Corporations

Question 1

What is a corporation?

Answer 1

A corporation is a legal entity created by complying with the statute governing incorporations; it is strictly a creature of statute – there is no common law right to organize a corporation.

The law regards the corporation as an entity distinct from its shareholders, whether it is a large public corporation with thousands of shareholders, or a small, closely held corporation with just 2 or 3 shareholders.

The major characteristics of a corporation are:

1. freely transferable shares;
2. a continuous existence, despite the death of individual shareholders;
3. limited liability of the shareholders; and
4. centralized management of assets by directors and officers.

Question 2

What law in South Carolina governs corporations?

Answer 2

The South Carolina Business Corporation Act of 1988 (SCBCA) governs corporate law in this state.

Question 3

What is required in order to form a corporation?

Answer 3

A corporation is ordinarily created by filing articles of incorporation with the Secretary of State.

Question 4

What is an incorporator?

Answer 4

An incorporator is a person or entity that assists in creating, developing, and organizing an enterprise into a corporation.

Question 5

What is the document required to be filed as a part of the articles of incorporation?

Answer 5

The Certificate of Incorporation must be filed in the creation of a corporation. This certificate must include the following:

1. The corporate name;
2. The incorporators’ names and addresses;
3. the name and address of the initial registered agent; and
4. the number of shares the corporation is authorized to issue.

Question 6

What is required of the corporation’s name?

Answer 6

• The name of the corporation MUST contain the word “corporation,” “company,” “incorporated,” or “limited,” or an abbreviation of one of these words.
• The name of the corporation may not be the same as, or deceptively similar to, the name of any domestic or foreign corporation authorized to transact business in the state, unless the first corporation files written consent with the Secretary of State.

Question 7

As part of the Certificate of Incorporation, must the corporation give specific details regarding the number of shares issued or the prices of those shares?

Answer 7

While the Certificate of Incorporation does require the number of shares the corporation is authorized to issue, the corporation does not need to issue as many shares as they have authorized; as little as one (1) share may actually be issued.

The articles of incorporation need not state the number and type of shares actually issued, or the consideration received for the shares.

Question 8

What may be included in the Certificate of Incorporation?

Answer 8

The Certificate of Incorporation must be filed in the creation of a corporation.

This certificate MUST include the following:

1. The corporate name;
2. The incorporators’ names and addresses;
3. The name and address of the initial registered agent; and
4. The number of shares the corporation is authorized to issue.
   
   1. The corporation need not issue as many shares as are authorized; as little as one share may actually be issued; and
   2. The Articles of Incorporation need not state the number and type of shares actually issued, or the consideration received for the shares.
5. If any preemptive rights are to be granted to the shareholders, the provisions applicable to this rights must appear in the articles of incorporation.

The certificate may include a set of optional provisions, such as:

1. the names and addresses of the individuals who will be serving as the initial directors;
2. a duration for the corporation’s existence; if not specified, the corporation will have perpetual existence.
3. any lawful provision regarding:
   
   1. the purpose(s) for which the corporation is being organized;
   2. managing the business and regulating the affairs of the corporation;
   3. defining, limiting, and regulating the powers of the corporation, its board of directors, and shareholders;
   4. a par value for authorized shares or classes of shares; or
   5. the imposition of personal liability on shareholders for debts of the corporation;
4. provisions regarding the granting of rights to stockholders;
5. any provision required or permitted to be set forth in the bylaws; and
6. Other relevant information regarding stock, including:
   
   1. the total number of shares and the par value, if any, of each class of stock that the corporation is authorized to issue; and
   2. if more than one class is authorized, the preferences, voting powers, qualifications, and special rights or privileges of each class and series.

Question 9

What is the next step in forming a corporation once the articles of incorporation have been filed with the Secretary of State?

Answer 9

There must be an organizational meeting.

If the initial directors of the corporation are named in the articles of incorporation, they must hold the meeting at the call of the majority of directors to complete the organization of the corporation by:

1. appointing officers;
2. adopting bylaws; and
3. carrying on any other business brought before the meeting.

If no initial directors have been named, then the incorporator(s) must hold the meeting at the call of a majority of incorporators to either:

1. elect directors and complete organization; or
2. elect a board of directors, who will then complete the organization of the corportion by:
   
   1. appointing officers;
   2. adopting bylaws; and
   3. carrying on any other business brought before the meeting.

