Corporations

Question 1

Four Basic Parts of Corporation

Answer 1

BUSINESS CORPORATION
A. Four Basic Parts
1. a separate jural personality with
2. Shareholders that are passive equity investors who elect the board of directors;
3. a board of directors who manage the corporation and appoints officers;
4. and officers who are agents of the corporation and carry out the board’s policies and manage the day-to-day business of the corporation

Question 2

Rights of Shareholders

Answer 2

1. Each share grants its registered owner a group of rights
   a. Group of Rights:

i. A vote to elect BOD
ii. A vote to approve extraordinary corp acts
iii. To dissent from extraordinary acts and be paid for the fair value (not mkt value) of shares
iv. Amend bylaws
v. Receive share of profits as dividends
vi. Receive share of net proceeds from dissolution
vii. Limited liability
viii. Access to certain information
ix. Bring a derivative action for corp
x. Preemptive rights

b. Registered Ownership: C’s obligations to shs run only to registered holders at registered addresses (corp secretary has list of registered voters)
i. When share transferred, must submit share certificate endorsed for transfer or some other evidence of transfer to new holder + requesting new certificate be issued to new sh⇒if not registered, beneficial possessor must look to registered sh for notices/distributions

Question 3

Authorized Shares

Answer 3

1. owning a share gives you the rights to:
   a) vote in the election of the board of directors
   b) vote to approve or disapprove extraordinary corporate acts (dissolution, sale of assets outside the ordinary course/liquidation, amendment of articles & merger- approve by 2/3 of votes entitled to be cast)
   c) dissent and appraisal (be paid cash for fair value of their shares)
   d) amend the bylaws
2. Shareholder’s rights
   a) bring derivative action on behalf of the corporation (statutory default)
   b) preemptive rights: a SH’s right (when a corp. decides to issue shares) to demand to be offered, at the offer price, the SH’s proportional ownership in the new issue of shares (statutory default)
   c) statutory defaults can be changed by amending the Articles of Incorporation
   d) do NOT have unlimited right to see corp. books and records; SH denied access, then can ask court for an order

Question 4

Shareholder Action

Answer 4

5. Shareholders take action:
   a) at annual meeting- required by statute- quorum required (majority of votes entitled
   b) at special meeting: called for special purpose, stated in notice of meeting and only that purpose can be addressed at the meeting- quorum required
   c) by unanimous written consent
6. quorum: a simple majority of votes entitled to be cast = 50% + 1 vote
7. proper notice of a meeting: not less than 10 nor more than 60 days before the meeting
8. can vote by proxy
9. only SH’s as of record date can vote (can get a proxy, coupled w/ interest is irrevocable)

Question 5

Shareholder Liability

Answer 5

C. Shareholders are usually not personally liable for corporate obligations, can be liable if: past exam question

1. K liability: SH’s can be liable in K by actions that justify a creditor relying on their personal credit
2. tort liability: SH’s can be liable in tort by committing the tort, the corporation will be vicariously liable under the usual agency rules
3. corporate veil is pierced

Question 6

Voting Groups

Answer 6

10. Voting Groups
    a) where 2 classes of stock have the exact same interest in a matter, they vote on it as a single voting group
    b) where action would deprive one class of some preference (affect that class in some particular way), it gets to vote as a separate voting group
    c) non-voting shares get to vote if the extraordinary act will affect their rights- get to vote as a voting group

Question 7

Piercing the Corporate Veil

Answer 7

D. Piercing the Corporate Veil: makes the SH’s personally liable

1. showing to establish piercing corporate veil:
   a) demonstrate SH’s themselves have ignored the corporate form
   b) demonstrate that fraud or some other fundamental unfairness or inequity would result if the court failed to disregard the corp. form and remove SH’s limited liability
2. typically the corporate veil is pierced because:
   a) undercapitalization
   b) commingling
   c) treat corporation as extension of their personal affairs
   d) ignoring corporate formalities

Question 8

Board of Directors: Purpose, Election and Action

Answer 8

E. Board of Directors: past exam question: what is board, purpose, how do they take action, what are their fiduciary duties

1. elected by the SH’s
   a) default method: cumulative voting: each SH multiples # of shares they own by the # of seats to be filled (10 shares x 5 seats = 50 votes) and can allocate the votes anyway you want; gives minority SH’s a chance
   (1) default can be changed in the Articles of Inc. to straight voting
   (2) can be elected by a plurality: directors receiving most votes win, even if don’t receive a majority
2. purpose: The purpose of the board of directors is to manage or direct the corporation by setting policy that is executed by the officers.
3. action: Directors are not agents of the corporation and can only take action at duly noticed meetings at which a quorum (a majority of directors in office) is present, or by a unanimous signed writing. Boards can also act through committees, created by the board, composed of at least 2 directors.

