Corporations

Question 1

The promoter is liable even after the corporation has been formed unless what occurs?

NLK

Answer 1

NLK
Novation Looks Knowledge

The promoter is liable even after the corporation has been formed unless:

1. The corporation formally releases the promoter from responsibility through a novation;
2. The third party looks only to the corporation for performance;
   OR
3. The promoter had no actual knowledge that the corporation’s charter has not yet been issued

Question 2

Under what theory can someone avoid personal liability when acting in good-faith in complying with the state’s incorporation requirements and operating his business as a corporation without knowing that the requirements were not met?

Answer 2

De Facto Corporation Doctrine

When a person makes a good-faith but unsuccessful effort to comply with the incorporation requirements, that person may be able to escape personal liability under the de facto corporation doctrine. In this case, the business entity is treated as a defacto corporation, and the owner is not personally liable for obligations incurred in the purported corporation’s name

Note: the de facto corporation doctrine has been abolished by the RMBCA, and therefore any state that has adopted the RMBCA has also abolished the de facto corporation doctrine. This should be at least mentioned on an exam.

Question 3

What is a corporation’s key constitutional document called and what must this document contain?

Answer 3

A corporation’s key constitutional document is called the Articles of Incorporation, and it must contain the corporation’s name including one of the following words: “corporation,” “company,” “incorporated,” or an abbreviation thereof

Question 4

In what three situations can an ultra vires act be challenged?

SCS

Answer 4

SCS
Shareholder Corporation State

An ultra vires act can be challenged in only the following situations:
1. A shareholder can file suit to enjoin the corporation’s ultra vires action;
2. The corporation can take action against a director, officer, or employee who engaged in the action,
OR
3. The state can initiate a proceeding to enjoin the corporation’s ultra vires action

Question 5

What is par-value stock?

Answer 5

Par value is the minimum price for which the stock can be sold by the corporation (need not be its market value).

Par value applies only when the stock is first sold by the corporation (as opposed to a shareholder selling it to another)

Question 6

Who may a director rely on in making decisions?

Answer 6

Reliance Protection:
A director may rely on information and opinions of officers, employees, outside experts (e.g. attorneys, accountants), or committes, so long as the director reasonably believes them to be reliable and competent

Question 7

What is a shareholder’s preemptive right?

Answer 7

Definition: a preemptive right is the right to buy enough stock to maintain your ownership percentage in the corporation if the corporation sells more stock; a waiver of preemptive rights in writing is irrevocable

Question 8

Generally, SHs have only limited liability for corporate acts and are only at risk to the extent of their investment. What is the exception to this rule?

Answer 8

Piercing the corporate veil – if a plaintiff can pierce the corporate veil, then the SHs can be held personally liable

Question 9

What is a director’s liability for unlawful distributions to shareholders? If liable, is the director entitled to contributions from other directors or shareholders?

Answer 9

If a director violates the duty of care or loyalty in approving an improper dividend, the director is personally liable for any amount above the lawful distribution amount.

A director is entitled to contributions from other directors who have also violated their duties and from the excess amount received by shareholders who knowingly accepted unlawful distributions

Question 10

How can you disinguish between a direct suit by a shareholder and a shareholder derivative suit?

Answer 10

The distinction between direct suits and derivative suits can be murky, but the basic idea is that an action that principally harms the shareholder is a direct action while an action that harms the corporation as an entity is a derivative action. (for example, an allegation that directors mismanaged the corporation is usually derivative)

Question 11

A corporate insider can be forced to return short-swing profits to the corporation through a Section 16(b) action. What 4 elements are necessary for a Section 16(b) cause of action?

PAISR

Answer 11

PAISR
Publicly Assets Insiders Short Report

The following four elements are necessary for a Section 16(b) cause of action:

1. Only
   a) publicly traded corporations that have securities traded on a national securities exchange
   OR
   b) Have assets of more than $10 million and more than 500 shareholders
2. Only corporate insiders (directors, officeres, and shareholders holding more than 10% of a class of stock) are subject to a Section 16(b) action
3. Short swing profits - a corporate insider both bought and sold corporation’s stock during any six-month period
4. SEC report of change in stock ownership

Question 12

When does a corporation engage in an ultra vires act?

Answer 12

A corporation engages in an ultra vires act when it has stated a narrow business purpose in its articles but subsequently engages in activities outside that stated purpose

Question 13

What is the general rule for a corporation’s liability for pre-incorporation transactions entered into by a promoter? What is the exception?

Answer 13

The corporation is not liable for contracts entered into by the promoter (because there is no fiduciary relationship between the promoter and corporation before the corporation exists)

However, the corporation is liable if it expressly or impliedly adopts a contract by accepting the benefits of the transaction, or gives an express acceptance of liability for the debt

Question 14

While the articles of incorporation must be filed to incorporate, they need not spell out the manner in which the corporation is governed. The bylaws contain any lawful provision for the management of the corporation’s business. If there is a conflict between the articles and bylaws, which of the two controls?

Answer 14

The Articles of Incorporation.

In the event of a conflict between a corporation’s articles of incorporation and its bylaws, the articles of incorporation control

Question 15

Other than using the de facto corporation doctrine, how else can someone who acted in good faith avoid personal liability when a company was not in compliance with a state’s incorporation requirements?

Answer 15

Corporation by Estoppel Doctrine:

A person who deals with an entity as if it were a corporation is estopped from denying its existence and thereby prevented from seeking the personal liability of the business owner

Question 16

There are two types of shareholders meettings: annual and special. Shareholders entitled to vote must be given notice of either type of meeting in a timely manner. What is considered to be a timely manner, and how do shareholders waive their rights to notice?

Answer 16

Voting shareholders must be notified of the time, date, and place in a timely manner no less than 10 days and no more than 60 days before the meeting. Shareholders may waive notice in writing or by attending the meeting

Question 17

Corporations may choose directors by cumulative voting if so provided in the articles. Rather than having separate votes for each directorial slot, shareholders are given a number of votes equal to the number of shares multipled by the number of positions being voted on. What is the effect of this?

Answer 17

The effect of cumulative voting is to allow minority shareholders to elect representatives to the board. In other words, shareholders can stack their votes on one or a small number of candidates if they wish, making it easier for minority shareholders to elect at least one director

Question 18

When is a presumption of good faith afforded by the business judgment rule overcome?

FDCC

Answer 18

FDCC
Fraud Dereliction Condoning Conflict

The presumption of good faith afforded by the business judgment rule is overcome if the challenger:
1. shows fraud,
2. dereliction of duty,
3. condoning illegal conduct,
OR
4. a conflict of interest

Question 19

If a shareholder wins a derivative suit, who recovers the judgment?

Answer 19

While a shareholder may have suffered harm directly, in a derivative action, the shareholder is suing on behalf of the corporation for harm suffered by the corporation. Thus, recovery generally goes to the corporation

Question 20

How does a court determine whether to pierce the corporate veil?

Answer 20

Courts are generally reluctant to pierce the corporate veil. A court’s analysis whether to do so in generally very fact intensive, and a court will look at the totality of circumstances (whether the corporation is being used as a facade for a dominant shareholder’s personal dealings.

Common factors courts will use in deciding whether to pierce the corporate veil are:
1. Undercapitalization
2. Disregard of corporate formalities
3. Using corporate assets as shareholder’s own assets
4. Self-dealing with the corporation
5. Siphoning of the corporation’s funds
6. Using corporate form to avoid statutory requirements
7. Shareholder’s domination over the corporation
8. Fraudulent dealings with a corporate creditor

Question 21

Who, if anyone, is responsible for contracts entered into before the corporation is actually formed?