Question 10

What are bylaws?

Answer 10

Bylaws are internal rules and regulations enacted by the corporation to govern its action and its relation to its shareholders, directors, and officers.

Bylaws may include any provisions for the regulation and management of the affairs of the corporation that are not inconsistent with law or with the articles of incorporation.

The bylaws often specify:

1. the time and place for the annual shareholders’ meeting;
2. the record date for determining the shareholders entitled to vote at meetings or to receive dividends;
3. the number of shareholders necessary to constitute a quorum;
4. the percentage of votes necessary to authorize corporate action; and
5. any restrictions on transferability of shares.

Bylaws are adopted during the organizational meeting.

Question 11

What is a promoter?

Answer 11

A promoter is one who causes a corporation to be formed, organized, and financed during the pre-incorporation period.

Generally, promoters will:

1. manage the initial financing of the corporation;
2. arrange for a meeting of the investors;
3. negotiate and prepare the preincorporation agreements;
4. lease office and factory space; and
5. contract for the initial needs of the business.

Question 12

What is the nature of the relationship between a promoter and the corporation?

Answer 12

Promoters stand in a fiduciary relationship to the corporation and its subscribers for stock, and to those who it is expected wll afterwards buy stock from the corporation. So, they have the duty of care and the duty of loyalty to the corporation, and must avoid self-dealing concerning any assets they sell to the corporation.

Also, promoters owe the corporation a duty of disclosure, meaning that they must fully disclose all material facts conerning any assets they sell to the corporation, including whether the promoters are making a profit on the sale. If the cost and manner of acquisition of the assets by the promoter is fully disclosed to an independent board of directors, and the board approves the transaction, then the promoter has not breached his fiduciary duty and can keep any profit from the sale.

EXCEPT, when the promoter(s) are made up of the only shareholders of the corporation, and no further issuance of stock is contemplated, failure to disclose their financial interests is not a violation of their fiduciary duty to the corporation, even if the shares are later sold to the public without disclosure.

The promoter will not be liable to the corporation if he made full disclosure to:

1. all the original subscribers for shares and obtained their approval; or
2. the shareholders of the established corporation, and they ratified the transaction.

Question 13

Assuming that there is more than 1 promoter, what is the nature of the relationship between promoters?

Answer 13

If there is more than 1 promoter of a corporation, the promoters are essentially joint venturers and therefore owe each other a fiduciary duty.

Question 14

What is the rule regarding promoter liability?

Answer 14

As a general rule, the promoter is personally liable on any contract he entered into on behalf of the pre-incorporated enterprise, unless the circumstances demonstrate that the other party to the K looked only to the newly formed corporation for performance.

A promoter may be relieved of perosnal liability if the newly formed corporation adopts the contract as a novation, replacing the promoter in the contract.

Unless the contract expressly reflects the other party’s intent to hold the new corporation responsible for performance, or a novation occurs, the promoter is personally liable on the contract.

BUT, provided the promoter undertook the K in good faith, even if he is held personally liable under the K, he may be entitled to reimbursement from the newly formed corporation, at least to the extent that the corporation benefited from the K.

Question 15

What is the rule regarding a newly formed corporation’s liabilty on pre-incorporation contracts?

Answer 15

As a general rule, a corporation is not liable on any preincorporation agreements its promoters entered into on its behalf unless it assumes liability by its own act after coming into existence.

Question 16

What are the two ways in which a newly formed corporation becomes liable for preincorporation contracts?

Answer 16

Novation and Adoption (express or implied).

Novation - if all the parties agree to substitute the liability of the corporation for that of the promoter, there is a novation and the promoter is discharged.

Adoption - if the corporation merely adopts the contract of the promoter, the promoter may remain liable on the contract, but will be entitled to indemnification from the newly created corporation.

1. Express Adoption usually occurs when the board of directors passes a resolution adopting the contract.
2. Implied Adoption may occur if the corporation accepts of acknowledged the benefits of the contract in some manner.

Question 17

What is the difference between de jure and de facto corporations?

Answer 17

De Jure Corporation - is a corporation organized in compliance with all mandatory statutory provisions for incorporation. Failure of the organizer(s) to comply with a mandatory statutory provision will preclude de jure status.