Question 9

Board of Directors - Extraordinary Corporate Acts

Answer 9

a) If Board decides to take an extraordinary corporate act, SH’s get to vote:
(1) amending the articles
(2) merger
(3) sale of assets outside the ordinary course
(4) dissolution
b) default to approve extraordinary act, 2/3 of votes entitled to be cast
c) non-voting shares get to vote to approve extraordinary act if it will affect their rights- vote as a voting group and must approve act by 2/3 of votes entitled to be cast
d) dissent & appraisal: SH’s who disagree with an extraordinary corporate act may dissent and be cashed out at fair value of their shares if:
(1) the act is a MERGER and the SH is entitled to vote on the merger
(2) the act is a SALE of all or subst. all of the assets of the corp. not in the ordinary course of business

(3) the act is an ARTICLES AMENDMENT that adversely affects the SH’s rights
* no right to dissent & appraisal for SHs of shares that are registered and traded on a stock exchange

Question 10

Distributions

Answer 10

4. distribution: any value conveyed by a corporation to SH on account of that person being a SH- dividends, residue or an old truck→ distribution made in the discretion of the board of directors if 2 tests are passed:
   a) balance sheet test: assets would not exceed liabilities on the corporate balance sheet
   b) equity insolvency test: the corporation will be able to pay its debts as they become due in the ordinary course of business
   c) the board doesn’t have to use GAAP but should use experts to satisfy statutory duty of care→ same for LLC’s

Question 11

BoD - Fiduciary Duties

Answer 11

5. fiduciary duties owed by the board of directors: Board of directors owe fiduciary duties to the corporation and its shareholders. Directors owe a duty of care to act in good faith as would an ordinary person in similar circumstances in the best interests of the corporation and its shareholders. The duty of care is breached by negligence, and the remedy is normally damages assessed against the directors personally. The board of directors also owe a duty of loyalty to the corporation and its SH’s. The duty of loyalty is most commonly breached by self-dealing or usurpation of corporate opportunity. The remedy is equitable remedies. Both the duty of care and the duty of loyalty are overlaid with a duty of good faith.

Question 12

Duty of Care - BoD

Answer 12

a) duty of care of directors: breached by negligence, have BJR ∆se; TO ACT
(1) in good faith
(2) as would an ordinary person in similar circumstances
(3) in the best interests of the corporation and its SH’s
b) Board’s ∆ses:
(1) met the duty of care
(2) hired an expert & thus satisfied the statutory duty of care
(3) business judgment rule

Question 13

Business Judgement Rule

Answer 13

c) business judgment rule: directors are not liable for ordinary negligence when they make a good faith, fully informed business judgment in the honest belief that it is in the best interest of the corporation and its SH’s; not protected by the BJR:
(1) gross negligence
(2) fraud
(3) knowing illegality
(4) breaches of the duty of loyalty

Question 14

Interested Director Transactions

Answer 14

d) interested director transactions past exam question typically violate the duty of loyalty. Where a director is directly or indirectly financially interested in a corporate decision, the director is said to be “interested” and to have a “conflict of interest.” The decision is called a “conflict of interest transaction.” The decision is voidable by the corporation unless the interested director makes a full disclosure and the act is ratified by the disinterested board or shareholders, or the transaction is fair to the corporation (within the range that might have been entered into at arms length by disinterested persons).

Question 15

Officers of Corporation

Answer 15

F. Officers are appointed by the board, and are agents of the corporation. Officers carry out the board’s policies and manage the day-to-day business of the corporation. Officers have the same fiduciary duties as the board of directors.