Answer 21

A promoter is personally liable for knowingly acting on behalf of a corporation before incorporation, and remains liable after the corporation comes into existence

Question 22

What are the two types of stock?

Answer 22

Common Stock - a basic ownership interest that entitles the owner to vote on corporate governance matters

Preferred Stock - has preference over other stock with regards to distributions

Question 23

When does a controlling shareholder owe a fiduciary duty to other shareholders, what is that duty, and when is the duty breached?

SED

Answer 23

SED
Selling Eliminate Distribution

Although shareholders do not owe fiduciary duties to the corporation or to each other, a fiduciary duty to the minority shareholders may arise if a controlling shareholder is:
1. Selling that interest to an outsider
2. Seeking to eliminate other sharehodlers; OR
3. Receiving a distribution denied to the other shareholders

A controlling shareholder has a duty to disclose information that a reasonable person would consider important in deciding how to vote on a transaction, and a duty of fair dealing when purchasing a minority shareholder’s interest

A controlling shareholder breaches the duty if nondisclosure causes a loss to the minority shareholders

Question 24

In an LLC, what document governs any or all aspects of its business?

Answer 24

An LLC may adopt an operating agreement to govern its business. The operating agreement can be oral, in a record, or implied by conduct. Statutory default provisions apply when the operating agreement is silent

Question 25

What are the three ways shareholders can vote together?

PTM

Answer 25

PTM
Pool Trust Management

The three ways shareholders can vote together are:

1. Voting pool - a binding voting agreement under which shareholders retain legal ownership; does not need to be filed with the corporation; no time limit
2. Voting trust - a trust to which legal ownership of shareholder’s stock is transferred; the trustee votes the shares and distributes the dividends in accord with trust; must be in writing, limited to 10 years, and filed with the corporation
3. Management agreement - allows shareholders to alter the way the corporation is managed even if the agreement is inconsistent with statutory provisions

Question 26

In an LLC, how are profits and losses allocated and distributed if the operating agreement fails to determine the manner?

Answer 26

In the absence of an operating agreement provision stating otherwise, profits and losses are allocated and distributions are made according to each member’s contributions to the LLC

Question 27

How does an S corporation differ from a C corporation?

Answer 27

A C corporation is a basic corporation and is a separate taxable entity from its shareholders, causing the corporation to face double taxation (profits taxed when brought in, and shareholders are taxed on distributions)

S corporations have “pass through” taxation (as with a partnership). The income and expenses of the corporation are passed through to the shareholders, who are then taxed on such items directly

Question 28

Shareholderes who have the right to vote on a merger, asset sale, share exchange, or amendment of the articles of incorporation are entitled to appraisal rights (in some states these are known as dissenters’ rights). What exactly do these rights give to a dissenting shareholder?

Answer 28

A shareholder who objects to a merger or acquisition, or whose rights are materially and adversely affected by an amendment to a corporation’s articles, may be able to force the corporation to buy his stock at fair market value.

Question 29

Who may bring a derivative shareholder action?

Answer 29

TO have standing to bring a suit, a plaintiff:
1. Must have been a shareholder at the time of harm
2. Must be a shareholdering at the time the action is filed,
AND
3. Must continue to be a shareholder during the litigation

Question 30

What is the minimum number of directors required for a board?

Answer 30

ONE

Traditionally, a board needed three or more directors, but today a board can have as few as one director, regardless of the number of shareholders.

Question 31

Who selects directors and when? What if there is a vacancy on the board?

Answer 31

Directors are selected by the shareholders at the annual meeting and may be elected by straight or cumulative voting and by one or more classes of stock.

When there is a vacancy (or an increase in the number of directors), either the shareholders or directors may fill the vacancy. If the vacancy leaves the board without a quorum, the remaining directors can elect a replacement director by a majority vote.

Question 32

In the time between when the articles are filed, but before the directors are elected, people may subscribe to purchase stock from the corporation for when it comes into existence. Can a person who subscribed to purchase stock cancel this subscription?

Answer 32

Absent agreement, the subscriber does not have the unilateral right to cancel a subscription, as a pre-incorporation subscription is irrevocable for six months from the date of subscription

Question 33

What are the benefits of an LLC?

Answer 33

Like an S corporation, an LLC combines the (federal) tax advantages of a partnership with the limited liability of a corporation. An LLC also provides flexibility in management.

Question 34

Under what circumstances may a shareholder bring an action for corporate dissolution (involuntary dissolution)?

AADD

Answer 34

Assets Acting Deadlock Deadlocked

1. A corporation’s assets are being misapplied/wasted
2. Directors are acting illegally, oppressively, or fraudulently
3. Shareholders are unable to break directors’ deadlock causing irreparable injury;
   OR
4. Shareholders are deadlocked in voting power and fail to elect successor directors

Question 35

What are the two basic duties directors owe to their corporation and how must directors act in discharging these duties?

Answer 35

Directors owe two basic duties to their corporation:

1. Duty of Care
2. Duty of Loyalty

In discharging these duties, a director must act in good faith and in a manner that a director reasonably believes (a prudent person standard) to be in the best interests of the corporation. A director is also required to use any additional knowledge or special skills possessed

Question 36

In what ways can a plaintiff overcome the business judgment rule?

FIMDIE

Answer 36

FIMDIE
Faith Informed Material Devote Investigate Entitled

It must be shown:
1. Director did not act in good faith
2. Director was not informed to the extent she reasonably believed was necessary
3. Director had material interests in challenged conduct and was not objective
4. Director failed to devote attention to the corporation’s affairs
5. Director failed to timely investigate matters of material concern;
OR
6. Director received financial benefits to which he was not entitled

Question 37

A fraudulent purchase or sale of stock or security can give rise to a Rule 10b-5 action. For a private person to pursue a Rule 10b-5 action, what 7 elements must be met?

P/S IFMSRH

Answer 37

P/S IFMRSH
Purcashed/Sold Interstate Fraudulent Material Scienter Relied Harm

1. Plaintiff purchased or sold the security
2. Transaction involved the use of interstate commerce
3. Defendant engaged in fraudulent or deceptive conduct
4. Conduct related to material information
5. Defendant acted with scienter
6. Plaintiff relied on defendant’s conduct
7. Plaintiff suffered harm because of defendant’s conduct

Question 38

Define controlling shareholder

Answer 38

A controlling shareholder is one (or a group of shareholders acting in concert) who holds a high enough percentage of ownership in a company to enact changes at the highest level. Anyone controlling 50% of a corporation’s shares, plus one, is automatically a controlling shareholder

Question 39

What are the safe harbors by which a conflict-of-interest transaction may be protected?

Answer 39

Disclosure of all material facts and majority approval by board of directors or shareholders without a conflict interest and fairness of the transaction to the corporation at the time of commencement

Question 40

What are the three ways distributions can be made to shareholders?

DBI

Answer 40

DBI
Dividend Buying Idebtedness

1. Paying out a dividend
2. Buying stock from shareholders
3. Distribution of indebtedness

Question 41

In addition to a conflict of interest transaction, a director may violate the duty of loyalty by usupring a corporate opportunity rather than first offering the opportunity to the corporation. What are the two main tests courts apply in determining if an opportunity should have first been offered to the corporation?

Answer 41

1. Interest or expectancy test - does the corporation have an existing interest or an expectancy arising from an existing right in the opportunity
2. Line-of-business test - is the opportunity within the corporation’s current or prospective line of business, and how expanisve is the corporation’s line of business

There are other factors courts look at in determining whether an opportunity belongs to a corporation, such as: relationship of the third party to the director and of the director to the corporation; how and when the director acquired knowledge of the opportunity

Question 42

What must be filed to create an LLC, and what must it include?

