Corporations And LLCs

Question 1

Incorporation

Answer 1

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

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

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

Question 2

Shareholders

Answer 2

Only owners—do not manage the corporation. They generally just have annual meetings.

Question 3

Notice of shareholders’ meetings

Answer 3

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

Question 4

How can shareholders vote at meetings?

Answer 4

By proxy: have someone vote their shares for them

By voting agreement

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

Question 5

Directors

Answer 5

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

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 only required for a special meeting.

Question 6

Directors’ duties are:

Answer 6

Duty of care and duty of loyalty

Question 7

Duty of care—business-judgment rule

Answer 7

There is a presumption that “in making a business decision, the directors acted on an (1) informed basis, (2) in good faith and (3) 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 8

What may directors rely on in their duty of care/business-judgment rule?

Answer 8

Information, opinions, reports, or statements of corporate officers, legal counsel, public accountants, etc., in making a decision.

Question 9

Who has the burden of proof when a director is accused of breaching her duty of care?

Answer 9

The party claiming that the breach occurred.

Question 10

Duty of loyalty

Answer 10

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.

Question 11

Three ways a duty of loyalty issue can arise:

Answer 11

(BCC): (1) director is on Both sides of a transaction—director has a material interest in a contract, as well as knowledge of that interest, yet still votes to approve the contract; (2) Competes with corporation; or (3) Corporate opportunity—corporate officer may not usurp a corporate opportunity.

Question 12

Defenses to liability for breach of the duty of loyalty

Answer 12

Three safe harbors that may protect a director who breaches his duty of loyalty: (1) approval by disinterested directors—if all relevant information is disclosed; (2) approval by disinterested shareholders; or (3) if the transaction is judged to be fair at the time it was entered into.

Question 13

Waiver of duty in an LLC

Answer 13

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 14

Voting requirements for shareholders:

Answer 14

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 15

Who votes out of the shareholders?

Answer 15

The record owner on the record date.

Record date: determines who is entitled to vote at a particular meeting—namely, those persons who were registered as shareholders of record on that date.

Exceptions: shareholder died (shareholder’s executor may vote) or executed a valid proxy (proxy may vote).

Unless the articles of incorporation provide otherwise, each outstanding share (regardless of class) is entitled to one vote on each matter voted on at a shareholders’ meeting.

Question 16

Voting by proxy

Answer 16

A shareholder may vote by proxy. A shareholder can appoint a proxy by (1) signing an appointment form or (2) making a verifiable electronic transmission.

A shareholder may not orally ask someone to serve as a proxy.

A proxy is generally revocable (even if it states it is irrevocable) and any action inconsistent with the grant of a proxy works to revoke it (ex: when two or more revocable proxies are given, the last given proxy revokes all previous proxies).

Question 17

When is a proxy not revocable?

Answer 17

If it explicitly states it is irrevocable and is coupled with an interest (ex: sale of shares).

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

Question 18

Lawsuits by shareholders against the corporation

Answer 18

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 19

Direct shareholder suits

Answer 19

Appropriate when the wrong done amounts to a breach of duty owed to the individual personally (ex: shareholder sues for denial of preemptive rights, payment of a dividend, or oppression in a close corporation).

Question 20

Derivative shareholder suits

Answer 20

Appropriate when the injury is caused to the corporation and a shareholder is trying to enforce the corporation’s rights (also applies to LLCs).

Question 21

Requirements for filing a derivative shareholder suit

Answer 21

Shareholder may not commence or maintain a derivative suit unless three requirements are met (SAD):

(1) Standing to bring a lawsuit;
(2) Adequacy—shareholder represents the corporation’s interests; and
(3) Demand—generally should file a written demand and wait 90 days before filing suit unless irreparable injury would result or a demand would be futile.

Question 22

Who gets recovery in a derivative suit?

Answer 22

The corporation

Question 23

Can a derivative suit be dismissed?

Answer 23

Yes—with court approval if it is not in the best interest of the corporation to continue it.