1. The differences between the board of directors and the officers are that directors are not agents of the corporation and officers are. The purpose of directors and officers are different. Directors can only act at duly noticed meetings with a quorum present, by committee, or by unanimous signed writing, while officers can act within the scope of their agency.
2. only officer you’re required to have is a corporate secretary to maintain records and authenticate corporate documents
3. same fiduciary duties as the board of directors

Question 16

Statutory Close Corporation

Answer 16

G. Statutory Close Corporation: shares are held by a small number of SH’s, sometimes only one; have much of their personal wealth invested and expect to earn significant return on their investments; SH’s tend to be involved in management

1. can organize under Statutory Close Corporation Supplement, by filing special articles of Incorporation with the Secretary of State, including an election to be governed by the SC Close Corp. Supp.
   a) no limit in number of SH’s
   b) allows for customized governance, control, and cash flow→ any kind of governance established in unanimous SH agreement
   c) only thing you have to describe in Articles is elimination of the board or at-will dissolution
   d) can get rid of board all together and just let SH’s manage corp. directly; no bylaws required; standard share buy-back provision upon event of exit or death

Question 17

SH Protections

Answer 17

e) SH protection: if SH can make showing of oppression, SH can bring an action for relief w/o resorting to a suit for dissolution (avoids fiction of filing for dissolution)→ remedies are broad and include removal of officers, payment of dividends, payment of damages, and purchase of shares of oppressed SH
2. can also have closely-held corp. under regular BCA
3. viewing close corp. as an extension of your personal affairs can contribute to piercing the corp. veil

Question 18

Plight of the Minority Shareholder

Answer 18

4. the plight of the minority shareholder: has been a bar question
   minority SH in a close corp very likely has no control (no ability to assure representation on the board, obtain employment with the corp, or assure that distributions are paid)

a) can’t sell their shares because there is usually no market for the shares of a closely held corp.
b) extreme cases, control SH’s will freeze out the sterile minority making their life miserable until they agree to sell their shares cheaply→ corporate oppression→ SH remedies:
(1) seek dissolution
(2) filed suit under dissolution statute seeking other remedies
(3) sue as a SH for breach of fiduciary duty
(4) bring derivative action on behalf of the corp for breach of duty or waste

Question 19

Foreign Corporations

Answer 19

H. Foreign Corporations “doing business” in SC must register w/ Sec. of State with their name and an agent & address for service of process; failure to do so closes the SC courts to the corp. and may result in a small fine

Question 20

Securities Regulations - Shares

Answer 20

J. Securities Regulations: shares are always securities under federal and state law, so when a corp is formed and whenever there is an offer or sale of shares in a corp, the securities laws are engaged

Question 21

Corporate Life Cycle

Answer 21

K. Corporate Life Cycle

1. Promotion
2. Incorporation
3. Carrying on Business
4. Dissolution
5. Winding Up/Liquidation

Question 22

Promotion and Promoter’s Duties

Answer 22

L. Promotion: past exam question
1. prior question: A promoter formed a contract with an LLC where his wife was one of the managers of the LLC. The corporation was formed and decided not to adopt the contract when it found out about the conflict of interest. The corporation sold subscriptions and reneged. Promoters prepare a business for incorporation, which often involves entering into contracts on behalf of the corporation.

2. Promoter’s Duties: are the usual components of care and loyalty (exclusivity) to act in the best interests of the corporation to be formed, to co-promoters as partners, and in some cases to the SH’s and creditors of the corporation to be formed. A promoter cannot act in selfish self-interest.

Question 23

Liability on Pre-Subscription K

Answer 23

3. Liable on the pre-subscription K with the LLC (in the exam question): There is a very strong presumption that the promoter is liable on any contracts he entered. The presumption can be rebutted only by a very clear showing that it was the creditor’s intent not to look to the promoter but to look only to the corporation when and if formed, but the courts deem this very unlikely. The corporation is not automatically bound to the promoter’s contract. The corporation is only bound if the corporation adopts the contract either expressly or impliedly with actual knowledge of the terms. The corporation may be liable on a quantum meruit basis.
   a) Once a corporation is formed, it can accept the subscription (during the six months or other period specified that it is irrevocable by the subscriber), upon which it becomes a contract between the corporation and the subscriber. If the subscriber fails to pay, the corporation can either sue the subscriber or rescind the agreement and resell the subscriber’s shares.
4. The pre-incorporation subscription agreements are SECURITIES. Offers made before incorporation to sell shares after incorporation are governed by the securities laws. Pre-incorporation planning must factor in the requirements of the securities laws.