Answer 42

An LLC is created by filing articles of organization with the state, and it must include the LLC’s name, mailing address, and, if there are no members upon filing, a statement to that effect

An LLC does not come into existence until it has at least one member

Question 43

What are the three officers that a corporation typically has?

Answer 43

Typically, a corporation’s officers are composed of a president, secretary, and treasurer

Question 44

What are the three types of authority an officer has?

Answer 44

Actual - as defined by the corporate bylaws or board

Implied - to perform those tasks necessary to carry out an officer’s duties by virtue of her status or position, so long as the matter is within the scope of ordinary business

Apparent - if a corporation holds the officer out as having the authority to bind the corporation to third parties

Question 45

What are the procedural requirements to merge two or more corporations?

BSD

Answer 45

BSD
Board Shareholders Documents

1. The board of directors for each corporation must approve the merger;
2. The shareholders of each corporation must usually approve themerger
   AND
3. The required documents must be filed with the state

Mergers without shareholder approval: parent-subsidiary merger and minnow-whale merger

Question 46

When will an asset acquisition require approval by both the board of directors and the shareholders of the transferor corporation?

Answer 46

A transfer involving all, or substantially all, of he corporation’s assets outside the usual course of business is a fundamental corporate change for the transferor corporation, and the corporation must follow the fundamental change procedures

Question 47

How can a corporation acquire control of another corporation without going through the process of a merger?

Answer 47

A corporation can acquire stock in another corporation and thereby secure control of that corporation without doing a merger by exchanging its own stock for that stock or by paying cash or other property for the stock

Question 48

If stock has already been issued by a corporation, what needs to happen in order to voluntarily dissolve the corporation?

Answer 48

Voluntary dissolution of a corporation is a fundamental change and requires a resolution by the directors and shareholder approval

Question 49

A dissolved corporation may continue to exist as a corporation for the limited purpose of doing what?

Answer 49

A dissolved corporation may continue to exist as a corporation for the limited purpose of winding up its affairs and liquidating its business. This includes collecting assets, disposing of property not distributed to shareholders, discharging liabilities, and distributing property among shareholders according to their interests

Question 50

How far in advance, absence other requirements in the articles or bylaws of a corporation, must notice be given of a special meeting? What other notice requirements are there for a valid special meeting.

Answer 50

TWO DAYS.

The notice must include the date, time, and place of the meeting.

The notice does NOT need to describe the purpose of the special meeting.

Question 51

What does “present” mean with regard to constituting a quorum for a corporation’s meeting?

Answer 51

Unless the articles or bylaws specify otherwise…

A quorum requires a majority of all directors to be present, and must be specifically present at the time a vote is taken in order to be counted as part of the quorum. “Present” can include participation in the meeting via communications equipment that allows all persons participating in the meeting to hear and speak to one another.

If any of the diretors cannot hear and speak to all the others present, these directors are not considered legally “present.” And, without be legally present, these directors’ votes would not count.

Question 52

What is the definition of a corporation and what are its benefits?

Answer 52

Corporation: A distinct legal entity that can conduct business in its own right by buying, selling, and holding property or by suing or being sued, and by lasting forever

Why form a corporation?
Limited liability; AND
Promoting investment

Question 53

Who are the players in a corporation?

Answer 53

Shareholders: investors, ultimate owners of a residuary interest in a corporations;

Directors: Elected by shareholders, responsible for major corporate decisions, appoint officers;

Officers: Run the corporation on a daily basis

Promoters (pre-incorporation player): Try to find investors who are willing to invest in the corporation; Enter into contracts on behalf of the corporation (even before it exists). Promoters are fiduciaries of the corporation - they cannot make secret profits

Question 54

Is a corporation liable for a pre-incorporation agreement?

Answer 54

NO.

Corporation is NOT for pre-incorporation agreements
Promoters are personally for any contracts entered into before the corporation exists

Question 55

What is required to form a corporation?

Answer 55

Must sign and file the articles of incorporation, pay a fee

Question 56

What must be included in the articles of incorporation?

NAIDPS

Answer 56

NAIDPS
Name Agent Incorporators Duration Purpose Shares

1. The name of the corporation, which must include: “corporation,” “company,” “incorporated,” “limited,” or an abbreviation of these words
2. The agent of the corporation (name and address within the state of incorporation);
3. The names and addresses of the incorporators
4. The duration of the corporation (most are perpetual)
5. The purpose of the corporation; AND
6. Authorized Shares: Must state the maximum number of shares of each class of stock that the corporation is authorized to issue

Question 57

Corporations: What are Ultra Vires and what are the consequences of Ultra Vires?

Answer 57

Ultra vires: acts beyond the powers of the corporation

If the corporation acts outside of its stated purpose, the acts will be held unenforceable

Shareholders can sue to enjoin an ultra vires action

Corporations can take action against ultra vires directors or officers

State can initiate proceedings to enjoin such actions

Today: the purpose is usually stated as “to engage in any lawful activity.” As a result, ultra vires claims are not as common

Question 58

What are corporate bylaws, what are their characteristics?

Answer 58

Bylaws set forth the day-to-day rules regarding the operation and management of the corporation

Could be put in the articles but most companies do not - why?
1. Bylaws are easier to amend
2. Board can typically change bylaws; articles can only be amended by the shareholders

NO obligation to file bylaws - almost every corporation does have them

If the bylaws and the articles of incorporation conflict, the articles always win

Question 59

When is a corporation formed and when does limited liability begin?

Answer 59

When the secretary of state accepts the fee and files the articles, the corporate existence begins

When all of the statutory requirements for incorporation have been satisfied, a de jure corporation is created

Moment of incorporation is when limited liability begins

Question 60

What is “Veil Piercing,” and what are the three factors courts will weigh in deciding to pierce the veil?

AUF

Answer 60

AUF
Alter Under Fraud

General Rule: shareholders are NOT personally liable for the debts of a corporation, but only liable for the amount invested into the corporation, except a court may “pierce the veil” of limited liability to avoid fraud or unfairness

Three factors in deciding whether to pierce the veil:
1. Alter Ego: the investor or shareholder has failed to observe any corporate formalities between the person and the corporation - treated the company just like itself
2. Under-Capitalization: Failure to maintain funds sufficient to cover foreseeable liabilities; AND
3. Fraud: the parties engaged in fraud or fraud-like behavior

Courts are more likely to pierce the veil in tort situations rather than contractual situations; more likely in small, closely held corporations
If you’re doing a question on corporations on the bar, veil piercing is a very popular topic.

Remember, the basic rule is that corporations enjoy limited liability, but there may be circumstances in which a court is willing to pierce the veil to get assets from shareholders

Question 61

What is the difference between shareholders and creditors, insofar as their rights to company value?

Answer 61

Creditors - hold the debt of a corporation
Entitled ONLY to repayment of their loan plus interest

Stockholders (equity holders) - entitled to ALL the value that remains in a corporation after the debts have been paid

Question 62

What is preferred stock?

Answer 62

Has preference over common stock with respect to:
1. Dividends (payments to shareholders); AND
2. Liquidation

Upon liquidation, a secured creditor will will generally take priority over even preferred shareholders

Question 63

What are the four concepts of issuance of stock to the investing public?

AIOT

Answer 63

AIOT
Authorized Issue Outstanding Treasury

1. Authorized shares
   Maximum number of shares that the directors of a corporation can sell
   Set in the articles of incorporation and need shareholder approval to sell more
2. Issue shares
   Number of shares from the authorized pool that the directors have actually sold
3. Outstanding shares
   Shares that were once issued to shareholders and still remain in the possession of the shareholders
   NOT reacquired by corporation
4. Treasury Shares
   Stock previously issued to shareholder, but then reacquired by the corporation

***Usually, only outstanding shares are voted. If the word or concept of “outstanding shares” comes up, that’s particularly important for determining who can vote. Remember, it’s only outstanding shares whose vote is important

Question 64

What is Par Value Stock and Watered Stock?

