Corporations Flashcards
Five Possible Fact Patterns
- Formation
- Issuance of Stock
- Directors and Officers
- Shareholders
- Fundamental Corporate Charges
Fact Pattern 1: Formation
For formation:
- Person - Incorporator, executes the articles and delivers them to the Secretary of State. Any person or entity may be an incorporator.
- Paper - Articles of Incorporation. Must include Corporate Name (Corp., Company, Inc., or Limited). Address of Incorporators. Name of registered agent, and address of registered office (must be in Georgia). Must give address of principal office (can be anywhere). Stock information.
- Act - Incorporator executes the articles and delivers them to the Secretary of State, along with a certificate of a request to publish the corporation’s formation, and pay fees. E-filing is okay.
If Ga. Secretary of State files the articles - De Jure Corporation.
Formation Terminology
A corporation formed in accordance with law is a de jure corporation. If all corporate laws have not been followed, a de facto corporation might result. Even if no attempt to incorporate is made, a business operating under a corporate name may be treated as a corporation for a particular transaction under the estoppel doctrine.
Articles of Incorporation
To form a corporation, we also need a particular paper—the articles of incorporation. This document must contain the information below:
Required Contents
- Corporate Name: A corporation’s name must include one of these “magic words,” or an abbreviation of them: corporation, company, incorporated, or limited.
- Name and Address of Each Incorporator: It is optional to name the initial directors in the articles. However, if they are named, their addresses must be given, too.
- Name of Registered Agent and Address of the Registered Office:The corporation’s registered office must be in Georgia. The registered agent is the corporation’s legal representative, meaning that they could, for example, receive service of process for the corporation.
- Address of the Principal Office
- Information About Stock:The articles must give certain details about the corporation’s stock. Note the following terminology:
- Authorized stock: The maximum number of shares the company can sell
- Issued stock: The number of shares the corporation actually does sell
- Outstanding stock: Shares that have been issued and not reacquired by the corporation
The articles must contain information about the corporation’s authorized stock. The articles may also create different classes of stock or allow the board of directors to do so.
Duration
If the articles say nothing about duration, then the corporation is presumed to have perpetual existence.
Purpose
If the articles say nothing about the corporation’s purpose, Georgia presumes that a corporation is formed to conduct any lawful business, and is allowed to do all things necessary and convenient to carry out its business purpose, unless the articles restrict its activity. Note that these provisions give authority for a corporation to do almost anything that is rationally related to a business purpose. Thus, unless the facts of an exam question provide a specific restriction on a corporation’s purposes, you should usually find corporate acts to be within the corporation’s powers.
Additional Provisions
The articles may also include any other provision regarding operation of the corporation that is not inconsistent with law.
Ultra Vires Activity
Formation - Articles of Incorporation
Narrow Business Purpose—Ultra Vires: Conceivably, the articles might contain a limited statement of purpose (though this is very rare). If a corporation does include a narrow business purpose in its articles, it is prohibited from undertaking action (such as entering a contract or buying property) unrelated to achieving the stated business purpose (“ultra vires” activities).
However, if it does, generally, the action isn’t void. The company’s action generally will be treated as valid, and the ultra vires nature of an action can be raised in only 3 circumstances:
- A shareholder may sue the corporation to enjoin a proposed ultra vires act
- The corporation may sue an officer or director for damages for authorizing an ultra vires act AND
- The state may bring an action to dissolve a corporation for committing an ultra vires act
Other Steps to Organize the Corporation
Formation
Organizational Meeting: If intitial directors were named in the Articles, they will hold the organizational meeting to select officers, adopt bylaws, transact other business.
If not named, then the incorporator will hold the organizational meeting, and she will elect the directors to proceed.
Bylaws: Internal document, don’t bind outsiders. Corporation’s operating manual. Bylaws may contain any provision for managing the corporation that is not inconsistent with the articles or law. Unlikely to ask about the content of a bylaw.
Bylaws are not filed with the State.
If Bylaws and Articles conflict, Articles will win.
- Bylaw Amendment/Repeal: Board or Shareholders can amend bylaws or adopt new ones.
Entity Status
Formation - Entity Status
A corporation is seen as a legal person, separate from its owners and managers. A corporation can sue and be sued, can be in a partnership, invest, and more. A for-profit corporation can make contributions to charity. If a business is to engage solely in charitable work, a “nonprofit corporation” can be formed under special provisions of Georgia law.
Non-Profit Corporations
Formation: Entity Status
In Georgia, charitable organizations (or nonprofit corporations) are governed by the Georgia Nonprofit Corporation Code and the Georgia Charitable Solicitations Act.
Unless exempted, charitable organizations must file a registration statement with the Secretary of State.
In addition, the articles of incorporation must state that the corporation is organized under the Georgia Nonprofit Corporation Code.
Within 1 year of filing, the charitable organization must file a financial statement. If it has received more than $1 million in contributions, the financial statement must be prepared by an independent certified public accountant.
To obtain tax exempt status, the charitable organization must file a section 501(c)(3) application with the IRS.
Once it receives a letter of determination as a tax exempt entity, it must file the letter within 30 days of receipt with the secretary of state in order to apply for state tax exemption.
Benefit Corporations
Formation: Entity Status
Georgia law also allows for the creation of benefit corporations, or “B Corps,” which are formed for profit and also to pursue some benefit to a broader social policy cause.
Things work as with a regular corporation, but the articles must say it’s a “benefit corporation” formed to pursue some sort of public benefit or benefits (such as having a positive effect, or reduction of negative effects, of an artistic, charitable, cultural, economic, environmental, scientific, or technological nature).
The board of directors of a B Corp must consider the public benefit(s) specified in the articles when managing or directing the B Corp’s business, in addition to impact on shareholders.
They must also adopt standards by which to measure the corporation’s performance in pursuing such benefit(s). The corporation must provide written reports (on at least an annual basis) to shareholders addressing the B Corp’s performance with respect to its pursuit of the benefit(s) stated in its articles.
Internal Affairs Doctrine
Formation
Under the internal affairs doctrine, the internal affairs of a corporation are governed by the law of the state of incorporation.
So, the internal affairs of a Georgia corporation (for instance, the roles and duties of directors, officers, and shareholders) are governed by Georgia law.
Limited Liability
Formation
One of the most important consequences of forming a corporation is limited liability.
Shareholders are not personally liable for debts. Shareholders are generally only liable to pay for their stocks, they are no liable for business debts.
Directors/officers are not liable for what the entity does.
The corporation itself is liable for what the corporation does.
Federal Income Taxation
Formation
In terms of corporate taxation at the federal level, 2 names (based on subchapters of the Internal Revenue Code (“IRC”)) are important to know:
C Corporation - Presume C corporation unless exam says otherwise
- Generally, a corporation is taxed as an entity distinct from its owners. (Under the tax laws, it is a “C corporation.”)
- Unless a bar exam question says otherwise, we have a C corporation under the IRC.
- The corporate tax rate generally is lower than the personal tax rate, so this arrangement can be advantageous to persons who want to delay the realization of income.
- However, this advantage comes at a price—double taxation—because when the corporation does make distributions to shareholders, the distributions are treated as taxable income to the shareholders, even though the corporation has already paid taxes on its profits.
S Corporation
- So, is it possible to form a corporation and legally avoid having it pay income tax at the corporate level?
- Yes, because the tax laws permit certain corporations to elect to be taxed like partnerships and yet retain the other advantages of the corporate form.
- Such corporations are called “S corporations” under the tax laws. Partnerships and S corporations are not subject to double taxation—profits and losses flow through the entity to the owners.
- There are a number of restrictions on S corporations (for example, stock can be held by no more than 100 persons, generally shareholders must be individuals and U.S. citizens or residents, there can be only one class of stock, and the stock must not be publicly traded).
Doctrine of Defective Incorporation
Formation
Where proprietors failed to form a de jure corporation, they will be personally liable for what the business does. But under two doctrines, the business gets treated as a corporation. To use either doctrine, the person must be unaware of the failure to form the de jure corporation.
- De Facto Corporation
- Corporation by Estoppel
One of the main reasons to incorporate is to avoid personal liability for obligations that the corporation incurs. If the incorporators thought they formed a corporation, but they failed to do so, they’d be personally liable for business debts. (Basically, the would-be incorporators have formed a partnership instead, and partners are liable for business debts.) But 2 doctrines may still allow the incorporators to escape liability: (1) de facto corporation and (2) corporation by estoppel. Under these doctrines, the business is treated as a corporation, so shareholders are not liable for what the business did. One important characteristic of both of these doctrines is that anyone asserting either doctrine must be unaware of the failure to form a de jure corporation.
De Factor Corporation Doctrine
Formation - Defective Incorporation
For a de facto corporation to exist, we must meet the following requirements:
- There must be a relevant incorporation statute. (On the exam, you can address this requirement quickly—it will always be met, because there’s an incorporation statute in every state.)
- The parties made a good faith, colorable attempt to comply with the statute, meaning the parties tried and came close to forming a corporation.
- There has been some exercise of corporate privileges, meaning the parties were acting as though they thought there was a corporation.
If the de facto corporation doctrine applies, the business is treated as a corporation for all purposes except in an action by the state(called a “quo warranto” action).
Status of De Factor Corpation Georgia
- Probably abolished, but not 100% clear.
- Georgia has abolished the de facto corporation doctrine—at least with respect to persons who know that articles have not been filed.
- Georgia law imposes joint and several liability on all persons who purport to act on behalf of a corporation knowing that there has been no incorporation.
- Thus, a person who signs a contract on behalf of a corporation knowing that the articles of incorporation have not been filed will be personally liable on the contract.
