Corporations

Question 1

Formation of a Corporation & Articles of Incorporation

Answer 1

A corporation’s existence begins on the date the Articles of Incorporation are filed with the Secretary of State, UNLESS a delayed effective date is specified.

An earlier effective date CANNOT be specified because a corporation CANNOT exist until the Articles of Incorporation are properly filed.

Question 2

The Articles of Incorporation Requirements

Answer 2

The Articles of Incorporation MUST contain: (1) the corporate name; (2) the number of shares the corporation is authorized to issue; (3) the address of the corporation’s initial registered office and the name of its initial registered agent at that office; AND (4) the name and address of each incorporator.

Question 3

Formation of an LLC

Answer 3

Generally, a Limited Liability Company (LLC) is formed when:

(1) the Articles of Organization (a.k.a. Certificate of Formation) is properly filed with the Secretary of State; AND

(2) the company has at least one member.

Question 4

Pre-Formation Contract Liability De Jure Corporation

Answer 4

A corporation that is not legally formed CANNOT enter into contractual obligations and in such instance personal liability of the owners/promotors will result UNLESS either:

(i) De Facto Corporation or

(ii) Corporation by Estoppel

Question 5

Pre-Formation Contract Liability De Facto Corporation

Answer 5

A corporation that failed to be properly established. A de facto corporation enjoys the same benefits and powers of a properly formed corporation.

HOWEVER, only a person who was unaware that the corporation was not properly formed may assert the de facto corporation doctrine.

A de facto corporation exists where the entity:

(1) made a good faith attempt to incorporate;

(2) is otherwise eligible to incorporate; AND

(3) took some action indicating that it considered itself a corporation.

Question 6

Corporation by Estoppel

Answer 6

If a person treats a business as if it were a corporation they are unable to later claim it was not a corporation.

The doctrine of corporation by estoppel applies to BOTH:

(a) third-parties that treated the business as a corporation; and

(b) an entity that held itself out as a corporation and benefited from that claim.

HOWEVER, the corporation by estoppel doctrine DOES NOT apply to tort actions.

Question 7

Promoter Liability

Answer 7

A promoter is a person who acts on behalf of a corporation that has not yet been formed. A promoter remains personally liable on any pre- incorporation contract entered into EVEN IF the corporation subsequently adopts the contract.

Question 8

Promoter Liability Exceptions

Answer 8

Two Exceptions to this rule exist:

(1) where there was a subsequent novation (an agreement by all parties to substitute the corporation for the promoter as the contracting party and to relieve the promoter of the contractual obligations); OR

(2) if the contract explicitly provides that the promoter has no personal liability on the contract.

A promoter may seek reimbursement from the corporation for any liability, but he CANNOT compel the corporation to pay for the same.

Question 9

Corporate Liability for Promoter Contracts

Answer 9

A corporation is NOT liable for a pre-incorporation contract is entered into by a promoter UNLESS the corporation adopts the contract.

A corporation may adopt the contract either:

(a) expressly – through a board resolution; OR

(b) impliedly – by knowing the materials terms and accepting/retaining benefits of the contract.

Question 10

Powers of a Corporation

Answer 10

A corporation has the power to do all things necessary or convenient to carry out its business and affairs, including:

(1) to sue and be sued;

(2) to own, lease, or convey real or personal property;

(3) to make contracts, incur liabilities, borrow money, issue notes or bonds;

(4) to lend money and make investments;

(5) to own or be involved with another business entity;

(6) to fix the compensation of directors, officers, and employees;

(7) to lend directors, officers, employees money;

(8) to make charitable donations;

(9) to make payments or donations that furthers the business and affairs of the corporation; and

(10) to pay or engage in lobbying to aid governmental policy.

Question 11

Ultra Vires Acts

Answer 11

A corporation may only engage in activities that are within the stated corporate purpose in its Articles of Incorporation. When a corporation’s activities are outside of the scope of the stated corporate purpose, such activities are deemed ultra vires.

Under common law, a corporation’s ultra vires acts are deemed void and unenforceable.

Under the Revised Model Business Corporation Act (RMBCA), the validity of ultra vires acts cannot be challenged on the grounds that the corporation lacked the power to act.

Question 12

Piercing the Corporate Viel

Answer 12

Generally, shareholders, directors, and officers are NOT personally liable for the liabilities and obligations of the corporation. However, courts may disregard the corporate form and hold individual corporate shareholders, directors, and officers personally liable for actions taken on behalf of the corporate entity.

