Corporations

Question 1

When is a promoter of a corporation liable?

Answer 1

A promoter is personally liable on pre-incorporation contracts.

Question 2

When is a corporation liable on pre-incorporation contracts?

Answer 2

A corporation is not liable on a promoter’s pre-incorporation contract unless it (1) adopts or (2) ratifies the contract.

adoption = board resolution

ratification = aware of contract and accepts benefits

Question 3

Novation

Answer 3

a new contract for which the promoter, the corporation, and the other party agree the corporation will replace the promoter

Question 4

What needs to be in the name in the charter of a corporation?

Answer 4

The name must include “corporation” or equivalent designation (“Inc.” is the most common)

Question 5

under the MBCA, is par value required in the charter?

Answer 5

No

Question 6

How should a corporation draft its purpose statement?

Answer 6

Include a broad purpose clause (unless you have a really good reason not to).

ultra vires acts (beyond the powers) are problematic.
- state can enjoin
- Corporate losses can be recouped from the directors and officers

Question 7

What must be included in the articles?

Answer 7

A PAIN

(1) Authorized shares
(2) Purpose

(3) Agent – name and address of registered agent

(4) Incorporator

(5) Name of corporation (with corporation/equivalent designation “Inc.”)

Question 8

What is defective incorporation?

Answer 8

When a corporation is not property formed. Anyone signing contracts on behalf of a non-existent corporation is liable

Question 9

two defenses tp defective incorporation

Answer 9

De facto corporation and corporation by estoppel

Question 10

De facto corporation

Answer 10

(1) The parties made a good-faith attempt to incorporate as statutorily required, and

(2) the entity has been conducting itself as a corporation.

Question 11

Corporation by estoppel

Answer 11

A third party is “estopped” from claiming there wasn’t a corporation, where they dealt with it as a properly formed corporation.

It typically applies where the third-party is trying to escape an obligation.

Question 12

De Jure corporation

Answer 12

a corporation that has fulfilled its statutory responsibilities

Question 13

debt vs equity financing

Answer 13

(1) Ownership dilution

(2) Leverage

(3) Repayment obligations

(4) Priority (loans get repaid before equity)

(5) Taxation (interest is tax deductible, distributions are not)

(6) Restrictions on operations (debt often imposes more contractual limits than preferred stock)

Question 14

What requires shareholder vote?

Answer 14

1. Election and removal of directors
   2. Amendments to the corporation’s charter;
   3. Shareholder (as opposed to board) initiated amendments to the corporation’s bylaws
   4. Dissolution of the corporation
   5. A merger of the corporation
2. A sale of all (or substantially all) of the corporation’s assets.

Question 15

Valid proxy must

Answer 15

• (1) be in writing,
  
  • (2) signed by the shareholder,
  • (3) sent to the corporation’s secretary, and
    (4) state it authorizes another to vote the shares.

Question 16

Director notice for board meetings

Answer 16

No notice required for regular meetings

2 days for special

Question 17

default voting requirements

Answer 17

Shareholders: more for than against

Directors: majority of those present

Question 18

Who makes the bylaws?

Answer 18

incorporators or board of directors

Question 19

What is the business judgment rule?

Answer 19

a presumption that in making a business decision the directors of a corporation acted (i) on an informed basis, (ii) in good faith and (iii) in honest belief it’s in the best interests of the company

Question 20

rebutting the business judgment rule

Answer 20

Plead and prove
(1) One of
(a) Bad faith (e.g., fraud, illegality);
(b) Breach of loyalty (conflict of interest, self-dealing); OR
(c) Breach of duty of care (gross negligence standard, usually for directors not being properly informed)

(2) the corporation or its shareholders were harmed, and

(3) the director’s conduct proximately caused the harm.

Question 21

duty of care

Answer 21

care a person in a like position would reasonably believe appropriate given the circumstances

requires board and officers be “adequately informed”

Question 22

Reliance defense

Answer 22

Directors are entitled to rely on the information and advice of corporate officers, outside experts, and other directors in making a board decision.