Question 24

Lawsuits against shareholders—piercing the corporate veil.

Answer 24

Only allowed in close corporations and LLCs—courts will hold a shareholder personally liable for corporate debt.

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

As a general rule, the law treats a corporation as ____.

Answer 25

An entity separate from its shareholders, even where one individual owns all the corporate stock.

Question 26

Shareholder’s right to inspect corporate books and records.

Answer 26

Shareholder has a right to inspect corporate books and records as long as his demand is made in (1) good faith and (2) for a proper purpose.

Proper purpose: reasonably related to a person’s interest as a shareholder.

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 27

Formation, rights, and duties for LLCs

Answer 27

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 28

What duties do members of an LLC have?

Answer 28

Fiduciary duties.

Question 29

Members of an LLC in a member-managed LLC are treated as ___ of the LLC.

Answer 29

Agents—with actual and apparent authority to bind the LLC in ordinary—but not extraordinary—affairs.

Question 30

Dissociation of an LLC

Answer 30

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 31

Liability of an LLC’s members

Answer 31

generally, individual members are not liable for losses. They are liable if the court decides to pierce the LLC veil or if proper procedures for dissolution and winding up have not been followed.

Question 32

May creditors enforce claims against each of the LLC members?

Answer 32

Yes—however, a member’s total liability may not exceed the total value of assets distributed to the member in dissolution.

Question 33

A corporation is owned by its ___.

Answer 33

Shareholders

Question 34

The group in charge of management of a corporation is the ___.

Answer 34

Board of directors

Question 35

Members of the board of directors are elected by the ___.

Answer 35

Shareholders

Question 36

The board appoints people to carry out its policy. Who are they?

Answer 36

Officers

Question 37

To form a corporation, we need:

Answer 37

A person, a paper, and an act.

Person: incorporator—must have one or more. They execute articles and deliver to the Secretary of State.

Paper: articles of incorporation—(1) name of the corporation; (2) name and address of each incorporator; (3) registered agent and street address of the registered office; (4) information regarding authorized stock.

Act: deliver notarized articles to the Secretary of State—this forms a de jure corporation.

Question 38

At the organizational meeting, the board of directors (or incorporator if no directors were named in the articles) must “complete the organization of the corporation.” This means:

Answer 38

Appoint officers and adopt initial bylaws.

Question 39

If bylaws and articles conflict, which governs?

Answer 39

Articles

Question 40

Entity status of a corporation:

Answer 40

It is a legal person—it can sue and be sued, hold property, be a partner in a partnership, invest in other companies or commodities, make contributions to charity, etc.

Question 41

“Double taxation”

Answer 41

Ordinarily, a corporation pays income tax on its profits. In addition, shareholders are taxed on distributions to them.

Question 42

If the corporation incurs a debt, commits a tort, or breaches a contract, are the shareholders personally liable for that debt?

Answer 42

No.

This is “limited liability”: shareholders generally are liable only to pay for their stock, not for corporate debts.

Directors or officers are not vicariously liable for corporate debts.

Question 43

Who is liable for corporate debts?

Answer 43

The corporation itself.

Question 44

Defective incorporation—who is liable for business debts?

Answer 44

The proprietors—they thought they formed a corporation but didn’t, so that means they are personally liable for business debts (they formed a partnership and partners are liable for business debts).

Two doctrines allow proprietors to escape liability: de facto corporation and corporation by estoppel

Question 45

De facto corporation

Answer 45

(1) relevant incorporation statute—always;
(2) parties made a good faith, colorable attempt to comply with it; and
(3) there has been some exercise of corporate privileges (they are acting as though they thought it was a corporation).

If this applies, the business is treated as a corporation for all purposes except in an action by the state.

Ex: incorporators’ documents are lost in the mail—in the meantime, they operate as a corporation and enter a contract—shareholders are personally liable on the contract unless the court applies de facto corporation.

Question 46

Corporation by estoppel

Answer 46

Someone who treats a business as a corporation may be estoppel from denying that it is a corporation.

