Corporations and LLCs

Question 1

Corporations Opening Statement

Answer 1

For corporations, state law and the Revised Model Business Corporations Act (RMBCA) control unless default provisions are modified by the Articles of Incorporation or bylaws.

Question 2

What is an incorporator?

Answer 2

An incorporator/promoter gets the initial capital and acts as an agent in forming a corporation. She is a fiduciary who owes the corporation the duties of good faith, loyalty, fair dealing, and can make no secret profit. She is personally (or j/s) liable for any pre-incorporation acts or contracts.

Question 3

What is involved in creating articles of incorporation?

Answer 3

Articles of incorporation must be filed, generally with the secretary of state, and include the corporate name, names and addresses of the incorporators, registered agent and office, and stock information.

Question 4

What may the article of incorporation not indemnify the director from?

Answer 4

Fiduciary duty breach, intentional wrongdoing, criminal act, or excess distributions to shareholders.

Question 5

What is shareholder liability like during the incorporation process?

Answer 5

A de jure corporation is one that substantially complies with relevant statutes (SHs then insulated from personal liability). If requirements are not met, the entity is de facto if acting in good faith as a corporation (SHs treated as general partners w/ j/s liability unless the court shields them).

Question 6

What happens at the organizational meeting?

Answer 6

The corporation accepts stock subscriptions, shares are distributed, the initial board of directors is elected (who will then appoint officers), and bylaws are adopted. Then, an initial report must be filed.

Question 7

What is a close corporation?

Answer 7

If owned by less than 10-50 owners, members each have a percentage ownership interest rather than shares. Each member is entitled to participate in management, and outside ownership sales may have restrictions.

Question 8

What is the hierarchy of authority limiting corporate activities?

Answer 8

State law, articles, bylaws, resolutions/minutes.

Question 9

What employee actions is a corporation liable for?

Answer 9

Corporate liability extends to the contracts of officers and agents with authority. A corporation is vicariously liable for employee torts (in the course/scope) under respondeat superior. Where a corporation acts outside its authority (ultra vires), a SH can seek to enjoin (corporation cannot defend suit based on contract being ultra vires though unless the third party knew).

Question 10

What do I need to know about stock subscriptions and shares?

Answer 10

Stock subscriptions are future SHs’ promises to buy stock (irrevocable for 6 months, unless just an option). Stock is negotiable. SHs have preemptive rights to new issue to keep their proportional share (if in the articles, under the RMBCA).
Preferred shares: superior rights to dividends but no voting rights
Outstanding shares: issued but unredeemed
Redeemed shares: shares a corporation bought back

Question 11

What is the board of directors?

Answer 11

The board of directors exercises corporate powers, makes tactical decisions, and manages the officers to assure long-term business success. Directors are elected by the SHs and may be removed with or without cause at a special meeting or by a court for fraud or gross abuse of the position.

Question 12

What are a director’s duties?

Answer 12

Under a standard of care of a prudent director, a director must act in good faith and in a manner she reasonably believes to be in the best interests of the corporation. A director must stay informed about financials conditions and have no conflicts of interest (competing with corp, usurping corp opportunity, or trade secret appropriation), requiring full disclosure and notice to SHs for self-dealing transactions.

Question 13

Tell me about corporate officers.

Answer 13

Officers are authorized by the board of directors to carry out the ordinary business of the corporation. They are at-will employees (unless contracted otherwise), and they have the same fiduciary duties as directors.

Question 14

What is the business judgment rule?

Answer 14

A defense available to directors and officers that honest, good-faith errors in judgment after reasonable investigation do not create personal liability (especially if reasonably relying on info from officers/employees). The standard is that of an ordinarily prudent business person under similar circumstances (any negligence cannot be gross).

Question 15

What rights to shareholders have?

Answer 15

Shareholders have the right to:

• vote for directors and resolutions at the annual meeting held after proper notice (>10, s notice)
• receive annual financial statements w/in 120 days of the FY end
• inspect and copy corporate records upon demand
• receive the fair value of their shares in cash if dissenting from a fundamental corporate change
• vote by proxy with a signed form
• form written voting trusts
• sue the directors/officers for gross negligence/fraud/breach of fiduciary duty, on their own or in a derivative action with the corp as P
• NO absolute right to dividends

Question 16

What liability does a shareholder have?

Answer 16

SHs are not liable for corporate acts beyond their original investment unless they owed a balance on their subscription agreement or received dividends that caused insolvency/balance sheet test failure.
*If the corporate form was intentionally used to avoid duties and disregarding the form is necessary to prevent aiding fraud, the corporate veil may be pierced and SHs are treated as partners.

Question 17

How does a corporate merger go through?

Answer 17

Both corporations’ boards must adopt a plan and give SHs due notice, and SH approval by a majority of the target corporation is required (unless a parent owns at least 90% of its subsidiary target), with buyout of the dissenters. To prevent hostile takeovers, many state statutes require offering all SHs the same price (no two-tier takeovers) and a duty for the target corp to obtain the highest price.

Question 18

How is a corporation dissolved?

Answer 18

Dissolution is the legal termination of the corporate entity. Because corporations have potentially unlimited life, an affirmative action is required to begin dissolution. If business has not started or no shares issued yet, the board may dissolve w/o SH approval. Otherwise, the board passes a resolution and gets majority SH approval, then submits articles of dissolution to the sec of state.
*A judicial dissolution may result from a SH suit for fraud/oppression/waste/deadlock or by a creditor w/ an unsatisfied judgment.

Question 19

What happens to creditors’ claims against a dissolved corporation?

Answer 19

Dissolved corporations may put creditors on notice that they have 120 days to put in a claim (enforceable against SHs to the extent they received corp assets). If the claim is rejected, the CR has 90 days to file a lawsuit. Unknown claims require publication in the county of the principal office, leaving three years to make claims.

Question 20

What is different about a professional service corporation?

Answer 20

Only licensed professionals may be SHs, directors, or officers, and only professional services may be performed by the corporation, but they are still shielded from personal liability. Idle funds can be passively invested in real estate or stocks. Dead SHs’ shares must be purchased at FMV.

Question 21

What is a limited liability company?

Answer 21

Members have limited liability like corporate SHs, but they receive the pass-through taxation benefits of partners.

Question 22

What are included in an LLC’s articles of organization?

Answer 22

NOMAD: the name, organizer’s name and address, whether it is member-managed (default) or has a manager, the address and registered agent, and the date of dissolution (or statement it’s perpetual).

Question 23

What duties to managers and members have?

Answer 23

The manager owes a duty of care to the LLC (but are not liable for simple negligence),and cannot be sued by members when the only harm is to the LLC. The members only owe a duty of loyalty and due care and are not liable for negligence.

Question 24

What is the LLC liable for?

Answer 24

The LLC is liable for contracts by authorized agents, but members or managers are not personally liable for those contracts unless they were a co-maker or lacked authority. The LLC is liable to third parties for torts committed in the course and scope of business, but members or managers are only liable if they participated or failed to supervise.

Question 25

How does a member dissociate from an LLC?

Answer 25

Dissociation from an LLC occurs upon member withdrawal (no need to buy the interest back), insolvency, death/incapacity, or expulsion (by court or unanimous vote).

Question 26

How does an LLC dissolve?

Answer 26

Dissolution of an LLC is very similar to that of a corporation and may be agreed upon or triggered by the date in the articles. Assets of the LLC are distributed pro rata to creditors (and creditor-members), then members owed distributions, returning members’ contributions, and finally sharing profits.