- On the other hand, a person who reasonably believes that articles of incorporation have been filed (for example, because they were sent to the state or because a business associate said he would do so) when, in fact, they have not been filed is not personally liable.
Corporation by Estoppel Doctrine
Formation - Defective Incorporation
- Under the estoppel doctrine, the “corporate” entity, and parties who have dealt with the entity as if it were a corporation, will be estopped from denying the corporation’s existence.
- In other words, say that you do business with people who hold their business out as a corporation. They think it’s a corporation and so do you. You write checks to the “corporation” and deal with it as a corporation. But there is no corporation.
- If you sue the proprietors individually, under the estoppel doctrine, you can’t win because you’ll be estopped to deny that the business was a corporation.
- Note that this doctrine can also prevent the corporation from avoiding liability by saying it was not a properly formed corporation.
- The estoppel doctrine applies on a case-by-case basis, but is generally applied only in contract cases and not in tort cases (on the rationale that a tort victim doesn’t allow himself to be injured in reliance on the business’s status as a corporation).
- This doctrine remains alive in Georgia.
Pre-Incorporation Contracts
Formation
A promoter is a person acting on behalf of a corporation not yet formed. Before a corporation is formed, promoters procure commitments for capital and other instrumentalities that will be used by the corporation after its formation.
Promoters’ Relationship with Each Other
Formation - Pre-Incorporation Contracts
Absent an agreement to the contrary, promoters are joint venturers who occupy a fiduciary relationship with each other.
They’ll breach their fiduciary duty if they secretly pursue personal gain at the expense of their fellow promoters.
Promoters’ Relationship with Corporation
Formation - Pre-Incorporation Contracts
A promoter’s fiduciary duty to the corporation is one of fair disclosure and good faith.
Breach of Fiduciary Duty Arising from Sales to the Corporation
A promoter who profits by selling property to the corporation may be liable for his profit unless all material facts of the transaction were disclosed. If the transaction is disclosed to an independent board of directors and approved, the promoter has met his duty and will not be liable for his profits. If the board is not completely independent, the promoter still will not be liable for his profits if the subscribers knew of the transaction at the time they subscribed or unanimously ratified the transaction after full disclosure. Disclosure must be to all who are contemplated to be part of the initial financing scheme. If the promoters purchase all the stock and subsequently sell their individual shares to outsiders, the promoters can’t be held liable for the profits from the sale of property to the corporation.
Fraud
Promoters may always be held liable if plaintiffs can show that they were damaged by the promoters’ fraudulent misrepresentations or fraudulent failure to disclose all material facts.
Promoters’ Relationship with Third Parties - Preincorporation Agreements
Formation - Pre-Incorporation Contracts
A promoter may enter into contracts on behalf of a corporation not yet formed. Our key question is who bears liability on these preincorporation contracts?
Corporation’s Liability
Since the corporate entity doesn’t exist prior to incorporation, it’s not bound on contracts entered into by the promoter in the corporate name prior to incorporation. The corporation may become liable only if it expressly or impliedly adopts the promoter’s contract.
How can adoption happen?
- Express adoption: The board takes an action adopting the contract.
- Implied adoption: The corporation accepts a benefit of the contract.
Promoter’s Liability
If a promoter enters into an agreement with a third party on behalf of a planned but unformed corporation, the promoter is personally liable on the contract.
The promoter’s liability continues after the corporation is formed, even if the corporation adopts the contract and benefits from it.
The promoter will be released from liability only if there is an express or implied novation (meaning, an agreement among all 3 parties—the promoter, the corporation, and the other contracting party—to release the promoter from liability and substitute the corporation for the promoter in the contract).
- Exception—Agreement Expressly Relieves Promoter of Liability: If the agreement expressly relieves the promoter of liability, there’s no contract; such an arrangement may be construed as a revocable offer to the proposed corporation, and the promoter has no rights or liabilities under the agreement.
Promoter’s Right to Reimbursement
Formation - Pre-Incorporation Contracts
A promoter who is held personally liable on a preincorporation contract may have a right to reimbursement from the corporation to the extent of any benefits received by the corporation.
Foreign Corporations
Formation
A foreign corporation may not transact business within Georgia until it has qualified (by obtaining a certificate of authority) and paid the prescribed fees.
Any jurisdiction outside of Georgia is considered foreign.
Trasnacting Business
Formation - Foreign Corporations
Transacting business means the regular course of intrastate (not interstate) business activity. This does not include owning property or sporadic business in Georgia.
Qualification
Formation - Foreign Corporations
To qualify, the foreign corporation gets a certificate of authority from the Georgia Secretary of State.
It applies by giving information from its articles and a certificate of good standing from its home state.
The corporation also must appoint a registered agent in Georgia.
A foreign corporation may not be denied a certificate of authority merely because the laws of its state of incorporation governing its organization and internal affairs differ from Georgia’s.
Failure to Qualify
Formation - Foreign Corporations
If a foreign corporation fails to qualify within 30 days of transacting business in Georgia, it will incur a civil penalty and cannot bring suit in Georgia courts (but can be sued and defend suits there).
The corporation can sue in Georgia once it qualifies and pays the fees and civil penalty. Failure to obtain a certificate does not usually impair the validity of any contract or corporate act.
Fact Pattern 2: Issuance of Stock
Background
To start and operate a corporation, we need money (capital).
The corporation can either borrow the money or raise it by selling stock (or both).
Either way, the corporation will issue a security to the investor. Security is a fancy word for investment.
Two types of Securities:
1. Debt Securities
2. Equity Securities
Debt Securities
Issuance of Stock
- When the corporation borrows money, it issues a debt security, which is usually called a bond.
- The bond is a promise that the corporation will repay the loan with interest.
- If the loan is unsecured by corporate assets, it may be called a debenture.
- Importantly, the holder of debt securities is a creditor, but not an owner, of the corporation.
Terminology
Debt obligations may be payable either to the holder of the bond (a bearer or coupon bond) or to the owner registered on the corporation’s records (a registered bond). A debt obligation may also have special features; for example, it may provide that it is convertible into equity securities at the option of the holder, or it might provide that the corporation may redeem the obligation at a specified price before the obligation matures.
Equity Securities
Issuance of Stock
- When the investor buys an ownership interest in the corporation, it issues equity securities, which is stock (the investor holds shares of stock).
- Importantly, the money invested does not create a debt.
- The shareholder is an owner, but not a creditor, of the corporation.
Terminology
Remember that shares described in the corporation’s articles of incorporation are authorized shares. Those shares that have been sold are issued and outstanding. Shares that have been reacquired by the corporation through purchase or redemption are authorized but unissued. These are sometimes referred to as treasury shares. Shares that were not authorized by the articles are void.
Classification of Shares
A corporation must have at least one class of stock, but it may have several classes or series of stock with differing rights. If the articles so allow, the board of directors may designate preferences, relative rights, and limitations of classes and series before issuance of any shares of the class or series. If only one type of shares is authorized, it will have all ownership rights and is called common stock.
Issuance
Issuance of Stock
An issuance of stock is when a corporation sells its own stock.
It’s important to remember that the rules below apply only when there is an issuance, meaning, when the corporation is selling its own stock.
Subscriptions
Issuance of Stock
Stock subscriptions are written offers from subscribers to buy stock in a corporation. One issue may be whether such an offer may be revoked.
Pre-Incorporation Subscriptions
Issuance of Stock
Under the GBCC, preincorporation subscriptions are irrevocable for 6 months unless otherwise provided in the terms of the subscription agreement or unless all subscribers consent to revocation.
Payment
- Unless otherwise provided, payment is upon demand by the board.
- Demand may not be made in a discriminatory manner.
- A subscriber who fails to pay may be penalized by sale of the shares or forfeiture of the subscription and any amounts paid on the subscription, at the corporation’s option.
Post-Incorporation Subscriptions
Issuance of Stock
Postincorporation subscriptions are revocable until accepted by the corporation.
In other words, the corporation and subscriber are obligated under a subscription agreement when the board of directors accepts the offer.
Consideration - Form
Issuance of Stock
Under the GBCC, shares may be paid for with any tangible or intangible property or benefit to the corporation.
This includes money (cash or check), tangible or intangible property, promissory notes to the corporation, promises to perform future services, services already done for the corporation, and release of an obligation.
Amount of Consideration
Issuance of Stock - Consideration
Board Determines Adequacy
The board is required to determine that the amount of consideration received is “adequate.” Whenever the board authorizes an issuance, it is presumed to be for “adequate” consideration, even if the issuance is for less than “par” value.
Traditional View—Par
- Par means minimum issuance price.
- Traditionally, stock could not be issued by a corporation for less than the stock’s stated par value, and the consideration received for par value stock had to be held in a certain account containing at least the aggregate par value of the outstanding par value shares.
- The GBCC has eliminated the account requirements for the proceeds of par value stock.
- Generally, as noted above, corporations may issue shares for whatever consideration the directors deem appropriate. However, directors may be liable for breach of duty if they issue stock with a stated par value for less than its par value.
Note: No par means no minimum issuance price. That means the board can have the stock issued for any price it sets.
Reacquired Stock
(Treasury Stock)
Issuance of Stock - Consideration
Reacquired stock (or treasury stock) is stock that was previously issued and has been reacquired by the corporation.
It becomes authorized but unissued, and the corporation can then resell it. If issued, the board sets an issuance price.
Right to Maintain Percentage Ownership
Issuance of Stock - Preemptive Rights
A preemptive right is the right of an existing shareholder to maintain her percentage of ownership by buying stock whenever there is a new issuance of stock for money (meaning cash or its equivalent, like a check).