Only applies in contract cases.

Question 47

Is a corporation liable on pre-incorporation contracts?

Answer 47

Only if the corporation adopts the contract—express (takes action adopting the contract) or implied (accepts a benefit of the contract).

Promoter acting on behalf of corporation not yet formed can enter a contract on behalf of the corporation.

Question 48

Is the promoter liable on pre-incorporation contracts?

Answer 48

Unless the contract clearly says otherwise, the promoter is liable on pre-incorporation contracts until there is a Novato on (agreement of the promoter, the corporation, and the other contracting party that the corporation replaces the promoter under the contract).

Adoption makes the corporation liable too, but does not relieve the promoter.

Question 49

Debt securities

Answer 49

The corporation borrows money from X and agrees to repay her with interest. Debt securities are usually called bonds. The person holding a bond is a creditor NOT an owner.

Question 50

Equity securities

Answer 50

Corporation sells an ownership interest to X. Equity securities are called stock. The person holding stock is an owner NOT a creditor.

Question 51

Issuance of stock

Answer 51

Corporation sells its own stock.

Question 52

What must the corporation receive when it issues stock (consideration)?

Answer 52

Stock (or an option to buy it) may be issued for any tangible or intangible property or benefit to the corporation. This includes money, property, services already performed, discharge of a debt, promissory notes to the corporation, and future services to the corporation.

A corporation can give employees options to buy stock as payment for services.

Question 53

Par

Answer 53

Minimum issuance price

C Corp. is issuing 10,000 shares of $3 par stock. It must receive at least $30,000. It could get more than $30,000.

Question 54

No par

Answer 54

No minimum issuance price. The board can have the stock issued for any price it sets

Question 55

Treasury stock

Answer 55

Stock the company issued and then reacquired.

Question 56

Watered stock

Answer 56

water: price they should’ve gotten for the par stock.

C Corp. issued 10,000 shares of $3 par to X for $22,000. The corporation wants to recover the $8,000 of “water.” Who is liable?

Directors: if they knowingly authorized the issuance

X, the person who bought the stock—no defense; charged with notice of the par value.

If X transfers stock to TP, TP is not liable if she acted in good faith (did not know about the water).

Only applies for an issuance!

Question 57

Preemptive right

Answer 57

The right of an existing shareholder of common stock to maintain her percentage of ownership by buying stock whenever there is a new issuance of stock FOR MONEY.

There are no preemptive rights if the articles are silent.

Question 58

Statutory requirements for directors

Answer 58

(1) there must be one or more
(2) if not named in the articles, they are elected by the incorporators at the organizational meeting. After that, elected by shareholders.
(3) shareholders can remove directors before their terms expire with or without cause
(4) vacancy on the board—board or shareholders select placeholder person
(5) board of directors must act as a group

Question 59

Is an individual director an agent of the corporation?

Answer 59

No. Individual directors have no authority to speak for or bind the corporation.

They must act as a group through unanimous agreement in writing (separate documents and email OK); at a meeting (satisfying quorum and voting requirements—conference call OK)

Question 60

Is notice required for a regular meeting of the board of directors?

Answer 60

No

Question 61

Is notice required for a special meeting of the board of directors?

Answer 61

Yes—unless the bylaws say otherwise, the corporation must give at least two days’ notice of date, time, and place; need not state purpose.

Question 62

Failure to give required notice for a board of directors meeting means that whatever happened at the meeting is ___, unless ___.

Answer 62

Voidable (maybe void); the directors not notified waive the notice defect. They can do this (1) in writing anytime or (2) by attending the meeting without objecting at the outset of the meeting.

Question 63

Can directors give proxies or enter voting agreements for how they will vote as directors?

Answer 63

NO—void because directors owe the corporation non-delegable fiduciary duties.

Question 64

Quorum for meetings of the board of directors.

Answer 64

For any meeting, there must be a quorum.

Unless the bylaws say otherwise, a quorum is a majority of all directors. Without a quorum, the board cannot act.

