Corporations

Question 1

Formation – Pre-Incorporation Transactions

Answer 1

1. Promoter liability
   • Pre-incorporation: promoters liable for pre-incorporation ks, C not liable even after incorporated unless novation or 3rd p relied on C to fulfill
   • Promoters have fiduciary duties to C
   • Compensation—a promoter can request compensation from C but not entitled
2. C’s liability
   • General rule—C is not liable for pre-incorporation transactions, even those for the
   benefit of C
   • Adoption—C is liable if it expressly or impliedly adopts a contract by accepting the
   benefits of the transaction, or gives an express acceptance of liability for the debt

Question 2

Formation – Incorporation

Answer 2

1. Articles of incorporation
   • Must include the corporate name and a statement of C’s legal purpose, and be filed with the state
   • May enumerate powers that C possesses, or limit its duration
   • Corporate comes into existence upon filing unless otherwise noted.
2. Ultra vires actions– C acted outside of its business/stated purpose
   • SH can sue to stop C; C can take axn against D/O/Ee to stop; State can stop
3. “De jure” C—when all statutory requirements for incorporation are satisfied, C is legally a C and liable
4. Defective incorporation
   • Lack of good faith—when person conducts business as C without good faith or fulfilling reqmts, personally liable
   • Good-faith effort—two ways to escape personal liability:
   o De facto C—the owner makes good faith effort to comply with C reqmts and believes it’s a C
   o Corporation by estoppel—when non-C deals with 3rd ps as a C, can’t deny that it’s a C to avoid liability

Question 3

Stock and Other Corporate Securities – Types

Answer 3

1. Common stock—a basic ownership interest, gives owner right to vote on C matters.
2. Preferred stock—has preference over other stock with regards to distributions

Question 4

Stock and Other Corporate Securities – Issuance of Stock

Answer 4

1. Issuance authorized by BD and/or SH
2. Given stock for adequate consideration (can be anything)
3. Stock subscriptions—a pre-incorporation subscription is irrevocable for six months from the date of subscription (unless all subscribers agree to a revocation)
4. Stock rights, options, and warrants—can also be issued by BD
5. SH’s preemptive rights—the right of a SH to maintain % of shares whenever stock issued (first option)
6. Securities registration—have to file registration with SEC before publicly offering stock (and give buyer prospectus)

Question 5

Stock and Other Corporate Securities – Distributions

Answer 5

1. BD is authorized to make distributions, usually cash
2. Limitations—C cant distribute if C is insolvent or distribution would cause insolvency
3. D’s liability for unlawful distributions in violation of duties of care/loyalty—D is personally liable to C for the amount in excess of a lawful amount
4. SH suit to compel distribution—SH can sue to enforce his individual right by funds legally available for distribution and D’s refusal is bad faith

Question 6

Stock and Other Corporate Securities – Sale of Securities

Private Restrictions

Answer 6

1. Private restrictions on sale
   • Enforceability—the security must be certified, the restriction must be conspicuously noted on the security certificate, and the person must have knowledge of the
   restriction
   • Challenge to restriction: was restriction rsbl?

Question 7

Governance – Instruments

Answer 7

1. Articles of incorporation—BD can amend. If stock’s been issued, then amendments have to be approved by maj of SH.
2. Can have bylaws, not necc
3. Articles win over bylaws

Question 8

Governance – Organizational Meeting

Answer 8

for appointment of Os, adoption of bylaws, and approval of contracts

Question 9

Shareholders – Meeting Requirements

Answer 9

failure to hold meetings does not affect C’s existence or invalidate C’s business

1. Annual—primary purpose is to elect Ds
2. Special—may be called by BD or SHs who own at least 10% of voting shares
3. Notice—voting SHs must be notified of time/date/place in a timely manner betwen 10-60 days before meeting; If no notice, SH may waive notice either in writing or by attending the meeting
4. Unanimous written consent—SHs can take any action that could have been taken at a meeting by unanimous written consent