Answer 64

Par Value Stock
A corporation may, but is not required to, issue stock at par value
If it does, it must sell the shares for at least the minimum par value amount

Today, par value is typically NOT required. If it is required, it will usually be set at a nominal value

Valuation of Consideration
-Corporation can receive any valid consideration that the board of directors deems adequate (e.g. labor, IP rights, etc.)
-Directors have discretion

Watered Stock: The corporation sets a par value amount and sells the stock for less than the stated amount

If the word “par” or “par value” comes up, it will almost certainly going to involve a question of watered stock, so keep those concepts close

Question 65

What is a stock subscription?

Answer 65

Stock subscriptions
Ask people to agree in advance to buy stock before the corporation is formed
Prior to incorporation: subscription agreements are irrevocable for six months

Question 66

Corporations: What are preemptive rights?

Answer 66

Right to acquire stock to maintain the percentage of ownership any time new shares are issued
Default rule in most jurisdictions: Shareholders do not have preemptive rights unless negotiated or included in the articles

Question 67

What are the two ways to get money out of a corporation?

Answer 67

1. Board can declare a dividend (usually cash)
2. Board can buy back shares of the corporation

Question 68

What authority does the board of directors have regarding distribution of corporate value?

Answer 68

Directors’ Authority and Liability
-Power to authorize dividends lies with the board of directors
-Shareholders have NO automatic rights to dividends, the shareholders’ investments no longer belong to them; but they can compel dividends if they can prove the board is acting in bad faith by not distributing
-Board CANNOT declare dividends under two circumstances
1. If the corporation is insolvent;
OR
2. If, by issuing the dividend, the corporation would become insolvent
-Directors who vote to authorize an unlawful dividend are personally jointly and severally, to the corporation for the amount in excess of the lawful amount
-Defense: a director will NOT be liable if he relied in good faith on financial statements

Question 69

Corporations: Priority of Distribution Example 1

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 shares of outstanding common stock:

Answer 69

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 shares of outstanding common stock: then each common stock share receives $5 dividend

Question 70

Corporations: Priority of Distribution Example 2

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 shares of common stock and 50,000 preferred shares with a $4 dividend preference:

Answer 70

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 shares of common stock and 50,000 preferred shares with a $4 dividend preference:

The preferred shares receive a total dividend of $200,000
The corporation is left with $300,000 to divide among the common shares
Thus, each common share receives $3 dividend per share

Question 71

Corporations: Priority of Distribution Example 3

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 shares of common stock and 50,000 “participating” preferred shares with a $4 dividend:

Answer 71

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 shares of common stock and 50,000 “participating” preferred shares with a $4 dividend

The 50,000 participating preferred shares are paid their $4 dividend to equal $200,000
The corporation is left with $300,000 to divide among the common shares AND the participating preferred share holders, because they also receive common stock share dividends; thus, to divide among 150,000 shareholders
Thus, the common stock holders $4 per share, and the participating preferred shareholders get $4 plus the $2 they already got, so $6 per share

Question 72

Corporations: Priority of Distribution Example 4

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 common shares and 50,000 “cumulative” preferred share with a $4 dividend preference and last year, no dividend was paid:

Answer 72

If a corporation declares $500,000 who will what portion of that dividend?

If there are 100,000 common shares and 50,000 “cumulative” preferred share with a $4 dividend preference and last year, no dividend was paid:

Each cumulative preferred share receives $4 for this year and $4 for last year, thus $8 per share
The corporation is left with $100,000 to divide among the common shares, so $1 per share

Question 73

How does each class of stock divide dividends?

Participating Preferred Stock
Cumulative Preferred Stock
Preferred Stock
Common Stock

Answer 73

Participating Preferred = entitled to a set amount dividend when dividends are ordered, plus the dividends ordered for common stock shares
Cumulative Preferred = entitled to a dividend every year of a set amount
Preferred = entitled to a set amount dividend when dividends are ordered
Common Stock = entitled to an equally divided share of the total amount for dividends

Question 74

What are the two major exceptions to the shareholders’ ability to sell shares to anyone at any time at any price?

Answer 74

closely held corporations and federal restrictions

Question 75

What is a closely held corporation?
What are the requirements of the private restrictions on the sale of securities?
How enforceable are these restrictions?
What are the nature of restrictions?
How can the restrictions be challenged?
Who is bound by the restrictions?

Answer 75

Closely Held Corporations (Private Restrictions on the Sale of Securities)

Purpose: To prevent outsiders from becoming involved in the corporation; So the initial shareholders can retain control over the shares

Restriction Must be conspicuously Noted: The stock certificate must contained either a full and conspicuous statement of what the restriction is or a statement that says that there are restrictions, which will be provided upon request

Enforceability:
Generally, restrictions are enforceable
Even a lawful restriction may not be used against someone with no knowledge of it; Unless the restriction is certified and conspicuous

Types of Restrictions:
1. Outright prohibition on transfers
2. Requires company’s consent
3. Company has an option to buy
4. Company has a right of first refusal

Challenge to Restrictions
-Usually made on the basis of restraint on alienation
-Test is one of reasonability
–It is reasonable to restrict to maintain legal status (e.g., an S Corp)

Who is Bound?
Anyone who agrees: Almost any shareholder in a closely held corporation agrees to these restrictions

Question 76

What is Rule 10b-5 and what must a private plaintiff prove to pursue a 10b-5 action?
Also, how are damages calculated?

P/S IFMSRH

Answer 76

P/S IFMSRH
Purchased/Sold Interstate Fraud Material Scienter Relied Harm

Fraudulent purchase or sale of stock or other securities (like bonds or option)
For a private person to pursue a 10b-5 action, the following must be met:

1. Plaintiff has to have purchased or sold the security
2. Transaction involves interstate commerce
3. Defendant engaged in fraudulent or deceptive conduct
   -Making an untrue of a material fact
   -Failing to state a material fact that is necessary to prevent statements already made from being misleading
   -Materiality: Material if a reasonable investor would find that fact important in deciding to purchase or sell the security
   -Exception: Opinions and predictions do not count as untrue statements of material fact
4. Conduct related to material information
5. Defendant acted with scienter: Statements must be made intentionally for scienter
6. Plaintiff relied on defendant’s conduct
7. Plaintiff suffered harm
   -A causal connection between the conduct and the harm

Computing Damages:
-Out of pocket damages: the difference between the stock’s value and the prince the plaintiff paid or received
-No punitive damages are allowed

Question 77

What is a Section 16(B) violation?

Answer 77

A corporate insider can be forced to return short-swing profits to the corporation
The reason for buying or selling or having non-public information is irrelevant

Necessary elements:
1. Applicable companies - only the following
a) Corporations with securities traded on a national securities exchange;
OR
b) Corporations with assets of more than $10 million and more than 500 shareholders

2. Corporate Insiders
   a) Directors, officers, or shareholders who hold more than 10% of any class of stock
   OR
   b) Officers - president, vice president, secretary, treasurer, comptroller, etc.
3. Transactions made before someone becomes a corporate insider are generally not subject to short-swing issues; transactions made after a corporate insider leaves office may be

Short-Swing Profits: During any six month period, a corporate insider who both buys and sells the corporation’s stock is liable to the corporation for any profits made on those transactions

Reporting: Corporate insiders must report changes in stock ownership to the SEC

Question 78

What are the most important duties of the shareholders?