A “new issuance” includes the sale of reacquired stock.
Right Must be Stated in Articles
Issuance of Stock - Preemptive Rights
In Georgia, shareholders of a corporation (other than a close corporation—see below) do not have a preemptive right to purchase newly issued shares to maintain their proportional ownership interest unless the articles provide the right.
Moreover, even if the articles do provide a preemptive right, shareholders generally have no preemptive right in shares issued:
1. as a dividend,
2. for consideration other than cash (for example, for services of an employee),
3. as compensation to corporate employees,
4. to effect a merger or share exchange or under a plan of reorganization, or
5. within a year after incorporation.
Exception—Statutory Close Corporation
In a statutory close corporation (that is, a corporation held by relatively few shareholders), preemptive rights exist unless the articles say they do not.
Fact Pattern 3:
Directors and Officers
The directors are responsible for the management of the business and affairs of the corporation.
Number and Qualifications
Directors - Statutory Requirements
There need only be one director, but the articles may provide for more than one. The number of directors is set in the articles or bylaws. Directors must be at least 18 years old, but need not be residents of Georgia or shareholders of the corporation. The articles or bylaws may set forth additional qualifications.
Election
Directors - Statutory Requirements
Initial directors can be named in the articles or elected by incorporators. Thereafter, shareholders elect directors at the shareholders’ annual meeting unless the articles provide otherwise.
Staggered Board
- The entire board is elected each year unless the articles or a shareholder-adopted bylaw divide the board into half or thirds.
- When this happens, only one-half or one-third of the board is elected each year. This is called a staggered board.
- For instance, if there are 9 directors, they could all be elected each year and serve one-year terms. Or, instead of electing all 9 each year, we could divide the board into 3 classes of 3 directors each, and they would serve 3-year terms.
Removal
Directors - Statutory Requirements
Shareholders can remove directors before their terms expire with the approval of a majority of the shares entitled to vote.
In Georgia, a director may be removed by the shareholders only at a meeting called for that purpose, and the notice of the meeting must state the purpose.
Generally, directors may be removed with or without cause.
However, if there is a staggered board, shareholders can remove directors only with cause (unless the articles or bylaws provide otherwise). A director elected by cumulative voting (discussed later) may not be removed if the votes cast against removal would be sufficient to elect her if cumulatively voted.
A director elected by plurality vote may be removed only by a majority of the votes entitled to be cast.
Vacancies
Directors - Statutory Requirements
Vacancies on the board may arise, for example, when a director resigns before her term is up. In such instances, who selects the person who will serve as director for the rest of the term? Unless otherwise provided by the articles or a bylaw approved by the shareholders, vacancies occurring on the board may be filled by the shareholders or by the board. However, if the director was elected by a particular class of stock, that class of stock selects the replacement.
Board Action
Directors - Statutory Requirements
Board Must Act as Group
When the board of directors takes an action, it must do so as a group. An individual director is not an agent of the corporation, so individual directors have no authority to speak for or bind the corporation. (Officers, on the other hand, are agents of the corporation.) So directors must act as a group (even if there is only one director). They may act in the following ways:
- By unanimous agreement in writing (email is fine) OR
- By passing a resolution at a meeting, which must satisfy the quorum and voting requirements discussed below
Board Meetings
- Types of Meetings; Notice: Methods for giving notice (for instance, by email) to the individual directors of a directors’ meeting are usually set in the bylaws. Directors may act in regular or special meetings:
- For regular meetings, notice is not required unless the bylaws provide otherwise
- For special meetings, unless the bylaws provide otherwise, at least two days’ written notice of date, time, and place is required. The notice need not state the purpose of the meeting
- Failure to Give Notice: Failure to give notice of a special meeting makes the actions taken at the meeting voidable unless the person not notified waives the notice defect. She may do so either (1) in writing (including fax or email) any time or (2) by attending the meeting without objecting at the outset of the meeting to the lack of notice.
- Proxies: Directors cannot give proxies or powers of attorney or enter into voting agreements for how they will vote as directors. Why? Because directors owe non-delegable fiduciary duties to the corporation. They’re bound to use their individual business judgment.
- Quorum: For any meeting of the board, we must have a quorum. Unless the bylaws say otherwise, a majority of the board of directors constitutes a quorum for the meeting (but the bylaws cannot set a quorum at fewer than one-third of the board members). Without a quorum, the board cannot act.
- Approval of Action: If a quorum is present at a meeting, passing a resolution (which is how the board takes an act at a meeting) requires only a majority vote of those present. So, if there are 9 directors, at least 5 directors must attend the meeting to constitute a quorum. If 5 directors attend, at least 3 must vote for a resolution for it to pass.
- Broken Quorum: A quorum of the board can be lost (“broken”) if people leave. Assume again that there are 9 directors. Five show up at a meeting and, during the meeting, 1 of the directors leaves. Can the other 4 take any action? No, because the quorum has been broken.
Action by Unanimous Written Consent
Remember that any action required to be taken by the directors at a formal meeting may be taken by unanimous consent, in writing or by electronic transmission, without a meeting.
Management
Directions - Role of Board of Directors
The board of directors manages the corporation. It sets policy, supervises officers, declares distributions, determines when stock will be issued, recommends fundamental corporate changes to shareholders, and so on.
Delegation of Authority
Directions - Role of Board of Directors
Unless the articles or bylaws provide otherwise, the board may create committees, with one or more members, and appoint members of the board of directors to serve on them. The committees may act for the board, but the board remains responsible for supervision of the committees. The board may also delegate authority to officers. A committee cannot do certain things, like (1) fill a board vacancy, (2) amend or repeal bylaws, or (3) propose a fundamental corporate change to shareholders. However, a committee can recommend such things for full board action.
Duty of Care - Standard
Directors and Officers - Duties, Liability, and Indemnification
Directors owe a duty of care to the corporation.
The Standard
A director must perform her duties as a director in good faith and with the degree of care an ordinarily prudent person in like position would exercise under similar circumstances. There is a presumption that the process a director followed was in good faith and that the director exercised ordinary care. Directors are not expected to insure the success of the business; rather, they are liable only for negligent acts or omissions in the performance of their duties. However, a director may be held personally liable for losses suffered by the corporation as the direct and proximate result of her breach of duty.
Burden of Proof
Directors and Officers - Duties, Liability, and Indemnification
To overcome the presumption above, the plaintiff must show gross negligence or a gross deviation from the standard of care. Thus, the burden in duty of care cases is on the plaintiff, unlike for the duty of loyalty, where the burden is on the defendant.
Two Common Scenarios
Directors and Officers - Duties, Liability, and Indemnification
On the exam, you’ll typically see the duty of care come up in 2 ways: (1) nonfeasance or (2) misfeasance.
Nonfeasance
Nonfeasance occurs when a director basically does nothing. In other words, we have a lazy director.
Misfeasance
Misfeasance occurs when the board makes a decision that hurts the corporation. Here, in contrast to cases of nonfeasance, causation is clear.
The presumption that the board’s process was undertaken in good faith and that the directors acted with ordinary care means that a court will not second-guess a good faith business decision made without conflict of interest. That’s why the burden is on the plaintiff to show that the directors did not do appropriate homework or did something galactically stupid. At common law, this presumption is called the business judgment rule. All of this means that when the directors make decisions for the corporation, they are not guarantors of success.
Illegal Action
Directors and Officers - Duties, Liability, and Indemnification
A director may be liable for causing the corporation to violate a statute, even if he exercised good business judgment in doing so.
Duty of Loyalty - Standard
Directors and Officers - Duties, Liability, and Indemnification
A director owes a duty of loyalty to the corporation. A duty of loyalty issue will arise if there is a conflict of interest between a director’s own interest and that of the corporation. Because of the conflict, the presumption we saw in duty of care does not apply. So the burden is on the defendant here, not on the plaintiff.
The Standard
A director must perform her duties as a director in good faith and with the degree of care an ordinarily prudent person in like position would exercise under similar circumstances. But note that the presumption that a director acted with ordinary care likely does not apply when the director has a conflict of interest.
Duty of Loyalty
Common Scenarios
Directors and Officers - Duties, Liability, and Indemnification
Interested Director Transaction
We have an interested director transaction if the elements of this test are met: (1) the corporation must enter the transaction; (2) the director must know of the deal and of her interest; and (3) the deal is between the corporation and (a) the director (meaning, the director is a party to the transaction or has a beneficial financial interest in the transaction or is so closely linked to it that her interest would reasonably be expected to influence her judgment if she were to vote on it), (b) a member of the director’s household, or (c) another business of the director’s.
-
Standards for Upholding Conflicting Interest Transactions: A conflicting interest transaction will not be enjoined or give rise to an award of damages due to the director’s interest in the transaction if:
1. The transaction was approved by a majority of the disinterested directors (but at least two) after all material facts have been disclosed to the board;
2. The transaction was approved by a majority of the votes entitled to be cast by shareholders without a conflicting interest in the transaction after all material facts have been disclosed to the shareholders; or
3. The director can prove that the transaction was fair to the corporation.
Competing Ventures
Directors may engage in unrelated businesses, but engaging in a competing business may create a conflict of interest. However, a director’s involvement in a competing business is not prohibited if the director scrupulously refrains from unfair competition; for example, refrains from divulging corporate information, luring away corporate employees or customers, or working on a competing business while being paid by the corporation.
Corporate Opportunity Doctrine
The directors’ fiduciary duties prohibit them from diverting a business opportunity from their corporation to themselves without first giving their corporation an opportunity to act. This is known as a “usurpation of a corporate opportunity.” The director cannot take the opportunity until he (1) tells the board and (2) waits for the board to reject the opportunity.
