CORPORATIONS Flashcards
Liability for Pre-Incorporation Contracts–Promoter Liability
A promoter is a person who acts on behalf of a corporation that has not yet been formed. A promoter remains personally liable on any pre- incorporation contract entered into EVEN IF the corporation subsequently adopts the contract. Two Exceptions to this rule exist: (1) where there was a subsequent novation (an agreement by all parties to substitute the corporation for the promoter as the contracting party and to relieve the promoter of the contractual obligations); OR (2) if the contract explicitly provides that the promoter has no personal liability on the contract. A promoter may seek reimbursement from the corporation for any liability, but he CANNOT compel the corporation to pay for the same.
Liability for Pre-Incorporation Contracts–Corporate Liability
A corporation is NOT liable for a pre-incorporation contract entered into by a promoter UNLESS the corporation adopts the contract. A corporation may adopt the contract either: (a) expressly – through a board resolution; OR (b) impliedly – by knowing the materials terms and accepting/retaining benefits of the contract.
Shareholder Liability & Piercing the Corporate Veil
Generally, shareholders, directors, and officers are NOT personally liable for the liabilities and obligations of the corporation. However, courts may disregard the corporate form and hold individual corporate shareholders, directors, and officers personally liable for actions taken on behalf of the corporate entity.
A court will pierce the corporate veil and hold the shareholders personally liable in the following situations:
(1) the corporation is acting as the alter ego of the shareholders – where there is little or no separation between the shareholder and the corporation (i.e. where an individual utilizes the corporate form for personal reasons);
(2) where the shareholders failed to follow corporate formalities;
(3) the corporation was inadequately capitalized at its inception to cover debts and prospective liabilities; OR
(4) to prevent fraud. A court is more likely to pierce the corporate veil for tort actions rather than contract disputes.
Shareholder Liability & Piercing the Corporate Veil–Shareholders in a Closely Held Corporations
Shareholders in a close-corporation owe the other shareholders the duty of loyalty and good faith, and will be liable for any damages resulting from a breach of said fiduciary duties.
Director and Officers’ Duty of Care–Business Judgement Rule
Directors (and Officers) are fiduciaries of a corporation, and as such owe a duty of care to the corporation. This means that they must discharge their duties:
(1) in good faith;
(2) in a manner the Director reasonably believes to be in the best interests of the corporation; AND
(3) with the care that a person in a like position would reasonably believe appropriate under similar circumstances.
If this three-part test is satisfied, then a Director will NOT be liable for corporate decisions that resulted in adverse consequences to the corporation. Under the common law, the above test was known as the Business Judgment Rule.
If a Director breaches the duty of care, he may be held personally liable to the corporation for any losses suffered as a result.
Director and Officers’ Duty of Care–Reasonably Informed Decisions
The duty of care requires that Directors be reasonably informed on the decisions they make. A Director may rely on the reasonable advice of advisors, such as attorneys, accountants, officers, or Committees of the Board when: (1) such reliance was reasonable; AND (2) the advisor or Committee was qualified to provide such advice.
If a Director breaches the duty of care, he may be held personally liable to the corporation for any losses suffered as a result.
Director/Officer–Duty of Loyalty
- A Director (or Officer) owes the corporation a fiduciary duty of loyalty, which means that the Director, in his dealings with the corporation, must act in the best interests of the corporation and without personal conflict.
- The duty of loyalty forbids Directors from:
(a) entering into conflicting interest transactions;
(b) usurping a corporate opportunity;
(c) competing with the corporation; OR
(d) trading on inside information.
Duty of Loyalty–Conflicting Interest Transaction
A conflicting interest transaction with the corporation is a breach of the duty of loyalty UNLESS the Director shows that:
(a) it was approved by a majority of disinterested Directors after full disclosure of all relevant material facts;
(b) it was approved by a majority of disinterested Shareholders after full disclosure of all relevant material facts; OR
(c) the transaction as a whole was fair to the corporation at the time it was entered into (the price must be comparable to what the corporation would receive in an arm’s length transaction and the process followed by the Board was appropriate).
Duty of Loyalty–Conflicting Interest Transaction
A conflict of interest occurs when the director/officer or a family member either: (a) is a party to the transaction; (b) has a beneficial interest in the transaction or is so closely linked to it that the director’s judgment may reasonably be affected; OR (c) is involved with another entity (director, employee, owner, etc.) that is conducting business with the corporation and that transaction would normally be brought before the Board of Directors because of its importance to the corporation.
Duty of Loyalty–Usurping a Corporate Opportunity
- A corporate opportunity is: (a) any opportunity that the corporation has an interest/expectancy in; OR (b) in the corporation’s line of business.
- A director/officer MAY ONLY pursue a corporate opportunity if he: (1) first presents it to the corporation’s Board of Directors; AND (2) the Board decides not to pursue the opportunity. Modern authorities construe a business opportunity broadly to include those outside the corporation’s traditional line of business. It is NOT a defense to show that the corporation would not have been able to take the opportunity.
