Corporations

Question 1

Requirements of Forming a Corporation (elements)

Answer 1

People, Paper, and Filing with State.

People: one or more incorporators, who must be natural persons.

Paper: articles of incorporation including: name of corp, number of authorized shares, name and address of incorporators and registered agent

Filing: Existence of the corp begins on proper filing of the articles of incorporation with the Secretary of State.

Question 2

Articles of Incorporation (requirements)

Answer 2

A certificate of incorporation must include:

1) the name of the corporation (X, Inc.)
2) name and address of the incorporators and registered agent
3) a statement of corporate purpose (can be anything, also could have none)
4) discussion of capital structure: (A) authorized stock (B) number of shares per class (C) info on any series (i.e. subclass) of preferred shares

Question 3

Ultra Vires Acts

Answer 3

Acts by the corporation beyond the scope of the articles (i.e. beyond its corporate purpose.

****This is VERY LIMITED – should not allow corp to get out of a K merely because it is ultra vires; usually.

Under CA LAW, ultra vires acts are generally enforceable in equity, EXCEPT:

• Shareholder sues corp to enjoin ultra vires act
• Corporation sues officer or director for damages for approving ultra vires act
• State brings an action to dissolve a corp for ultra vires act

Question 4

Authorized stock

Answer 4

The maximum number of shares the corporation can sell, as set in articles of incorporation.

Question 5

Issued stock

Answer 5

The number of shares the corporation actually sells (directly, not counting resales).

Question 6

Outstanding stock

Answer 6

Stock the corporation has sold and has not reacquired

Question 7

General Liability for Corporate Debts, Breaches, and Torts

Answer 7

Generally directors, officers, and shareholders are NOT liable for what the corporation does. Only the corporation is (subject to piercing the veil)

Question 8

De Facto Corporation Doctrine and Corporation by Estoppel

Answer 8

Very limited application. A de facto corporation may exist when a de jure corporation fails to form, IF:

1) the parties made a good faith, colorable attempt to form a corporation
2) the business is being run as a corporation
3) person using the defense (officer/director/etc) LACKED KNOWLEDGE of the defect.

Similarly if plaintiff acted as if corporation existed and D had no knowledge of defect, P should not be able to use lack of corporation to back out of K now.

Question 9

Bylaws

Answer 9

Bylaws are internal rules governing the corporation. Initial bylaws are adopted by incorporators at the first organization meeting.

The articles are supreme over any bylaws.

Bylaws can be modified or repealed by majority vote of shareholders or directors.

Question 10

Pre-Incorporation Contract (definition)

Answer 10

A pre-incorporation contract is one entered into by a PROMOTER - a person acting on behalf of a corporation not yet formed - for the benefit of the corporation.

Question 11

Liability on pre-incorporation contracts

Answer 11

A corporation is liable on a pre-incorporation contract if:

1) it expressly adopts the contract through a board action
2) it impliedly adopts the contract by accepting the benefit of the contract.

A promoter is liable on pre-incorporation contracts EVEN AFTER the corporation has adopted the contract, UNTIL there is a novation - a new agreement between the corporation, promoter, and third party that the corporation will replace the promoter under the contract.

Question 12

Secret Profit Rule (promoters)

Answer 12

A promoter cannot make a secret profit on her dealings with the corporation, if she does she is liable and has to “account for the profit” (return it to the corporation).

She is entitled to a reasonable, open profit though.

Question 13

Characteristics and Types of Corporations

Answer 13

A corporation is a business entity that exists indefinitely, can do business and hold title independently of its owners, and assumes liability independent of its owners (shareholders, directors, officers not liable for corporate obligations).

A “C Corp” is a regular corporation and is subject to tax on corporate profits.

An “S Corp” has limited liability and perpetual existence like a regular corporation but is taxed like a partnership (profits/losses pass through to owners). There are restrictions on S corps, eg, stock can be held by no more than 100 persons, shareholders must be individuals, only one class of stock, etc

Question 14

Subscription

Answer 14

A subscription is a written, signed OFFER to buy stock from the corporation.

Sometimes it is revocable, sometimes not.