- Corporation Must Have Interest or Expectancy: A usurpation problem arises only if a director takes advantage of a business opportunity in which the corporation has a legitimate interest or expectancy which it can afford. If the opportunity diverted was of such a nature that its development by the corporation would be an ultra vires act, the corporation has no interest or expectancy. Even if the corporation is authorized to pursue almost every business venture, a corporation’s interest does not extend to every conceivable business opportunity. And even if an opportunity is within the scope of a corporation’s business, the courts will not uphold a claim for diversion of the opportunity if the corporation was financially unable to undertake the opportunity.
- Remedies: If a director does not give the corporation an opportunity to act, but rather usurps the opportunity, the corporation can recover the profits that the director made from the transaction or may force the director to convey the opportunity to the corporation, under a constructive trust theory, for whatever consideration the director purchased the opportunity.
- Note that the corporation may disclaim its interest in any opportunity, which will allow D to obtain it. The disclaimer may be set out in the articles or bylaws or may be made by action of the board of directors or by the shareholders.
- Ratification of a Diversion: If complete disclosure of the opportunity has been made to the disinterested members of the board, it may be ratified.
Common Law Insider Trading -
Special Circumstances Rule
Directors and Officers - Duties, Liability, and Indemnification
A director has no common law duty to disclose all facts relevant to a securities transaction between the director and the other party to the transaction. However, courts have found a duty to disclose where a director knows of special circumstances (for example, an upcoming extraordinary dividend or a planned merger).
Ultra Vires Acts
Directors and Officers - Duties, Liability, and Indemnification
Remember that responsible managers are liable for ultra vires losses.
Improper Distributions
Directors and Officers - Duties, Liability, and Indemnification
Directors are liable for improper distributions
Which Directors Are Liable?
Directors and Officers - Duties, Liability, and Indemnification
Whatever the basis of liability, how do we determine exactly which individual directors are liable?
General Rule
A director is presumed to have concurred with board action unless she objected to transacting business or her dissent or abstention is noted in writing in corporate records. In writing means (1) in the minutes or (2) delivered in writing to the presiding officer at the meeting or (3) written dissent to the corporation immediately after the meeting. Oral dissent at the meeting by itself is not sufficient. A director cannot dissent if they voted yes at the meeting.
Exceptions to the General Rule
- Absence
- Reasonable Reliance Defense: In discharging her duties, a director is entitled to in good faith rely on information, opinions, reports, or statements (including financial statements), if prepared or presented by:
- corporate officers or employees whom the director reasonably believes to be reliable and competent;
- legal counsel, accountants, investment bankers, or other persons as to matters the director reasonably believes are within such person’s professional competence; or
- a committee of the board of which the director is not a member, if the director reasonably believes the committee merits confidence—unless the director has knowledge concerning a matter that makes reliance unwarranted.
On the exam, watch for this issue of reliance to come up regarding a claim that the board approved an improper distribution, which we’ll discuss below. And remember, what’s required for this defense is good faith reliance, not blind reliance.
Limitation of Personal Liability of Directors
Directors and Officers - Duties, Liability, and Indemnification
The articles may contain a provision eliminating or limiting the personal liability of a director to the corporation or its shareholders for damages arising from breach of duty, except there can be no such limitation of liability for:
1. an appropriation of a corporate business opportunity;
2. intentional misconduct or knowing violation of law;
3. unlawful distributions; or
4. transactions from which the director received an improper personal benefit.
Officers - Status and Powers
Directors and Officers - Duties, Liability, and Indemnification
Officers are agents of the corporation, so officers can bind the corporation by acts for which they have authority to bind it. Watch out on the exam for crossover questions here with Agency. Remember, the corporation is the principal, and the officer is the agent. Ordinary rules of agency determine authority and powers.
Note that the president has inherent authority to bind the corporation to contracts and conveyances in the ordinary course of business. An officer does not have inherent authority to fire other officers, except that the officer who appointed an officer may fire that officer.
Offices
Directors and Officers - Duties, Liability, and Indemnification
The GBCC does not require a corporation to have any specific officers, but rather provides that a corporation is to have the officers described in its bylaws or appointed by the board pursuant to the bylaws. So the offices to be held are usually set in the bylaws. There must be an officer with the responsibility of preparing minutes of directors’ and shareholders’ meetings and maintaining and authenticating required corporate records (usually called the corporate secretary). One person may simultaneously hold more than one office.
Officer Selection and Removal
Directors and Officers - Duties, Liability, and Indemnification
Officers are selected by and removed by the board, which also sets officer compensation. (The bylaws or board action can allow an officer to appoint other officers, but we will assume that’s not the case.) The corporation has the power to remove an officer at any time, with or without cause. If the removal is a breach of contract, the nonbreaching party may have a right to damages, but note that mere appointment to office itself does not create any contractual right to remain in office.
Remember that shareholders hire and fire directors. Shareholders do not hire and fire officers.
Officer Duties and Liabilities
Directors and Officers - Duties, Liability, and Indemnification
Officers owe the same duties of care and loyalty to the corporation as directors. Interested officer transactions are treated similarly to interested director transactions. Officers are liable for contracts and obligations incurred by them in violation of their agency authority and can be personally liable for the corporation’s torts if the officers directed or participated in committing the tortious act.
Indemnification of Dirtectors and Officers
Directors and Officers - Duties, Liability, and Indemnification
Let’s say someone has been sued by (or on behalf of) the corporation in her capacity as an officer or director. She has incurred costs, attorneys’ fees, maybe even fines, and a judgment or settlement in that litigation. Now, she seeks indemnification (reimbursement) from the corporation. There are 3 categories of indemnification.
- Prohibited
- Mandatory
- Permissive
Prohibited Indemnification
Directors and Officers - Duties, Liability, and Indemnification
A corporation cannot indemnify a director or officer for a proceeding concerning conduct for which she was held to have received an improper financial benefit.
Mandatory Indemnification
Directors and Officers - Duties, Liability, and Indemnification
A corporation must indemnify a director or officer who prevailed in defending a proceeding against the officer or director for reasonable expenses, including attorneys’ fees, incurred in connection with the proceeding. For mandatory indemnification to apply, the director or officer must be “wholly” successful, on the merits or otherwise, in defending the suit, meaning she won a judgment on the entire case, not just on one of multiple claims.
Permissive Indemnification
Directors and Officers - Duties, Liability, and Indemnification
This category, in which the corporation may indemnify, covers anything not satisfying the first 2 categories. A good example of this is when the suit against the director or officer settled.
Eligibility Standards
A corporation may indemnify a director who was made a party to a proceeding because of his relationship with the corporation if the director:
- Acted in good faith AND
- Believed that his conduct was (a) in the best interests of the corporation (when the conduct at issue was within the director’s official capacity); (b) not opposed to the best interests of the corporation (when the conduct at issue was not within the director’s official capacity); or (c) not unlawful (in criminal proceedings)
Who Determines Eligibility?
Generally, the determination whether to indemnify is to be made by a disinterested majority of the board, or if there is not a disinterested quorum, by a majority of a disinterested committee or by independent legal counsel. The shareholders may also make the determination (the shares of the director seeking indemnification are not counted).
Extent of Indemnification
If the proceeding was a derivative action, indemnification is limited to expenses incurred; in other cases, the corporation may indemnify against any liability incurred.
Court-Ordered Indemnification
Notwithstanding the above rules, the court in which the director or officer was sued may order reimbursement.
Limitation of Liability
Directors and Officers - Duties, Liability, and Indemnification
The articles can provide for limitation or elimination of director liability to the corporation for damages, but not for:
- Wrongful appropriation (usurping) of a corporate business opportunity
- Acts or omissions involving intentional misconduct or a knowing violation of law
- Improper distributions OR
- A transaction in which the director received an improper personal benefit
In other words, the articles can exculpate directors from liability for breach of a duty of care.
Shareholder-Approved Indemnification and Limitation of Liability
Directors and Officers - Duties, Liability, and Indemnification
If authorized by the articles or a bylaw, contract, or resolution approved or ratified by the shareholders (not counting shares of interested directors), a corporation may indemnify a director (subject to the limitations mentioned above).
Advance for Expenses
Directors and Officers - Duties, Liability, and Indemnification
A corporation may advance expenses incurred prior to final disposition as long as the director
1. gives the corporation a statement that he believes in good faith that he met the appropriate standard of conduct for permitted indemnification or that the conduct is conduct for which the articles have eliminated personal liability; and
2. will repay the advance if he is later found to have not met the appropriate standard.
Director Rights
Directors and Officers - Duties, Liability, and Indemnification
Right to Inspect Books and Records
A director is entitled to have access to the books and records of the corporation.
Fair and Reasonable Compensation
Unless otherwise provided by the articles or bylaws, the board of directors may fix compensation, even of the directors. The amount of compensation authorized must be fair (that is, reasonably related to the value of services rendered). Otherwise, it may be challenged as a “waste” of corporate assets.
Fact Pattern 4 - Shareholders
The power to manage the corporation generally is vested in the directors. Generally, the shareholders have no direct control in management of the corporation’s business.
Close Corporations
Shareholders: Management and Liability
Shareholders can run the corporation directly in a close corporation. The characteristics of a close corporation are that there are few shareholders and the stock is not publicly traded. Shareholders can also run the corporation directly through a shareholder management agreement, described below. If the articles do not include such a special provision, shareholders exercise only indirect control of the corporation through their voting power, by which they elect and remove directors, adopt and modify bylaws, and approve fundamental changes in the corporate structure.