Answer 78

Most important duty - elect the board of directors

Also:
Vote on major decisions that affect fundamental changes in the corporation

Question 79

What two types of meetings do shareholders have and qhat are their purposes?

Answer 79

1. Annual Meeting
   Every corporation must hold an annual meeting to elect directors and conduct other shareholder business
2. Special Meetings
   -May be called to vote upon fundamental changes in the life of the corporation (e.g. dissolution, merger)
   -State laws typically specify who may call special meetings (e.g. board of directors, senior officer, a certain percentage of shareholders or shares, etc.)

Question 80

What are the requirements of notice for a shareholder meeting?

Answer 80

Shareholders must be given notice of either type of meeting (annual or special) no fewer than 10 days, but no more than 60 days, before the meeting

Must include the time, date, and location of the meeting

Special Meeting: Notice must include the purpose of the meeting
Insufficient notice can allow a shareholder to challenge any actions taken at the meeting

Waiver of notice: Notice can be waived by actually attending the meeting

Question 81

Corporations: what is a record date and why is it important?

Answer 81

Used to determine which shareholders are eligible to vote

The directors must fix a record date

Must be no more than 70 days before the meeting

ONLY shareholders who actually own shares on the record date are entitled to vote

Question 82

Can shareholders take action without holding a meeting?

Answer 82

YES.

All shareholders may take an action without a meeting by unanimous written consent

Question 83

What are shareholder proxies and when are they legally effective?

WSSAV

Answer 83

WSSAV
Writing Signed Secretary Authorizes Valid

Proxy:
Allows large corporations to deal with meeting logistics - shareholders rarely attend the meeting in person
Authorizes others to vote shares in accordance with the wishes of the shareholder

To be legally effective, a proxy must:
1. Be in writing
2. Be signed by the shareholder as of record
3. Be sent to the secretary of the corporation
4.State that it authorizes another to vote the shareholder’s shares;
AND
5. Cannot be valid for more than 11 months, unless otherwise specified

Question 84

What do shareholders typically vote on?

DMSASD

Answer 84

DMSASD
Directions Mergers Share Amendments Sales Dissolution

1. Election of directors
2. Mergers
3. Share exchanges
4. Amendments to the articles of incorporation
5. Sales of all or substantially all of its assets; OR
6. Dissolution

Question 85

What are the requirements of quorum and voting for shareholder meetings?

Answer 85

Quorum:
For the vote to be effective, a quorum of the majority of the corporation’s outstanding shares represented at the start of the meeting

Necessary Vote:
If a quorum is present a shareholder vote is effective if the votes cast in favor of the proposal exceed the votes cast against the proposal

Question 86

Corporations: What is cumulative voting and to whom does it apply?

Answer 86

Shareholders are given a number of votes that is equal to the number of shares they own, multiplied by the number of director positions being voted on
Votes can be spread around or put on one director

Applies only to the election of directors
Protects shareholders’ right to elect directors
Corporations can choose to permit cumulative voting in the articles

Question 87

What is a shareholder’s Inspection Rights?

Answer 87

A shareholder may inspect the corporation’s records in person or through an agent as long as the shareholder states a proper purpose for doing so

Must be a shareholder and have a proper purpose - related to the shareholder’s financial interest in the corporation

Improper purpose - designed to harass the corporate officers

Question 88

What is a shareholder Direct Lawsuit?

Answer 88

Shareholder is suing in the shareholder’s own name for damages and the damages go directly to the shareholder

A shareholder can sue directly if the shareholder has been harmed directly, including:
1. Interference in voting rights or dividends
2. misinformation about important issues
3. tort injury

Question 89

What is a shareholder derivative lawsuit?
What are the requirements of a derivative lawsuit?
What is the demand requirement?What is the nature of recovery on a derivative lawsuit?

Answer 89

Shareholder is suing on behalf of the corporation
Alleged harm harms the corporation, principally
-Harm to corporation - bad business decisions (e.g. disloyalty)

Requirements:
1. Claim must be made in the company’s name and any recovery belongs to the company
2. Standing - Must maintain contemporaneous stock ownership
a) Must have been a shareholder at the time of the harm
b) Must hold the shares throughout the litigation; AND
c) Must fairly and adequately represent the interests of the corporation

Demand Requirement
1. The plaintiff shareholder is generally required to first demand that the board of directors bring the lawsuit in the corporation’s name before the shareholder can bring the suit
2. Demand Futility Provision - demand is not required if it would be futile (e.g. directors have been named as the potential defendants)
3. Although the futility exception is recognized in some states, it is not recognized in states that have adopted the RMBCA

Recovery
-Any recovery goes to the corporation, NOT the shareholder
-Attorney’s fees: if the litigation produces a “substantial benefit” to the corporation, the plaintiff’s attorneys are entitled to have their fees paid by the corporation

Question 90

What are the duties of shareholders to other shareholders?

Answer 90

Shareholders do NOT owe a duty to fellow shareholders in the corporation

However…
Duties of a Controlling Shareholder
-Controlling Shareholder: those who own 50% plus one, or more
***If less than 50% plus one - look to the nature of the ownership of the company
-An exception to the general rule pertains to controlling shareholders
-A controlling shareholder MAY owe a fiduciary duty to minority shareholders in two circumstances
-Sale of Stock to an Outsider/Looter
—A controlling shareholder may be liable for damages caused to other shareholders when the controlling shareholder sells stock to an outsider if the stock was sold to an outsider intent on looting or destroying the company
—Classic red flags include: the looter had done this before or the looter had given some indication that this is what they intended to do
-Controlling Shareholder Transacts with the Corporation
–A controlling shareholder who receives a special distribution or otherwise conducts major business transactions to his own benefit owes a duty of loyalty

Question 91

What are the main duties of the board of directors?

Answer 91

1. Appoint officers
2. Oversee officers; AND
3. Make high-level corporate decisions

Directors may (and usually do) receive compensation

Question 92

What are the requirements to be a director?
How is a director chosen?
How long does a director serve?
How is a director removed/replaced?

Answer 92

Requirements:
A corporation must have at least one director
Directors must be natural persons

Term and Selection:
Elected by Shareholders
Serve a limited term - usually one year

Removal and Replacement:
-Shareholders may remove directors with or without cause
-There is an important exception: Staggered board
–Classes of directors are elected at different times - e.g. nine directors: three elected in year one, three in year two, three in year three
–May only be removed for cause, only if the articles provide; and
–Different classes of shareholders may elect different directors - only directors elected by a particular class may be removed by that class
-Vacancy or size of the board has increased - new director(s) can be chosen by the increased at a special meeting OR by the board of directors itself

Question 93

If a board meeting fails to provide adequate notice, what happens if a board member does not challenge it?

Answer 93

Attendance at the meeting waives notice, unless the director promptly objects at the meeting

Question 94

Corporate Director Voting Rules

Answer 94

Directors CANNOT vote by proxy or enter into voting agreements

Voting Requirements
1. Quorum: A majority of the total number of the directors, unless the bylaws specify a higher or lower number
2. Affirmative Vote: As long as a quorum is present, a resolution of the board will pass upon a majority vote of those present at the meeting
3. Unanimous Written Consent: The board may approve a proposal and avoid a meeting, if agreed upon by unanimous written consent

Question 95

Corporations: How does a director dissent?

MAS

Answer 95

MAS
Minutes Adjourned Secretary

To avoid potential liability for a board decision with which a director disagrees, the director must dissent by:
1. Entering dissent in the meeting minutes
2. File written dissent before the meeting is adjourned; OR
3. Provide written dissent by certified or registered mail to the corporation’s secretary immediately following the adjournment of the meeting

Question 96

What are officers of a corporation and what are their duties/standards?