Question 15

Pre-incorporation subscriptions

Answer 15

A pre-incorporation subscription is irrevocable for SIX months, UNLESS the subscription provides otherwise or all subscribers agree to let you revoke.

Question 16

Revocation of post-incorporation subscriptions

Answer 16

A post-incorporation subscription is revocable until accepted by the board of the corporation (at which time it’s no longer just an offer, but a K!)

Question 17

Sale of stock to subscribers

Answer 17

Once the corporation decides to sell stock to its subscribers, it must be uniform within each class or series of stock - it cannot sell to some and not others.

Question 18

Default on payment by subscribers

Answer 18

Payment is due on demand by the board; if subscriber fails to pay, their shares are forfeit and can be sold to others.

Question 19

Types of Consideration for Stock

Answer 19

1) Any kind of tangible or intangible property
2) services already performed for the corporation (contrast with K doctrine of ‘past consideration is no consideration’)
3) a promise
4) a binding obligation to perform future services having an agreed upon value

Question 20

Preemptive Rights

Answer 20

The right of an existing shareholder to maintain her percentage of ownership by buying stock whenever there is a new issuance of common stock, for money.

It exists ONLY if the certificate says so; no default preemptive rights.

Typically not allowed within first 6 months of incorporation, nor for distribution (no voting power) only.

Question 21

Number of Directors

Answer 21

Need one or more natural persons to be a director. The number is set by:

1) the bylaws
2) by shareholder act
3) or by the Board if the bylaws allow it

Question 22

Election of Directors

Answer 22

The initial election of directors is by the incorporators. After that, shareholders at the annual meeting elect directors.

Question 23

Removal of Directors

Answer 23

Shareholders can remove directors with or without cause.

The Board can only remove a director for cause if the articles of incorporation or a bylaw allows it - normally they cannot.

Shareholders can remove directors without cause, only if the certificate or bylaws allow.

Question 24

Valid Acts of the Board of Directors

Answer 24

Individual directors cannot act for the corporation. Rather, the Board acts, through either:

1) unanimous written consent, or
2) a vote at a board meeting.

Any other way of acting is void unless later ratified by a valid act.

Question 25

Director Meetings

Answer 25

Regular board meetings do not requires notice, if time and place are set in bylaws or by the board.

Special board meetings require notice - must state time and place, but not purpose.

If notice is not given, any action taken at the meeting is void unless the director not given notice waives the notice defect, by:

1) attending the meeting without objection, or
2) waiving in a signed writing

Question 26

Quorum for a Board Meeting

Answer 26

There must be a majority of the “entire board” (i.e. all the possible seats of the board) to be a quorum.

A simple majority can act; also unanimous written consent is a valid act.

Question 27

Powers/Purpose of the Board of Directors

Answer 27

The board of directors manages the business of the corporation. It sets policy, monitors officers, declares dividends and other distributions, decides when the corporation will issue stock, recommends fundamental corporate changes, etc.

The board sets the compensation of directors, but it must be reasonable and in good faith.

Question 28

Powers of Committee of Board of Directors

Answer 28

The board can delegate some powers to committees of ONE or more directors.

Full board must maintain oversight of committees.

Question 29

Director’s Duty of Care and Breach

Answer 29

A director must discharge her duties in good faith and with a degree of diligence, care and skill that an ordinarily prudent person would exercise under similar circumstances.

Breach of the duty of care:

1) Nonfeasance - a director does NOTHING - never attends meetings, doesn’t monitor anything - and this inattention caused a loss to the corporation (the causation can be hard to prove).
2) Malfeasance - a director actively hurts the corporation with an action (subject to defense of Business Judgment Rule).

Question 30

Business Judgment Rule

Answer 30

If a Director is challenged because he acted in a way that caused losses for the company, the business judgment rule states that if the director gathered appropriate information, deliberated, and analyzed, he exercised a reasonable degree of care.

Question 31

Director’s Duty of Loyalty and Breach

Answer 31

A director must act in good faith and with the conscientiousness, fairness, morality and honesty that the law requires of fiduciaries.