A court will pierce the corporate veil and hold the shareholders personally liable in the following situations:

(1) the corporation is acting as the alter ego of the shareholders – where there is little or no separation between the shareholder and the corporation (i.e. where an individual utilizes the corporate form for personal reasons);

(2) where the shareholders failed to follow corporate formalities;

(3) the corporation was inadequately capitalized at its inception to cover debts and prospective liabilities; OR

(4) to prevent fraud.

A court is more likely to pierce the corporate veil for tort actions rather than contract disputes.

Question 13

Dividend Decision Board of Directors

Answer 13

Decisions to declare dividends or make distributions to shareholders are within the discretion of the Board of Directors, and are normally protected under the business judgment rule.

Only the Board of Directors have the power to issue dividends (an Officer cannot). Once a distribution is declared, the shareholder affected has a legal right to that distribution.

Question 14

Shareholder and Dividend Rights

Answer 14

Generally, a shareholder DOES NOT have the right to compel a corporation to issue a distribution (whether in the form of a dividend or otherwise), UNLESS such right is expressly granted in the Articles of Incorporation.

However, a court will interfere with the Board’s discretion and order a dividend/distribution upon a showing:

(1) of bad faith or dishonest purpose; AND

(2) that funds were available for the dividend/distribution.

Question 15

Proxy Agreements

Answer 15

A shareholder may vote her shares at a shareholders meeting without physically attending the meeting through the use of a proxy.

A valid proxy must be signed on:

(a) an appointment form; OR an electronic transmission. AND

(b) delivered to the corp or agent of corp

An oral proxy appointment is invalid.

An individual who is granted the power to vote another’s shares by a proxy MUST act in accordance with any agreement between the parties. A shareholder may also grant a proxy holder the ability to vote shares as the proxy holder deems appropriate.

A proxy is only valid for 11 months, unless the proxy provides otherwise.

Question 16

Proxy Revocability

Answer 16

Proxy agreements are freely revocable by the shareholder, even if the proxy states that it is irrevocable (any action inconsistent with the grant of the proxy acts as a revocation).

One exception to this rule is a proxy coupled with an interest or legal right, which is irrevocable if the proxy expressly states as such.

Question 17

Shareholder Voting Agreements

Answer 17

Shareholders may enter into a binding voting agreement, also known as a voting pool, which provides for the manner in which they will vote their shares.

Under such an agreement, shareholders retain ownership of their stock, and the contract may be specifically enforced. It does not need to be filed with the corporation and there is no time limit.

Question 18

Shareholder Voting Agreement

Answer 18

In general, an agreement between directors as to how to vote (i.e., a pooling agreement) is unenforceable.

Each director is expected to exercise independent judgment

Question 19

Shareholder’s Right to Inspect Books and Records

Answer 19

A shareholder may inspect the corporation’s records during regular business hours in person or through an agent w/ 5 days notice as long as the shareholder states a proper purpose

It must be a shareholder who asks and a proper purpose is one related to the shareholder’s financial interest in the corporation.

An improper purpose is one designed to harass the corporate officers.

The right of inspection CANNOT be abolished or limited by a corporation’s Articles of Incorporation or Bylaws.

Question 20

Right to Inspection Requirements Continued

Answer 20

Additionally, a shareholder has the right to inspect and copy certain accounting records (annual financial statements prepared for the corporation for its last three fiscal years and any audit/other reports with respect to such financial statements), excerpts of the Board of Directors’ meeting minutes, and the record of shareholders ONLY IF:

(1) the inspection is made during regular business hours at a reasonable location specified by the corporation; (2) the shareholder provides at least 5-days written notice; (3) the demand is made in good faith and for a proper purpose; (4) the purpose is described with particularity; AND (5) the records are directly connected with the purpose.

Question 21

Proper Purpose

Answer 21

A proper purpose is a purpose reasonably relevant to the shareholder’s interest as a shareholder.

The following have been deemed to be a proper purpose: (a) determination of the value of shares; (b) whether the corporation engaged in illegal conduct; (c) to investigate wrongdoing or mismanagement; and/or (d) to protect the shareholder’s financial interest in the corporation, the interest in voting or selling shares, or bringing a lawsuit to protect those interests.

To show good faith, the shareholder must present some evidence to establish a credible basis to infer possible wrongdoing (a mere suspicion is insufficient). A good faith interest in exposing/preventing wrongdoing is sufficient.

Question 22

Board of Directors Meeting: Quorum

Answer 22

The Board of Directors can only act if a quorum is present. A majority of the Board of Directors is necessary to make a quorum, UNLESS there are provisions in the Articles of Incorporation stating that a higher or lower number is required. However, the Articles of Incorporation MUST require that at least one-third of the directors be present to make a quorum.

