Corporations Flashcards
CORPORATION FORMATION
Articles of Incorporation: Date of Filing
Under the Model Business Corporation Act (MBCA), corporate existence begins when the articles of incorporation are filed. This date of filing rule applies even if the filed articles recite an effective date prior to the date of filing. The MBCA allows the parties to specify a “delayed effective date” but not an earlier effective date.
LIABILITY
Personal liability among individuals of a corporation
Under the MBCA, when a corporation’s articles of incorporation have not been filed, a person is liable for pre-incorporation transactions only when the person purporting to act on behalf of a corporation not yet formed (participation) possesses actual knowledge (knowledge) that the corporation’s charter has not yet been issued.
Actual knowledge—it is not enough to establish liability that a person should have inquired about the entity’s status and should have known that the corporation was not formed.
FIDUCIARY DUTIES
Duties of controlling shareholders
The MBCA does not specify the duties of controlling shareholders to a controlled corporation or its minority shareholders. Instead, the duties of controlling shareholders generally arise as a matter of the court’s “inherent equity power” to fashion fiduciary duties owed by majority shareholders to minority shareholders. Generally, courts have examined business dealings between a controlling shareholder (such as a parent corporation) and the controlled corporation using a fairness test—that is when a parent causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders.
But when the transaction does not involve self-dealing, then the “business judgment” standard applies.
IMPROPER TRANSACTIONS
Director’s conflicting interest transaction (DCIT)
The MBCA defines a DCIT as a transaction effected by the corporation to which a director is a party. Although the common law treated such director self-dealing transactions as null and void, modern courts and statutes will uphold such a transaction if it is properly approved by informed, disinterested directors or shareholders. Absent such approval, the transaction may nonetheless be upheld if the conflicted director shoulders the burden of showing the transaction was fair to the corporation. Fairness can be shown if the director’s self-dealing transaction was beneficial to the corporation on terms comparable to what might have been obtained in an arm’s length transaction. If the conflicted director cannot show that the transaction is fair to the corporation, they have violated their fiduciary duty of loyalty.
IMPROPER TRANSACTIONS
Breach/self-dealing transaction
Generally, the person seeking to justify a self-dealing transaction has the burden of proving its fairness to the corporation. The MBCA has described “fairness” in connection with directors’ conflicting-interest transactions, to include no only the “market fairness of the terms of the deal—whether it is comparable to what might have been obtainable in an arm’s length transaction—but also whether the transaction was one that was reasonably likely to yield favorable results (or reduce detrimental results) for the corporation.
IMPROPER TRANSACTIONS
Usurping corporate opportunity
- The MBCA does not address the duties of controlling shareholders to not usurp corporate opportunities of partially owned corporations. Nonetheless, an official comment to the MBCA explains the corporate opportunity doctrine in connection with the duties of directors: the corporate opportunity doctrine [applicable to directors] is anchored in a significant body of case law clustering around the core question whether the corporation has a legitimate interest in a business opportunity, either because of the nature of the opportunity or the way in which the opportunity came to the director, of such a nature that the corporation should be afforded prior access to the opportunity before it is pursued (or usurped) by a director.
- The American Law Institute (ALI) Principles of Corporate Governance define a corporate opportunity, for purposes of directors and senior executives, generally as a business opportunity where either the person offering the opportunity expects it to be offered to the corporation, the opportunity would be of interest to the corporation or the opportunity is closely related to a business in which the corporation is engaged or expects to be engage. For business opportunities allocated within a corporate group, courts have accepted that the parent should have some leeway in allocating business opportunities within the group.
CORPORATION TRANSACTIONS
Business Judgment Rule
Under the “business judgment” standard, a corporation can offer a rational business justification for a policy or transaction.
The business judgment rule does not protect decisions by directors not acting in good faith.
In basic principle, a board of directors enjoys a presumption of sound business judgment . . . that, in making a business decision, directors act in good faith, on an informed basis, and in the honest belief that the action taken is in the best interests of the corporation. Specifically, the business judgment rule, while normally protecting the honest business judgment of directors, does not apply upon a showing of “illegality.”
Directors breach their fiduciary duties—and the business judgment rule provides no protection— when they approve illegal business operations (or refuse to investigate alleged illegal business activities), even though the illegal business may be profitable to the corporation.
CORPORATE DISSOLUTION
Judicial Dissolution
The MBCA gives courts discretion to order the judicial dissolution of a corporation if a shareholder can demonstrate that the majority (or controlling) shareholder is acting in a manner that is oppressive.
