Corporations

Question 1

Duty of Loyalty - usurping corporate opportuinty

Answer 1

Directors are fiduciaries of their corporation and as such, have a duty of loyalty. This duty prohibits the director from competing with the corporation or usurping corporate opportunities, meaning a director cannot take for himself a business opportunity in which the corporation might have an interest unless he first offers the opportunity to the corporation and the corporation rejects it.

• Not every conceivable opportunity
• Recover profits or force transfer of opportunity

Question 2

Removing directors

Answer 2

Generally, only the shareholders have the power to remove directors unless the bylaws provide otherwise.

• With or without cause
• Special meeting, 10 day notice
• Quorum and majority of votes

Question 3

Corporate liability for pre-incorporation contracts

Answer 3

As a general rule, corporations are legal entities separate from their shareholders. As such, corporations are not liable for contracts made prior to incorporation.

• Promotors liable for pre-incorporation contracts
• Only liable if contract is adopted or novation
• Implicit explicit adoption

Question 4

Shareholders as creditors

Answer 4

Shareholders that lend the corporation money may become creditors to the corporation. Shareholders who are unsecured are not subordinate to outside unsecured creditors.

• Can be subordinated with showing of wrongdoing

Question 5

Promoter liablity

Answer 5

A promoter is a person who undertakes to procure commitments for a corporation before it is formed, called stock subscriptions. A promoter has the duty of fair disclosure and good faith. A promoter who enters into a contract knowing that there has been no valid incorporation is personally liable on the contract. Unless:

• Indicated in contract or a novation

A promoter who profits on the sale of property to the corporation may be liable to the corporation for the profit, or may be forced to rescind the sale, unless the promoter has disclosed all of the material facts of the transaction.

Question 6

Shareholder liablity

Answer 6

Shareholders in a properly formed corporation are not personally liable for the obligations of their corporation. A court will ignore this and pierce the corporate veil to hold shareholders liable if the privilege of conducting business as a corporation has been abused.

• Ignoring corporate formalities
• Inadequate capitalization
• Used for fraud

Question 7

SEA 16(b) liablity

Answer 7

Section 16(b) of the Securities Exchange Act provides that any profit realized by a shareholder owning more than 10% of outstanding shares from any purchase and sale of any equity security within less than six months must be returned to the corporation.

• Large, publicly held corporations
• Strict liability

Question 8

Rule 10b-5 liablity

Answer 8

Under Rule 10b-5, it is unlawful for any person by the use of interstate commerce to, in connection with the purchase or sale of any security to:

• Employ a scheme to defraud
• Make untrue statements of material fact
• Engage in any practice that constitutes fraud

Requires proof of:

• Fraudulent scheme
• Connected with sale of securities
• Use of interstate commerce
• Reliance
• Damages

Facts are material if a reasonable investor would consider it important when making an investment decision.

Question 9

Insider Trading

Answer 9

Corporate insiders have a duty to not use inside information for personal benefit or for the benefit of others and will be liable under 10b-5. Insiders include directors, officers, controlling shareholders, and others with a duty of confidence.

Question 10

Shareholder claims

Answer 10

Shareholders may bring both direct and derivative suits. Direct actions seek to redress injuries to the personal rights of the plaintiff. Derivative suits seek to redress injuries to the corporation. Remedies in direct suits inure to the shareholder, remedies in derivative suits inure to the corporation.

Derivate suits require a showing that:

• shareholder at time of harm and throughout suit
• written demand
• adequate representation by shareholder

Question 11

Directors duties

Answer 11

Directors are fiduciaries of their corporation. As such, they owe the corporation a duty of care and a duty of loyalty. The duty of care requires directors to act with the care that an ordinarily prudent person would exercise in a like position. The duty of loyalty requires directors act in good faith with a reasonable belief that they are acting in the corporation’s best interests.