Shareholder Management Agreements
Under the GBCC, if the corporation’s stock is not traded on a national exchange, shareholders can enter into a shareholder management agreement that eliminates the board and sets up management by shareholders, a third party, or a single person. This allows for less formal management. If the articles don’t include such a special provision, shareholders exercise only indirect control of the corporation through their voting power, by which they elect and remove directors, adopt and modify bylaws, and approve fundamental changes in the corporate structure. There are 2 ways to set up a shareholder management agreement:
- In the articles or bylaws and approved by all shareholders OR
- By unanimous written shareholder agreement
Either way, this authorization should be noted conspicuously on the front and back of the stock certificates. These agreements are limited to terms of no more than 20 years. If the shareholders do this and set up management by shareholder or by a manager, who owes the duties of care and loyalty to the corporation? It’s whoever manages the corporation. Managing shareholders will thus have the liabilities that a director ordinarily would have with respect to that power.
Special Fiduciary Duty in Close Corporations
We just saw that whoever manages the corporation will owe the duties of care and loyalty to the corporation. In addition, courts may impose a fiduciary duty on shareholders owed to other shareholders in the close corporation. Why? Because a close corporation looks like a partnership (with few owners, who usually are employed by the business). Because partners owe each other a fiduciary duty of utmost good faith, courts apply the same duty in the close corporation.
- Duties of Controlling Shareholders to Minority Shareholders: A controlling shareholder must refrain from using his control to cause the corporation to take action that unfairly prejudices minority shareholders. For example, the controlling shareholders might deny the minority any voice in corporate affairs, fire them from employment, refuse to declare dividends, and refuse to buy the minority’s stock (so the minority is getting no return on investment).
- Oppression of Minority Shareholders: If there is oppression of minority shareholders, they can sue the controlling shareholders who oppress them for breach of the fiduciary duty owed to them. Why do some courts let the minority shareholder sue here? Because oppression thwarts their legitimate goals for investing and they have no way out.
Statutory Close Corporation
To be a statutory close corporation,
1. the articles must say it’s a statutory close corporation;
2. there must be 50 or fewer shareholders; and
3. the shares must not be publicly traded. No board of directors is required.
The managing shareholders, in that case, would owe the duties of care and loyalty to the corporation.
Professional Corporations
Shareholders: Management and Liability
Licensed professionals may elect to incorporate and practice as a professional corporation.
Formation
The name of a professional corporation (“P.C.”) must include “associated,” “professional association,” “professional corporation,” or an abbreviation of one of these terms. The articles are basically the same as those for a regular business corporation and are filed in the same way, but must state that the purpose is to practice in the profession named and that the corporation is governed by the Georgia Professional Corporation Act (“GPCA”).
Employees
Shareholders of a P.C. must be licensed professionals. A P.C. may practice only one profession through its officers, employees, and agents who are duly licensed to practice that profession in Georgia. At least one director and the president must be a licensed professional. May the P.C. employ non-professionals? Yes, but not to render professional services to the public.
Liability
Each professional in the P.C. is personally liable for her own malpractice, despite the corporate form. Remember: everyone is liable for their own torts. The professional corporation itself is also liable for the malpractice of one of its shareholders in rendering professional services. However, the professionals are not vicariously liable for other shareholders’ malpractice or for the P.C.’s liabilities. This is one advantage of forming a P.C. rather than a partnership.
Operation
In general, the rules governing regular corporations apply to the P.C. For example, merger (discussed below) works the same for P.C.s as for regular corporations. What happens to a shareholder’s stock when she dies or retires? The P.C. buys her stock back within 6 months.
Except where the GPCA provides otherwise, a professional corporation operates in the same manner as a regular business corporation. Thus, general corporate law issues—such as voting, board decisionmaking, piercing the corporate veil—can arise in the professional corporation just as they do in a general business corporation. This can be an important point in a bar exam question.
Professions to Which Applicable
The GPCA applies to persons licensed to practice: certified public accountancy, architecture, chiropractic, dentistry, professional engineering, land surveying, law, pharmacy, psychology, medicine and surgery, optometry, osteopathy, podiatry, veterinary medicine, registered professional nursing, and harbor piloting.
Can Shareholders Be Held Liable for the Acts or Debts of the Corporation?
Shareholders: Management and Liability
Shareholders generally cannot be held liable for corporate debts. Why? Because the corporation is liable for what it does. But a shareholder might be personally liable for what the corporation did if the court pierces the corporate veil. This can happen in close corporations only.
Piercing the Corporate Veil
Shareholders: Management and Liability
To pierce the corporate veil and hold shareholders personally liable:
- The shareholders must have abused the privilege of incorporating AND
- Fairness must require holding them liable
So courts may pierce the corporate veil to avoid fraud or unfairness by shareholders in a close corporation, such as evasion of contract or tort responsibility or evasion of public policy. But something like sloppy administration is not enough.
Common Scenarios -
Elements Justifying Piercing
Shareholders: Management and Liability
There are 3 situations in which the corporate veil is often pierced:
Alter Ego (Identity of Interests)
If the corporation ignores corporate formalities such that it may be considered the “alter ego” of the shareholders or another corporation, the corporate veil may be pierced. These situations may arise if shareholders treat corporate assets as their own, fail to observe corporate formalities, and so on, and some basic injustice results.
Undercapitalization
In Georgia, the corporate veil may be pierced for undercapitalization only if the corporation was undercapitalized at formation with the intent to avoid the corporation’s further obligations.
Note: It is hard to prove the intent element required for undercapitalization. A corporation generally will not be considered undercapitalized if the shareholders provided unencumbered capital reasonably adequate for its prospective liabilities.
Avoidance of Existing Obligations, Fraud, or Evasion of Statutory Provisions
The corporate veil may be pierced if necessary to prevent fraud or to prevent an individual shareholder from using the entity to avoid his existing personal obligations. But the mere fact that an individual chooses to adopt the corporate form of business to avoid future personal liability is not itself a reason to pierce the corporate veil.
Who is Liable?
Shareholders: Management and Liability
Normally, only shareholders who were active in the operation of the business will be personally liable. Liability is joint and several. Remember, piercing the corporate veil allows imposition of liability on a shareholder. That shareholder might be another corporation. For example, a parent corporation forms a subsidiary to avoid its own obligations. The court might pierce the corporate veil and hold the parent corporation liable just as it could if the shareholder were a human.
Types of Liability
Shareholders: Management and Liability
The corporate veil is easily pierced in tort cases, but not in contract cases since parties who contracted with the corporation had an opportunity to investigate its stability. Note that if the corporation is insolvent, claims of shareholder-creditors may be subordinated to outside creditors’ claims if equity so requires (for example, because of fraud).
Who May Pierce?
Shareholders: Management and Liability
Generally, creditors may be allowed to pierce the corporate veil. Courts almost never pierce the veil at the request of a shareholder.
Shareholder as Plaintiff and Recovery
Shareholders: Derivative Suits
In a derivative suit, a shareholder is suing to enforce the corporation’s claim, not her own personal claim. In other words, if a shareholder believes the corporation has been wronged but the directors have not done anything to enforce its rights with respect to the wrong, the shareholder may be able to bring a shareholder derivative suit to enforce the corporation’s rights. It’s a case in which the corporation is not pursuing its own claim, so a shareholder steps in to prosecute it for the corporation.
So, you should always ask: could the corporation have brought this suit? If so, it’s probably a derivative suit
Direct Actions
Shareholders: Derivative Suits
A direct action may be brought for a breach of a fiduciary duty owed to the shareholder by an officer or director. To distinguish breaches of duty owed to the corporation and duties owed to the shareholder, ask: (1) who suffers the most immediate and direct damage, the corporation or the shareholder; and (2) to whom did the defendant’s duty run, the corporation or the shareholder? In a shareholder direct action, any recovery is for the benefit of the individual shareholder.
Recovery to Corporation
Shareholders: Derivative Suits
In a derivative action, the shareholder is asserting the corporation’s rights rather than her own right. So if a shareholder-plaintiff wins a derivative suit, who gets the money from the judgment? The corporation. Remember, it is the corporation’s claim.
Court May Order Payment of Expenses
The shareholder-plaintiff may recover costs and attorneys’ fees, usually from the judgment won for the corporation (after all, the shareholder did a favor for the corporation by suing and winning). If the shareholder-plaintiff loses the derivative suit, she cannot recover costs and attorneys’ fees. If the court finds that the action was commenced or maintained without reasonable cause or for an improper purpose, it may order the plaintiff to pay reasonable expenses of the defendant. So the shareholder may be liable to the defendant she sued for that defendant’s attorneys’ fees if she sued without reasonable cause.
Standing
Shareholders: Derivative Suits - Requirements
Stock Ownership at Time of Wrong
To commence and maintain a derivative proceeding, a shareholder must have been a shareholder at the time the claim arose or must have become a shareholder through transfer by operation of law from someone who did own stock at the time the claim arose (the person must also hold stock throughout the litigation). Examples of “transfer by operation of law” include getting stock through inheritance or by divorce decree.
Adequate Representation
The shareholder must also fairly and adequately represent the corporation’s interest.
Demand Requirements
Shareholders: Derivative Suits - Requirements
The shareholder must make a written demand on the corporation (usually, that means the board) to take suitable action. A derivative proceeding may not be commenced until 90 days have elapsed from the date of the demand, unless:
1. the shareholder has earlier been notified that the corporation will not act (meaning, for example, that the directors have rejected the demand); or
2. irreparable injury to the corporation would result by waiting for the 90 days to pass.
This demand is apparently never excused, even if the present directors will be the defendants.
Corporation Joined as Defendant
Shareholders: Derivative Suits - Requirements
The corporation must be joined to the suit as a defendant. Even though the suit asserts the corporation’s claim, since the corporation did not do so, it is joined initially as a defendant.