This duty is breached if:

1) the director engaged in self-dealing
2) the director is running a competing venture
3) the director usurped an opportunity of the corporation

A director engages in self-dealing if he is in an interested transaction (a deal he or close relative made with the corporation), UNLESS:
1) the deal was fair and reasonable to the corporation when approved OR
2) the director’s interest was disclosed or known and the deal was approved by
A) a shareholder action,
B) board approval by sufficient vote not counting the votes of the interested directors, or
C) unanimous vote of disinterested directors if this number is too small for a board action.

The remedy is to disgorge the cash by making the director account for his profits.

Question 32

Director Liability for Board Actions

Answer 32

If the board does something bad:
A director is PRESUMED to agree with a board action unless her dissent is noted in writing in the corporate records. She can do this by: 1) stating her dissent in the minutes 2) writing to the secretary at the meeting 3) registered letter to the secretary promptly after the meeting.

If a director MISSED the meeting, he must register written dissent within a reasonable time after learning of the bad acts.

In Defense: Directors can claim good faith reliance on the information, opinions, reports or statements of officers or employees of the corporation, lawyers or public accountants, or a committee of which the person relying is not a member. (This defense is most likely for improper distribution)

Question 33

Officers (definition, powers, selection/removal)

Answer 33

Officers are appointed by directors to help manage the corporation.

The Board selects and removes officers. The Board sets the compensation of officers.

Officers are agents of the corporation and if given the authorization to do so,they can bind the corporation to acts they take on the corporation’s behalf.
Ex: the president has the inherent authority to sue on behalf of the corporation and bind it to contracts entered in the ordinary course of business.

Question 34

Reimbursement of Officers and Directors

Answer 34

If someone is sued in her capacity as an officer or director, she might be entitled to reimbursement for legal fees from the corporation.

Of Right: the corporation MUST reimburse if she won a judgment on the merits or otherwise.

Permissive: the corporation MAY reimburse if the case was settled, if the director/officer acted in good faith and for purposes reasonably believed to be in the corporation’s best interest. The board (if a quorum are disinterested) or shareholders can make this call.

The corporation can NEVER reimburse if the director/officer is held liable to the corporation itself.

A court can order the corporation to reimburse if it finds the director/officer is reasonably entitled to it.

Question 35

Shareholders - Management, Meetings

Answer 35

Generally shareholders don’t manage the corporation, unless the articles of incorporation specify it is a closely-held corporation in which shareholders can manage. In these situations, the managing shareholders owe each other, and the corporation and other shareholders, duties of care and loyalty.

For all corps, shareholders must have meetings at least once per year. Shareholders must be notified of time, place, and date of meeting not less than 10 and not more than 60 days in advance.

Question 36

Shareholder Derivative and Direct Suits

Answer 36

In a derivative suit, a shareholder sues to enforce the corporation’s claim, not her own. The shareholder must 1) own stock when the claim arose and 2) at the time she is bringing the suit. FIRST, shareholder must make a demand on directors that the corporation correct the wrong and grant 90 days, unless it would be futile to do so (e.g. directors are all bad). Then can sue.

When the shareholder sues directors for breaching a duty or wasting corporate assets, that is always a derivative suit.

Shareholder receives costs and attorney’s fees, from the judgment won for the corporation.

If a majority of impartial directors make a good faith inquiry and find the suit meritless, it will be dismissed.

Shareholder can also file a “direct suit” if their interests were specifically and personally harmed by a breach, more than other shareholders or the corp itself.

Question 37

Director/Officer “Derivative” Suits

Answer 37

A director or officer can sue another D/O to account for violations of duties or misappropriations of assets.

The suing director/officer does not have to meet the requirements of a derivative suit.

Question 38

Shareholder Voting - Mechanisms of Voting and Cumulative Voting to Choose Directors

Answer 38

Articles of incorp can override all of these default rules.

• Generally, quorum exists if a majority of outstanding shares are present.
• Simple majority allows any changes except fundamental changes
• Even without quorum or a meeting can agree to a course of action by valid written consent.

IF articles allow cumulative voting, then when voting for directors, each shareholder gets a number of votes equal to his voting shares TIMES the number of directors to be chosen, then can apportion these votes however he wants (ie can give ALL to one director).

