Corporations

Question 1

Pre-Incorporation Transactions (Promotor)

Answer 1

A promoter is a person who, prior to formation of a corporation, procures capital and enters into contracts to bring the corporation into existence.

A corporation is not liable for pre-incorporation contract entered into by a promoter, unless
a novation occurs, or it adopts the contract.

Question 2

Promotor liability for pre-incorporation agreements

Answer 2

A promoter is personally liable for a contract entered into pre-incorporation, even after the corporation comes into existence, unless there is a novation or adoption.

Question 3

Novation

Answer 3

If the corporation and the other party to the contract agree to substitute the corporation for the promoter in the contract, the promoter will no longer be liable.

Question 4

Adoption

Answer 4

If the corporation adopts the contract (expressly or by using the benefits of the contract) and agrees to accept sole liability on the contract, the promoter may no longer be liable.

Question 5

Corporate Incorporation

Answer 5

To form a corporation, a document (articles of incorporation) must be filed with the state. The articles must include a statement of the corporation’s purposes; a broad statement is acceptable.

Question 6

Ultra Vires

Answer 6

If a corporation has a narrow business purpose in its articles of incorporation and engages in activities outside the purpose, it has engaged in an ultra vires act. If an ultra vires act occurs, a shareholder can file a suit to enjoin the action and/or the corporation can take action against a director, officer, employee who engaged in the act.

NOTE: In past CA bar essays, the a corporation has engaged in an act to perform actions outside its stated purpose with a third party. The third-party will eventually try to get out of the contract by claiming that the corporation has engaged in an ultra vires act.

However, the third party will not be released from the contract due to the corporation’s ultra vires act.

Question 7

De Jure Corporation:

Answer 7

When the statutory requirements for incorporation are met, a “de jure” corporation has been formed. The corporation is then liable for activities (not the individuals).

Question 8

Failure to meet requirements for a corporation

Answer 8

When a person makes a good faith effort to incorporate, but does not meet the requirements, that person may still be able to escape personal liability.

Question 9

De Facto Corporation

Answer 9

If the owner made a good faith effort to incorporate and operates the business without knowing that the requirements were not met, the business will be treated as a “de facto” corporation by the court. The individual owner will not be individually liable.

Question 10

Corporation by Estoppel

Answer 10

A party who deals with an entity as if it were corporation is estopped from denying its existence and is thereby prevented from seeking personal liability against the business owner. This is limited to contractual agreements. The owner must have made a good faith effort to incorporate and operated the business without knowing that the requirements were not met

Question 11

Securities (Stock)

Answer 11

In general, the issuance of stock must be authorized by the board of directors.

The board of directors must determine that the consideration (for example, money) paid for the stock is adequate.

Question 12

Par Value Stock

Answer 12

In the process of incorporating, a corporation may issue par value stock.

For such stock, the corporation is required to receive at least the value assigned to the stock (the par value). The par value does not have to be market value and can be a nominal (small amount).

Question 13

Sale of stock below par value

Answer 13

If the board of directors issues (sells, trades) par value stock for below par value, the board of directors is liable to the corporation for the difference between the par value and amount actually received. A shareholder that knowingly received par stock for below par value is also liable to the corporation.

Question 14

Shareholders Meetings:

Answer 14

An annual meeting of shareholders is required. The primary purpose is to elect directors.

Question 15

Shareholder Voting

Answer 15

The primary issue upon which shareholders are entitled to vote is the selection of the board of directors. Shareholder approval is also required for fundamental corporate changes (frequently tested issue), such as structural changes to the corporation (sale/merger of corporation).

Question 16

Proxy Voting

Answer 16

A proxy is a written agreement by a shareholder to allow a person (can be another shareholder or a representative of the original shareholder) to vote for them. The proxy is valid for 11 months unless otherwise stated and is generally revocable. To be irrevocable, the proxy must state it is irrevocable and the person who is receiving the shareholder’s right to vote must provide something of value in exchange to the shareholder.

Question 17

Shareholder Agreements

Answer 17

Shareholders may enter into a binding voting agreement which governs how they will vote their shares. The agreement is a contract and may be enforced; there is no time limit.

Question 19

Liability – Piercing the Corporate Veil

Answer 19

Generally, shareholders are not personally liable for corporate acts. However, courts may allow a plaintiff to “pierce the corporate veil” and sue a shareholder(s) individually. This issue is likely to arise when there is a closely held corporation with only a few shareholders.

To determine whether to pierce the corporate veil, the court will look at the totality of the circumstances, including:

Under capitalization of the corporation at the time of formation

Disregard of corporate formalities

Use of corporate assets as a shareholder’s own assets

Self-dealing with the corporation
Siphoning corporate funds or stripping assets

Question 20

Controlling shareholders

Answer 20

Anyone with more than 50% of a corporation’s shares is a controlling shareholder. If a shareholder otherwise holds enough shares to enact changes through the voting process, s/he will be considered a controlling shareholder.

Question 21

Controlling shareholders’ fiduciary duties

Answer 21

A controlling shareholder owes a fiduciary duty to minority shareholders to not use his/her power in a way to disadvantage them.