Dismissal or Settlement Requires Court Approval
The parties can settle or dismiss a derivative suit only with court approval. The court may give notice to shareholders and get their input on whether to settle or dismiss.
Corporation May Move to Dismiss
After the derivative suit is filed, the corporation may move to dismiss upon an independent good faith investigation that shows the suit is not in the corporation’s best interests (for example, there was a low chance of success or the expense would exceed recovery). If the court finds that such investigation was made in good faith by independent directors or a court-appointed panel of one or more independent persons, it will dismiss the case.
Expenses
Upon termination of a derivative action, the court may order the corporation to pay the plaintiff’s reasonable expenses if it finds that the action has resulted in a substantial benefit to the corporation. If the court finds that the action was without reasonable cause or for an improper purpose, it may order the plaintiff to pay reasonable expenses of the defendant.
Outstanding Stock and Record Shareholders
Shareholders: Voting
Remember, authorized stock is the number of shares the corporation may issue (it’s set in the articles). Issued stock is the number of shares the corporation has sold. So what’s outstanding stock? It’s the shares the company has issued but has not reacquired.
Note that unless the question says otherwise, you should assume that each outstanding share gets one vote. But you must be the record shareholder as of the record date to vote, as discussed below.
General Rule—Record Shareholder and Record Date
Shareholders of record on the record date may vote at the meeting. The record date is a voter eligibility cut-off. The record date is fixed by the bylaws or the board of directors but may be no less than 10 or more than 70 days before the meeting. Joint owners of shares must unanimously agree on how the shares will be voted, or no vote can be cast.
Exceptions
There are a few exceptions to the general rule that the record owner on the record date is who votes:
- Reacquired Stock: Suppose the corporation reacquires stock before the record date, so the corporation is the owner as of the record date. Does the corporation vote this stock? No. No one votes this stock, because it was not outstanding on the record date.
- Death of Shareholder
- Voting By Proxy: A shareholder may vote her shares in person or by proxy (meaning, she appoints someone to vote her shares). A proxy is (1) a writing (fax and email are fine), (2) signed by the record shareholder (email is fine if the sender can be identified), (3) directed to the secretary of the corporation, (4) authorizing another to vote the shares. Proxies are valid for 11 months unless they provide otherwise.
- Revocation of Proxy: A proxy is generally revocable by the shareholder and may be revoked in writing, by the shareholder attending the meeting to vote himself, or by subsequent appointment of another proxy.
- Irrevocable Proxies: A proxy will be irrevocable only if it states that it is irrevocable and is coupled with an interest or given as security. This requires (1) the proxy says it’s irrevocable and (2) the proxyholder has some interest in the shares other than voting.
- Statutory Proxy Control: The rules governing proxy solicitation provide that (1) there must be full and fair disclosure of all material facts with regard to any management-submitted proposal upon which the shareholders are to vote; (2) material misstatements, omissions, and fraud in connection with the solicitation of proxies are prohibited; and (3) management must include certain shareholder proposals on issues other than election of directors, and allow proponents to explain their position.
- Holder Not of Record: A receiver or a representative of the record holder (for example, administrator, executor, guardian) may vote the shares without a transfer of such shares into his name.
Shareholder Voting Trusts and Voting Agreements
Shareholders: Voting
Voting Trusts and Pooling Agreements
Let’s say X, Y, and Z own relatively few shares of C Corp. An exam question might ask you for your opinion as to how they might pool their voting power. They may do so in a voting trust or a voting agreement. These are fine if they’re for a proper purpose. For instance, it’s okay to do so to prevent rivals from taking control, but it is not okay to do so to guarantee yourself a large salary.
Requirements for Voting Trust: A voting trust is a written agreement of shareholders under which all of the shares owned by the parties to the agreement are transferred to a trustee. The trustee votes the shares and distributes the dividends in accordance with the provisions of the voting trust agreement. The trust is not valid for more than 10 years, but it can be extended for additional terms of up to 10 years. The requirements are:
- A written trust agreement controlling how the shares will be voted
- Legal title to the shares is transferred to the voting trustee
- Transfer of legal title is recorded with the corporation (including a list of the names and addresses of the beneficial owners of the trust and the number and class of shares each one transferred to the trust)
- The original shareholders receive trust certificates and retain all shareholder rights except for voting
- Requirements for Voting (Pooling) Agreement
Rather than creating a trust, shareholders may enter into a voting (or “pooling”) agreement providing for how they’ll vote their shares. The requirements are that the agreement be in writing and signed. A voting agreement is not valid for more than 20 years, but it can be renewed for an additional 20 years. It will be specifically enforceable.
Convening Meetings
Shareholders: Voting
Shareholders usually take action at a meeting that satisfies quorum and voting rules. Or, they can act by unanimous written (fax and email are fine) consent signed by the holders of all voting shares. (Additionally, the articles can provide for action without a meeting with less than unanimous approval.) Shareholder meetings can be held within or outside Georgia. The meetings can be held via telephone or internet as long as the participants can communicate with one another (participation is presence). There are 2 kinds of shareholder meetings:
Annual Meetings
Corporations must hold annual shareholders’ meetings. If the annual meeting is not held within the earlier of 6 months after the end of the corporation’s fiscal year or 15 months after its last annual meeting, a shareholder may seek an order from the superior court that the meeting be held. And what do shareholders do at the annual meeting? Primarily, they elect directors.
Special Meetings
Special meetings may be called by (1) the board of directors, (2) the holders of 25% or more of all shares entitled to vote at the meeting, or (3) anyone else authorized in the articles or bylaws. Note that the board may increase the percentage of shares needed to call a special meeting. Also, remember that shareholders’ special meetings must be called for a proper shareholder purpose.
Notice
Shareholders: Voting
Every shareholder entitled to vote must be notified of meetings (whether annual or special) not less than 10 or more than 60 days
before the meeting. Notice may be given, usually in writing (fax or email are fine) but reasonable oral notice works as well. The notice must be given to every shareholder entitled to vote. This applies to every meeting (annual or special). Notice may be waived in writing or by attendance.
Contents of the Notice
The notice must state the date, time, and place of the meeting. For special meetings, the notice must also state the purpose of the meeting. Why is the statement of purpose important? The shareholders cannot do anything else at that meeting. Also, if a fundamental corporate change or removal of a director is on the agenda (even at an annual meeting), the notice must say so.
Consequences of Failure to Give Proper Notice
If proper notice is not given to all shareholders, whatever action was taken at the meeting is voidable unless those who were not given notice waive the notice defect. How can such a waiver occur? In either of 2 ways:
- Express waiver, meaning in writing and signed any time (fax or email are fine) OR
- Implied waiver, meaning the shareholder(s) attend(s) the meeting without objecting at the outset
How Do Shareholders Vote?
Shareholders: Voting
Shareholders generally get to vote on these things:
- To elect directors
- To remove directors
- On fundamental corporate changes
They may also vote on other things, such as amending bylaws, or if the board asks for a shareholder vote on other things.
Quorum
Shareholders: Voting
Every time the shareholders vote, we must have a quorum represented at the meeting. If a quorum is not present, the only action the shareholders can take is to adjourn the meeting. Determination of a quorum focuses on the number of shares represented, not the number of shareholders. The general rule is that a quorum requires a majority of the outstanding shares, unless the articles or bylaws specify a greater or lesser number (but no less than one-third of the shares). Note that a shareholder quorum will not be lost if people leave the meeting.
Voting—In General
If the quorum requirement is met, the shareholders may vote. Absent a contrary provision in the articles, each share is entitled to one vote. However, the articles may provide for weighted or contingent voting. If a quorum is present, generally, shareholders will be deemed to have approved a matter if the votes cast in favor of the matter exceed the votes cast against the matter, unless the articles or bylaws require a greater proportion. Unless the articles or bylaws provide otherwise, the specific votes required for certain matters are:
- To elect a director: Plurality (meaning, the person who gets more votes for that seat on the board than anyone else is elected)
- To remove a director: Majority of the shares entitled to vote
- To approve a fundamental corporate change: As we’ll see later, usually a majority of all outstanding shares entitled to vote
- Other matters: Majority of the shares that actually vote on the issue
Cumulative Voting Optional
Shareholders: Voting
Cumulative voting is a system that gives smaller shareholders a better chance of electing someone to the board of directors. It is available only when shareholders elect directors. If the articles are silent about cumulative voting, it does not exist.
Compare—Straight Voting
Usually, with “straight” voting, we have a separate election for each seat on the board being elected. Each outstanding share gets one vote for each seat. The candidate who gets more votes than any other is elected to that seat.
Mechanics of Cumulative Voting
With cumulative voting, we don’t vote for each seat individually. We have one at-large election. The top 2 (or however many) finishers are elected to the board. To determine your voting power when cumulative voting exists, multiply the shareholder’s number of voting shares times the number of directors to be elected. The total number may be divided among the candidates in any manner that the shareholder desires, including casting them all for the same candidate.
Class Voting
Whenever an amendment to the articles of incorporation will affect only a particular class of stock, that class has a right to vote on the action even if the class otherwise does not have voting rights.
Stock Transfer Restrictions
Shareholders: Stock Transfer Restrictions
One great thing about corporations is transferability of the ownership interest. A shareholder can sell or give her stock away. Sometimes people want to restrict transferability, especially in a close corporation (so they can keep outsiders out). Transfer restrictions may:
- Require the corporation or other persons to purchase the shares (one common agreement is to require the corporation or other shareholders to buy a shareholder’s stock when she wants to liquidate her holdings)
- Require the shareholder to offer the first opportunity to purchase the shares to the corporation or specified other persons (“RFR”)
- Require the corporation or any other person to approve the transfer
- Prohibit transfer to specified persons or specified classes of persons
For example, S is a shareholder of Corporation, Inc. Her stock is subject to a right of first refusal. S sells the stock to X, a third party, in violation of the agreement. Was she allowed to do so? To figure this out, we need to know a few rules regarding stock transfer restrictions.