A quorum must be present at the time when a vote is taken. If a quorum is present at the beginning of a meeting, but directors subsequently leave breaking the quorum before a vote, then the Board of Directors CANNOT vote or act.

Question 23

Board of Directors Meeting: Voting & Objection to Actions

Answer 23

If a quorum of the Board of Directors is present when a vote is taken at a meeting, an act is approved by the affirmative vote of a majority of directors present UNLESS the Articles of Incorporation or bylaws require a greater number.

A director who is present at a meeting of the Board of Directors when corporate action is taken is deemed to have assented to the action taken UNLESS: (a) the director objects at the beginning of the meeting (or promptly upon arrival) to holding it or transacting business at the meeting; (b) the dissent or abstention from the action taken is entered into the meeting minutes; OR (c) the director delivers written notice of the director’s dissent or abstention to the presiding officer of the meeting before its adjournment or to the corporation immediately after adjournment of the meeting. The right of dissent or abstention is NOT available to a director who votes in favor of the action taken.

Question 24

Compensation of Directors & Officers

Answer 24

Unless the corporation’s bylaws or Articles of Incorporation state otherwise, the Board of Directors is allowed to determine the compensation of directors and officers.

However, the Board of Directors have a duty to set compensation in accordance with reasonable parameters, taking into account the needs of the corporation and ensuring that they do not commit waste of corporate assets.

Question 25

Election of Directors

Answer 25

Shareholders elect directors at the corporation’s annual shareholders’ meeting. An agreement that prohibits shareholders from electing directors is contrary to public policy and is unenforceable.

Question 26

Removal of Directors

Answer 26

A director may be removed from a corporation’s Board of Directors by a vote of the majority of the shareholders for cause or without cause UNLESS the Articles of Incorporation set forth that a director may only be removed for cause. An agreement that prohibits shareholders from removing directors is contrary to public policy and unenforceable.

Question 27

Removal of Officers

Answer 27

An Officer may be removed at any time with or without cause by: (a) the Board of Directors; (b) the Officer who appointed such Officer; OR (c) any other Officer (if authorized). An officer’s removal DOES NOT affect the officer’s contract rights (if any) with the corporation.

Question 28

Officer Authority

Answer 28

An officer has actual authority to act consistently with their duties: (a) as outlined in the Bylaws; OR (b) as provided by the Board of Directors.

An officer has apparent authority to bind the corporation when:

(1) a third-party reasonably believes the person/entity has authority to act on behalf of the corporation; AND

(2) that belief is traceable to the corporation’s manifestations (the
corp. holds the officer out as having authority).

Question 29

Officer Implied Authority

Answer 29

An officer generally has implied authority necessary to perform the functions of his position. The President of a
corporation generally has implied authority to bind the corporation for matters within its ordinary course of business, BUT DOES NOT have authority to bind the corporation for extraordinary acts.

Question 30

Duty of Care

Answer 30

Directors have a duty to act with the care of an ordinarily prudent person in a like position and similar circumstances. As an objective standard, the director is presumed to have the knowledge and skills of an ordinarily prudent person. In deciding how to act, the director is also required to use any additional knowledge or special skills that he possesses.

Next apply BJR or Reliance

Question 31

+ Duty of Care (Business Judgment Rule)

Answer 31

Officers and Directors are fiduciaries of a corporation, and as such owe a duty of care to the corporation. A court will NOT disturb decisions subject to the Business Judgment standard if a rational business purpose exists. A party attacking a board decision must normally rebut the presumption that its business judgment was an informed one.

If the three-part test is satisfied, then a Director will NOT be liable for corporate decisions that resulted in adverse consequences to the corporation.

This means that they must discharge their duties:

(1) in good faith;

(2) in a manner the Director reasonably believes to be in the best interests of the corporation; AND

(3) with the care that a person in a like position would reasonably believe appropriate under similar circumstances.

Question 32

Duty of Care (Reliance)

Answer 32

The duty of care requires that Directors be reasonably informed on the decisions they make.

A Director may rely on the reasonable advice of advisors, such as attorneys, accountants, officers, or Committees of the Board when:

(1) such reliance was reasonable; AND

(2) the advisor or Committee was qualified to provide such advice.

Question 33

Business Judgment Rule Exceptions

Answer 33

Business Judgment Rule DOES NOT apply or protect Directors:

(i) financially interested in a transaction (a conflict of interest);

(ii) not acting in good faith; OR

(iii) who engaged in fraud or illegality.

Question 34

Director Breach of Duty of Care

Answer 34

If a Director breaches the duty of care, he may be held personally liable to the corporation for any losses suffered as a result.

Question 35

Duty of Loyalty

Answer 35

A Director (or Officer) owes the corporation a fiduciary duty of loyalty, which means that the Director, in his dealings with the corporation, must act in the best interests of the corporation and without personal conflict.