Question 10

Shareholders – Voting Requirements

Answer 10

1. Eligibility—generally, only official stockholders are permitted to vote; Have to be stockholder by record date to vote at next meeting
2. Quorum requirements—Need a maj of shares at meeting (quorum), then need maj of quorum to make decisions
3. SH can cumulate votes (based on shares) to vote for Ds
4. SHs can vote by proxy if written notice given to C
5. Voting with other SHs
   • Voting pool—a binding voting agreement under which SHs retain legal ownership;
   does not need to be filed with the C; no time limit
   • Voting trust—a trust to which legal ownership of SH’s stock is transferred; the trustee
   votes the shares and distributes the dividends in accord with trust; must be in writing,
   limited to 10 years, and filed with the C
   • Management agreement—allows SHs to alter the way the C is managed even if the
   agreement is inconsistent with statutory provisions

Question 11

Shareholders – Inspection of Records

Answer 11

SH can inspect and copy C records with 5 days notice

Question 12

Shareholders – Shareholder Suits

Answer 12

1. Direct actions—SH directly sues for breach of fiduciary duty by D or O, or an action based on grounds unrelated to SH’s status
2. Derivative actions—SH sues on behalf of C to enforce C rights

• Standing—SH/plaintiff must have been SH at time of injury and still SH
• SH must first make written demand to BD re issue unless futile
• Litigation expenses—the plaintiff can seek reimbursement from the C for reasonable litigation expenses

Question 13

Shareholders – Liability

Answer 13

1. Piercing the corporate veil
   • Totality of circumstances
   o Courts look to whether C is being used as a façade or alter ego for a dominant SH’s
   personal dealings, and whether there is unity of interest and ownership between the
   C and its members
   o The plaintiff must prove that the incorporation was just a formality and that C
   neglected corporate formalities and protocols
   • Factors considered—undercapitalization, disregard of corporate formalities, using C’s
   assets as SH’s own assets, self-dealing with C, siphoning of C’s funds, using corporate
   form to avoid statutory requirements, SH’s domination over C, and fraudulent dealings
   with a corporate creditor
2. Controlling SH’s fiduciary duty to minority SHs
   • A controlling SH is a SH (or a group of SHs acting in concert) who holds a high enough
   percentage of ownership in a company to enact changes at the highest level; a SH
   owning 50% plus one of a C’s shares is automatically a controlling SH
   • The duty arises if the controlling SH is selling interest to an outsider, seeking to
   eliminate other SHs from the C, or receiving a distribution denied to other SHs
   • Duty to disclose information that a reasonable person would consider important in
   deciding how to vote on a transaction, and a duty of fair dealing when purchasing a
   minority SH’s interest

Question 14

Board of Directors – Composition Requirements

Answer 14

can have as few as one; D must be a natural person and not a C; Ds are selected at the annual SH meeting

Question 15

Board of Directors – Term, Compensation

Answer 15

typically one year, but may serve longer if terms are staggered; Ds can be removed by SHs with or without cause unless the articles provide otherwise; D may resign at any time with written notice to the BD, its chair, or C

Compensation is permitted

Question 16

Board of Directors – Meeting Requirements

Answer 16

Ds only entitled to notice of special meetings; BD can act by unanimous written consent without holding a meeting

Question 17

Board of Directors – Voting Requirements

Answer 17

1. The assent of a majority of Ds present is necessary for board approval (generally)
   • To be a valid act, a quorum must have been present
   • A majority of all Ds in office constitutes a quorum
2. Agreements between Ds as to how to vote (pooling agreements) are generally
   unenforceable
3. Ds may not vote by proxy

Question 18

Board of Directors – Committees

Answer 18

may generally exercise whatever powers are granted to them by the BD, articles, or bylaws