• Liable for damages

Question 12

Business judgement rule

Answer 12

Under the business judgement rule, directors who meet the standards set by the duty of care and the duty of loyalty are protected against lawsuits challenging their decisions. In making those decisions, directors are entitled to rely on the opinions and reports of other directors, corporate officers, corporate employees, and outside experts if the reports are within their competence.

Question 13

Director indemnification

Answer 13

A director is entitled to reimbursement from a corporation for expenditures for corporate purposes. If a director is successful in defending a lawsuit brought against the director in his corporate capacity, indemnification is mandatory. Even if they loose indemnification can be granted if the director acted in good faith and he believed his conduct was in the corporations best interest.

• Majority of disinterested members of directors or commitee

Question 14

Fundamental corporate change

Answer 14

A fundamental corporate change may not be made unless:

• majority of directors adopt resolution
• directors call special meeting
• change is approved by shareholders
• change is formalized if necessary

Question 15

Director’s interest in a transaction

Answer 15

Most states have a statutory safe harbor which states that a transaction will no be set aside merely because a director has a personal interest if the director can prove that:

• Fair to corporation
• Material facts were disclosed to the board and approved by disinterested members

Question 16

Dissolution

Answer 16

Shareholders may seek judicial dissolution for a few reasons, including where directors are acting in a way that is fraudulent, illegal, or oppressive, or where corporate assets are being wasted or misapplied to non-corporate purposes.

Question 17

Corporate formation

Answer 17

A corporation is formed by filing Articles of Incorporation with the secretary of state. An incorporator is one who signs the Articles. A corporation is presumed to be for any lawful business purpose unless state other wise. Operating outside of the stated purpose is ultra vires.

Question 18

Ultra Vires

Answer 18

Where a corporation commits an ultra vires act, a shareholder may sue to enjoin the act, the corporation can sue officers and directors for damages arising out of the act, and the state may seek dissolution of the corporation. Directors generally cannot be removed for causing ultra vires acts, although it may be a violation of their duty of care and make them liable for damages.

Question 19

Piercing the corporate veil

Answer 19

Three main theories justify piercing the corporate veil: the corporation is the alter ego of individuals resulting in a failure to conform to corporate formalities, inadequate capitalization at the time of incorporation, or avoidance of existing obligations.

Question 20

Issuance of stock

Answer 20

Formation of a corporation requires the issuance of stock, which can be issued in consideration of any tangible or intangible property or benefit to the corporation. Many states still prohibit issuance of stock for promissory notes or future services.

Question 21

Shareholder voting

Answer 21

Shareholders are responsible for electing directors and amending the articles and bylaws. They must also vote on fundamental corporate changes, including sale of large assets, mergers etc. Shareholders may vote in person or by written proxy, but absentee.

Question 22

Proxies and shareholder agreemetns

Answer 22

A proxy is the right to vote in the place of a shareholder. Proxies are revocable unless expressly irrevocable and coupled with an interest. In any event a proxy may only last 11 months.
A shareholder agreement, either a voting agreement or voting trust, can involve any aspect of the exercise of corporate powers or management.

Question 23

Share restriction

Answer 23

A corporation may restrict the transfer of shares for any reasonable purpose, and restrictions may include a first right of refusal, a buy-back provision, transfer approval, and prohibition of transfer to particular persons or groups. A transferee is bound if they have notice or if the restriction is noted on the certificate.

Question 24

Duty of care

Answer 24

The duty of care requires that directors act in good faith and with the care that an ordinarily prudent person would exercise under similar circumstances, in a manner the director reasonably believes to be in the best interests of the corporation.

Question 25

The duty of loyalty

Answer 25

The duty of loyalty involves three main areas: conflict of interest, usurpation of corporate opportunity, and insider trading.
A conflict will not be enjoined or result in damages if it is approved by a majority of disinterested directors or shareholders, or at the time was unfair to the corporation.

Question 26

Sarbanes-Oxley Act

Answer 26

Requires that corporations establish an audit committee made up of independent board members, none of whom are employed or affiliated with the company.