If a quorum is present at a meeting, passing a resolution requires only a majority vote of those PRESENT.

Question 65

Fiduciary duties owed to the corporation—the standard

Answer 65

A director must discharge her duties in good faith and with the reasonable belief that her actions are in the best interest of the corporation (duty of loyalty). She must also use the care that a prudent person in like position would reasonably believe appropriate under the circumstances (duty of care).

Question 66

Two ways for problems with a director’s duty of care to come up:

Answer 66

Burden on plaintiff.

(1) nonfeasance—director does nothing, he’s lazy. He is liable only if his breach causes a loss to the corporation.
(2) misfeasance—board makes a decisions that hurts the business. A director is not liable if she meets the business judgment rule—a prudent person in a like position would do appropriate homework, if they did appropriate homework, they are not liable.

Question 67

Business judgment rule

Answer 67

Presumption that when the board took the act, it did appropriate homework—burden is on the plaintiff to show that the board did not do appropriate homework or did something galactically stupid.

The court will not second-guess a business decision if it was made in good faith, was informed, and had a rational basis.

Question 68

Does the Business Judgment Rule apply in duty of loyalty cases?

Answer 68

NO—it can never apply when the fiduciary has a conflict of interest.

Question 69

Three ways for problems with a director’s duty of loyalty to come up.

Answer 69

Defendant has the burden of proof.

(1) self-dealing: any deal between the corporation and one of its directors (or a close relative of the director) or another business of the director’s. Director won’t be liable if he shows either (a) deal was fair to the corporation when entered OR (b) her interest and relevant facts were disclosed or known, and the deal was approved by either a majority of disinterested directs or majority of disinterested shareholders.
(2) competing ventures: director cannot compete directly with her corporation.
(3) corporate opportunity: a director cannot usurp a corporate opportunity until he (a) tells the board about it and (b) waits for the board to reject the opportunity.

Question 70

Can the corporation make a loan to a director?

Answer 70

Yes—if reasonably expected to benefit the corporation.

Question 71

A director is presumed to concur with board action unless

Answer 71

Her dissent or abstention is noted in writing in corporate records.

In writing: (1) in the minutes or (2) delivered in writing to the presiding officer at the meeting or (3) written dissent to the corporation immediately after the meeting.

Exceptions: not liable if you weren’t at the meeting r had a good faith reliance on information presented by an officer/employee/committee.

Question 72

Officers owe what duties?

Answer 72

The same duties of care and loyalty as directors

Question 73

Officers are ___ of the corporation.

Answer 73

Agents. The corporation is the principal. Whether the officer can bind the corporation is determined by whether she has agency authority to do so (actual/apparent).

Question 74

Who selects and removes officers?

Answer 74

The board—NOT shareholders (they only hire and fire directors).

The board also sets officer compensation.

Question 75

The corporation CANNOT indemnify a director/officer who:

Answer 75

Was held liable to the corporation or to have received an improper benefit.

Question 76

The corporation MUST indemnify a director/officer who:

Answer 76

Was successful in defending merits or otherwise

Question 77

The corporation MAY indemnify a director/officer her litigation expenses if she shows:

Answer 77

Acted in good faith with the reasonable belief that what she did was in the company’s best interest.

Question 78

Characteristics of a close corporation

Answer 78

Few shareholders, stock not publicly traded.

Shareholders can run this directly—cannot run a normal corporation directly because that’s the board of directors’ job.

Question 79

Can shareholders be held liable for corporate debts?

Answer 79

Generally no, the corporation is liable for what it does.

Question 80

In what kinds of corporations can the court pierce the corporate veil?

Answer 80

Close corporations only

Question 81

To pierce the corporate veil and hold shareholders personally liable,

Answer 81

(1) they must have abused the privilege of incorporating and

(2) fairness must require holding them liable.

