Corporations and Limited Liability Companies

Question 1

Where are the articles of incorporation filed for a corporation?

Answer 1

The articles of incorporation are filed with the state

Question 2

Articles of Incorporation v. Bylaws: which controls?

Answer 2

The articles of incorporation are filed with the state, and, if in conflict with bylaws, the articles control.

Question 3

Is a corporation liable for a contract entered into pre-incorporation?

Answer 3

A corporation is not generally liable for a contract entered into prior to incorporation unless it expressly or impliedly adopts (ratifies) the contract.

Question 4

Who is liable for a contract entered before a corporation was incorporated?

Answer 4

The promoter (person entering the contract on behalf of the to be formed corporation) is liable.

Question 5

What are the requirements for shareholder meetings?

Answer 5

Generally just have annual meetings.

Written notice of meetings is required 10−60 days prior and must state the time, place, and purpose of the meeting.

Shareholders can vote by proxy (have someone vote their shares for them) or by voting agreement.

Generally, a quorum (majority of all outstanding shares required to vote) must be present to hold a vote.

Question 6

What is the role of directors?

Answer 6

Directors manage the corporation and (like shareholders) act as a body by voting.

Directors may exercise all corporate powers that are not limited by the articles of incorporation or a shareholders’ agreement, including the power to form contracts and acquire liabilities.

Shareholders hire and fire directors.

Directors cannot vote by proxy or agreement.

A quorum (majority of directors) needs to be present for a vote to take place, but unlike shareholders, directors can “break quorum” by leaving.

Notice is required only for special meetings.

Question 7

Duties on the MEE

Answer 7

The duty of loyalty and duty of care are heavily tested. Whether a director of a corporation (or member of an LLC) breached the duty of care or loyalty is very fact-based. However, usually when duty of loyalty is an issue, the director or member has breached the duty.

Question 8

How does the business judgment rule apply to the duty of care?

Answer 8

There is a presumption that “in making a business decision, the directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.”

Directors must be informed to an extent that they reasonably believe is appropriate.

Question 9

What can directors rely on under the BJR?

Answer 9

They are entitled to rely upon information, opinions, reports, or statements of corporate officers, legal counsel, public accountants, etc., in making a decision.

Question 10

Who has the burden of proof in a claim that dircectors breached duty of care?

Answer 10

A party claiming that the directors breached their duty of care has the burden of proof.

Question 11

Director Duty of Loyalty

Answer 11

A director must act in good faith and with a reasonable belief that what he does is in the corporation’s best interest.

The business-judgment rule presumption does not apply if there is a duty of loyalty issue. A duty of loyalty issue arises in three ways

Question 12

In what three ways does a duty of loyalty arise?

Answer 12

• Director is on both sides of a transaction: a director has a material financial interest in a contract, as well as knowledge of that interest, yet still votes to approve the contract.
• Competes with corporation: a director may not compete with his corporation.
• Corporate opportunity: a corporate officer may not usurp a corporate opportunity.

Question 13

What are shareholders?

Answer 13

Shareholders are only owners and do not manage the corporation.

Question 13

What are the defenses for a director’s breach of a duty of loyalty?

Answer 13

The Revised Model Business Corporation Act (MBCA) includes three safe harbors that may protect a director who breaches his duty of loyalty:

(1) approval by disinterested (qualified) directors (if all relevant information is disclosed),

(2) approval by disinterested (qualified) shareholders, or

(3) if the transaction is judged to be fair to the corporation at the time it was entered into.

A qualified director is a director without a conflicting material interest. Qualified shares are those not held by a conflicted director or related person.

Question 14

Can an LLC operating agreement waive the duty of loyalty?

Answer 14

an LLC operating agreement may waive the duty of loyalty (e.g., allow members to open competing businesses) so long as it is not “manifestly unreasonable.”

Question 15

Voting requirements for a corporation

Answer 15

in order for a resolution to pass, there needs to be a quorum present, and more votes must
be cast in favor of the resolution than against it.

Question 16

Who can vote at corporation meeting?

Answer 16

The record owner on the record date.

Question 17

How does a shareholder vote by proxy?

Answer 17

A shareholder may vote by proxy.