Restrictions Are Fine If Reasonable
Shareholders: Stock Transfer Restrictions
Restrictions are valid if they are not an undue restraint on alienation. The RFR is valid. It does not restrict the ability to transfer, but only requires the shareholder to offer the stock first to the corporation. So it’s not unreasonable, as long as the corporation pays a reasonable price. In addition to any reasonable purpose, the articles, bylaws, or a shareholder agreement may restrict the sale of shares to maintain corporate status when it is dependent on the number or identity of the shareholders (for example, to maintain close corporation status), or to preserve exemptions under the securities laws.
Enforcing Restriction Against Transferee
Shareholders: Stock Transfer Restrictions
If the restriction is valid, can it be enforced against the transferee, a third-party purchaser (X, in our example)? Yes, if (1) the restriction is conspicuously noted on the stock certificate or (2) the transferee had actual knowledge of the restriction at the time of the purchase.
Transfer Requirements
Shareholders: Stock Transfer Restrictions
Stock may be certificated (that is, represented by stock certificate) or uncertificated. Shareholders’ rights and liabilities are not affected by how ownership is represented, but the requirements for transfer depend on whether stock is certificated or uncertificated. Transfer of control over certificated shares generally is accomplished by delivering the stock certificate to the transferee. If the stock is uncertificated, control generally is transferred by obtaining an agreement from the issuer that it will comply with the purchaser’s instructions regarding the stock.
Inspection Rights
Shareholders: Right to Inspect
A shareholder has the right, personally or by an agent, to inspect (and copy) the books and records of the corporation. The right to inspect may not be limited by the articles, except that the articles may limit inspection of limited access records to shareholders owning more than 2% of the outstanding shares.
Procedure
Shareholders: Right to Inspect
The procedure followed depends on the material sought. Generally, for sensitive information (that is, information that generally should be kept secure from outsiders), shareholders have an unqualified right of access; for more sensitive material, their right of access is qualified.
Unqualified Right for Certain Records
Any shareholder has the right to demand access to inspect and copy during regular business hours the following records:
- The articles and bylaws
- The most recent annual registration statements
- The names and business addresses of the current directors and officers
- Minutes of shareholder meetings and related documents and actions taken by shareholder consent within the past 3 years
- All communications in writing or by electronic transmission to shareholders within the past 3 years
- Resolutions increasing or decreasing the number of directors or creating classes or series, fixing their relative rights, if shares have been issued pursuant to the resolution
The shareholder must make a written demand at least 5 business days in advance. The shareholder need not make a statement of why she wants to see these documents.
Qualified Right
For more sensitive material, such as:
- Corporate accounting records A list of the shareholders
- Minutes from the directors’ meetings or shareholders’ meetings if not available under the unlimited access provision (for example, more than 3 years old)
- Records of action taken by a committee acting in place of the board or by the board, or by the shareholders without a meeting if not available under the unlimited access provision, the shareholder must state a proper purpose for the demand. What’s a proper purpose? It’s one that’s reasonably related to the person’s interest as a shareholder. The records must be directly connected to the stated purpose and can be used only for that purpose. The shareholder also must provide 5 business days’ advance notice.
Failure to Allow Proper Inspection
Shareholders: Right to Inspect
If the corporation fails to allow proper inspection, the shareholder can seek an order from the superior court, which has the power to compel production of the records.
Directors’ Inspection Rights
Shareholders: Right to Inspect
Recall that directors need not go through this procedure to get access to corporate books and records. Directors have unfettered access to such materials.
Distributions
Shareholders: Distributions
Distributions are payments by the corporation to shareholders.
Types of Distributions
Shareholders: Distributions
Distributions can take the form of dividends, repurchases of a shareholder’s stock, or redemptions (meaning, a forced sale to the corporation at a price set in the articles). The board may declare distributions out of cash, property, or its own shares—provided that the funds are legally available, as we’ll see below.
Right to Distributions
Shareholders: Distributions
Declaration Generally Solely Within Board’s Discretion
The decision whether to declare distributions generally is within the directors’ discretion. A shareholder has a “right” to a dividend or other distribution only when the board declares it.
Compelling Distributions
The shareholders have no general right to compel a distribution. Because the decision about distributions is the board’s, it’s difficult to win a case to force the declaration of a distribution. To win, the plaintiff must show a gross abuse of discretion (directors acted in bad faith or otherwise in violation of their duties). For example, maybe the corporation consistently makes profits and the board refuses to declare a dividend while paying themselves a bonus.
Which Shareholders Get Dividends
Shareholders: Distributions
The record shareholder of the stock as of the record date will receive the dividend.
Terminology
Shares may be divided into classes with varying rights (for example, some classes may be redeemable, others not; some may have no right to receive distributions, others could have preferences, and so on). Note that distribution payments may not discriminate between members of the same class of stock or violate the preferences of a preferred class of shareholders. Preferred stock is paid before common stock is paid. The right to the preferred dividend may or may not accumulate if unpaid in a particular year (that is, “cumulative” vs. “noncumulative” preferred shares), or may accumulate only if there are sufficient current earnings (that is, “cumulative if earned” preferred shares). Preferred shares have no right to a share of the distributions made on common shares unless the preferred shares provide that they are “participating.”
Determining the Legality of Any Distribution
Shareholders: Distributions
The corporation must be solvent for payment of a distribution to be legal. So a corporation cannot make a distribution if it is insolvent or if the distribution would render it insolvent. Insolvent means either:
- The corporation is unable to pay its debts as they come due OR
- Total assets are less than total liabilities (liabilities include preferential liquidation rights, which we’ll discuss below)
Liability for Unlawful Distributions
Shareholders: Distributions
Director Liability
Directors are jointly and severally liable for an improper distribution if declaring it was grossly negligent, reckless, or intentional.
A director who votes for or assents to a distribution that violates the above rules is personally liable to the corporation for the amount of the distribution that exceeds what could have been properly distributed, if it’s established that he did not perform his duties with regard to the distribution. But remember, directors have a good faith reliance defense: A director isn’t liable for distributions if in making the determination that a distribution is not prohibited, the board relied on financial statements prepared on the basis of reasonable accounting statements, or on a fair valuation or other reasonable method. A director who is held liable for an unlawful distribution is entitled to contribution from
1. every other director who could be held liable for the distribution (that is, those who voted in favor of the distribution) and
2. each shareholder who knowingly accepted an unlawful distribution.
Shareholder Liability
Shareholders are personally liable only if they knew the distribution was improper when they received it. Their maximum liability is the distribution they received.
Fact Pattern 5 - Fundamental Corporate Changes
Types of Fundamental Corporate Changes
Fundamental Corporate Changes
Fundamental corporate changes are extraordinary, so the board generally cannot do them alone. They include the following types of changes:
- Amending the articles
- Merging or consolidating into another company
- Transferring substantially all assets (or having stock acquired in a “share exchange”)
- Converting to another form of business
- Dissolving
Procedure for Fundemental Corporate Changes
Fundamental Corporate Changes
Generally, to do any fundamental corporate change, we need:
1. the board to adopt a resolution of fundamental change;
2. the board to submit the proposal to the shareholders and give written notice of a meeting to vote on the proposal;
3. the shareholders to approve the changes by a majority of all outstanding votes entitled to be cast; and
4. in most cases, the changes in the form of articles to be filed with the state.
Note the distinction between shareholder voting on regular issues and shareholder voting on fundamental changes: Regular issues can be approved by a majority of the shares cast at a meeting, as long as there is a quorum, whereas a fundamental corporate change must be approved by a majority of all votes entitled to be cast—not just those cast at a meeting.
Dissenting Shareholders’ Right of Appraisal
Fundamental Corporate Changes
If a corporation approves a fundamental change, the shareholders who did not vote in favor of the change may have appraisal rights. The dissenting shareholder right of appraisal is the right of a shareholder to force the corporation to buy their stock for fair value.
Applies Only to Certain Fundamental Changes
Only certain fundamental corporate changes will trigger the right of appraisal:
- Certain amendments to the articles
- A plan of merger to which the corporation is a party, generally if approval of the shareholders is required or if the corporation is a subsidiary that is merged with its parent
- A sale or exchangeof all or substantially all of the corporation’s property if shareholder approval is required; however, if the sale is for cash pursuant to a plan by which the net proceeds of the sale will be distributed to the shareholders within 1 year after the date of sale, then there is no right of appraisal (because such a deal essentially amounts to dissolution of the corporation)
- A plan of share exchange to which the corporation is a party as the corporation whose shares will be acquired, if the shareholder is entitled to vote on the plan
- Any other corporate action taken pursuant to shareholder vote to the extent that the articles, bylaws, or board resolution provide for the right to dissent
Exists in Close Corporations
Note that even if the company is doing 1 of these changes, there is no appraisal right if the company’s stock is listed on a national exchange (that is, it’s a publicly traded corporation) or if the company has 2,000 or more shareholders (not shares, shareholders), unless the articles or board provide otherwise. Note that appraisal rights are also not available in a merger or share exchange if the holders are required to accept for their shares anything except shares of a publicly held corporation of comparable status. In other words, the right of appraisal exists in close corporations. This makes sense because if you don’t like a fundamental change in a public corporation, you can just sell your stock on the public market. But in a close corporation, there is no market to buy the stock, so you can force the company to buy your stock. In our hypotheticals in this section, we’ll assume we’re dealing with a close corporation.