Answer 96

-Officers are selected by the board of directors
-Run the corporation on a daily basis
-Typically consist of a president, secretary, and treasurer

Duties: owe fiduciary duties of loyalty and care
1. Duty of Care
-Directors and officers owe a fiduciary duty of care to the corporation
-Business Judgment Rule
–Directors and officers are protected from legal liability under the business judgment rule
–Rule: In the absence fraud, illegality, or self-dealing, courts will not disturb good-faith business decisions
2. Standard of Care
-Act with the care that a person in a like position would reasonably believe appropriate under similar circumstances
-Special skills are expected to be used (i.e. accounting background, legal background)
3. DUTY OF LOYALTY
-General Rule: May not receive an unfair benefit to the detriment of the corporation without effective disclosure and ratification
-Self-Dealing Transactions: A transaction in which the director, officer, or their relative receives a substantial benefit directly from the corporation (e.g. a salary)
-Corporate Opportunity Doctrine: Usurping or stealing a corporate opportunity
-Insulation from Liability/Ratification: A self-interested transaction may be upheld if it is disclosed and ratified by:
a. A majority of disinterested directors of the board; OR
b. A majority of disinterested shareholders of the company
-Ratification doesn’t always win the case - it might only shift the burden
-Fairness: If a director or officer can demonstrate that the transaction was fair, then they will win

Question 97

What is the Business Judgment Rule

Answer 97

Directors and officers are protected from legal liability under the business judgment rule

Rule: In the absence fraud, illegality, or self-dealing, courts will not disturb good-faith business decisions

Question 98

Corporations: What is the Reliance Defense?

Answer 98

A director or officer is entitled to rely on the expertise of officers and other employees, outside experts, and committees of the board

Question 99

What is indemnification in Corporations and what are the three types?

RPP

Answer 99

RPP
Required Prohibited Permissive

Indemnification: The practice of corporations paying for the costs of a director’s or officer’s defense in litigation, usually by purchasing insurance

1. Required or Mandatory Indemnification: The corporation is ALWAYS required to pay the costs of defense if the director or officer successfully the case
2. Prohibited Indemnification: The corporation CANNOT indemnify a director or officer who is liable for receiving an improper benefit from the corporation or otherwise loses a lawsuit
3. Permissive Indemnification: The corporation may, but is NOT required, to indemnify a director or officer for the costs of a suit if the director or officer:
   a) Acted in good faith with no intent to harm the corporation; OR
   b) Had no reasonable cause to believe the conduct was illegal

Question 100

Who must approve fundamental changes to a corporation?
What are examples of fundamental changes and how do they work?
What is the process for making a fundamental change?

Answer 100

Required Approval: BOTH the shareholders and directors must approve fundamental changes

Merger Consolidation
1. Merger: the combination of two or more corporations where one corporation survives and assumes the assets and the liabilities of the other corporation
2. Consolidation: the combination in which neither of the two corporations survives
–New entity is created
–New entity assumes the assets and liabilities of both corporations

Dissolution: The existence of a corporation is extinguished either voluntary by the shareholders and the directors or involuntarily by disgruntled parties
–Involuntary Dissolution: A corporation may be dissolved involuntarily by its creditors if the creditors show the corporation is not paying its debts
–Shareholders can have a corporation dissolved if the shareholders can show:
a) The corporate assets are being wasted
b) The directors are acting fraudulently; OR
c) The directors and shareholders are deadlocked

Process
1. The board must adopt a resolution proposing the change
2. Notice must be sent to the shareholders of the special meeting; AND
3. A majority of the shareholders casting a vote must cast in favor of the fundamental change

Question 101

What are a dissenter’s rights or appraisal rights?
What are the procedural requirements?
What is Fair Market Value Determination?

Answer 101

General Rights:
If a shareholder does not wish to participate in a duly authorized merger, asset sale, share exchange, or amendment of the articles, the shareholder is entitled to dissenters’ or appraisal rights

> > Entitled to have their shares purchased from them by the corporation at a fair value determined by the court

Procedural Requirements
To invoke dissenters’ rights:
1. The shareholder must send written notice to the corporation prior to the vote of her intent to dissent
2. At the meeting, the shareholder must abstain or vote “no” (dissent) at the meeting; AND
3. The shareholder must make prompt written demand for fair market value after the action has been approved

Fair Market Value Determination
If the shareholder and the corporation disagree as to fair market value, a court can appoint an expert appraiser to issue a binding appraisal of the value

Question 102

What is a Close Corporation and how does it operate?

Answer 102

“Close Corporations” (or “closely held corporation”)
-Term used to describe a corporation with few shareholders
-Characteristics
—Shareholders are often also directors and officers
—Typically NOT publicly traded
—Relaxation of rigid rules for corporations - it is hard to get out due to the lack of a market to sell the shares
-Voting Agreements
—Can form voting agreements
—Different from regular corporations (where it is not permitted)
-Preemptive Rights: The default rule prohibiting preemptive rights may be relaxed

Question 103

What is an S Corp?

Answer 103

An S Corp is really just a corporation for state corporate law purposes, but it gets special treatment for tax purposes
Only taxed once, like a partnership
NOT taxed at entity level - allows “pass-through” taxation
An S Corp is limited in the number of shareholders it may have

Question 104

What is an LLC and what are its characteristics?

Answer 104

In General
-The LLC combines the limited liability of corporations with the tax treatment of a partnership
-Generally no limitations on the number of shareholders, no residency requirements, and no natural person requirements (more flexible than an S Corp)

Key Characteristic
-An LLC files articles of organization and an operating agreement with the state
-The owners are called members, rather than shareholders
-An LLC is presumed to be managed by ALL of its members

Comparison to Corporations
-Legally, LLCs are generally treated like corporations
-There is a difference in terminology and taxing features, but otherwise, analyze LLCs under general corporate law principles

Question 105

What is the effect of noncompliance with corporate law requirements on the individuals who act on behalf of the noncompliant “corporation?”

Answer 105

When a person conducts business as a corporation without attempting to comply with the statutory incorporation requirements, that person is liable for any obligations incurred in the name of the nonexistent corporation.

Question 107

What is the corporation by estoppel doctrine?

Answer 107

A person who deals with an entity as if it were a corporation is estopped from denying its existence and is thereby prevented from seeking the personal liability of the business owner.

This doctrine is limited to contractual agreements.

Question 108

When do shareholders owe other shareholders a duty?

Answer 108

A controlling shareholder, such as a parent corporation, generally does not owe fiduciary duties to the corporation or other shareholders. However, decisions by a majority shareholder or control ground may be reviewable by a court for good faith and fair dealing toward the minority shareholders under the court’s inherent equity power.

Unless a decision involves self-dealing, controlling shareholder action is analyzed under the BUSINESS JUDGMENT standard

Question 109

What is the business judgment standard?

Answer 109

The business judgment rule is a rebuttable presumption that the controlling shareholder reasonably believed that his actions were in the best interests of the corporation.

A typical decision protected by the business judgment rule includes whether to declare a dividend and the amount of any dividend.

Question 110

Are controlling shareholders answerable for decisions regarding dividends?

Answer 110

YES.

Even though control over the distribution of dividends lies with the directors, controlling shareholders are the backbone of a company and therefore their direct and indirect control over all of the business’s actions is not lost on the courts

Question 111

Can shareholders sue to compel dividends?

FF

Answer 111

FF
Funds Faith

YES.