• In general, corporate existence begins when the articles of incorporation become effective (generally upon being filed with the proper state agency as prescribed by statute).
• A certified statement of the fact of incorporation by the state is generally considered evidence of de jure status.

De Facto Corporation - if a corporation’s compliance with mandatory statutory provisions is insufficient for becoming a de jure corporation, a de facto corporation may still be deemed to exist if:

1. a good faith colorable attempt was made to comply with the incorporation statute; and
2. the corporate principals acted in good faith as if they were a corporation.

• De facto status insulates directors and shareholders from liability except in a direct action by the state.
• The de facto doctrine rarely applies today, however, because the state must approve the articles before they are filed, and a statement by the state of the fact of incorporation is conclusive evidence of incorporation.

Question 18

What is Corporation by Estoppel?

Answer 18

Absent de jure or de facto status, a corporation may still exist by estoppel.

If a creditor always dealt with the principals as if they were a corporation, the creditor will be estopped from later alleging that the corporation is defective if that would unjustly harm the principals.

In the same manner, a defendant that has held itself out to be a corporation cannot then attempt to avoid liabilty by claiming that the plaintiff has not cause of action because the defendant is not a legal entity.

The estoppel doctrine is not a defense to a tort claim, as the claimant has not previously dealt with the principals as if they were a corporation in a contractual transaction.

It may be relevant to K claims, however, where a prior business relationship exists.

Question 19

What is the Ultra Vires Doctrine?

Answer 19

Under the ultra vires doctrine, a corporation cannot be obliged to undertake a contract or activity that is beyond the scope of its power as described in the certifcate of incorporation or bylaws.

This doctrine has little applicability today, since the articles of incorporation typically authorize the corporation to engage in “all legal activities,” which covers a broad scope that only excludes (1) illegal activities; and (2) activities that are not directed to any business purpose.

Under the SCBCA, a corporation’s power to act may only be challenged:

1. in a proceeding by a shareholder to enjoin the act;
2. in a proceeding by the corporation (directly, derivatively, or through a representative) against a current or former director, officer, employee, or agent of the corporation; and
3. in a proceeding by the attorney general based on the grounds that:
   
   1. the corporation obtained its articles through fraud; or
   2. the corporation has continued to exceed or abuse the authority conferred upon it by law.

Question 20

When is it permissible to “pierce the corporate veil”?

Answer 20

As a general rule, a corporation will be looked upon as a separate legal entity; however, a court may disregard its separate entity and hold shareholders or affiliated corporations liable on corporate obligations when necessary to prevent fraud or achieve equity.

South Carolina courts have outlined a two (2) prong test to determine whether a corporate veil should be pierced:

1. whether corporate formalities have been observed by the dominant shareholders; and
2. whether there would be an element of injustice or fundamental unfairness if the acts of the corporation were not regarded as the acts of the individuals.

Although adequacy of capitalization is a factor considered by the courts, inadequate capitalization along will not ordinarily lead to piercing the corporate veil.

Question 21

What is required to be a director upon the Board of Directors of a corporation in South Carolina?

Answer 21

The minimum number of directors is specified in, or fixed in accordance with, the articles of incorporation or bylaws.

Under the SCBCA, only one (1) director is required, although more may be provided for.

A director does not need to be a resident of South Carolina, nor must he be a shareholder of the corporation [unless the bylaws require it]. The articles or bylaws may prescribe further qualifications.

Question 22

What is a quorum?

Answer 22

A quorum is the number of directors that must be present for the board to be legally competent to transact business.

Unless the certificate of incorporation or bylaws require a greater number, a quorum of a board of directors consists of a majority of the total number of directors.

Question 23

How does the board of directors transact business and take action on behalf of the corporation?

Answer 23

Once a quorum is present, a vote of the majority of directors present at the meeting constitutes an act of the board, unless the articles of incorporation or bylaws require a greater margin, or even a unanimous vote.

The board does not ordinarily run the corporation on a day to day basis. It may delegate its powers to officers and executive committees. If the articles of incorporation or bylaws permit, the board may elect an executive committee or other committee of directors.

