Corporations Flashcards
What is the Business Judgment Rule?
The BJR is a rebuttable presumption that insulates directors from liability for decisions that the directors made in good faith and in the best interests of the corporation. The exercise of managerial powers by a director is generally subject to the BJR.
A director who breaches the duty of care will not be protected by the BJR.
What is the duty of loyalty?
The duty of loyalty requires a director to act in a manner that the director reasonably believes is in the best interests of the corporation. RMBCA § 8.60. Typically, a director breaches this duty by placing his own interests before those of the corporation (e.g., engaging in “self-dealing”–a transaction in which the director would stand to personally benefit–or a usurpation of a corporate opportunity).
With respect to the duty of loyalty, what is the “safe harbor” for a director engaged in self-dealing?
A director who engages in self-dealing may nonetheless avoid liability under the so-called “safe harbor” rules.
A director’s conflict-of-interest transaction may enjoy protection if (i) the director provided full disclosure of all material facts and the transaction was approved by either a majority vote of disinterested directors or a majority of the votes entitled to be cast by disinterested shareholders, or (ii) the director can show the transaction was substantively and procedurally fair to the corporation.
What is required, procedurally, for valid action by the Board of Directors?
For a board of directors’ acts at a meeting to be valid, absent more stringent requirements in the articles of incorporation or bylaws, a quorum of directors must be present at the meeting and the assent of a majority of the directors present at the time the vote takes place is necessary for board approval.
(Presence includes appearances made using communications equipment that allows all persons participating in the meeting to hear and speak to one another.)
What are the shareholder’s rights re: inspection of corporate records?
A shareholder has a right to inspect and copy corporate records upon five days’ written notice.
Although a shareholder may generally inspect the main records of the corporation, such as the bylaws and articles and the minutes of shareholder meetings, the shareholder must demonstrate a proper purpose (i.e., relating to his interest in the corporation) before inspecting certain records, such as the financial statements of the corporation, the accounting records of the corporation, and excerpts from minutes of any meeting of the BOD. (This inspection right is usually restricted to normal business hours at the corporation’s principal place of business.)
What are shareholder’s rights with respect to dividends?
The power to authorize a dividend rests with the BOD. In general, a shareholder cannot compel the BOD to authorize a dividend because that decision is usually discretionary.
When a board acts in bad faith and abuses its discretion by refusing to declare a dividend, however, a court may order the board to authorize a dividend.
To prevail in a suit to compel a dividend, a shareholder must prove the existence of (i) funds legally available for the payment of a dividend and (ii) bad faith on the part of the directors in their refusal to pay.
What is a shareholder derivative suit, and what must be true for a shareholder to have standing to bring this kind of suit?
In a derivative action, the shareholder sues on behalf of the corporation for a harm suffered by the corporation, and any recovery generally goes to the corporation.
In addition to being a shareholder at the time the action is filed and continuing to be a shareholder during the litigation, a plaintiff must also have been a shareholder at the time of the act or omission to bring a derivative action. This is known as the “contemporaneous ownership” rule. In addition, the shareholder must fairly and adequately represent the interests of the corporation.
The plaintiff must also make a written demand upon the BOD 90 days before filing unless it would be futile.
What is the duty of care?
Directors have a duty to act with the care of an ordinary prudent person in a like position and similar circumstances and to make decisions in good faith. In deciding how to act, the director is required to use any additional knowledge or special skills that he possesses.
What is a shareholder direct action (as compared with a derivative suit)?
In a direct action to enforce a shareholder’s rights, the shareholder sues the corporation for breach of a fiduciary duty owed to the shareholder by a director or an officer. Any recovery goes to the shareholder.
(As contrasted witha derivative action, where the shareholder sues on behalf of the corporation for a harm suffered by the corporation, and any recovery generally goes to the corporation.)
What are a shareholder’s preemptive rights?
When the board of directors decides to issue new shares, the rights of shareholders to purchase those shares in order to maintain their proportional ownership share in the corporation are known as “preemptive rights.” Shareholders automatically had such rights at common law, but the RMBCA explicitly precludes preemptive rights unless the articles of incorporation provide otherwise. RMBCA § 6.30(a).
What factors do courts consider in deciding when to pierce the corporate veil?
In most jurisdictions, no bright-line rule exists for when a court will pierce the corporate veil, so they will consider the totality of the circumstances, including the following 8 factors:
1) Undercapitalization of the corporation at the time of its formation: if the initial shareholders fail to supply adequate capital to the corporation considering its business needs (e.g., purchase of equipment, acquisition of facilities from which to operate the business, payment of employees).
2) Disregard of corporate formalities: if the corporation fails to issue stock, select directors, hold meetings of the board of directors or the shareholders, appoint officers, keep records, or otherwise comply with statutory requirements.