Question 23

exculpation provision

Answer 23

A corporation can include in its charter a provision eliminating a director’s personal liability for money damages for breach of the duty of care

does NOT preclude injunctive relief

MAY NOT eliminate duty of loyalty

Question 24

When does entire fairness come up under the MBCA?

Answer 24

Conflicting interest transactions

Question 25

entire fairness

Answer 25

must show
(1) fair dealing, and
(2) fair price

Question 26

Duty of loyalty

Answer 26

A director must act (1) in good faith and (2) with a reasonable belief that what the director does is in the corporation’s best interest

Question 27

Conflcting interest transaction

Answer 27

(1) The director is a party to it;

(2) The director had knowledge and a material financial interest in it; OR

(3) The director knew that a related person was a party or had a financial interest in it.

Question 28

Director breach of the duty of good faith

Answer 28

Actual intent to do harm; or

Intentional dereliction of duty

Question 29

Duty to monitor/oversight

Answer 29

considered a breach of the duty of loyalty NOT the duty of care

(1) The directors utterly failed to implement an oversight system; or

(2) The directors ignored red flags and consciously failed to monitor operations.

very high bars

Question 30

Usurping a corporate opportunity

Answer 30

A director or officer cannot usurp a corporate opportunity for his or her own benefit.
(1) in the corporation’s line of business, and
(2) the corporation is able to financially exploit it

Question 31

Defense to usurping a corporate opportunity

Answer 31

a director or officer must have

(1) disclosed the conflict and presented the opportunity to the corporation, and

(2) a majority of disinterested directors or shareholders must have rejected the opportunity.

Question 32

3 requirements for shareholder derivative suit

Answer 32

(1) The shareholder has standing (owns shares throughout the lawsuit)

(2) The shareholder adequately represents the interests of the corporation (large shareholder); and

(3) The shareholder files a written demand on the board and waits 90 days before filing a suit UNLESS irreparable injury to the corporation would result.

Question 33

Common causes for direct suits

Answer 33

Denied right to vote (not having an annual meeting for example)

Failure to pay dividends (so long as there was some failure that resulted in the non-payment)

Question 34

Controlling shareholders also owe fiduciary duties to the company and shareholders. What is a controlling shareholder?

Answer 34

(A) Majority stock ownership; or

(B) Significant minority ownership plus control over a corporation’s actions

Question 35

Mandatory indemnification

Answer 35

a corporation must indemnify a director or officer if the person wholly wins the suit on the merits. (not settlement)

Question 36

A corporation may indemnify if

Answer 36

(1) The person acted in good faith,

(2) The person reasonably believed their conduct was in the best interests of the corporation, and

(3) In a criminal case, the person had no reasonable cause to believe their conduct was unlawful.

Question 37

Permissive indemnification for direct vs derivative suits

Answer 37

Direct suits: A corporation can pay expenses (attorneys’ fees) and settlements.

Derivative suits: A corporation can pay only expenses, not settlements. (But—D&O insurance can help here!)

Question 38

Side A, D and O insurance

Answer 38

provides directors and officers with insurance protection when indemnification from corporation is not available

Question 39

Side B, D and O insurance

Answer 39

reimburses a corporation for amounts it pays fulfilling its indemnification obligations.

Question 40

A board may not make a distribution if

Answer 40

(1) the corporation would not be able to pay its debts as they come due; or

(2) the corporation’s (i) assets are lower than its (ii) liabilities plus liquidation preference for preferred shareholders.

Question 41

Qualified Small Business Stock

Answer 41

Stock must be (1) issued by a C Corporation with gross assets under $50 million; and (2) held for a minimum of 5 years.

provides a capital gains exclusion: Up to 100% exclusion of capital gains on the greater of $10 million or 10x the adjusted basis of the investment

Question 42

Transfer restrictions

Answer 42

Transfer restrictions can be in a charter, bylaws, or an agreement among the shareholders

may not be “manifestly unreasonable”

Question 43

Under § 5 of the Securities Act of 1933, it’s unlawful to

Answer 43

sell a security (such as shares) unless the sale is (1) registered with the Securities and Exchange Commission (SEC) or (2) exempt from registration.

