Corporations

Question 1

what is an LLC

Answer 1

an LLC is a form of business association that combines many of the most attractive features of corporations and partnerships. Like Corporations, and LLC generally provides its investors-called “members”– with limited liability for firm debts. Like general partnerships, LLCs provide members with considerable flexibility in developing rules for decision making and control. Bc LLCs are a relatively new form of business association bearing many similarities to corporations and parternships, courts often turn to either corporate or partnership law to analyze issues in the LLC context.

Question 2

Fiduciary relationships in LLCs

Answer 2

Courts generally hold that members of an LLC, like partners in a general partnership, are in a fiduciary relationship. this fiduciary relationship is defined as a relationship in which members owe one another the duty of utmost trust and loyalty. As a result, in an LLC, as in a general partnership, direct competition by members would ordinarily be precluded as a violation of the duty of loyalty.

Question 3

Operating agreements in LLCs

Answer 3

Under most LLC states, members of an LLC can agree to restrict or limit the duty of loyalty, provided the opt-out is specified in the operating agreement. Thus, the operating agreement controls over the provisions of the statute.

Question 4

Uniform Limited Liability Company Act (2006) ULLCA

Answer 4

according to ULLCA, “if not manifestly unreasonable, the operating agreement may restrict or eliminate the duty to refrain from competing with the company in the conduct of the company’s business before the dissolution of the company.” In addition, so longs as it is not “manifestly unreasonable” the operating agreement may also “identify specific types or categories of activities that do not violate the duty of loyalty.”

Question 5

The general rule of LLCs to provide limited liability to its members does not apply in a few situations

Answer 5

including when

(1) the proper procedures for dissolution and winding up have not been followed, and
2. a court decides to “pierce the LLC veil.”

Question 6

Dissolution of an LLC

Answer 6

requires consent of all the members.

However, after dissolution as part of the winding up process, the LLC must provide notice of the dissolution to creditors so that they can make claims against the dissolving entity. The notice sent to creditors must outline the steps that are necessary for enforcing their claims.

Question 7

When the procedures of winding up an LLC have not been followed and if the LLCs assets have been liquidated and distributed to the members,

Answer 7

then a creditors claim against the LLC may be enforced against each of the LLC members to the extent of the members proportionate share of the claim or to the extent of the assets of the LLC distributed to the member in liquidation, whichever is less.

However, a members total liability for creditor claims may not exceed the total value of assets distributed to the member in dissolution.

the filing of articles of dissolution is not required for a proper dissolution of an LLC.

Question 8

Piercing the veil in LLC context

Answer 8

is a common law equitable doctrine that prevents members from hiding behind the veil of limited liability in situations where they have improperly used the LLC form.

To pierce the LLC veil, courts generally apply the same analysis and factors as in cases where a third party attempts to pierce the corporate veil and hold shareholders of a corporation personally liable for firm debts.

This requires analyzing whether members have traded the LLC as a separate entity or whether it has instead become the “alter ego” of the members. If the latter is true, members will not be permitted to “enjoy immunity from individual liability for the LLCs acts that cause damage to third parties.”

Each member for whom the veil is pierced becomes subject to doing and several liability to the creditor bringing the claim.

The use of business funds for personal use is a frequent factor for piercing in both the corporate and and LLC contexts.

In fact, in the corporate context when courts determine that business assets have been intermingled and used for personal use, piercing follows in about 85 percent of the cases. in addition, courts have identified the intermingling of personal and business funds as a factor for piercing in the corporate context, as well as in the LLC context.

The Act further provides that “the failure of a limited liability company to observe any particular formalities in relating to management of its activities” is not a proper ground for imposing personal liability on members for debts of the firm.

Question 9

Alter ego doctrine

Answer 9

Among the factors that courts have used under the alter ego doctrine. in the corporate context is whether the “dominant shareholder siphoned corporate funds,” a factor also used in the LLC context.

