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 corp) is liable

Question 2

shareholders

Answer 2

-shareholders are only owners and DO NOT manage the corp
-they generally just have annual meetings
-written notice of meetings is required 10-60 days prior to the meeting 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 3

directors

Answer 3

-manage the corporation and (like shareholders) act as a body by voting
-may exercise all corporate powers that are not limited by the articles of incorp or the 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 4

Know the duty of loyalty and duty of care

Answer 4

*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 5

Duty of care—business-judgment rule

Answer 5

-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.
-They are entitled to rely upon information, opinions, reports, or statements of corporate officers, legal counsel, public accountants, etc., in making a decision.
-A party claiming that the directors breached their duty of care has the burden of proof.

Question 6

duty of loyalty

Answer 6

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 (mnemonic=BCC):

Question 7

a director is on Both side of the transaction

Answer 7

-a director has a material financial interest in a contract, as well as knowledge of that interest, yet still votes to approve the contract.

Question 8

a director Competes with the corp

Answer 8

a director may not compete with his corporation.

Question 9

a director usurps Corporate opportunity

Answer 9

a corporate officer may not usurp a corporate opportunity.

Question 10

defenses to liability for breach of the duty of loyalty

Answer 10

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 11

waiver of duty in an LLC

Answer 11

-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 12

voting requirements for shareholders:
-voting in general:

Answer 12

Voting: 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 13

who votes?

Answer 13

The record owner on the record date.

Question 14

voting by proxy

Answer 14

-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.
-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.
**Exception: 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 15

when shareholders can sue and be sued:
-lawsuits by shareholders against the corp:

Answer 15

-A 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 16

direct suits

Answer 16

-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 17

derivative suits

Answer 17

-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 18

extra requirements for filing a derivative lawsuit

Answer 18

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 19

lawsuits against shareholders: piercing the corporate veil

Answer 19

-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.
-piercing is ONLY allowed in close corporations and LLCs.

Question 20

piercing cont’d: P showing required and personal liability

Answer 20

-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 21

shareholder’s right to inspect corporate books and records:

Answer 21

-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 (eg. 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 22

LLCs: formation, rights and duties

Answer 22

-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.
-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 23

dissociation

Answer 23

-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 24

liability

Answer 24

-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.)