Exclusive Remedy
The right of appraisal is a shareholder’s exclusive remedy if they don’t like a fundamental change unless a vote was obtained by fraudulent and deceptive means or the corporate action failed to comply with procedural requirements or with the corporation’s articles or bylaws.
Perfecting Right of Appraisal
For a shareholder to perfect a right of appraisal:
- Before a vote is taken, the shareholder must deliver written notice of her intent to demand payment for her shares if the proposed action is taken. She cannot vote in favor of the proposed action (so she can abstain or vote against it).
- Within 10 days after the corporate action is taken, the corporation must send a dissenter’s notice to shareholders who have filed their intent to demand payment.
- The shareholder must demand payment within the time specified within the dissenter’s notice, or she will not be entitled to payment for her shares. The dissenter’s notice states where payment demand must be sent and sets a date by which demand must be received (not less than 30 or more than 60 days after the date on which the notice is delivered).
- Within 10 days after approval or a payment demand is received (whichever is later), the corporation must offer to pay each dissenter the amount it estimates to be the fair value of her shares, plus interest.
If the shareholder is dissatisfied with the corporation’s determination of fair value, the shareholder has 30 days in which to send the corporation her own estimate of fair value. If the corporation thinks the shareholder’s demand is too high, it must file suit in court within 60 days for a determination of fair value. To aid determination of the fair value, the court may appoint an appraiser.
Amendments to the Articles of Incorporation
Fundamental Corporate Changes
A corporation can amend its articles with any provision that would be lawful in original articles on the day of amendment by following the procedure described above (board of director action, notice to shareholders, and then shareholder approval). Note that certain “housekeeping” amendments (for example, deleting the names of initial directors named in the articles or changing the number of authorized shares after a stock split) can be made without shareholder approval. If the amendment is approved, there are dissenting shareholder rights of appraisal only if the amendment harmed the shareholder’s rights. If approved, the certificate of amendment must be delivered to the Secretary of State.
Mergers
Fundamental Corporate Changes
A merger involves the blending of 1 or more corporations into another corporation, and the latter corporation survives while the merging corporations cease to exist following the merger (for example, B, Inc. merges into A Corp., after which B, Inc. disappears and A Corp. survives). For this change, board of director action (by both corporations) is required, as well as notice to shareholders and shareholder approval, generally by both corporations (the required vote is a majority of the shares entitled to vote). If approved, the surviving corporation must deliver articles of merger to the Secretary of State. There is a right of appraisal, generally, for shareholders of both corporations entitled to vote on the merger and also for shareholders of the subsidiary in a short form merger (discussed below).
No Shareholder Approval Required In Certain Circumstances
Fundamental Corporate Changes
Short Form Merger of Subsidiary
No shareholder approval is required for a short form merger. With short form mergers, a parent corporation owning at least 90% of the outstanding shares of each class of a subsidiary corporation may merge the subsidiary into itself without the approval of the directors or shareholders of the subsidiary. Only the directors of the parent need approve the merger (approval by shareholders of the parent corporation is needed only if their rights will be substantially affected by the merger).
No Significant Change to Surviving Corporation
Shareholders have no right to vote on a merger or share exchange if: (1) their corporation’s articles remain unchanged; (2) their share of ownership remains unchanged; and (3) the shares outstanding after the merger or share exchange were authorized before the merger or share exchange.
Effect of Merger
Fundamental Corporate Changes
The surviving corporation succeeds to all rights and liabilities of the disappearing corporation. This makes sense because 1 corporation disappeared. So a creditor of that corporation can sue the survivor. This is known as successor liability.
Transfer of All or Substantially All Assets and Share Exchange
Fundamental Corporate Changes
Another fundamental corporate change involves the transfer (sale, lease, exchange, or other disposition) of all or substantially all of the assets of a corporation not in the ordinary course of business. We can group this together with a similar fundamental corporate change, the share exchange, which is when one company acquires all of the stock of another. We treat these alike because functionally, they’re the same idea: one company is gobbling up another (either all of its assets or all of its stock).
Fundamental Corporate Change for Selling Corporation Only
Fundamental Corporate Changes
Both the transfer of all or substantially all assets and the share exchange are fundamental corporate changes for the selling corporation only—not for the buyer. So the corporation disposing of the property must follow the fundamental change procedure.
Fundamental Corporate Change for Selling Corporation Only: Procedure
Fundamental Corporate Changes
Board action by both corporations is required, as well as notice to the selling corporation’s shareholders. We also need approval by the selling corporation’s shareholders only. There are dissenting shareholder rights of appraisal for shareholders of the selling corporation (but not for shareholders of the buying corporation). For a share exchange, articles of exchange must be delivered to the Secretary of State. No filing is required in a transfer of assets.
Fundamental Corporate Change for Selling Corporation Only: Successor Liability
Fundamental Corporate Changes
For the sale of substantially all assets, we do not expect successor liability. Why? Because the selling corporation still exists, meaning creditors can still sue it. So the company that buys assets is not liable for the debts of the company that sold the assets (unless it agrees to be). However, there is an exception if the buyer is a “mere continuation” of the seller, that is, it has the same management, shareholders, and so on.
Fundamental Corporate Change for Selling Corporation Only: Conversion
Fundamental Corporate Changes
A conversion involves one business entity changing its form to another business form, such as a corporation converting itself into an LLC or a limited partnership. The procedure for undertaking this fundamental corporate change will sound familiar: we need board approval and notice to shareholders, as well as unanimous approval by the shareholders. We also need to deliver a document showing conversion to the Secretary of State.
Dissolution
Fundamental Corporate Changes
Dissolution of a corporation may be voluntary or involuntary (by court order).
Voluntary Dissolution
Fundamental Corporate Changes
Dissolution by Incorporators or Initial Directors
If shares have not yet been issued or business has not yet been commenced, a majority of the incorporators or initial directors may dissolve the corporation by delivering articles of dissolution to the state. All corporate debts must be paid before dissolution, and if shares have been issued, any assets remaining after winding up must be distributed to the shareholders.
Dissolution by Corporate Act
The corporation may dissolve by a corporate act approved under the fundamental change procedure. This means that we need board of director action and shareholder approval. In addition, the corporation must (1) publish a notice of intent to dissolve and notify creditors so they can make any claims, (2) file a notice of intent to dissolve with the Secretary of State, (3) cease all business activity except that necessary to wind up its affairs, and (4) file articles of dissolution with the state after winding up is completed.
Revocation of Voluntary Dissolution Proceedings
At any time prior to filing the articles of dissolution, the dissolution may be revoked if authorized by a majority vote of shareholders and a notice of revocation of intent to dissolve is filed with the state.
Involuntary Dissolution
Fundamental Corporate Changes
Involuntary dissolution is also known as “judicial dissolution” because, as mentioned, it happens by court order. Different players can ask for this.
Action by Shareholders
Shareholders may petition for involuntary dissolution on any of the following grounds:
- The directors are deadlocked in the management of corporate affairs, the shareholders are unable to break the deadlock, and the corporation is suffering or is threatened with irreparable injury
- Corporate assets are being misapplied or wasted
- The shareholders are deadlocked in voting power and have failed to elect successor directors for a period that includes at least 2 consecutive annual meeting dates OR
- The directors have acted in a manner that is illegal, oppressive, or fraudulent, and the proceeding is initiated with at least 20% of the holders of the outstanding shares
- Election to Purchase in Lieu of Dissolution: As an alternative to ordering involuntary dissolution, a court might order a buy-out of the objecting shareholder. This might be especially likely in a close corporation.
Creditors
Creditors may petition for dissolution if the corporation is insolvent and: (1) the creditor’s claim has been reduced to judgment which is unsatisfied; or (2) the corporation has admitted in writing that the creditor’s claim is due and owing.
Action by Attorney General
The attorney general may seek involuntary dissolution of a corporation on the ground that the corporation fraudulently obtained its articles of incorporation or that the corporation is exceeding or abusing its authority.
Administrative Dissolution by Secretary of State
Fundamental Corporate Changes
The state may bring an action to administratively dissolve a corporation for reasons such as the failure to pay fees or penalties, failure to pay its license tax for 1 year, failure to file an annual report, and failure to maintain a registered office and/or agent in the state. The state must serve the corporation with written notice of the failure. If the corporation does not correct the grounds for dissolution or show that the grounds do not exist within 60 days after service of notice, the Secretary of State can sign a certificate of dissolution, dissolving the corporation. The corporation can apply for reinstatement within 5 years after the effective date of dissolution. The application must state that the grounds for dissolution either did not exist or have been eliminated and that all taxes owed have been paid. Reinstatement relates back to the date of dissolution, and the corporation may resume carrying on business as if the dissolution had never occurred.
Winding Up
Fundamental Corporate Changes
Dissolution is not the end of the corporation. It is the beginning of a process that will end the corporate existence. The corporation continues to exist, so it can sue and be sued. It cannot start new business but must wind up (liquidate). Winding up consists of: (a) gathering all assets, (b) converting them to cash, (c) paying creditors, and (d) distributing the remainder of cash to shareholders, pro rata by share unless there is a liquidation preference. What’s a liquidation preference? It means “pay first,” so it works like a dividend preference. So if there were 1,000 shares with a liquidation preference of $2, the first $2,000 would go to them upon liquidation. This might come up on the bar exam if the corporation is insolvent. If, during the wind-up, the company gives money to its shareholders rather than its creditors, the creditors can sue the shareholders to recover the money.