This is a suit based on the shareholder’s individal right to distribution and NOT a derivative lawsuit. To prevail in a suit to compel a dividend distribution, a shareholder must prove the existence of
1. funds legally available for the payment of a dividend
AND
2. bad faith on the part of the directors in their refusal to pay

Question 112

When a parent company directs its subsidiary to participate in a business transaction that prefers the parent at the expenses of the subsidiary, which duties/standards are breached?

Answer 112

Duty not to self-deal
Duty of loyalty
Conflict of interest

The parent company has violated its duty of loyalt UNLESS the transaction is protected us the safe harbor rule, which requires:
1. Disclosure of all material facts to, and approval by a majority of, the board of directors without a conflicting interest
2. Disclosure of all material facts to, and approval of, the votes entitled to be cast by the shareholders without a conflicting interest,
OR
3. Fairness of the transaction to the corporation at the time of commencement
*Fairness in a potential Parent Company self-dealing situation looks to (substantive fairness:) whether the transaction is comparable to what would have been obtained at fair play. Procedural fairness is not an issue unless there is a change in control.

Self-dealing is NOT protected by the business judgment rule

Question 113

What are the three safe harbors that a corporation can use when accused of self-dealing or conflict of interest?

DVF

Answer 113

DVF
Directors Votes Fairness

1. Disclosure of all material facts to, and approval by a majority of, the board of directors without a conflicting interest
2. Disclosure of all material facts to, and approval of, the votes entitled to be cast by the shareholders without a conflicting interest,
   OR
3. Fairness of the transaction to the corporation at the time of commencement
   *Fairness in a potential Parent Company self-dealing situation looks to (substantive fairness:) whether the transaction is comparable to what would have been obtained at fair play. Procedural fairness is not an issue unless there is a change in control.

Question 114

When does a corporate director commit usurpation, violating his duty of loyalty?
Which tests is used to determine if usurpation has occurred?

Answer 114

A director may violate his duty of loyalty by usurping a corporate opportunity rather than first offering the opportunity to the corporation.

The tests used to determine if usurpation has occured are the:
1. Interest or Expectancy Test
OR
2. Line of Business Test

Interest or Expectancy Test: whether the corporation has an existing interest or an expectancy arising from an existing right in the opportunity, or if the corporation is actively seeking a similar opportunity

Line of Business Test: whether the opportunity is within the corporation’s current or prospective line of business

Question 115

What is the business judgment rule?

Answer 115

The business judgment rule is a rebuttable presumption that a director reasonably believed that is actions were in the best interests of the corporation. The exercise of managerial powers by a director is generally subject to the business judgment rule.

However, the business judgment rule DOES NOT apply to a conflict-of-interest (“self-dealing”) transaction. The business judgment rule is only applicable when the safe harbor rule applies to this exception, which requires that
1. a majority of the disinterested directors
OR
2. disinterested shareholders
OR
3. fairness of the transaction to the corporation at the time of commencement.

Question 116

What is the business judgment rule’s safe harbor rule?

DAF

Answer 116

DAF
Disclosure Approval Fairness

When a director acts in a way that appears to be a conflict-of-interest or “self-dealing” transaction, the director can escape liability in one of three ways:
1. Disclosure of all material facts to, and approval by a majority of, the board of directors without a conflicting interest
2. Disclosure of all materal facts to, and approval by a majority of, the votes entitled to be cast by the shareholders without a conflict interest;
AND
3. Fairness of the transaction to the corporation at the time of commencement

Question 117

What qualifies as “fairness” under the third possible safe harbor exception to the prohibition against a corporate director’s self-dealing?

Answer 117

Fairness is measured by:

-Substance of the transaction (equal value given and taken)

-Procedure of the transaction (appropriateness of directors in reaching decision)

-Interested directors on both sides of transaction have burden of proving procedural and substantive fairness

-When a parent corporation is accused of self-dealing, the court weighs what was obtained versus what would have been obtained in an arm’s-length transaction

Question 118

What is the threshold line for a transaction to be one that could result in an accusation against a director for self-dealing?

Answer 118

A conflict-of-interest or self-dealing transaction is any transaction between a director and his corporation that would normally require approval of the board of directors and that is of such financial significance to the director that it would reasoanbly be expected to influence the director’s vote on the transaction.

The interest can be direct or indirect, but it must be financial and material

Question 119

What is the duty of loyalty that directors owe the corporation?

Answer 119

The duty of loyalty requires a director to act in a manner that the director reasonably beleives is in the best interests of the corporation.

A conflict-of-interest transaction is a violation of the duty of loyalty unless it falls within one of the three safe harbor exceptions.

Question 120

What is the duty of care that directors owe the corporation?

Answer 120

The duty of care requires directors to act with the same care that a person in a like position would reasonably believe appropriate under similar circumstances.

The director is presumed to have the knowledge and skills of an ordinarily prudent person, and is required to use any additional knowledge or special skills that he possesses.

Question 121

How does an accusor (such as a shareholder suing under a “contemporaneous owner” theory in a derivative suit) overcome the business judgment rule presumption?

FIOAIB

Answer 121

FIOAIB
Faith Informed Objectivity Attention Investigate Breach

To overcome the business judgment rule, it must be shown that:
1. The director did not act in good faith
2. The director was not informed to the extent that the director reasonably believed was necessary before making a decision
3. The director did not show objectivity or independence from the director’s relation to or control by another having material interest in the challenged conduct
4. There was a sustained failure by the director to devote attention to an ongoing oversight of the business and affairs of the corporation
5. The director failed to timely investigate a matter of significant material concern after being alerted in a manner that would have caused a reasonably attentive director to do so
OR
6. The director received financial benefit to which he was not entitled, or any other breach of his duties to the corporation

Question 122

What is the difference between a member-managed or a manager-managed LLC?

Answer 122

A member-managed LLC is managed directly by its members

A manager-managed LLC involves centralized management of the LLC by one or more managers who need not be members

In the absence of an agreement specifying the type of management an LLC will have, the default is member-managed

Question 123

What authority do members of an LLC have to bind the LLC to contracts?

Answer 123

In a manager-managed LLC, the members do NOT have authority to bind the LLC to a contract.

In a member-managed LLC, members have broad authority to bind the LLC, similar to that of a partner in a general partnership. Each member has equal rights with respect to the management of the LLC, so long as it is within the ordinary course of the company’s activities. Otherwise, it must have the consent of ALL members.

If a member of an LLC enters into a contract outside of the LLC’s regular course of activities and without actual or apparent authority, the LLC will NOT be bound by the contract.

Question 124

What are the ways in which an LLC can dissolve?

CPOE

Answer 124

CPOE
Consent Passage Order Event

1. Consent of all members
2. 90 days’ passage without any members
3. By court order
4. By an event specified in the operating agreement

Question 125

LLC: What is dissociation, how is it done, and what is its effect?

Answer 125

Dissociation is the act of a member of an LLC withdrawing from the LLC.

A member can, by providing notice (written or not) to the LLC, dissociate at any time and without reason, even if it violates the operating agreement.

When a member dissociates, the LLC does not dissolve, and instead the following occurs:
1. The dissociated member is not permitted to conduct business with the LLC
2. The dissociated member will continue to receive their share of distributions
3. The dissociated member will NOT receives a pro rata share of the LLC’s assets
4. The dissociated member cannot force the LLC to make payments to him other than the distributions he is owed

Question 126

How are the board of directors and shareholders each involved in the establishment of corporate bylaws?

Answer 126

The board of directors adopts the initial bylaws. After this, the bylaw maintenance is shared by the directors and shareholders.