Question 39

Proxies in Voting

Answer 39

For Shareholder voting only:
In a signed writing directed to the secretary of the corporation, a shareholder can authorize another to vote his shares. A proxy is good for 11 MONTHS unless it expressly says otherwise.
- A proxy can be revoked in writing or if the shareholder attends and votes.

• To be truly irrevocable, a proxy must expressly state it is irrevocable, and the proxy-holder must have given some consideration.

Question 40

Piercing the Corporate Veil

Answer 40

Shareholders who are ACTIVE participants in the biz can be liable if:
(1) Ignoring Formalities/Alter Ego/Mere Instrumentality:
If (1) corp ignores corporate formalities such that it is a mere instrumentality of the shareholders or another corporation, AND (2) an injustice results, the veil should be pierced.
(2) Inadequate Capitalization at time of formation:
If AT THE TIME corp was formed there was clearly not enough capital to cover possible liabilities, can pierce the corporate veil
(3) Fraud/Bad Faith Acts:
If the shareholder is using the corporate entity to avoid existing obligations or the law, or if there is fraud, the veil can be pierced.

NOTE: PCV applies to shareholders not directors or officers.

Question 41

Debt Securities (Bond and Debenture)

Answer 41

When a corporation has borrowed money and made a promise to repay the creditor, the creditor has a promissory interest NOT an ownership interest.

A debenture is an UNSECURED interest in being repaid by the corporation.

A bond is a SECURED interest, payable either to the holder of the note (a “bearer bond”) or the owner of the debt is registered with the company (a “registered bond”).

Question 42

Classifications of Shares and Share Options

Answer 42

The articles of incorporation set forth how many shares are authorized and whether they are all of the same type (“common shares”) which create an equal interest for all, or whether there are different classes and series of shares.

For articles to create class/series it must:**

(1) Prescribe the number of shares for each class
(2) Prescribe a distinguishing designation for each class (eg Class A preferred)
(3) Either describe the rights, preferences, and limitations of each class or series or provide that they shall be determined by the board prior to issuance.

Share Options:
An option is the right to purchase shares in the future under any terms decided by the directors (paid for with consideration – like option K).

Question 43

Shareholder Rights

Answer 43

A shareholder has the right to reasonably inspect the corporation’s articles and bylaws, meeting minutes, board resolutions on classification of shares, and a copy of the most recent annual report.

Question 44

Shareholder Agreements

Answer 44

Shareholders can make agreements with each other:
(1) Voting Trust (2) Shareholder Voting Agreement (3) Shareholder Management Agreement (4) Restrictions on Transfer of Stock.

Voting Trust: shareholders give title and voting power to 1 person but retain beneficial interest (the dividends). Lasts for 10 years and must be registered with the corporation.

Shareholder Voting Agreement: shareholders retain independent title but agree to all vote the same way. Nothing needs to be filed with corporation.

Shareholder Management Agreement: In a CLOSELY HELD corp, can make any agreement on how the corporation should be managed if it does not contravene the articles or bylaws, and decision is UNANIMOUS among shareholders. Lasts 10 years.

Restrictions on Transfers of Stock: permissible if the restriction is reasonable (eg a right of first refusal is reasonable); prob only for closely held corps not pub traded?

Question 45

Distributions to Shareholders

Answer 45

Distribution must be done according to the order established by share classifications.

The corporation must be solvent for a distribution to take place – both its assets must be greater than liabilities, and corp must be able to pay its debts in the normal course of business.

Question 46

Fundamental Change in Corporate Structure - definition and elements

Answer 46

A fundamental change in corporate structure is a: (1) merger (2) share exchange (3) dispensation of substantially all assets outside the normal course of business (4) amendment to the articles of incorporation (5) Conversion of type of corporation.

If there is a fundamental change in corporate structure, must follow this procedure:

(1) Board adopts resolution;
(2) Written notice is given to shareholders;
(3) Shareholders approve changes;
(4) Changes in the form of articles are filed with the state.

Question 47

Merger rules

Answer 47

To approve a merger must go through 4 steps of fundamental change in corporate structure: (1) board resolution (2) written notice to shareholders (3) shareholder approval (4) new articles filed with the state.