Question 24

Under the SCBCA, the board of directors of a corporation is permitted to delegate all the authority of the board to one or more committees, except for the power to:

Answer 24

1. Authorize the payment of any dividend or distribution to shareholders;
2. Approve or recommend to shareholders actions or proposals required to be approved by shareholders;
3. Fill vacancies on the board of directors or any of its committees; or
4. Adopt, amend, or repeal the bylaws.

Question 25

What are some of the rights of shareholders?

Answer 25

1. To elect and remove directors;
2. To approve amendments to the articles of incorporation;
3. To amend the bylaws; and
4. To approve extraordinary actions in the corporation, such as merger, consolidation, share exchange, transfer of assets, and dissolution.

Question 26

How frequently must shareholders have meetings?

Answer 26

A meeting of shareholders is to be held annually for the election of directors and the transaction of any other business.

Question 27

What are the rules with regard to notice of shareholder meetings?

Answer 27

Written Notice stating the

1. place
2. date
3. hour
4. and purpose(s)

of the meeting MUST be given by the clerk to each shareholder entitled to vote not less than 10, and not more than 60, days prior to the meeting.

Question 28

With regard to shareholder voting rights, what are shareholder voting agreements?

Answer 28

Shareholder Voting Agreements are, in essence, contracts designed to ensure the shareholders will vote in concert with regard to issues designated by the agreement. Such agreements are ordinarily used by minority shareholders to marshall the aggregate number of votes necessary to be elected to the board, or to veto corporate action of which they disapprove.

Question 29

What is the default rule with regard to voting rights within the corporation?

Answer 29

Unless a statute or the articles of incorporation provide otherwise, each share is entitled to one (1) vote, and each fractional share is entitled to a proportionate vote.

Only shareholders of record are entitled to vote, but by statute, a shareholder may vote such shareholders’ share in person or by proxy.

Question 30

What does it mean for a shareholder to vote by proxy?

Answer 30

The term proxy means the grant of authority by a shareholder to another person to vote the shareholder’s stock. It may also mean the instrument granting the authority, or the agent to whom authority is granted (aka the proxy holder).

Question 31

What is a voting trust?

Answer 31

One or more shareholders may create a voting trust, conferring on a trustee the right to vote or otherwise act for them.

Question 32

What information are shareholders entitled to examine upon request?

Answer 32

Shareholders of record are entitled to examine the original, or attested copies, of:

1. the articles of incorporation;
2. the bylaws;
3. the records of all meetings of incorporators and of shareholders; and
4. the stock and transfer records, which must contain the names and addresses of all shareholders and the amount of stock held by each.

Question 33

What is the standard of care owed by a director or officer?

Answer 33

Duty of Care

A director or officer has a duty to act in good faith, in the honest belief that he is acting in the best interests of the corporation on an informed basis.

Question 34

What is the business judgment rule?

Answer 34

The business judgment rule shields directors from liability in the case of honest errors in judgment. It creates a rebuttable presumption that directors are honest, well-meaning, and acting through decisions that are informed and rationally undertaken in good faith.

Usually, a director or officer who makes a good faith error of business judgment will not have breached his duty of care.

Question 35

What are acts that, in the absence of good faith action or reliance, subject directors to statutory liabilities?

Answer 35

1. Improper declaration of dividend;
2. Distribution during liquidationl
3. Improper redemption and repurchase of shares or purchasing corporation’s shares; and
4. failure to give notice to barred creditors.

Question 36

What is the Duty of Loyalty and to whom does it apply?

Answer 36

The Duty of Loyalty is owed by all fiduciaries, specifically here, by all officers, directors, and employees of the corporation. It requires that they be loyal to the corporation and not promote their own interests in a manner injurious to it.

Question 37

What are some potentional situations involving officers and directors that may constitute a breach of the duty of loyalty?

Answer 37

A conflict of interest constituting a breach of the duty of loyalty arises where the individual:

1. has business dealings with the corporation;
2. takes advantage of a corporate opportunity; or
3. enters into competition with the corporation.

Interlocking directors may also constitue a breach.

Question 38

What are interlocking directors?

Answer 38

A conflict of interest violating the duty of loyalty would arise if a director were on the board of two corporations transaction business with each other. This is known as interlocking directors.

These transactions, while not void, are, at most, voidable by or on behalf of the corporation UNLESS the interested person can prove that:

1. the material facts of the conflict were disclosed and fully described to the board, and the transaction was validly approved by a majority of disinterested directors;
2. the material facts of the conflict were disclosed and fully described to the shareholders, and the transaction was validly approved by a majority of disinterested shareholders; or
3. a court determines the transaction was fair and reasonable to the corporation.