Question 82

Two times a court might pierce the corporate veil:

Answer 82

(1) alter ego—shareholder of close corporation treats corporate assets as his own.
(2) undercapitalization—shareholders failed to invest enough to cover prospective in a close corporation

Question 83

Outstanding stock

Answer 83

The shares the company issued (sold) and has not reacquired.

Question 84

What is a proxy:

Answer 84

(1) a writing—email and fax OK (2) signed by record shareholder—email sender ID OK (3) directed to secretary of corporation (4) authorizing another to vote the shares.

Question 85

Two ways to revoke a proxy

Answer 85

In writing to the corporate secretary or by attending the meeting and voting.

Question 86

General rule: a quorum of shareholders requires

Answer 86

A majority of outstanding shares

Question 87

Stock transfer restrictions are OK if they are ___.

Answer 87

Reasonable—not an undue restraint on alienation; Right of first refusal is valid (stock transfer restriction that requires shareholder to offer stock first tot he corporation).

Question 88

Is a stock transfer restriction is valid, can it be enforced against the transferee?

Answer 88

Yes—if (1) the restriction is conspicuously noted on the stock certificate or (2) the transferee had actual knowledge of the restriction.

Question 89

Distributions and different types

Answer 89

Payments by the corporation to the shareholders.

(1) dividends or (2) to repurchase shareholder’s stock or (3) redemption—forced sale to corporation at price set in articles.

Question 90

Types of fundamental corporate change:

Answer 90

• amend the articles
• merge or consolidate into another company
• transfer substantially all assets
• convert to another form of business
• dissolve

Question 91

Can the board make fundamental corporate changes alone?

Answer 91

Generally no—these are extraordinary.

Question 92

How to carry out a fundamental corporate change:

Answer 92

Need:

(1) board action adopting a resolution of fundamental change
(2) board submits proposal to shareholders with written notice
(3) shareholder approval by majority of shares entitled to vote.
(4) most states require delivery of a document to Secretary of State.

Question 93

Dissenting shareholder right of appraisal

Answer 93

Right to force the corporation to buy your stock for fair value.

Only these changes trigger the right of appraisal:

(1) merging or consolidating,
(2) transferring substantially all assets,
(3) stock being acquired in a share exchange, or
(4) conversion to another form of business.

No appraisal if the company’s stock is listed on a national exchange or if the company has 2,000+ shareholders.

Right of appraisal exists in: close corporations.

Question 94

To perfect your right of appraisal:

Answer 94

1. Before the shareholders vote, file with the corporation a written notice of objection and intent to demand payment;
2. At the shareholder vote, abstain or vote against the proposed change; and
3. After the vote, within time set by corporation, make written a demand to be bought out and deposit stock with the corporation.

Question 95

Is the right of appraisal the shareholder’s exclusive remedy if she does not like a fundamental change?

Answer 95

Yes, absent fraud.

Question 96

Is dissolution the end of the corporation?

Answer 96

No—it is the beginning of a process that will end the corporate existence. The corporation continues to exist, so it can sue and be sued. It cannot start new business but must wind up (liquidate).

Question 97

What is a promoter?

Answer 97

A person who procures commitments for capital and instrumentalities on behalf of a corporation that will be formed in the future.

Question 98

Are promoters liable on contracts they enter into on behalf of the to-be-formed corporation?

Answer 98

Generally, yes. Promoter liability continues even after the corporation is formed and even if the corporation also becomes liable on the contract by adopting it.

Question 99

When will a promoter not be liable on a pre-incorporation contract?

Answer 99

If the agreement between the parties expressly indicates that the promoter is not to be bound. In such a case, the “contract” is considered to be an offer to the proposed corporation.

Question 100

Is a corporation liable on a contract entered into by a promoter?

Answer 100

Generally, no. It can become liable on a promoter’s contract if it adopts the contract. Adoption can be express or implied.

Express adoption requires express official action to adopt the contract with knowledge of the meatier law facts, such as a resolution by the board of directors.

Implied adoption requires someone in authority to accept the benefits of the contract with knowledge of the material facts (e.g., by acquiescence or conduct normally constituting estoppel).