The duty of loyalty forbids Directors from:

(a) entering into conflicting interest transactions;

(b) usurping a corporate opportunity;

(c) competing with the corporation; OR

(d) trading on inside information

Question 36

Duty of Loyalty Conflicting Interest Transaction Exceptions

Answer 36

A conflicting interest transaction with the corporation is a breach of the duty of loyalty UNLESS the Director shows that:

(a) it was approved by a majority of disinterested Directors after full disclosure of all relevant material facts;

(b) it was approved by a majority of disinterested Shareholders after full disclosure of all relevant material facts; OR

(c) the transaction as a whole was fair to the corporation at the time it was entered into (fair price, beneficial to corporation, and fair dealing).

Question 37

Duty of Loyalty Conflicting Interest Transaction

Answer 37

A conflict of interest occurs when the director/officer or a family member either:

(a) is a party to the transaction;

(b) has a beneficial interest in the transaction or is so closely linked to it that the director’s judgment may reasonably be affected; OR

(c) is involved with another entity (director, employee, owner, etc.) that is conducting business with the corporation and that transaction would normally be brought before the Board of Directors because of its importance to the corporation.

Question 38

Usurping a Corporate Opportunity

Answer 38

A corporate opportunity is any opportunity that:

(a) the corporation has an interest/expectancy in; OR

(b) is in the corporation’s line of business.

A director/officer MAY ONLY pursue a corporate opportunity if he:

(1) first presents it to the corporation’s Board of Directors; AND

(2) the Board decides not to pursue the opportunity.

It is NOT a defense to show that the corporation would not have been able to take the opportunity.

Question 39

Direct Action Lawsuit

Answer 39

A direct action involves an injury or breach of a duty owed to a shareholder of a corporation. The damages awarded in a direct action will be paid directly to the shareholder or member.

Question 40

Derivative Action Lawsuit

Answer 40

In a derivative action, a shareholder is suing to enforce the corporation’s claim, not his own personal claim. The damages awarded in a derivative action will be paid to the corporation (not the shareholder), but the shareholder may recover the reasonable cost of the litigation.

Question 41

Derivative Action Lawsuit Requirements

Answer 41

To commence or maintain a derivative suit, the plaintiff- shareholder must meet the following requirements: (1) be a shareholder at the time of the act or omission or became a shareholder by operation of law from such a shareholder; (2) be a shareholder through entry of judgment; (3) he must fairly and adequately represent the interests of the corporation; AND (4) he must make a written demand upon the corporation to take suitable action.

A derivative suit CANNOT be commenced until 90 days after a written demand UNLESS: (a) the corporation rejects the demand; (b) the corporation will suffer irreparable harm if forced to wait; OR (c) the demand would be futile (under the RMBCA, there is NO exception to the demand requirement for futility).

Question 42

Fundamental Changes to a Corporation

Answer 42

Generally, a fundamental change MUST be approved by a majority of the total votes entitled to be cast for the corporation, not just a majority of votes present at the meeting.

A fundamental change includes a merger, consolidation, amendment of the Articles of Incorporation, sale of all or substantially all of the corporation’s assets, or dissolution.

Question 43

Fundamental Change and Special Meeting

Answer 43

A corporation MUST hold a special meeting when a fundamental change is proposed.

A special meeting requires notice to be mailed to the shareholders, which must include the reason for the meeting and the date, time, and place of the meeting. Business that is not included in the notice cannot be discussed at the special meeting.

Question 44

Corporate Dissolution

Answer 44

Upon dissolution, corporate assets are converted to cash and then distributed in the following order:

(1) outside creditors (which includes promissory note holders and those without an equity interest in the corporation);

(2) inside creditors (shareholders who made loans to the corporation); and

(3) the remaining assets are distributed to the shareholders according to their share of ownership.

Question 45

Equitable Subordination & The Deep Rock Doctrine

Answer 45

In bankruptcy under equitable subordination, all unsecured creditors (whether shareholder creditors or outsider creditors) will be treated the same and collect their debt from the corporation equally.

However, under the Deep Rock Doctrine, the claim of a shareholder (especially one with a controlling interest) who makes a loan to the corporation will be subordinated to the claims of outside creditors if: (a) the corporation was undercapitalized; OR (b) if the shareholder acted wrongfully.

Question 46

LLC Operating Agreement

Answer 46

Unless stated otherwise, the Operating Agreement governs:

(1) the relations between the members and the LLC;

(2) the rights and duties of managers;

(3) the activities and affairs of the company; AND

(4) any means and conditions for amending the Operating Agreement.