A corporation may rescind a transaction that is not fair; or, if a recission is not feasible, the corporation may recover damages for losses as a result of entering into the transaction with an interested director.

Question 39

What is a corporate opportunity and when is it permissible for a director or officer to take advantage of it?

Answer 39

The fiduciary duty of loyalty prohibits directors and officers (and sometimes employees) from taking for their own benefit any business opportunity that properly belongs to the corporation, UNLESS:

1. the opportunity is fully disclosed to the corporation, the corporation is first given a chance to pursue the opportunity, and the corporation decides not to pursue the opportunity; OR
2. the corporation could not have taken the opportunity

Question 40

What are the duties of controlling shareholders?

Answer 40

A majority or controlling shareholder owes a fiduciary duty to minority shareholders and the corporation. They must refrain from exercising control to obtain a benefit from the corporation not shared proportionately with the minority shareholders, such as:

1. causing the board of directors to guarantee, or enter into, a loan made by or with a majority shareholder;
2. causing the board of directors to issue additional stock to a controlling shareholder at less than FMV for the purpose of diluting the minority’s interest;
3. causing the board of directors to enter into a K with a majority shareholder, or an entity affiliated with a majority shareholder, on unfair terms; and
4. causing the board of directors to dissolve the corporation, merge it with a company owned by the controlling shareholders, or sell its assets, for the purpose of excluding the minority shareholders from participation in a profitable business.

Question 41

What is Rule 10b-5 about?

Answer 41

Rule 10b-5 and Insider Trading in Securities

• Under the Model Act, corporate executives, shareholders, and employees have a fiduciary duty to disclose material facts they learn that affect the value of the corporation’s stock, and to refrain from trading in stock using inside information.
• The duty to disclose extends to existing shareholders in connection with a sale or purchase of the corporation’s stock. The insider must abstain from trading or disclosing.

Question 42

What are the two (2) types of securites that investors receive as tangible evidence of their investment?

Answer 42

Debt Securities and Equity Securities

1. A debt security respresents money loaned to the corporation, and a person holding debt securities is a creditor of the corporation (i.e., debentures, bonds, and notes).
2. An equity security represents the captial of the corporation that is at risk in the business (shares of stock).

Question 43

What are they different types of debt securities and how do they differ?

Answer 43

A debt security respresents money loaned to the corporation, and a person holding debt securities is a creditor of the corporation. They can be in the form of :

1. Debentures - unsecured obligations of the corporation; holders are general creditors;
2. Bonds - secured by mortgage or security interest in specific assets of the corporation; holders are secured creditors; and
3. Notes - short-term debt securities that may be secured or unsecured; holders are typically institutional lenders.

Each of these creditors has priority over that of holders of Equity Securities upon a liquidation, but none have the right to vote in matters of the corporation.

Question 44

What is an Equity Security and what rights come with ownership of them?

Answer 44

An equity security represents the captial of the corporation that is at risk in the business (shares of stock). Equity security holders, aka Stockholders, have no right to repayment of the amount invested or to a return on the investment. But, upon the liquidation of the corporation, once the creditors have been satisfied, all of the remaining corporate assets go to these shareholders - which could be very little, but it could be a whole lot.

Rights of shareholders are usually:

1. Dividend Rights - the right to a dividend, if any, as they are declared at the board’s discretion;
2. Liquidation Rights - the right to a share of the corporate assets at the end of the corporation’s existence; and
3. Voting Rights - the right to a voice in the management of the corporation; ALL shares have EQUAL voting rights, unless otherwise specified in the certificate of incorporation;

The certificate of incorporation may authorize one or more classes of stock.

Question 45

What is Common Stock?

Answer 45

Common Stock represents the residual ownership interest in the corporation; upon liquidation, the holders of the common stock divide all the assets remaining after satisfaction of creditors and payment have been made to the preferred shareholders of their liquidation preference.

Every corporation MUST authorize and issue at least one (1) class of common stock.

Shareholders of common stock have a potentially unlimited return on their investment, but also have the greatest risk of losing their investment.

Common shareholders have no right to a dividend UNLESS declared by the directors after payment of preferred stock dividends.