HOWEVER: no shareholder approval is required IF:

(1) Articles of surviving corp will not differ from before the merger;
(2) Each shareholder of the survivor will hold the same number of shares with the same preferences, limitations, and rights;
(3) Voting power of the shares issued as a result of the merger will be no more than 20% of the voting power of the shares of the surviving corporation prior to the merger

Or, if merger is of a subsidiary where surviving corp already has 90% ownership.

Question 48

Dispensation of substantially all property outside the normal course of business (definition)

Answer 48

Sale of all or substantially all (more than 75%) of a corporation’s property is a fundamental corporate change for the corp disposing of the property.

The purchaser does not become liable for seller’s obligations.

HOWEVER, if this is actually a disguised merger, a court might treat it as a de facto merger and hold the purchaser liable for seller’s obligations as if merger had occurred.

Question 49

Dissenter Shareholders’ Appraisal Remedy

Answer 49

If shareholders do not approve of the fundamental change they can force the corporation to pay a fair price if they:

(1) give corporation notice of intent to demand appraisal rights BEFORE the vote on the change
(2) Do not vote in favor of the change
(3) demand payment after the change is approved

Question 50

Tender Offers for Shares

Answer 50

A widespread offer made to the public for sale of shares.

Regulated such that:

• If bidder would obtain more than 5% of all shares must file disclosure with the state regarding their plans for the target, past dealings, source of funds.
• Offers must be open for at least 20 days
• Shareholders must be allowed to withdraw while offer is open
• If oversubscribed, purchase on a pro rata basis
• managers of the target corporation must give advice on the deal

Question 51

Control Share Acquisition statutes

Answer 51

State regulations on corporate takeovers typically state that if a certain ownership threshold is crossed (eg more than 20% ownership) the shares will not have voting rights UNLESS a majority of disinterested shares vote to grant the rights in the acquired shares.

LIMITATION:
To be valid, control share acquisition statutes must be limited to corps with a significant connection the regulating state (eg many outstanding shares within the state)

Question 52

Dissolution of Corporations

Answer 52

Voluntary Dissolution: if shares have already been issued, a corporation can only dissolve by going through steps of fundamental change procedure.

If no biz undertaken and no shares issued, a majority of incorporators could dissolve by filing articles of dissolution with the state.

Administrative Dissolution: technical dissolution by the state for failure to pay fees, paperwork issues. Can be reinstated and ‘relate back’ as if never dissolved.

Judicial Dissolution: court can dissolve a corporation for many reasons.

(1) shareholders are oppressed, directors are malfeasant, decisions cannot be made.
(2) creditors have a judgment or a good claim and the corporation is insolvent.

Question 53

Effect of Corporate Dissolution

Answer 53

Corporation does not automatically cease to exist – continues to exist for purpose of winding up the business.

However cannot do any other business not related to liquidating assets and affairs related to dissolution.

Question 54

Federal Securities Rule 10b-5

Answer 54

This rule makes it llegal for any person to:

(1) use any means of interstate commerce
(2) in connection with the purchase/sale of any security (incl stock)
(3) to employ any scheme to defraud, misrep or omit a material fact, or engage in any practice of fraud.

D need NOT have purchased or sold securities, also covers false information (press releases)

P must prove reliance and damages

Also prohibits trading based on inside information. Breaches a duty of trust and confidence owed to (1) the issuer of the share (2) shareholders (3) another person who is the source of the material nonpublic info.
- Both tipee and tipper are liable. No pecuniary exchange for tip needed for liability.

Question 55

Federal Securities Rule 16(b)

Answer 55

In a publicly held corporation, STRICT LIABILITY rule for any shareholder, director, or officer with more than 10% share of stock who profits from the PURCHASE AND SALE (or SALE AND PURCHASE) of company stock within a 6 month period must forfeit the profit.

Prevents use of insider info or manipulation to make short term profit.

Question 56

Sarbanes-Oxley

Answer 56

Applies to publicly held companies. Requires certain companies to establish an audit board to review accounting audits of company, ensure no misfeasnce.