Question 10

MBCA states that the bylaws

Answer 10

Under the MBCA, shareholders may amend the corporations bylaws.

The MBCA states that the bylaws may contain any provision that is not inconsistent with law or the articles of incorporation.

In addition, the MBCA was revised in 2009 to address shareholder nomination of directors in public corporations (known “proxy access”) and specifies that the bylaws “my contain a requirement that the corporation include in its proxy materials one or more individuals nominated by a shareholder.”

Further, a shareholder-approved bylaw generally can limit the power of the board to later amend or repeal it.

Question 11

The board shares power to amend corporation bylaws with shareholders unless:

Answer 11

1. the corporation’s articles “reserved that power exclusively to the shareholders, or
2. the shareholders in amending, repealing, or adopting a bylaw expressly provide that the board of directors may not amend, repeal, or reinstate that bylaw.

Shareholder-approved bylaw provisions can amend or repeal existing bylaw provisions, whether originally approved by the board or by shareholders.

Question 12

The revision of the MBCA I 2009 dealing with shareholder proxy access

Answer 12

specifies that a shareholder-approved bylaw dealing with director nominations may not limit the board’s power to amend, add, or repeal “any procedure or condition to such a bylaw in order to provide for a reasonable, practicable and orderly process.

Thus, according to the revision, if shareholders approve a bylaw amendment that limits further board changes, the board would nonetheless retain the power to “tinker” with the bylaw to safeguard the voting process, but could not repeal the shareholder-approved bylaw.

The revision is “not intended to allow the board of directors to frustrate the purpose of the shareholder-adopted proxy access provision.”

Question 13

Derivative suit initiation

Answer 13

The MBCA generally requires that shareholders make a demand on the board of directors before initiation of a derivative suit.

Question 14

Derivative suit

Answer 14

is essentially two suits in one, where the plaintiff-shareholder seeks to bring on behalf of the corporation a claim that vindicates corporate rights, usually based on violation of fiduciary duties. The demand permits the board to investigate the situation identified by the shareholder and take suitable action. No demand on the board is required , however, if the shareholder brings a direct suit to vindicate the shareholder’s own rights, not those of the corporation.

Question 15

The MBCA defines a derivative proceeding as

Answer 15

one brought in the right of a domestic corporation.

Question 16

The MBCA does not specify the duties of controlling shareholders to a controlled corporation or its minor shareholders

Answer 16

instead, the duties of controlling shareholders generally arise as a matter of the court’s “inherent equity power” to fashion fiduciary duties owed by majority shareholders to minority shareholders.

Generally, courts have examined business dealings between a controlling shareholder (such as a parent corporation) and the controlled corporation using a fairness test.

Question 17

When a transaction does not involve self-dealing (as is the case with respect to dividends payable to all shareholders of the controlled corporation)

Answer 17

then the “business judgment” standard applies. That is, the fairness test applies to parent-subsidiary dealings only where the “parent . . . causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders . . . .”

Question 18

Generally, the person seeking to justify a self-dealing transaction has the burden of proving its fairness to the corporation. The MbcA has described fairness in connection with director’s conflicting-interest transactions,

Answer 18

to include not only “the market fairness of the terms of the deal–whether it is comparable to what might have been obtainable in an arm’s-lenght transaction–but also . . . whether the transaction was one that was reasonably likely to yield favorable results (or reduce detrimental results)” for the corporation.

Question 19

The corporate opportunity doctrine [applicable to directors]

Answer 19

is anchored in a significant body of case law clustering around the core question whether the corporation has a legitimate interest in a business opportunity, either because of the nature of the opportunity or the way in which the opportunity came to the director, of such a nature that the corporation should be afforded prior access to the opportunity before it is pursued (or, to use the case law’s phrase, “usurped” by a director.