Common shareholders usually have the right to vote, but common stock may be divided into classes, some of which may be nonvoting or, in the election of the directors, limited.

Question 46

What is Preferred Stock?

Answer 46

Shareholders of preferred stock are generally entitled to receive fixed dividends before any dividends are paid to common shareholders.

While the directors ordinarily have discretion as to whether to declare a dividend, if a dividend is declared, the preferred shareholders are entitled to receive their stipulated amount before the common shareholders receive any dividends.

Some typical characteristics of Preferred Stock are:

1. it is often nonvoting stock, but voting rights may accrue if the dividend is not paid, or if an attempt is made to alter its rights by amending the articles of incorporation.
2. it is usually nonparticipating, meaning preferred shareholders receive no more than their stipulated dividend.
3. it is usually preferred as to a stated amount of dividends, which are ordinarily both limited and cumulative.
4. It is usually preferred and limited as to liquidation rights.
5. It may also be redeemable at the option of the shareholder.

Question 47

What are two (2) limitations on the directors’ ability to declare a dividend?

Answer 47

Under the SCBCA, the directors may not declare a dividend if:

1. the corporation would not be able to pay its debts and they become due in the ordinary course of business; or
2. the corporation’s total assets would be less than the sum of its total liabilites plus the amount the corporation would need, if it were dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferences are superior to thise recieving the distribution.

Dividends may be paid only to the extent of surplus.

Question 48

What is “surplus”?

Answer 48

Surplus is defined as the excess of the net assets of the corporation over the amount determined to be its capital.

Net assets are defined as the amount by which total assets exceed total liabilities. Capital and Surplus are not liabilities for this purpose.

Dividends are paid out of the surplus.

Question 49

What occurs once the directors declare a dividend?

Answer 49

A soon as a dividend has been declared, a debtor-creditor relationship arises between the corporation and the shareholders, and the funds to pay the dividend are considered segregated from other corporate funds.

A shareholder may enforce his dividend right as a creditor of the corporation.

Question 50

With regard to dividends, what is Redemption and Repurchase?

Answer 50

Redemption occurs when a corporation has the right to compel a shareholder to sell the shareholder’s shares back to it.

A repurchase is a voluntary agreement by the corporation to buy its own shares of either common or preferred status. As a general rule, authorization in the certificate of incorporation is not required; instead, the repurchase of shares may be authorized by the board of directors.

Question 51

When may a corporation authorize amendments to its articles of incorporation without shareholder approval?

Answer 51

A corporation may amend its articles of incorporation in any respect if the amendment would be a legal provision in the original articles filed on the date of the amendment.

Without the approval of shareholders, a corporation may authorize amendments of its articles of incorporation in order to:

1. delete the names and addresses of the initial directors;
2. delete the name and address of the initial registered agent or registered office, if a statement of change is on file with the Secretary of State;
3. change each issued and unissued authorized share of an outstanding class into a greater number of whole shares if the corporation has only shares of that class outstanding;
4. change the corporate name by substituting the word “corporation,” “incorporated,” “company,” “limited,” or an abbreviation of one of these words, for a similar word in the name or by adding, deleting, or changing a geographical attribution for the name; or
5. make any other change expressly permitted by law to be made without shareholder action.

Any shareholder who is adversely affected by an amendment of the articles of incorporation and who objects to the action is entitled to an appraisal and payment for his stock.

Question 52

In attempting to pierce the corporate veil, what is the 2 prong test adopted by SC Courts to determine whether the veil should be pierced? What must the plaintiff demonstrate?

Answer 52

South Carolina courts have outlined a two (2) prong test to determine whether a corporate veil should be pierced:

1. whether corporate formalities have been observed by the dominant shareholders; and
2. whether there would be an element of injustice or fundamental unfairness if the acts of the corporation were not regarded as the acts of the individuals.

To pierce the corporate veil, a plaintiff must demonstrate that:

1. there is control so complete that the corporation has no separate will or existence of its own, and in fact the shareholder was the alter ego of the corporation or a mere instrumentality of a parent corporation;
2. the corporate form has been used fraudulently or for an improper purpose (e.g., using corporate assets for personal benefits or a commingling of funds); and
3. injury or unjust loss resulted to the plaintiff from such control and wrong.