A majority vote by either directors OR shareholders can adopt, amend, or repeal a bylaw
UNLESS
1. the corporation’s articles reserve that power exclusively to the shareholders
OR
2. the shareholders, in amending, repealing, or adopting a bylaw, expressly provide that the board of directors may not amend, repeal, or reinstate that bylaw

However, a shareholder-approved bylaw dealing with director nominations may not limit the board’s power to amend, add, or repeal to ensure an orderly process. Thus, if shareholders approve a bylaw amendment that limits further board changes, the board could only amend or add to the bylaw to SAFEGUARD the voting process; it could not repeal the shareholder-approved bylaw.

A committee established by the board of directors CANNOT adopt, amend, or repeal bylaws.

Question 127

When can the board of directors decline to present a shareholder proposal?

Answer 127

The board can decline to present a shareholder proposal that is “improper under state law.”

Question 128

Corporations: What is the limit to the record date?

Answer 128

A record date is fixed by the board of directors, but can be set by reference to the articles of incorporation or the corporate bylaws and, failing corporate guidance, by statute.

The record date can be NO MORE THAN 70 DAYS prior to the meeting to vote at a subsequent shareholders’ meeting.

Any shareholder receiving voting shares after the record date can only participate in a vote via obtaining a proxy to vote the shares from his transferor.

Question 129

Corporations: What is required to vote by proxy?

Answer 129

A shareholder may vote by proxy, which must be executed in writing and delivered to the corporation or its agent.

A proxy is valid for 11 months unless otherwise specified.

A proxy is revocable unless it expressly provides that it is irrevocable and the appointment of the proxy is coupled with an interest.

An act by the shareholder that is inconsistent with a proxy, such as attending a shareholder meeting and voting the shares, revokes the proxy.

Question 130

Corporations: When is a proxy coupled with an interest?

Answer 130

A proxy is coupled with an interest when the proxy holder has:
1. a property right in the shares
OR
2. a security interest given to him to protect him regarding any obligations he incurred or money he advanced

Question 131

Before a shareholder files a derivative action upon the company, what must the shareholder do?

Answer 131

The plaintiff in a derivative action must make a written demand upon the board of directors and cannot commence with a derivative action until 90 days have passed since the demand.

Only states that do not recognize the RMBCA will permit a “futility exception,” where the plaintiff can file a derivative suit without making a demand on the board first if the demand would be futile.

Under RMBCA, the requirement of waiting 90 days before filing suit after the damand will be excused if waiting would result in irreparable harm to the corporation.

Question 132

When the board rejects a shareholder’s demand, what is the result?

Answer 132

If the board specifically rejects the demand, the rejection is tested against the business judgment rule.

To overcome a business justification for the rejection, the plaintiff must establish that the board’s rejection was due to a lack of care, loyalty, or good faith to persuade the court to override the board’s refusal.

Question 133

What are the limits to a shareholder-approved bylaw dealing with director nominations?

Answer 133

A shareholder-approved bylaw dealing with director nominations may not limit the board’s power to amend, add, or repeal to ensure an orderly process.

Thus, if shareholders approve a bylaw amendment that limits further board changes, the board could only amend or add to the bylaw to safeguard the voting process, it could not repeal the shareholder-approved bylaw.

Question 134

Who may call a special meeting at a corporation?

Answer 134

Generally, a special meeting may be called by the board of directors or shareholders who own at least 10% of the shares entitled to vote at the meeting.

Question 135

Corporations: What is a Rule 10b-5 action?

P/S IFMRSH
Purcashed/Sold Interstate Fraudulent Material Scienter Relied Harm

Answer 135

P/S IFMRSH
Purcashed/Sold Interstate Fraudulent Material Scienter Relied Harm

The FRAUDULENT purchase or sale of any stock or other security can give rise to a Rule 10b-5 action.

For a private person to pursue a Rule 10b-5 action, EACH of the following must be met:

1. The plaintiff purchased or sold a security;
2. The transaction involved the use of interestate commerce;
3. The defendant engaged in fraudulent or deceptive conduct;
4. The conduct related to material information;
5. The defendant acted with scienter (intent or recklessness);
6. The plaintiff relied on the defendant’s conduct;
   AND
7. The plaintiff suffered harm because of the defendant’s conduct

Question 136

Corporations: What is a Section 16(b) action?

Answer 136

A Section 16(b) action can force a corporate insider to return short-swing profits to the corporation. Reasons for the trade are immaterial, and insider trading is not required.

A Section 16(b) cause of action requires:
1. A publicly traded corporation that is traded on a national exchange OR has assets of >$10m and >500 shareholders
2. The trader is a corporate insider (directors, officers, and shareholders with >10% of any class of stock)
3. A short-swing profit is made (purchase and sale of a stock within 6 months of each other)
4. Must report. Failure to report will result in the tort of fraud (A corporate insider is required to report a change in his stock ownership to the SEC to encourage compliance with this rule)

The profits made in a short-swing transaction must be returned to the corporation. Failure to report will result in fraud.

Question 137

Can shareholder-approved bylaws amend or repeal existing bylaws approved by the board of directors?

Answer 137

YES.

Sharedholders have the power to amend bylaws, regardless of how they came into being.

However, a shareholder-approved bylaw dealing with director nominations may NOT limit the board’s power to amend, add, or repeal to ensure an oderly process. Thus, if shareholders approve a bylaw amendment that limits further board changes, the board could only amend or add to the bylaw to safeguard the voting process, but could not repeal the shareholder-approved bylaw.

Question 138

What is a direct suit against a corporation brought by a shareholder, and does it require making a demand on the board of directors first?

Answer 138

In a direct action, the shareholder is vindicating his own rights and is not required to make a demand on the board of directors before proceeding with the litigation.

The shareholder’s rights can be personal or the rights specific to their role as a shareholder.

However, even when a shareholder has suffered a personal injury, when the shareholder opts for a DERIVATIVE SUIT instead of a direct suit, the damages awarded to the shareholder-plaintiff goes to the corporation.

Question 139

What is a derivative suit against a corporation brought by a shareholder?
When does the shareholder-plaintiff have standing?
Does it require making a demand on the board of directors first?

Answer 139

In a derivative action, a shareholder brings suit on behalf of the corporation and is typically based on a breach of fiduciary duties by the board of directors.

To have standing, the shareholder must have been a shareholder at the time of the alleged wrong and at the time the action was filed, and continue to be a shareholder throughout the litigation.

The shareholder is required to make a written demand upon the board of directors unless the demand would be futile, but not all jurisdictions recognize the futility exception.

Even when a shareholder has suffered a personal injury, when the shareholder opts for a derivative suit instead of a direct suit, the damages awarded to the shareholder-plaintiff goes to the corporation.

Question 140

What does the duty of loyalty require of directors of a corporation?

Answer 140

The duty of loyalty requires a director to act in a manner that the director reasonably believes is in the best interests of the corporation.

A director breaches this duty by placing his own interests before those of the corporation (conflict of interest / self-dealing).

A conflict-of-interest transaction is any transaction between a director and the director’s corporation that would normally require the approval of the board of directors and that is of such financial and material significance to the director that it would reasonably be expected to influence that director’s vote on the transaction.

Question 141

What are the safe harbors for transactions that might otherwise be considered a conflict-of-interest or self-dealing?

Answer 141

1. All material facts were disclosed to and approved by a majority of directors without a conflicting interest
2. All material facts were disclosed and approved by a majority of votes entitled to be cast by shareholders without a conflicting interest
   OR
3. The transaction was fair to the corporation at the time of commencement

The fairness test looks at:
1. Substance of transaction: whether the corporation received something of comparable value in exchange for what it gave to the director
2. Procedure of transaction: whether the process followed by the directors in reaching their decision was appropriate