Question 44

Preemptive rights

Answer 44

Preemptive rights give an existing shareholder the right to buy a proportionate part of to-be-issued shares before they are issued to other persons

• not default but can be added in charter
• may also be accomplished through contracted right of first refusal

Question 45

Requirement for basic and expanded inspection rights

Answer 45

Written notice is required for both basic and expanded inspection rights.

For expanded rights, the shareholder must make the demand (1) in good faith and (2) for a proper purpose.

The notice must include the purpose and records requested.

Question 46

When can a shareholder petition the court for judicial dissolution?

Answer 46

(1) The directors are deadlocked, preventing the business from functioning.

(2) The shareholders are deadlocked, preventing director elections.

(3) Those in control of the corporation are acting illegally, oppressively, or fraudulently

(4) Corporate assets are being misapplied or wasted.

Question 47

Heightened fiduciary duty, similar to that of loyalty for partners

Answer 47

shareholders in a close corporation owe to each other the duty of utmost good faith and loyalty.

Question 48

Can you sell your shares in a close corporation?

Answer 48

No

Question 49

Company is required to register securities with the SEC if

Answer 49

1. The securities are listed on a national securities exchange (e.g., NYSE or NASDAQ);
   2. The company has $10 million or more in total assets and a class of equity securities held of record by (a) 2,000 or more persons, or (b) 500 or more persons who are not accredited investors; or
2. The company has filed a registration statement under the Securities Act that became effective.

Question 50

The anti fraud provision, section 10(b)

Answer 50

makes it unlawful to “use or employ, in connection with the purchase or sale of any security” a “manipulative or deceptive device or contrivance in contravention of such rules

Question 51

Elements for a 10(b) action

Answer 51

1. Material misrepresentation. The defendant misrepresented a material fact or omitted a material fact.
2. Scienter. Defendant acted knowingly or with reckless disregard for the truth or falsity. [Hard to prove!]
3. Reliance. The plaintiff relied on the misrepresentation in buying or selling stock.
4. Causation. The misrepresentation proximately caused the plaintiff’s losses.
   Damages. The plaintiff suffered damages.

Question 52

Classical theory of insider trading

Answer 52

(1) corporate insiders are prohibited from trading securities

(2) based on material nonpublic information

(3) in violation of their fiduciary duties

Question 53

Misappropriation theory

Answer 53

obtained through a breach of a fiduciary duty owed to the source of the information.

Question 54

Misappropriation theory duties of trust or confidence

Answer 54

1. Person agrees to maintain confidence
2. Parties have “history, pattern, or practice of sharing confidences,” or
3. Information is received from a spouse, parent, child, or sibling

Question 55

Tender offers

Answer 55

Rule 14e-3 prohibits any person who possesses material non-public information relating to a tender offer from trading in the securities of the companies involved

Question 56

Tipper liability

Answer 56

(1) intentionally or recklessly communicated,

(2) material, nonpublic information,

(3) in breach of
(i) a fiduciary duty [classic theory] or
(ii) confidentiality owed to the source of the information [misapprop theory],

(4) for a personal benefit to the tipper.

Question 57

Tippee liability

Answer 57

(1) the tipper breached a duty by tipping;

(2) the tippee knew or had reason to know the material nonpublic information was obtained through the tipper’s breach; and

(3) the tippee used the information by trading or tipping for the tippee’s own benefit

Question 58

Who needs to approve mergers

Answer 58

the target’s board and shareholders

Board: majority vote

Shareholders: Under MBCA, at a properly notice meeting with a quorum, more votes for than against. (Under Del., need majority approval.)

Question 59

When do bidder shareholders vote on a merger?

Answer 59

Bidder shareholders generally do NOT vote on the acquisition, unless the bidder will be issuing shares > 20% of its outstanding voting power

Question 60

Appraisal rights

Answer 60

Under the MBCA, a merger, share exchange, or sale of substantially all the corporation’s assets triggers appraisal rights for target shareholders who dissent from the transaction.

Consequence: A dissenting shareholder is entitled to have the corporation buy their shares for cash for fair value, as determined by a court.