Corporations MEE

Question 1

Pre-incorporation transactions

Answer 1

1. Promoter liability
   * Pre-incorporation agreements—a promoter is personally liable for knowingly acting on behalf of a corporation (C) before incorporation, and remains liable after C comes into existence unless (i) there is a subsequent novation releasing the promoter from liability, (ii) the third party looks only to C for performance, or (iii) the promoter had no actual knowledge that the corporation’s charter has not yet been issued
   * Fiduciary duty—a promoter can be liable to C for violating fiduciary duties
   * Compensation—a promoter may seek compensation/reimbursement for related expenses, but cannot compel C to pay because the acts were not undertaken at C’s direction
2. C’s liability
   * General rule—C is not liable for pre-incorporation transactions, even those for the benefit of C (there is no principal-agent relationship)
   * Adoption—C is liable if it expressly or impliedly adopts a contract by accepting the benefits of the transaction, or gives an express acceptance of liability for the debt

Question 2

Articles of Incorporation

Answer 2

• Must include the corporate name and be filed with the state
• May enumerate powers that C possesses, or limit its duration; may include statement of C’s legal purpose
• Corporate existence—begins when the articles are filed, unless the articles establish a later date

Question 3

Ultra vires actions

Answer 3

• Act—when a C that has stated a narrow business purpose in its articles subsequently engages in activities outside that stated purpose; a third party generally cannot escape liability for a transaction that is an ultra vires corporate act
• Challenges to ultra vires acts under RMBCA (will only be enjoined if it is equitable to do so)—a shareholder can file suit to enjoin the C’s ultra vires action; C can take action against a director (D), officer (O), or employee who engaged in the action, or the state can initiate a proceeding

Question 4

De jure Corporation

Answer 4

when all statutory requirements for incorporation are satisfied, C is liable for C activities

Question 5

Defective incorporation

Answer 5

• Lack of good faith—a person who conducts business as a C without complying with the incorporation requirements is personally liable for the nonexistent C’s obligations
• Good-faith effort—two ways to escape personal liability:
  o De facto C—the owner must make a good-faith effort to comply with the incorporation requirements and operate C without knowing the requirements were not met
  o Corporation by estoppel—a person dealing with an entity in a contractual agreement as if it were a C is estopped from denying its existence and seeking personal liability

Question 6

Types of Stock

Answer 6

1. Common stock—a basic ownership interest that entitles the owner to vote on corporate governance matters
2. Preferred stock—has preference over other stock with regards to distributions

Question 7

Issuance of Stock

Answer 7

1. Authorization—by board of directors (BD) and/or shareholders (SH)
2. Consideration—if adequate, the stock is deemed fully paid and non-assessable
3. Stock subscriptions—a pre-incorporation subscription is irrevocable for six months from the date of subscription (unless all subscribers agree to a revocation)
4. Stock rights, options, and warrants—can also be issued by BD
5. SH’s preemptive rights—the right of a SH to purchase newly issued shares in order to maintain the SH’s proportional ownership share as provided by the articles; a waiver of preemptive rights in writing is irrevocable
6. Securities registration—required for public offerings of stocks; C must file a registration statement with SEC and provide the buyer with a prospectus

Question 8

Distributions

Answer 8

1. BD is authorized to make distributions, usually in the form of cash dividend payments
2. Limitations—C cannot distribute if C is insolvent or if the distribution would make C insolvent
3. D’s liability for unlawful distributions in violation of duties of care/loyalty—D is personally liable to C for the amount in excess of a lawful amount
4. SH suit to compel distribution—SH can sue to enforce his individual right by proving the existence of funds legally available to pay a distribution and D’s bad faith for refusing to pay the distribution

Question 9

Private restrictions on sale of securities

Answer 9

• Enforceability—the security must be certified, the restriction must be conspicuously noted on the security certificate, and the person must have knowledge of the restriction
• Challenge to restrictions on transfer of stock—the test is one of reasonableness

Question 10

Federal causes of action

Answer 10

• Rule 10b-5 action—must meet each of the following requirements:
  o The plaintiff purchased or sold the security
  o Use of interstate commerce
  o The defendant’s fraudulent/deceptive conduct—untrue statements of material fact, failure to prevent misleading statements, or insider trading
  o Materiality—a reasonable investor would find the fact important in deciding whether to purchase or sell a security
  o Scienter—the defendant must make the statement intentionally or recklessly
  o The plaintiff’s justifiable reliance on the defendant’s fraudulent conduct
  o Harm to the plaintiff
• Rule 16(b) action—elements:
  o Publicly traded Cs—must have securities traded on a national securities exchange or have assets of more than $10 million and more than 500 SHs
  o Corporate insiders—Ds, Os, or SHs with more than 10% of stock
  o Short-swing profits—a corporate insider both bought and sold C’s stock during any six-month period
  o SEC report of change in stock ownership

Question 11

Corporate Governance

Answer 11

A. Instruments
1. Articles of incorporation—BD can amend the articles if no stock has been issued; if stock has been issued, then BD adopts the amendments and submits them to SHs for majority approval
2. Bylaws—lawful provisions for the management of C’s business and the regulation of its affairs, not inconsistent with the articles
3. Conflict between the articles and the bylaws—the articles control

