Corporations

Question 1

Formation - Promoter Liability

Answer 1

A promoter is a person acting on behalf of a corporation not yet formed. Promoters have a fiduciary duty to the corporation and co-promoters. Promoters are solely liable for pre-incorporation Ks, but liability is shared if the formed corporation expressly or impliedly adopts the agreement. The promoter has no liability after there has been a novation. Here,

Question 2

Formation - De Jure Corporation

Answer 2

Corporations are a separate legal entity capable of suing/being sued, holding property, being a partner, and paying taxes. A de jure corporation is validly formed when articles of incorporation are filed with the secretary of state that include (APAIN) 1) authorized shares, 2) purpose of business, 3) agent of serves, 4) incorporator name(s), 5) name of corporation. A corporation generally shields owners from personal liability. Here,

Question 3

Formation - De Jure Corporation: Purpose of Business

Answer 3

It is presumed the business has a general purpose to engage in any lawful activity in perpetuity. However, if a specific purpose is stated and the business acts outside its purpose, then Officers and Directors could be liable for “ultra vires” acts. Here,

Question 4

Formation - DeFacto Corporation and Estoppel

Answer 4

If the articles of incorporation were unintentionally never filed with the secretary of state, the shareholders may still have some protection from personal liability if they can show the existence of a DeFacto Corporation or a Corporation by Estoppel. However, these doctrines are abolished in some states. Here,

Question 5

Formation - De Facto Cororation

Answer 5

De Facto corporation status will be granted if there was a good faith attempt to comply with the incorporation statute and there was an exercise of corporate privileges, i.e. acting like we already formed corporation. Here,

Question 6

Formation - Corporation by Estoppel

Answer 6

Under the Corporation by Estoppel doctrine, a party entering a contract with the business, as if it were a valid corporation, will be estopped from later denying its corporate status. Here,

Question 7

Pierce the Corporate Veil

Answer 7

Even if a close corporation is validly formed, individual shareholders may still be liable for corporate damages if they intentionally abuse the privileges of incorporation and fairness requires it. Courts are more willing to PCV for tort victims because, unlike a K claimant, a tort claimant did not willingly choose to transact with the corporation. Here,

Question 8

PCV - Close Corporation

Answer 8

A close corporation has a small number of shareholders and no public market for stock. members have a fiduciary duty to not oppress each other (similar to partnership). Here,

Question 9

PCV - Alter Ego

Answer 9

The corporate veil may be pierced, and individual shareholders may be liable, if he abuses the protections of incorporation by co-mingling personal and corporate assets. Horizontal PCV occurs when the shareholder abuses the use of a sibling corporation. Here,

Question 10

PCV - Under Capitalization at Formation

Answer 10

The corporate veil may be pierced, and individual shareholders may be liable, if he fails to invest enough capital (or insurance) to cover reasonably foreseeable liabilities. Here,

Question 11

PCV - Fraud

Answer 11

The corporate veil may be pierced when necessary to prevent fraud or to prevent an individual from using the entity to avoid existing personal obligations. Here,

Question 12

Capitalization - Issuance of Stock

Answer 12

Issuance of stock occurs when a corporation sells or trades its own stock to raise capital for the corporation. Here,

Question 13

Stock Subscriptions

Answer 13

Subscriptions are written offers to buy stock from a corporation. Pre-incorporation subscriptions are irrevocable for 6 months. Post-incorporation subscriptions are revocable up until acceptance. Acceptance is valid once approved by the board. Here,

Question 14

Consideration

Answer 14

The Board determines the value of consideration in good faith. Corporation must receive valid consideration in the form of 1) money 2) tangible or intangible property, or 3) services already performed. In some states, promissory notes and future services are acceptable. Here,

Question 15

Consideration - Par Value

Answer 15

Par means the minimum issuance price. Stock sold for less than par is “watered stock” and Directors are liable for the shortfall in value if they knowingly issued below par stock. Here,

Question 16

Consideration - Treasury Stock

Answer 16

The corporation may repurchase shares from shareholders who voluntarily offer to sell their shares to the corporation, however, shareholders cannot force the corporation to repurchase their shares. Here,

Question 17

Shareholders

Answer 17

Generally, shareholders do not manage the corporation directly, but rather elect the Directors who in turn select Officers to manage the company. Shareholders are usually not liable for the obligations of the corporation. Here,

Question 18

Shareholders - Voting Rights

Answer 18

Record shareholders on record date have a right to vote at the annual meeting, special meeting, or by unanimous written consent. Shareholder may vote by proxy or through a shareholder voting agreement. A valid vote requires a quorum based on a majority of the outstanding shares present, and a majority vote once a quorum is established. Here,

Question 19

Shareholders - Voting Rights: Proxies

Answer 19

A proxy is a signed written agreement to vote on behalf of a shareholder. Proxies are freely revocable and are valid for 11 months, unless expressly stated otherwise. Here,