Question 22

Board of Directors

Answer 22

The board of directors manages and directs the management of the corporation’s business and affairs.

Question 23

Board of Directors More

Answer 23

Board of Directors

i. Selection: Directors are selected by the shareholders at the annual shareholder’s meeting.

ii. Removal: Shareholders may remove a director for breach of fiduciary duty (common law) or without cause (modern trend).

iii. Voting: For the board of directors’ acts at a meeting to be valid, a quorum of directors must be present at the meeting. A majority of all directors constitutes a quorum.

Question 24

Board of Directors Fiduciary Duties

Answer 24

A director owes two basic duties: a duty of care and a duty of loyalty.

Question 25

Duty of Care

Answer 25

Directors have a duty to act with the care of an ordinarily prudent person in a like position and similar circumstances (objective standard).

Question 26

Duty of Care (Reliance)

Answer 26

A director is entitled to rely on the performance of other officers, employees, and outside experts. This includes reliance on information, reports, and opinions provided by these people.

Question 27

Duty of Care (Business Judgment Rule)

Answer 27

The business judgment rule (BJR) is a rebuttable presumption that a director reasonably believed his actions were in the best interest of the corporation. The BJR will protect a director from liability for breaching the duty of care if he acted in good faith.

Question 28

To overcome the BJR, one of the following must be shown:

Answer 28

Question 29

Duty of Loyalty

Answer 29

The duty of loyalty requires a director to act in a manner that the director reasonably believes is in the best interest of the corporation. Self-dealing and usurping corporate opportunities are violations of the duty of loyalty.

Question 30

Director Self-Dealing

Answer 30

A director that engages in a transaction with a corporation that benefits himself, or a closely related family member will be considered to have engaged in self-dealing. If the transaction benefits another corporation or partnership that the director is associated with or his closely related family member is associated with, this will also be self-dealing. Self-dealing violates the duty of loyalty unless the transaction is protected under the safe-harbor rule. The business judgment rule does not apply to a self-dealing transaction.

Question 31

Self Dealing Safe Harbor

Answer 31

There are three ways that a self-dealing transaction can be protected and avoid violating the duty of loyalty:

• The interested director discloses all material facts to the board of directors and receives approval by a majority of disinterested board of directors; or
• The interested director discloses all material facts to shareholders and receives approval by a majority of disinterested shareholder votes; or
• The transaction is fair to the corporation at the time of the deal. The fairness test asks if the substance of the transaction was fair and burden is on the interested director to show fairness.

Question 32

Self Dealing Rememdies

Answer 32

A self-dealing transaction that is not protected by the safe harbor provisions can be enjoined or rescinded and the corporation can seek damages from the interested director.

Question 33

Usurpation of Corporate Opportunity

Answer 33

A director may violate the duty of loyalty by “usurping” a corporate opportunity for business and taking the opportunity for himself rather than offering it to the corporation first.

Question 34

Corporate Opportunity Test

Answer 34

To determine whether a business opportunity is one that must first be offered to the corporation, a court will ask if the corporation is seeking the opportunity or if the opportunity is within the corporation’s current or prospective line of business.

If the opportunity is a corporate opportunity, the director must present it to the corporation first and it must be declined by the corporation. At that time, the director can take/accept the opportunity for himself without violating the duty of loyalty.

Question 35

Officers

Answer 35

A typical corporation’s officers are president, secretary, and treasurer. They are elected by the board of directors.

Question 36

Officer Authority

Answer 36

An officer’s authority to act on behalf of a corporation is governed by agency law.

The corporation is the principal and the officer is the agent. Authority can be actual (express or implied) or apparent.

Question 37

Express Actual

Answer 37

Express authority is defined by the by laws or set by the board of directors.

Question 38

Implied Actual

Answer 38

An officer has implied authority to perform tasks necessary to carry out the duties of his position. The officer does not have authority to bind the corporation to extraordinary act.

Question 39

Apparent Authority

Answer 39

An officer has apparent authority if the corporation holds the officer out as having authority to bind the corporation to third parties (for example, the position title of the officer may give apparent authority).

Question 40

Dissolution

Answer 40

A corporation may voluntarily terminate its status.

Question 41

Winding Up:

Answer 41

A dissolved corporation may continue to exist for the limited purpose of winding up its affairs and liquidating its business.

Question 42

Distribution

Answer 42

Upon dissolution, corporate assets must be distributed in the following order:

a. Creditors of the corporation

b. Shareholders of stock with preferences in liquidation

c. Other remaining shareholders of stock

Question 43

Direct Lawsuits

Answer 43

A direct claim is a lawsuit brought by a shareholder to enforce his own rights.

The shareholder must prove actual injury that is not solely the result of an injury suffered by the corporation.

If a direct claim is successful, the proceeds go to the shareholder.

Question 44

Derivative Suit

Answer 44

A shareholder may bring a derivative action on behalf of the other shareholders of the corporation for a breach of fiduciary duties by the directors. Any recovery will go to the corporation rather than to the shareholder personally. Demand necessary unless futile