B. Organizational meeting—for appointment of Os, adoption of bylaws, and approval of contracts

Question 12

Shareholder meeting requirements

Answer 12

failure to hold meetings does not affect C’s existence or invalidate C’s business

1. Annual—primary purpose is to elect Ds
2. Special—may be called by BD or SHs who own at least 10% of voting shares
3. Notice—voting SHs must be notified of time/date/place in a timely manner no less than 10 days and no more than 60 days before the meeting; SH may waive notice either in writing or by attending the meeting
4. Unanimous written consent—SHs can take any action that could have been taken at a meeting by unanimous written consent
5. Shareholder resolutions—submitted for SH action at SH meeting; cannot bind C or BD unless amending bylaws; can regulate political expenditures

Question 13

Shareholder voting requirements

Answer 13

1. Eligibility—generally, only record owners of voting stock are permitted to vote; an owner of voting stock at the close of business on the record date has the right to vote; C generally cannot vote its own stock
2. Quorum requirements—a majority of the votes entitled to be cast on a matter
3. Cumulative voting for Ds—SHs can cumulate votes to allow minority SHs to elect representatives to BD
4. Proxy voting—must be in writing and delivered to the C or its agent
5. Voting with other SHs
   * Voting pool—a binding voting agreement under which SHs retain legal ownership; does not need to be filed with the C; no time limit
   * Voting trust—a trust to which legal ownership of SH’s stock is transferred; the trustee votes the shares and distributes the dividends in accord with trust; must be in writing, limited to 10 years, and filed with the C
   * Management agreement—allows SHs to alter the way the C is managed even if the agreement is inconsistent with statutory provisions

Question 14

Shareholder inspection of records

Answer 14

a SH with a proper purpose (relates to SH’s interest) has the right to inspect and copy corporate records upon five days’ written notice

Question 15

Shareholder suits

Answer 15

1. Direct actions—an action to enforce SH rights for breach of fiduciary duty by D or O, or an action based on grounds unrelated to SH’s status
2. Derivative actions—SH sues on behalf of C for harm suffered by C
   * Standing—plaintiff must have been a SH at the time of the wrong and at the time the action is filed, must continue to be a SH during the litigation, and must fairly and adequately represent C’s interests
   * Written demand upon BD must be made unless it would be futile; the futility exception is not recognized under the RMBCA; a rejection of a demand is tested against the business judgment rule
   * Litigation expenses—plaintiff can seek reimbursement from the C for reasonable litigation expenses
   * Dismissal by board—only if a majority of qualified directors decide in good faith after reasonable inquiry that the action is not in the corporation’s best interest

Question 16

Piercing the corporate veil

Answer 16

• Totality of circumstances—look to whether C is being used as a façade for a dominant SH’s personal dealings (i.e., whether C is “alter ego” or “mere instrumentality” of SH), and whether there is unity of interest and ownership between the C and its members
• Factors considered—undercapitalization, disregard of corporate formalities, using C’s assets as SH’s own assets, self-dealing with C, siphoning of C’s funds, using corporate form to avoid statutory requirements, SH’s domination over C, and fraudulent dealings with a corporate credito

Question 17

Controlling SH’s fiduciary duty to minority SHs

Answer 17

• A controlling SH is a SH (or a group of SHs acting in concert) who holds a high enough percentage of ownership in a company to enact changes at the highest level; a SH owning 50% plus one of a C’s shares is automatically a controlling SH
• The duty arises if the controlling SH is selling interest to an outsider, seeking to eliminate other SHs from the C, or receiving a distribution denied to other SHs
• Duty to disclose information that a reasonable person would consider important in deciding how to vote on a transaction, and a duty of fair dealing when purchasing a minority SH’s interest

Question 18

BoD Composition requirements

Answer 18

can have as few as one; D must be a natural person and not a C; Ds are selected at the annual SH meeting

Question 19

BoD Term

Answer 19

—typically one year, but may serve longer if terms are staggered; Ds can be removed by SHs with or without cause unless the articles provide otherwise; D may resign at any time with written notice to the BD, its chair, or C

Question 20

BoD Compensation

Answer 20

permitted

Question 21

BoD Meeting Requirements

Answer 21

Ds are entitled to two days’ notice of the date, time, and place of special meetings (purpose is not required); regular meetings may be held without notice of the date, time, place, or purpose; BD can act by unanimous written consent without holding a meeting

Question 22

BoD voting requirements

Answer 22

1. The assent of a majority of Ds present is necessary for board approval (generally)
   * To be a valid act, a quorum must have been present
   * A majority of all Ds in office constitutes a quorum
2. Agreements between Ds as to how to vote (pooling agreements) are generally unenforceable
3. Ds may not vote by proxy

Question 23

BoD Committees

Answer 23

may generally exercise whatever powers are granted to them by the BD, articles, or bylaws