Question 20

Shareholders - Voting Rights: Shareholder Trust/Agreement

Answer 20

Shares are generally freely transferrable so any restrictions on transfers must be reasonable. A shareholder trust allows shares to be transferred to a trustee who will vote shares according to the trust agreement. A shareholder agreement is a signed written agreement to pool shares for a specific time or purpose. Unlike a voting trust, the shareholder agreement need not be filed with the corporation and is not subject to any time limit. Here,

Question 21

Shareholder - Inspection Rights

Answer 21

Any shareholder has a limited right to inspect the accounting records with proper advanced notice, an an unqualified right (regardless of purpose), to review article bylaws, minutes, annual reports, etc. Here,

Question 22

Shareholder - Preemptive Rights

Answer 22

A shareholder’s preemptive right is his right to maintain the same percentage of ownership by buying stock whenever there is a new issuance of stock for money. No preemption for non-monetary stock issuance compensation. Preemptive rights do NOT exist unless expressly stated in the Articles. Here,

Question 23

Shareholder Suits - Direct Actions

Answer 23

A shareholder may sue the corporation to enforce a personal right as a shareholder, and any recovery will go to the shareholder. Here,

Question 24

Shareholder Suits - Derivative Suits

Answer 24

A shareholder may sue the corporation to enforce a right belonging to the corporation. The shareholder must own stock at the time of the wrongful act and must maintain stock throughout the litigation. The shareholder must first demand the Board of Directors bring suit unless doing so is futile, i.e. suit is against. The recovery of any losses will go to the corporation, minus reasonable litigation expenses reimbursed to the shareholder. Here,

Question 25

Shareholder - Distributions

Answer 25

A distribution of dividends is within the discretion of the board of directors and a strong case is required to induce a court to order the directors to declare a dividend. Priority of distributions is 1) cumulative shares, 2) preferred stock, 3) participating preferred, and 4) common stock. Here,

Question 26

Controlling Shareholder Liability

Answer 26

Generally, shareholders may act in their own personal interest and have no fiduciary duty to the corporation or other shareholders, however, controlling shareholders may not act in a way that unfairly prejudices minority shareholders or allows the majority shareholders to obtain a special advantage. Here,

Question 27

Controlling Shareholder Liability - Sale to Looters

Answer 27

Controlling shareholders who sell their stock to person who “loot” the company will be liable for damages unless reasonable measures were taken to investigate the buyer. The seller’s duty of investigation depends on whether she has notice of the possibility of looting by the purchaser. Here,

Question 28

Controlling Shareholder Liability - Sale at a Premium

Answer 28

Payment of a premium is an important circumstance that puts a controlling shareholder on notice to investigate the buyer. Controlling shareholders may be held liable for the sale of shares at a premium where the premium was really paid for some illegal purpose resulting in private gain. If so, the shareholders may be held liable for the premiums they received from the sale of their stock. Here,

Question 29

Controlling Shareholder Liability - Appointment of New Directors

Answer 29

A majority shareholder prejudices the rights of minority shareholders when he uses his majority shares to remove directors and substitutes in his own directors. Here,

Question 30

Directors

Answer 30

Directors are a group of natural persons elected by shareholders at the annual meeting to manage the business of the corporation. Directors have a duty to manage the corporation and can delegate to committees of one or more Directors and can rely on specialist opinions. Directors also owe the corporation a duty of care and a duty of loyalty. Here,

Question 31

Directors - Board Action

Answer 31

Directors can only act by a unanimous written agreement or by a vote satisfying quorum and majority voting requirements. No voting agreements or proxies are allowed. Special meetings require two days’ notice of date, time, and place (but not purpose). Committees can be used to inform advise Directors, but cannot declare distributions, amend bylaws, or fill board vacancies. Here,

Question 32

Directors - Board Vacancy

Answer 32

A vacancy on the board may be filled by either the other directors or by the shareholders. However, if the shareholders remove a director, the shareholders will replace that director. Here,

Question 33

Directors - Duty of Care

Answer 33

Directors must perform in good faith and exercise the care of a prudent person under similar circumstances. A breach can be the result of nonfeasance (doing nothing) or misfeasance (a wrong decision). Directors are only liable for a breach if it actually caused a loss to the corporation and the Business Judgment Rule does not apply. Here,

Question 34

Directors - Duty of Care: Business Judgment Rule

Answer 34

A court will not second-guess a Director’s business decision if it was 1) informed, 2) made in good faith, 3) made without a conflict of interest, and 4) had a rational basis. Even decisions that were very wrong are still protected if made using the factors above. Here,

Question 35

Directors - Duty of Loyalty SOW

Answer 35

Directors must act in good faith and not engage in self dealings, usurping corporate opportunities, or wasting corporation assets. (SOW) Here,

Question 36

Directors - Duty of Loyalty: Self Dealings (Interested Director Transaction)

Answer 36

Self-dealing is when a director, or a close relative of a director, has a personal interest in a transaction with the corporation. Here,

Question 37

Directors - Duty of Loyalty: Approved Self Dealings

Answer 37

The transaction of a self-dealing director will be void unless the director can show the transaction was 1) objectively “fair” to the company or 2) fully disclosed and approved by a majority of disinterested directors. Here,