A shareholder can appoint a proxy in writing by
signing an appointment form or making a verifiable electronic transmission.

Question 18

Is a proxy revocable?

Answer 18

A proxy is generally revocable (even if it states it’s irrevocable), and any action inconsistent with the grant of a proxy works to revoke it.

Thus, when 2 or more revocable proxies are given, the last given proxy revokes all previous.

There is an exception to this

Question 19

Is a proxy ever irrevocable?

Answer 19

A proxy is not revocable if it explicitly states it’s irrevocable and is coupled with an interest (e.g., sale of shares).

Many states say a proxy is valid for 11 months unless otherwise stated.

Question 20

When can a shareholder sue the corporation?

Answer 20

Shareholder may file an action to establish
that the acts of the directors are illegal, fraudulent, or willfully unfair and oppressive to either the corporation or the shareholder.

Whether a suit is appropriately brought as a direct or derivative action depends on the injury.

Question 21

When is a direct suit appropriate?

Answer 21

A direct suit is appropriate when the wrong done amounts to a breach of duty owed to the individual personally.

(E.g., shareholder sues for denial of preemptive rights, payment of a dividend, or oppression in a close corporation.)

Recovery from a derivative lawsuit goes to the corporation, not the shareholder.

Question 22

When is a derivative suit appropriate?

Answer 22

A derivative suit is appropriate when the injury is caused to the corporation and a shareholder is trying to enforce the corporation’s rights. (This also applies to LLCs.)

Question 23

What are the extra requirements for filing a derivative suit?

Answer 23

A shareholder may not commence or maintain a derivative suit unless three requirements are met (mnemonic=SAD):

(1) standing to bring a lawsuit,
(2) adequacy (the shareholder represents the interests of the corporation), and
(3) demand (generally, the shareholder should file a written demand and wait 90 days before filing suit unless irreparable injury would result or demand would be futile).

Standing requires the shareholder to be a contemporaneous owner at the time of the alleged act or omission. A derivative suit can be dismissed with court approval if it’s not in the best interest of the corporation to continue it.

Question 24

Lawsuit agaist shareholders: when is a corporate veil pierced?

Answer 24

Generally, the law treats a corporation as an entity separate from its shareholders, even where one individual owns all the corporate stock.

In some (very limited) circumstances, courts will disregard the LLC form and hold a shareholder personally liable for corporate debt.

To do so is called piercing the corporate veil. It is only allowed in close corporations and LLCs.

Generally, a plaintiff must show that shareholders of the corporation or members of an LLC abused the privilege of incorporating and fairness requires holding them liable. One generally needs to show undercapitalization of the business, failing to follow formalities, commingling of assets, confusion of business affairs, or deception of creditors. Only the shareholders or members who participated in the wrong are personally liable.

Question 25

When does a shareholder have a right to inspect corporate books and records?

Answer 25

A shareholder has a right to inspect corporate books and records as long as his demand is made in good faith and for a proper purpose.

A proper purpose is a purpose reasonably related to a person’s interest as a shareholder (e.g., shareholder articulates a purpose to address “economic risks” to the corporation).

A shareholder must state (1) his purpose, (2) the records he desires to inspect, and (3)
that the records are directly connected to his purpose.

Question 26

How is an LLC formed?

Answer 26

Articles of organization must be filed to create an LLC.

Since LLCs are a relatively new form of business association, courts tend to analyze them in the context of corporate or partnership law.

Question 27

How are members of an LLC viewed by courts?

Answer 27

Members of an LLC have fiduciary duties.

Members of an LLC in a member-managed LLC are treated as agents of the LCC (with actual and apparent authority to bind the LLC in ordinary—but not extraordinary—affairs).

Question 28

What happens when a member leaves an LLC?

Answer 28

if a member leaves, then it leads to dissociation of that member, but it does not lead to winding up or dissolution unless the other members unanimously agree to dissolve the LLC.

Question 29

How are LLC members liable?

Answer 29

Generally, individual members are not liable for losses.

They are liable if the court decides to pierce the LLC veil (discussed above) or if proper procedures for dissolution and winding up have not been followed.

(Creditors may enforce claims against each of the LLC members. However, a member’s total liability may not exceed the total value of assets distributed to the member in dissolution.)