Oppressive—In applying the oppression test, many courts have looked at whether the conduct of the majority shareholders defeats the “reasonable expectations” that the majority knew, or reasonably should have known, were held by the minority shareholders.
SHAREHOLDER MEETINGS
Notice
Unless the articles of incorporation or bylaws provide otherwise, notice of a special meeting of a corporation’s board of directors must be given at least two days prior to the date of the meeting. The notice must include information regarding the time, location, and date of the meeting but does not need to include information regarding the purpose of the meeting.
Waiver of notice—A director who attends a special meeting of the board of directors despite not receiving proper notice waives such notice unless the director objects to the holding of the meeting and thereafter does not vote at the meeting.
SHAREHOLDER MEETINGS
Quorum to Take Action
In order for action taken at a special meeting of directors to be proper, a quorum must be present at the meeting. Unless the articles of incorporation or bylaws provide otherwise, when a corporation has a fixed number of directors, a quorum consists of a majority of that fixed number. If quorum is present, the meeting is legally held.
Simultaneously hearing—While directors generally are entitled to participate in special meetings over the telephone, such participation is valid only if all directors participating may simultaneously hear each other during the meeting. Only directors who satisfy this requirement are deemed to be present at the meeting.
SHAREHOLDER VOTING
Record Date
A record date determines who is entitled to vote at a particular shareholder meeting, namely those persons who were registered as shareholders “of record” on that date.
SHAREHOLDER VOTING
Shareholder Proxy
Generally, a shareholder proxy is revocable. Any action taken inconsistent with a proxy revokes that proxy. A proxy may be made irrevocable only if the proxy form explicitly states so and the proxy is coupled with an interest.
SHAREHOLDER VOTING
Shareholder Voting
A shareholder of record is entitled to attend and vote at an annual shareholders’ meeting unless he or she has executed a valid, irrevocable proxy covering his shares.
SHAREHOLDER VOTING
Reacquired Shares
Shares that are repurchased by a corporation are considered authorized but not outstanding and thus may not be voted. In counting shareholder votes, each outstanding share is entitled to one vote on each matter voted on at a shareholders’ meeting.
SHAREHOLDER VOTING
Conflict between Articles of Incorporation and Bylaws
When a corporation’s articles of incorporation conflict with its bylaws regarding how many shares must vote in favor of a shareholder proposal in order for that proposal to be approved, the articles of incorporation prevail over the bylaws.
LLCs
Limited Liability Company
Under the rule of limited liability, if the LLC becomes indebted, obligated, or otherwise liable to an outside party, no member or manager becomes liable on that debt, obligation, or liability solely by reason of acting as a member or manager.
LLCs
Piercing Corporate Veil
A court may pierce the corporate/LLC veil if there is an indication of fraud or other inequitable conduct in the formation or operation of the entity. There must exist some circumstances that would justify piercing on equitable grounds, such as undercapitalization of the business, failure to follow formalities, commingling of assets, confusion of business affairs, or deception of creditors.
FIDUCIARY DUTIES
Fiduciary Duties
Under a member-managed limited liability company (LLC), members have fiduciary duties to the LLC and other members of the LLC. These fiduciaries include both a duty of loyalty and a duty of care.
FIDUCIARY DUTIES
Duty of Loyalty
Members of a LLC have a duty of loyalty to account to the company and to hold as trustee for the company any benefit derived by the member in the conduct of the company’s activities.
FIDUCIARY DUTIES
Duty of Care
Subject to the business judgment rule, the duty of care requires members of a LLC to act with the care that a person in a like position would reasonably exercise under similar circumstances and in a manner the member reasonably believes to be in the best interests of the company.
LAWSUIT
Derivative Suit
A derivative action in a member-managed LLC may be brought only if 1) a demand is made on the other member to bring an action and the member fails to do so, or 2) such demand would be futile.
The MBCA defines a “derivative proceeding” as one brought “in the right of a domestic corporation.”
The MBCA generally requires that shareholders make a demand on the board of directors before initiation of a derivative suit.
A derivative suit is essentially two suits in one, where the plaintiff-shareholder seeks to bring on behalf of the corporation a claim that vindicates corporate rights, usually based on violation of fiduciary duties.
LAWSUIT
Direct Suit
An LLC is an entity distinct from its members. A member cannot advance a claim on its own behalf against another member unless the complaining member can plead and prove an actual or threatened injury that is not solely the result of an injury suffered or threatened to be suffered by the LLC.