Question 20

In a similar view to the corporate opportunity doctrine, the American Law Institute (ALI) Principles of Corporate Governance define a corporate opportunity,

Answer 20

for the purposes of directors and senior executives, generally as a business opportunity, where either “the person offering the opportunity expects it to be offered to the corporation,” the opportunity “would be of interest o the corporation,” or the opportunity is “closely related to a business in which the coproaiton is engaged or expects to engage.

For business opportunities allocated within a corporate group, courts have accepted the the parent should have some leeway in allocating business opportunities within the group.

Question 21

Under the MBCA “persons purporting to act as or on behalf of a corporation, knowing there was no incorporation

Answer 21

are jointly and severally liable for all liabilities created while so acting.

The Official Comment clarifies that an “erroneous but in good faith” belief that incorporation has happened does not constitute knowledge under the section.

Question 22

de facto corporation or corporation by estoppel doctrines

Answer 22

Under the common law, courts have inferred corporate limited liability in case of defective incorporation in two situations. First, under the “de facto corporation” doctrine, courts recognize corporate limited liability when there was (1) a colorable, good-faith attempt to incorporate and (2) actual use of the corporate form, such as by carrying on the business as a corporation or contracting in the corporate name.

Second, under the “incorporation by estoppel” doctrine, most jurisdictions recognize corporate limited liability when a third party deals solely with the “corporation” and has not relied on the personal assets of the promoter. In these cases, courts have rejected the imposition of personal liability on equity grounds because the third party would otherwise receive more than originally bargained for.

Question 23

A shareholder, whether of record or who beneficially owns her shares, has a right to inspect minutes of board meetings and “accounting records”

Answer 23

for a proper purpose. A proper purpose is a purpose reasonably related to a person’s interest as a shareholder, “such a desire . . . . too determine whether improper transactions have occurred.”

An inspection request myst be granted whenever the shareholder articulates a purpose to address “economic risks” to the corporation.

Question 24

A shareholder seeking inspection of corporate documents must offer

Answer 24

credible evidence that there was mismanagement or other improper conduct.

Question 25

The MBCA allows a shareholder to inspect only

Answer 25

relevant excerpts of board minutes . . . directly connected with the shareholder’s purpose.

Question 26

The MBCA also allows inspection of “accounting records” although this category is not as broad as the “books and records” category found in other corporate states.

Answer 26

According to the Official comment, accounting records are “records that permit financial statements to be prepared which fairly present the financial position and transactions of the corporation.

Under the MBCA, the corporation could refuse to allow inspection of non-financial documents related to the alleged foreign bribery.

Question 27

Under the MBCA, the board can seek dismissal of the shareholder’s derivative action if

Answer 27

a majority of the board’s “qualified directors”–those directors who do not have a material interest in the derivative action–determine in good faith, after conducting a reasonable inquiry upon which its conclusions are based, that continuance would be contrary to the corporation’s best interests.

Question 28

Although the Official Comment to MBCA suggests that a full-blown board investigation is not necessseray, the board’s request for dismissal must have

Answer 28

“some support in the findings of the inquiry.” Failure to investigate credible allegations of corporate illegality constitutes lack of “good faith.”

Question 29

A director is liable to the corporation for the director’s decisions or failures to take action that were “not in good faith”

Answer 29

Conduct involving knowingly illegal conduct that exposes the corporation to harm will constitute action not in good faith, and belief that decisions made (in connection with such conduct) were in the best interests of the corporation will be subject to challenge as well.

Question 30

Courts applying the duty of good faith have made clear that corporate directors

Answer 30

cannot consciously violate–or permit the corporation to violate-legal norms, even when such violations may be profitable to the corporation.

Question 31

The duty to act in good faith requires corporate directors to establish procedures to ensure

Answer 31

the corporation’s compliance with legal norms.

Thus, courts have required corporate directors to establish “corporate information and reporting systems” that provide “timely, accurate information . . . concerning both the corporation’s compliance with law and its business performance.