Question 38

Directors - Duty of Loyalty - Corporate Opportunity Doctrine

Answer 38

Directors cannot usurp a corporate opportunity, or otherwise compete against his corporation, i.e. something 1) within the corporation’s line of business or 2) something discovered using company time or resources. If a director takes a corporate opportunity for himself, the corporation may recover either: damages, constructive trust, or the corporation gets opportunity at cost. Here,

Question 39

Directors - Duty of Loyalty - Corporate Opportunity Doctrine: Approved Corporate Opportunity

Answer 39

The Director can take the opportunity only after informing the board and waiting for it to reject the opportunity. Here,

Question 40

Directors - Duty of Loyalty - Waste

Answer 40

Directors can set their own compensation, but it must be reasonable to avoid “waste” and a breach of the duty of loyalty. Here,

Question 41

Directors - Indemnification

Answer 41

Directors and Officers may seek reimbursement for fees and costs incurred when sued by, or on behalf of, the corporation. No indemnification is allowed if the D/O is held liable to the corporation. Mandatory indemnification if the D/O wins the case on its merits. Permissive indemnification in a settlement. Articles can eliminate director liability for breach of care, but not for breach of loyalty. Here,

Question 42

Officers

Answer 42

Officers are hired and fired by the Board and are agents of the corporation, so they can bind the corporation by authorized acts. Officers owe the same duties of care and loyalty as Board members. Here,

Question 43

Fundamental Corporate Changes

Answer 43

Fundamental changes such as Mergers, Sale of substantially all assets (75%), Amendment of Articles, and Dissolution cannot be done by the Board alone. These changes require 1) board resolution 2) notice to shareholders 3) shareholder approval by ordinary voting rules, and 4) Articles of the change filed with the state. Here,

Question 44

Mergers

Answer 44

Generally, mergers must be approved by Directors and shareholders from both companies. However, this is not required in a Parent-Subsidiary merger (short-term merger) or when the rights of the survivor’s shareholding is not significantly affected. Here,

Question 45

Dissenter’s Appraisal Remedy

Answer 45

A shareholder who does not approve of the fundamental change may force the corporation to purchase their shares at a fair market price. But this right is only if shares are not listed on a national exchange where shares could easily be sold, i.e. close corps. Reserving this right requires notice of intent to demand appraisal before the vote/change, a vote against the change (or abstain), and a demand for payment after the change is approved. Here,

Question 46

Dissoultion

Answer 46

The board can dissolve a corporation by following the rules for fundamental changes. Dissolution is not the end of the corporation, but rather the beginning of the winding up process. This consists of liquidating all corporate assets, paying creditors, and paying any remaining funds to shareholders pro-rata or based on liquidation preferences in Articles. Here,

Question 47

Securities Laws - Rule 10b-5

Answer 47

10b-5 prohibits “any manipulative or deceptive device” used to buy or sell a security. Some instrument of interstate commerce must be used (always met).

Question 48

Rule 10b-5 - Material Representation

Answer 48

A material misrepresentation requires 1) a transaction involving interstate commerce 2) an intent (scienter)to defraud or misrepresent a material fact, 3) reliance on the fraud caused P to buy or sell securities, and 4) P suffered damages. Here,

Question 49

Rule 10b-5 - Material Information

Answer 49

Information is material if there is a substantial likelihood a reasonable investor would consider it important in making investment decision. Press releases and annual reports that contain material errors can be material if made with intent or recklessness. Damages are limited to the difference in price paid (or received) and the average share price in the 90 days after corrective info was disseminated. Here,

Question 50

Rule 10b-5 - Insider Trading

Answer 50

Insider trading is trading securities based on material inside information obtained from anyone with a position of trust and confidence in the corporation (usually officer/directors, but could be a secretary with special access). Here,

Question 51

Rule 10b-5 - Tipper Liability

Answer 51

The tipper who shared the inside information can be held liable if the tip was made for any improper purpose. Traditionally, the improper purpose was a share in the profits, but the tipper may be liable if instead of money he receives a gift or enhancement to his reputation. Here,

Question 52

Rule 10b-5 - Tippee Liability

Answer 52

A tippee who receives inside information from a tipper can be held liable if the tippee knew, or should have known, that the tipper was breaching a duty and he still bough or sold stock based on that information. Here,

Question 53

Rule 10b-5 - Misappropriation Theory

Answer 53

Under the misappropriation doctrine, a person who owes a duty of trust and confidence to the source of the information has a duty to abstain from trading or disclosing that information to others. Here,

Question 54

Section 16(b)

Answer 54

Under 16(b) a director of officer of a reporting company, or 10% shareholder at time of purchase, may NOT buy and sell, or sell and buy, the company’s own stock within a 6-month period (short swing trading). Any profits from short swing trades must be returned to the corporation. Here,

Question 55

Sarbanes Oxley Act of 2002

Answer 55

Only a public accounting firm, registered with the Oversight Board, may prepare or issue audit reports with respect to a registered company. The CEO and CFO must certify each report. Here,