Question 19

Board of Directors – Duty of Care

Answer 19

• Prudent person—a D has a duty to act with the care that a person in a like position would reasonably believe appropriate under similar circumstances (objective standard), and is required to use any additional knowledge and special skills he possesses when deciding how to act

• Reliance protection—a D can rely on information and opinions of Os, employees,
outside experts (e.g., attorneys, accountants), or committees, if D reasonably believes
them to be reliable and competent

• Business judgment rule (BJR)
o Rule—a rebuttable presumption that D reasonably believed his actions were in the
best interest of C; does not apply when D engages in a conflict-of-interest
transaction with C
o Overcoming the rule—it must be shown that: D did not act in good faith; D was not
informed to the extent he reasonably believed was necessary; D had material
interests in challenged conduct and was not objective; D failed to devote attention
to C’s affairs; D failed to timely investigate matters of material concern; or D received financial benefits to which he was not entitled

Question 20

Board of Directors – Inspection Rights

Answer 20

D has a right to inspect and copy C’s books and records

Question 21

Board of Directors – Duty of Loyalty

Answer 21

requires D to act in a manner that D reasonably believes is in the best interest of C

• Self-dealing (conflict-of-interest transaction)
o Rule—a D who engages in a conflict-of-interest transaction with his own C violates
the duty of loyalty unless the transaction is protected under the safe-harbor rules; D
cannot profit at C’s expense
o Type of transaction—one that would normally require approval of BD and is of
such financial significance to D that it would reasonably be expected to influence D’s
vote on the transaction (also includes dealings with persons related to D)
o Safe harbors—disclosure of all material facts and majority approval by BD or SHs
without a conflicting interest; fairness (comparable exchange in value) of the
transaction to C at the time of commencement

• Usurpation of corporate opportunity
o Interest or expectancy test—does C have an existing interest or an expectancy
arising from an existing right in the opportunity
o Line-of-business test—is the opportunity within the C’s current or prospective
line of business, and how expansive is C’s line of business
o Other factors—relationship of the third party to D and of D to C; how and when D
acquired knowledge of the opportunity

• Competition with C—a D who engages in a business venture that competes with C
has breached the duty

Question 22

Board of Directors – Duty of Care – Indemnity/Insurance

Answer 22

C is required to indemnify D for any reasonable expense incurred in the successful
defense of a proceeding against the D
• C is prohibited from indemnifying D against liability due to the receipt of an improper
personal benefit
• C may indemnify in an unsuccessful defense if D acted in good faith with a reasonable
belief that the conduct was in C’s best interest and D did not have reasonable cause to
believe the conduct was unlawful

Question 23

Officers and Other Employees – Selection, Authority

Answer 23

Selection – elected by BD

Authority

1. Actual—as defined by the corporate bylaws or BD
2. Implied—to perform those tasks necessary to carry out O’s duties by virtue of her status
   or position, so long as the matter is within the scope of ordinary business (i.e., not
   “extraordinary” transactions)
3. Apparent—if C holds O out has having the authority to bind C to third parties

Question 24

Officers and Other Employees – Duties, Liability

Answer 24

Duties—same as D’s duties (see above); the CEO and CFO of a publicly traded C are subject to the Sarbanes-Oxley Act, and must certify the accuracy of C’s financial reports to the SEC

Liability—an O is liable to a third party if O has acted in O’s personal capacity or has engaged in purposeful tortious behavior; (O is not liable merely for the performance of O’s duties to C)

Question 25

Officers and Other Employees – Indemnification/insurance, Removal

Answer 25

Indemnification/insurance—same as Ds (see above)

Removal—with or without cause at any time

Question 26

Officers and Other Employees – Other Employees

Answer 26

an employee can act on behalf of C to the extent of the employee’s authority and is usually protected as an agent from liability for actions undertaken in accordance with that authority

Question 27

Mergers and Acquisitions – Mergers

Answer 27

require BD and SH approval by a majority vote at a meeting with a quorum (at least
a majority of the shares entitled to vote) present for each C; required documents must be filed with the state