Question 32

The “good faith” standard requires that directors, among other things, not

Answer 32

approve (or condone) wrongful or illegal activity. Even when disregard of legal norms might result in a net financial benefit to the corporation, directors are required to comply with the law.

Question 33

The business judgment rule doe snot protect decisions by directors

Answer 33

not acting in good faith.

Question 34

As the official comment to MBCA section 8.31 summarizing the business judgment rule states:

Answer 34

In basic principle, a board of directors enjoys a presumption of sound business judgement. . . that, in making a business decision, directors act in good faith, on an informed basis, and in the honest belief that the action taken is in the best interest of the corporation. Specifically, the business judgement rule, while normally protecting the honest business judgement of directors, does not apply upon a showing of “illegality.” Directors breach their fiduciary duties–and the business judgement rule provides no protection–when they approve illegal business operations (or refuse to investigate alleged illegal business activities), even though the illegal business may be profitable to the corporation.

Question 35

When a certification of organization fails to specify whether the LLC is member-managed or manager-managed

Answer 35

the LLC is presumed to be member-managed, unless the member’s operating agreement specifies how the LLC is to be managed.

Question 36

Under RULLCA, each member in a member-managed LLC has

Answer 36

equal rights in the management and conduct of the company’s activities. Thus, consistent with general agency law principles and with the approach of other acts governing LLCs, each member of a member-managed LLC can bind the company to contracts for apparently carrying on the ordinary business of the company unless the member lacks authority to do so and the other party to the contract has notice that the member lacks such authority.

Thus, a member of a member-managed LLC has the authority–both actual and apparent–to bind the LLC, much as a partner in a general partnership.

Question 37

The 2006 RULLCA does not provide for “statutory” apparent authority, but instead

Answer 37

leaves questions of a member’s authority to agency law principles.

Question 38

Some earlier LLC acts provide that, absent a contrary provision in the certificate of organization, an LLC member

Answer 38

has authority to sign and deliver a deed of the company’s interest in real property and “the instrument is conclusive” in favor of a bona fide purchaser for value without notice. Under these earlier statutes, acts of members not “in the ordinary course of the company’s business” bind the company only if authorized by the other members.

Question 39

Under RULLCA, the express will of a member to withdraw results in

Answer 39

“dissociation.” Dissociation does not result in dissolution of the LLC. Dissolution under RULLCA requires the consent of all the members.

Question 40

The MBCA defines a “director’s conflicting interest transaction” as

Answer 40

one affected by the corporation “respecting which . . . the director had knowledge and a material financial interest.

Question 41

A “director’s conflicting interest transaction” (that is, a director self-dealing transaction) is not absolutely prohibited

Answer 41

Instead, modern corporate law permits such transactions–with the consequence that the business judgement rule applies if, after full disclosure of all relevant facts, qualified directors authorized the transaction. If, however, the self-dealing transaction is not show to have been properly authorized, the business judgment rule does not apply and the transaction must be shown to have been fair to the corporation.

Question 42

Directors can satisfy the fiduciary duty of loyalty by showing that

Answer 42

“the transaction, judged according to the circumstances at the relevant time, was fair to the corporation.” The directors have the burden to show that the transaction as a whole was fair in terms of “fair price” and “fair dealing.”

This means the courts will inquire into (1) whether the transaction price was comparable to what might have been obtained in an arm’s-length transaction, given the consideration received by the corporation, and (2) whether the process followed by the directors in reaching their decision was appropriate. A breach of the directory’s duty to deal fairly with the corporation can result in personal liability.

Question 43

Under the MBCA, under the duty of care, a director

Answer 43

is called on to exercise “the care that a person in a like position would reasonably believe appropriate under similar circumstances” in “becoming informed in connection with their decision-making function.”

A director may be liable for harm to the corporation from a board decision where it is proven that the director was “not informed to an extent the director reasonably believed appropriate in the circumstances.”