Business opportunities within a corporate group
For business opportunities allocated within a corporate group, courts have accepted that the parent should have some leeway in allocating business opportunities within the group.
Shareholder right to inspect board minutes and accounting records
A shareholder, whether of record or who beneficially owns her shares, has a right to inspect minutes of board meetings and “accounting records” for a proper purpose. A proper purpose is a purpose reasonably related to a person’s interest as a shareholder, “such as a desire . . . to determine whether improper transactions have occurred.”
A shareholder seeking inspection of corporate documents must offer credible evidence that there was mismanagement or other improper conduct.
Under the MBCA, the shareholder’s right to inspect corporate documents relevant to the alleged bribery is subject to certain limitations.
LLCs and member management
When the certificate of organization fails to specify whether the LLC is member-managed or manager-managed, the LLC is presumed to be member-managed, unless the members’ operating agreement specifies how the LLC is to be managed
Under RULLCA, “each member [in a member-managed LLC] has equal rights in the management and conduct of the company’s activities.” Thus, consistent with general agency law principles and with the approach of other acts governing LLCs, each member of a member-managed LLC can bind the company to contracts for apparently carrying on the ordinary business of the company unless the member lacks authority to do so and the other party to the contract has notice that the member lacks such authority.
Dismissal of shareholder derivative claims
Under the MBCA, the board can seek dismissal of the shareholder’s derivative action if a majority of the board’s “qualified directors”—those directors who do not have a material interest in th e derivative action—determine in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that continuance would be contrary to the corporation’s best interests.
Director liability
A director is liable to the corporation for the director’s decisions or failures to take action that were “not in good faith.”
Courts applying the duty of good faith have made clear that corporate directors cannot consciously violate—or permit the corporation to violate—legal norms, even when such violations may be profitable to the corporation
In addition, the duty to act in good faith requires corporate directors to establish procedures to ensure the corporation’s compliance with legal norms. Thus, courts have required corporate directors to establish “[corporate] information and reporting systems” that provide “timely, accurate information . . . concerning both the corporation’s compliance with law and its business performance.”
The “good faith” standard requires that directors, among other things, not approve (or condone) wrongful or illegal activity.
Director’s duty of good faith and fair dealing
The directors have the burden to show that the transaction as a whole was fair in terms of “fair price” and “fair dealing.” This means courts will inquire into (1) whether the transaction price was comparable to what might have been obtained in an arm’s-length transaction, given the consideration received by the corporation, and (2) whether the process followed by the directors in reaching their decision was appropriate.
Director’s duty of care
Under the MBCA, a director is called on to exercise “the care that a person in a like position would reasonably believe appropriate under similar circumstances” in “becoming informed in connection with their decision-making function.”
Normally, “the party attacking a board decision as uninformed must rebut the presumption that its business judgment was an informed one.”
Incorporation of corporations
Normally, the existence of a corporation begins with the filing of the articles of incorporation. MBCA § 2.03(a) (“Unless a delayed effective date is specified, the corporate existence begins when the articles of incorporation are filed”).
Failure to properly incorporate
Under the MBCA, “persons purporting to act as or on behalf of a corporation, knowing there was no incorporation . . ., are jointly and severally liable for all liabilities created while so acting.”
Under the common law, courts have inferred corporate limited liability in cases of defective incorporation in two situations. First, under the “de facto corporation” doctrine, courts recognize corporate limited liability when there was (1) a colorable, good-faith attempt to incorporate and (2) actual use of the corporate form, such as by carrying on the business as a corporation or contracting in the corporate name
Under the “incorporation by estoppel” doctrine, most jurisdictions recognize corporate limited liability when a third party deals solely with the “corporation” and has not relied on the personal assets of the promoter.
Governance of the internal affairs of the corporation
Internal affairs of the corporation, such as the conduct of shareholder meetings and election of directors, are subject to the corporate law of the state of incorporation.
Under the MBCA, “shareholders may amend . . . the corporation’s bylaws.”
The MBCA states that the bylaws “may contain any provision that is not inconsistent with law or the articles of incorporation.”
The inclusion of director-nomination procedures in the bylaws is consistent with practice and is recognized by the Delaware courts, whose views on corporate law carry significant weight. Typically, the procedures for nomination of directors are found in the bylaws.
Under the MBCA, shareholders have the power to amend the bylaws. The board shares this power with the shareholders, unless (1) the corporation’s articles “reserve that power exclusively to the shareholders” or (2) “the shareholders in amending, repealing, or adopting a bylaw expressly provide that the board of directors may not amend, repeal, or reinstate that bylaw.”