3) Intermingling of corporate and personal assets: if the shareholders fail to separate their personal assets from the corporation’s assets (e.g., maintenance of single bank account).
4) Use of corporate assets for personal purposes: if corporate assets are used for personal purposes (e.g., a company vehicle). (Note: when such use results in harm to a third party, such as through an accident, that tort may result in direct personal liability of the shareholder without piercing the corporate veil.)
5) Self-dealing with the corporation: Typically, this occurs when a shareholder sells to or buys from the corporation goods or other property on terms that are not fair to the corporation. While this action can constitute a breach of a director’s duty of loyalty owed to the corporation, a shareholder does not owe a similar duty to the corporation. However, such conduct by a shareholder may justify piercing the corporate veil.
6) Siphoning of corporate funds or stripping of corporate assets: implies that the purpose underlying the distribution is to defraud corporate creditors. (There is also a prohibition on a corporate distribution that leaves the corporation insolvent and a corresponding provision for recoupment from shareholders.)
7) Use of the corporate form to avoid existing statutory requirements or other legal obligations (e.g., if a single shareholder tries to escape liability for releasing hazardous chemicals into the environment by claiming that it was a corporate action).
8) Wrongful, misleading, or fraudulent dealings with a corporate creditor
In the case of two corporations, the focus is whether there is “unity of interest and ownership” between the corporations such that the corporation in fact did not have an existence independent of the controlling (parent) corporation. However, the failure of a shareholder to respect the corporation as a separate entity is insufficient by itself to justify piercing the corporate veil; such failure must also adversely affect a third party’s ability to recover from the corporation.
Note: Not all of the above factors need to be met for the court to pierce the corporate veil, but many of the factors focus on whether the corporation is being used as a “façade” for a dominant shareholder’s personal dealings (i.e., whether the corporation is an “alter ego” or “mere instrumentality” of the shareholder).
What is a controlling shareholder?
When one shareholder—or a group of shareholders acting in concert—holds a high enough percentage of ownership in a company to enact changes at the highest level, the shareholder or group is a “controlling shareholder.” Anyone controlling 50 percent of a corporation’s shares, plus one, is automatically a controlling shareholder.
A much smaller interest can be controlling if the remaining shares are widely dispersed (as in a large, publicly traded corporation) and not actively voted.
What duties does a controlling shareholder have?
Although shareholders do not owe fiduciary duties to the corporation or to each other, a fiduciary duty to the minority shareholders may arise if the controlling shareholder is (i) selling that interest to an outsider, (ii) seeking to eliminate other shareholders from the corporation, or (iii) receiving a distribution denied to the other shareholders.
A controlling shareholder also has a duty to disclose to the minority shareholder any information that it knew or should have known if it is information that a reasonable person would consider important in deciding how to vote on a transaction.
A controlling shareholder breaches her fiduciary duty to the minority shareholders if nondisclosure causes a loss to the minority shareholders.
What arguments can be made to overcome the business judgment rule?
To overcome the business judgment rule, it must be shown that:
i) The director did not act in good faith (if the challenger shows fraud, dereliction of duty, condoning illegal conduct, or a conflict of interest);
ii) The director was not informed to the extent that the director reasonably believed was necessary before making a decision;
iii) The director did not show objectivity or independence from the director’s relation to or control by another having material interest in the challenged conduct;
iv) There was a sustained failure by the director to devote attention to an ongoing oversight of the business and affairs of the corporation;
v) The director failed to timely investigate a matter of significant material concern after being alerted in a manner that would have caused a reasonably attentive director to do so; or
vi) The director received a financial benefit to which he was not entitled, or any other breach of his duties to the corporation.
What must occur, procedurally, for a merger to be proper?
A merger is the combination of two or more corporations such that only one corporation survives. To merge:
i) The board of directors for each corporation must approve of the merger;
ii) The shareholders of each corporation must usually approve of the merger; and
iii) The required documents (e.g., plan of merger, amended articles of incorporation) must be filed with the state.
What is a shareholder’s appraisal rights?
A shareholder who objects to a merger or an acquisition may be able to force the corporation to buy his stock at a fair value as determined by an appraisal. This right is also available for shareholders whose rights are materially and adversely affected by an amendment of the corporation’s articles of incorporation.
To do so, the shareholder must:
(1) give written notice to the corporation before the shareholders vote on the proposed action;
(2) vote against or abstain from the vote;
(3) make a written demand upon the corporation for payment after the proposed corporate action has been approved
The corporation must then pay the estimated fair market value within 30 days. If the corporation and shareholder cannot agree on the fair value, then it will be determined through a court action.