Question 24

Formation

Answer 24

1. Four Steps—(1) choose name (2) file AOI (3) hold organization meeting (4) adopt bylaws
   a. Corp Veil: not apply until formation completed
   b. Name: must be different from others + include a corp signifier
   c. AOI: must include (1) corp name (2) registered agent (3) registered street address (4) description of authorized stock (quantity and character) (5) name and address of incorporators and (6) certificate by lawyer of compliance
   d. Organizational Meeting: three different ways—named director meeting to complete organization; named incorporators meeting to complete organization; named incorporator’s meeting to elect BOD and resign
   e. Bylaws: required by BCA—must adopt at org meeting. May include anything for managing corp
2. Default—BOD amends, but shs can d it an Shs can reserve power in bylaws

Question 25

Dissolution

Answer 25

N. Dissolution: does not end a corporation’s existence;

1. 3 ways dissolution can happen:

a) voluntarily
b) administratively
c) by court action (judicial dissolution)

2. Effects of dissolution:

a) existence of corp. continues but only as appropriate for winding up and liquidation
b) title to property is not transferred
c) officers & directors continue to be subject to their respective duties
d) corp. governance rules remain in effect
e) suits can still be filed against the corp
f) ongoing suits against the corp continue

Question 26

Professional Corporations

Answer 26

O. Professional Corporations: business corporations formed by filing special articles of incorporation with the Secretary of State electing to be professional corporations

1. the purpose must be to practice a single profession & professional services rendered by PC must be rendered by licensed individuals
2. shares may be owned & transferred ONLY to licensed professional or other PC’s in the same profession
3. upon death/disqualification of a SH, that person’s shares must be reacquired by the PC or an appropriately licensed professional
4. at least half of directors and all of the officers (except secretary & treasurer) must be licensed professionals
5. shares voted by proxy may be voted only by licensed professionals
6. doctrines of professional confidentiality & privilege apply as between a PC & its clients

Question 27

Non-Profit Corpiration

Answer 27

P. Nonprofit Corporations: are not business corporations, don’t have SH’s, equity owners; formed by filing simple articles of incorporation with the Secretary of State

1. may have members if they so elect
2. aren’t forbidden to make profits and aren’t necessarily tax exempt
3. why organize a business as a non-profit:
   a) limited liability of members
   b) special liability protection for directors
   c) memberships are not securities
   d) easier to qualify for tax exemption
   e) easier to obtain charitable donations
   f) governing statute is less intrusive than BCA
   g) “nonprofit” sounds good
   h) tax-exempt status = $300k for physical torts

Question 28

3 Types of Non-Profits

Answer 28

4. 3 types of nonprofits
   a) religious corporations: church & church-related; hardly regulated except can’t distributed profits to members; benefit from limited liability
   b) mutual benefit corporations: members can buy and sell memberships and participate in residue at dissolution (ex: country clubs, housing regimes, and after hours drinking clubs)
   c) public benefit corporations: non-religious, charitable in nature; can’t buy or sell memberships or participate in residue; residue must be distributed to another public benefit corp. or a gov’t. agency

Question 29

I. Control/Restrictions on sale of shares

Answer 29

1. “buy back” or “first refusal” agreements: give a right of first refusal to other SH’s or the corp. when SH wishes to sell shares; maybe mandatory of on death
2. Restrictions on sale of shares: allowed if the purpose is reasonable and does not foreclose all possible markets for the shares
   a) reasonable if
   (1) to maintain some corp. status which reqs limited # of SH’s
   (2) to preserve exemptions under state or federal securities law
   b) acceptable restrictions:
   (1) required right of first refusal be given to corp. or other SH’s
   (2) required approval of the corp. or some other person to permit share transfer if not “manifestly unreasonable”
   (3) prohibition of transfer to certain persons or classes of person so long as not manifestly unreasonable