Question 28

Mergers and Acquisitions – Asset Acquisition

Answer 28

same as merger approval procedure except only the transferor C’s BD and SHs are entitled to vote on the transaction; transferor C remains liable for its debts

Question 29

Mergers and Acquisitions – Stock Acquisition

Answer 29

a C can acquire stock in another C to acquire control of that C without doing a merger by exchanging its own stock for that stock or by paying cash or other property for the stock

Question 30

Mergers and Acquisitions – Dissenting Shareholders Right of Appraisal

Answer 30

1. Rule—a SH who objects to a merger or acquisition, or whose rights are materially and
   adversely affected by an amendment to C’s articles, may be able to force the C to buy his stock at a fair value as determined by an appraisal
2. Qualifying SHs—any SH entitled to vote on a merger, acquisition, or amendment of C’s articles

Question 31

Termination of Corporate Status – Voluntary Dissolution

Answer 31

1. Procedure after issuance of stock—BD: adopts proposal of dissolution; maj SH vote to approve
2. Winding up—dissolving C can continue to exist to collect assets, dispose of property not
   distributed to SHs,

Question 32

Termination of Corporate Status – Involuntary Dissolution

Answer 32

1. Creditors can pursue involuntary dissolution only if C is insolvent
2. SHs can pursue involuntary dissolution if C’s assets are being misapplied/wasted, Ds are acting illegally/oppressively/fraudulently, SHs are unable to break Ds deadlock causing irreparable injury, or if the SHs are deadlocked and fail to elect successor Ds
3. Oppression doctrine—doctrine of SH oppression protects minority from oppressive majority control; statutory provisions regarding involuntary dissolution are interpreted to protect the reasonable expectations of SHs

Question 33

Special Types of Corporations – Closely Held/Close Corporations, Foreign Corporations, Professional Corporations, S Corporation

Answer 33

A. Closely held and close corporations—only a few SHs; stock not publicly traded; more relaxed style of governance

B. Foreign corporation—incorporated in another state; must register and seek a certificate of authority from the current state

C. Professional corporation—the purpose is statutorily limited to the rendering of a professional service

D. S corporation—C avoids double taxation by passing income and expenses through to its SHs, who are then taxed directly

Question 34

Limited Liability Company [LLC] – Creation

Answer 34

LLC - enjoys the pass-through tax advantage of a partnership and the limited liability of a corporation

Creation—an LLC is created by filing articles of organization with the state, including the LLC’s name, mailing address, and, if there are no members upon filing, a statement to that effect

1. Operating agreement—the articles of organization only reflect an LLC’s existence, but an LLC may also adopt an operating agreement to govern business; agreement can be oral, in a record, or implied by conduct; statutory default provisions apply when the operating agreement is silent
2. Membership—no limit (but some states require at least two members); to become a new member requires the consent of all other LLC members (a transfer of a membership interest also requires the consent of all members)
   • Transfer of membership—the transferee only acquires the transferor’s right to share
   in the LLC’s profits and losses, not a right to participate in the LLC’s management
   • Termination of membership—does not automatically trigger a dissolution of the LLC; LLC may elect to liquidate the fair value of that person’s interests
   • Allocation of profits and losses—unless determined by an operating agreement,
   allocations are made according to each member’s contributions to the LLC
   • Inspection rights—LLC members generally have inspection rights similar to SHs of Cs

Question 35

Limited Liability Company [LLC] – Management – Liabilities

Answer 35

LLC - enjoys the pass-through tax advantage of a partnership and the limited liability of a corporation

Management—can be direct (by members) or centralized (by one or more managers who
need not be members)

