plurality; cumulative voting may be used if allowed by the articles
>Cumulative voting = each share can cast as many votes as there are BoD vacancies and multiple votes can be cast for one seat
Proxies - shareholders can vote their shares via proxy executed in writing
>Revocability - appointment of a proxy is generally revocable
»Exception - proxy appointment is irrevocable if it is coupled with an interest and clearly states that it is irrevocable
Shareholder Lawsuits
Shareholders may bring suit against the corp, either directly or through a derivative action (to enforce the corp’s rights)
Direct suit - rare, but can occur where a corp, its officer, or director caused harm to, or breached a duty owed to, a particular shareholder
>Note - if the duty breached is owed to the corp, as opposed to an individual shareholder, the proper avenue is a derivative suit
>Recovery is for the benefit of the shareholder or shareholder class
Derivative suit - shareholder sues to enforce the corp’s rights when the corp has a cause of action but fails to pursue it (i.e., suit brought by shareholder, on behalf of corp, against the corp)
>Often arises where a director or officer breaches a duty owed to corp, but corp has not taken action
>Standing - shareholders bringing suit must have been shareholders at the time of the alleged wrong
>Recovery - goes to corp, but shareholders may recoup legal expenses
>Written demand required - shareholder must make a written demand on the corp and wait 90 days before filing suit, unless:
»a) Corp has already rejected shareholder’s demand, or
»b) Irreparable injury to corp will result by waiting the full 90 days
Note - derivative suits often arise as essay questions that present a wrong committed by an officer or director that harms the corp and ask you to identify whether a breach has occured and what shareholder remedies are available
Directors’ Responsibility & Authority
Corp’s BoD is generally responsible for corp affiars and management
BoD characteristics:
>Number of directors - provided for in bylaws or articles; can be a variable rangle, but there must be at least one director
>Election - elected by shareholders at annual shareholder meeting
>Removal - may be removed with or without cause by shareholders unless articles provide for removal only with cause
BoD meetings - board may hold regular or special meetings
>Can be held in person or through any means by which all participating directos can simultaneously hear one another
>Notice - regular meetings may be held without notice, but special meetings require two-day notice
>Quorum - usually set by articles but, if not, quorum consists of majority of the number of directors in corp
>Action without meeting - BoD can take action without a meeitng if all directors provide written consent describing the action taken
Delegating authority - BoD does not run the day-to-day of the corp, but rather delegated day-to-day management to officers and executives
>Committees - BoD may create committees, each comprised of one or more BoD members, with power to oversee corp affairs
»Limitation - cannot make major corp decisions requiring full BoD consent
Dutes - have duty of care and loyalty to corp
Duty of Care & Business Judgment Rule
Directors and officers owe the corp a fiduciary duty of care; in determining whether that duty was breached, courts apply the Business Judgment Rule
Business Judgment Rule - courts will not second guess a poor or erroneous decision made by a director or officer if the decision was made:
1) In good faith;
2) With the care that a person in a like position would reasonbly believe appropriate under similar circumstances; and
3) In a manner the director/officer reasonably believed to be in the best interests of the corp
Liability - if a director/officer breaches their duty of care, they can be held personally liable for damages
>Articles can limit directors/officers’ personal liability
>Exceptions - articles cannot limit director/officer liability for;
»a) Intentional violations of criminal law,
»b) Unlawful corp distributions,
»c) Receiving unentitled financial benefits, or
»d) Intentionally inflicted harm on the corp or its shareholders
Duty of Loyalty
Directors and officers owe a duty of loyalty to the corp, which prohibits them from profiting at the expense of the corp
>Arises with conflicts of interest or usurpation of a corp opportunity
Conflicts of interest - officer/director has a personal interest in some transaction in which the corp is a party
>Occcurs if: officer/director knows that he and/or a family member is:
»a) A party to the transaction,
»b) Has a beneficial financial interest or is closely linked to the transaction such that it could reasonably be expected to influence how the director/officer votes on the transaction, or
»c) Is affiliated with another entity that is a party to the transaction
>Safe harbors - officer/director with a potential conflict of interest in a transaction will not be personally liable if the transaction is either:
»a) Fair to the corp given circumstances existing at the time, or
»b) Approved, after material facts have been disclosed, by either:
»>i. Disinterested shareholders, or
»>ii. A majority of disinterested board members
Corporate opportunities - fiduciary duties prevent officers/directors from diverting a business opportunity to themselves where:
1) Corp would have an interest or expectancy in the opportunity; and
2) Officer/director does not give corp an opportunity to act first
Mergers
A merger occurs when two or more companies combine; one of the companies may be absorbed or a new company entirely can be created
Requirements for approval - mergers are considered fundamental corp changes and, as such, generally require each corp to get approval of:
1) Board - need a board vote by whatever vote authorizes board action (e.g., majority, supermajority)
2) Shareholders - votes for exceed votes against required
>Exception - no significant change to surviving corp
»Surviving corp’s shareholders need not approve of a merger where the surviving corp has no significant changes (e.g., articles do not differ post-merger, shareholders’ shares and rights do not change, etc.)
Effect - surviving corp owns all property and assumes all obligations of prior separate entities
Short-form merger - where a parent corp owns at least 90% stock of a subsidiary, the subsidiary can be merged into the parent corp without approval of either corp’s shareholders
Dissenters’ rights - dissenting shareholders can challenge the merger or demand payment for their shares at a fair value
>Mutual notice required - before a vote is taken on the merger, corp must give shareholders notice of their intent to demand payment
>If approved, corp must pay dissenters fair market value for their shares
Dissolution & Dispotition of Corporate Property
Dissolution - termiation of corp’s existence
>Effect - corp continues to exist while it winds up and liquidates its affairs, but no other business may be carried out
>Voluntary dissolution - considered a fundamental change and requires both board and shareholder approval
>Administrative dissolution - action brought by state to dissolve corp
»Usually ocurs due to failure to adhere to statutory requirements or formailities, but can be rememdied by corp
>Judicial dissolution - action by attorney general or shareholders
»Attorney general - can act to dissolve a corp on the ground that is abused its authority, commited fraud, etc.
»Shareholders - can seek judicial dissolution where:
»>a) Deadlock among BoD or shareholders,
»>b) Corp has abandoned its business and failed to dissolve, or
»>c) Corp’s assets are wasted/missued for non-corp purpose
Disposition of property - where corp sells, leases, or otherwise disposes of al or substantially all property outside the regular course of business
>Deemed a fundamental change requiring shareholder/board approval
>”Substantially all” = sale or disposition leaves corp without significant continuing business activities
>”Outside regular course of business” = dispostion is not considered a normal business activity for the corp