1. Liabilities
   • Members are generally not liable for the LLC’s obligations; managers are not personally
   liable for obligations incurred on behalf of the LLC
   • Piercing the veil—members may be liable if the veil is pierced due to
   undercapitalization, commingling of assets, confusion of business affairs, or deception of creditors
   o Mere instrumentality test—(i) members dominated the entity such that the LLC had no will of its own, (ii) members used that domination to commit a fraud or
   wrong, and (iii) the control and wrongful action proximately caused an injury
   o Unity of interest and ownership test—the LLC did not have an existence
   independent of the members because there was such a unity of interest and
   ownership between the entity and the members that the failure to pierce the veil
   would be unjust or inequitable
   • Creditors can obtain a charging order (judgment lien) against a member’s LLC interest,
   requiring the LLC to pay to the judgment debtor distributions that otherwise would be
   paid to the member; the operating agreement cannot alter this rule to the prejudice of
   third parties

Question 36

Limited Liability Company [LLC] – Direct and Derivative Suits

Answer 36

LLC - enjoys the pass-through tax advantage of a partnership and the limited liability of a corporation

1. Direct—an action to enforce a member’s rights as a member under the operating
   agreement and the state LLC statute; there must be an actual or threatened injury that is
   not just a result of an LLC injury
2. Derivative—an action by a member on behalf of the LLC to enforce the rights of the LLC; must show that a demand was made or that demand would be futile

Question 37

Limited Liability Company [LLC] – Dissolution

Answer 37

LLC - enjoys the pass-through tax advantage of a partnership and the limited liability of a corporation

Dissolution—an LLC may merge with another LLC or other business entity; may dissolve upon the occurrence of various events (mutual consent of members, lack of members for 90 consecutive days, court order, or events provided in the operating agreement)

1. Member may seek involuntary dissolution if a controlling member acts in a way that is oppressive and directly harmful to the member seeking the order; action must action violate member’s reasonable expectations
2. Winding up—the LLC must (i) discharge the LLC’s debts, obligations, or other liabilities;
   and (ii) settle and close the LLC’s activities, and marshal and distribute the LLC’s assets;
   may perform acts necessary or appropriate to the winding up

Question 38

Limited Liability Company [LLC] – Management – Duties

Answer 38

LLC - enjoys the pass-through tax advantage of a partnership and the limited liability of a corporation

Management—can be direct (by members) or centralized (by one or more managers who
need not be members)

Duties—members owe each other and managers duties of loyalty and care
• Must account to the LLC for any benefit derived by the member related to the LLC’s
business, refrain from dealing with the LLC on behalf of one having an adverse
interest, and refrain from competing with the LLC
• Duty of care to LLC is subject to BJR; members are not liable for simple negligence
• Fiduciary waivers are recognized in LLCs; may agree to specific activities that do not
violate the duty of loyalty, as long as the agreement is not manifestly unreasonable

Question 39

Stock and Other Corporate Securities – Sale of Securities

Federal Restriction – 10b-5 action

Answer 39

Federal causes of action
• Rule 10b-5 action (– when there’s a fraudulent buying/selling of stock/securities, etc. ) —must meet each of the following requirements to bring this axn:
o The plaintiff purchased or sold the security
o Use of interstate commerce
o The defendant’s fraudulent/deceptive conduct—untrue statements of material fact,
failure to prevent misleading statements, or insider trading
o Materiality—a reasonable investor would find the fact important in deciding whether
to purchase or sell a security
o Scienter—the defendant must make the statement intentionally or recklessly
o The plaintiff’s justifiable reliance on the defendant’s fraudulent conduct
o Harm to the plaintiff

Question 40

Stock and Other Corporate Securities – Sale of Securities

Federal Restriction – 16(b) action

Answer 40

• Rule 16(b) action— can’t buy/sell public stock
4 required elements:
o Applicable Corp: Publicly traded Cs OR C with $10mill+ assets and more than 500 SHs
o Applicable Def: Corporate insiders—Ds, Os, or SHs with more than 10% of stock
o Short-swing profits—a corporate insider both bought and sold C’s stock during any six-month period
o SEC report of change in stock ownership