Question 24

BoD Duty of Care

Answer 24

• Prudent person—a D has a duty to act with the care that a person in a like position would reasonably believe appropriate under similar circumstances (objective standard), and is required to use any additional knowledge and special skills he possesses when deciding how to act
• Reliance protection—a D can rely on information and opinions of Os, employees, outside experts (e.g., attorneys, accountants), or committees, if D reasonably believes them to be reliable and competent
• Business judgment rule (BJR)
  o Rule—a rebuttable presumption that D reasonably believed his actions were in the best interest of C; does not apply when D engages in a conflict-of-interest transaction with C
  o Overcoming the rule—it must be shown that: D did not act in good faith; D was not informed to the extent he reasonably believed was necessary; D had material interests in challenged conduct and was not objective; D failed to devote attention to C’s affairs; D failed to timely investigate matters of material concern; or D received financial benefits to which he was not entitled
  o Good faith presumption—overcome in the case of fraud, dereliction of duty, condoning illegal conduct, or conflict of interest

Question 25

BoD Duty of Loyalty

Answer 25

—requires D to act in a manner that D reasonably believes is in the best interest of C

• Self-dealing (director’s conflicting interest transaction)
  o Rule—a D who engages in a conflict-of-interest transaction with his own C violates the duty of loyalty unless the transaction is protected under the safe-harbor rules; D cannot profit at C’s expense
  o Type of transaction—one that would normally require approval of BD and is of such financial significance to D that it would reasonably be expected to influence D’s vote on the transaction (also includes dealings with persons related to D); the interest must be financial and material
  o Safe harbors—disclosure of all material facts and majority approval by BD or SHs without a conflicting interest; fairness (substantive and procedural) of the transaction to C at the time of commencement
• Usurpation of corporate opportunity
  o Interest or expectancy test—does C have an existing interest or an expectancy arising from an existing right in the opportunity
  o Line-of-business test—is the opportunity within the C’s current or prospective line of business, and how expansive is C’s line of business
  o Other factors—relationship of the third party to D and of D to C; how and when D acquired knowledge of the opportunity
• Competition with C—a D who engages in a business venture that competes with C has breached the duty

Question 26

BoD Indemnity/insurance

Answer 26

• C is required to indemnify D for any reasonable expense incurred in the successful defense of a proceeding against the D
• C is prohibited from indemnifying D against liability due to the receipt of an improper personal benefit
• C may indemnify in an unsuccessful defense if D acted in good faith with a reasonable belief that the conduct was in C’s best interest and D did not have reasonable cause to believe the conduct was unlawful

Question 27

BoD Inspection Rights

Answer 27

—D has a right to inspect and copy C’s books and records

Question 28

Officers and Other Employees

Answer 28

A. Selection—elected by the BD

B. Authority
1. Actual—as defined by the corporate bylaws or BD
2. Implied—to perform those tasks necessary to carry out O’s duties by virtue of her status or position, so long as the matter is within the scope of ordinary business (i.e., not “extraordinary” transactions)
3. Apparent—if C holds O out has having the authority to bind C to third parties

C. Duties—same as D’s duties (see above); the CEO and CFO of a publicly traded C are subject to the Sarbanes-Oxley Act, and must certify the accuracy of C’s financial reports to the SEC

D. Liability—an O is liable to a third party if O has acted in O’s personal capacity or has engaged in purposeful tortious behavior; (O is not liable merely for the performance of O’s duties to C)

E. Indemnification/insurance—same as Ds (see above)

F. Removal—with or without cause at any time

G. Other employees—an employee can act on behalf of C to the extent of the employee’s authority and is usually protected as an agent from liability for actions undertaken in accordance with that authority

Question 29

Mergers and Acquisitions

Answer 29

A. Mergers—require BD and SH approval by a majority vote at a meeting with a quorum (at least a majority of the shares entitled to vote) present for each C; required documents must be filed with the state

B. Asset acquisition—same as merger approval procedure except only the transferor C’s BD and SHs are entitled to vote on the transaction; transferor C remains liable for its debts

C. Stock acquisition—a C can acquire stock in another C to acquire control of that C without doing a merger by exchanging its own stock for that stock or by paying cash or other property for the stock

D. Dissenting shareholder’s right of appraisal
1. Rule—a SH who objects to a merger or acquisition, or whose rights are materially and adversely affected by an amendment to C’s articles, may be able to force the C to buy his stock at a fair value as determined by an appraisal
2. Qualifying SHs—any SH entitled to vote on a merger, acquisition, or amendment of C’s articles

Question 30

Termination of Corporate Status

Answer 30

A. Voluntary dissolution
1. Procedure after issuance of stock—BD adopts a proposal for the dissolution of C and a majority of SHs approve
2. Winding up—dissolving C can continue to exist to collect assets, dispose of property not distributed to SHs, discharge liabilities, and distribute property among SHs according to their interests

B. Involuntary dissolution
1. Creditors can pursue involuntary dissolution only for an insolvent C
2. SHs can pursue involuntary dissolution if C’s assets are being misapplied/wasted, Ds are acting illegally/oppressively/fraudulently, SHs are unable to break Ds deadlock causing irreparable injury, or if the SHs are deadlocked and fail to elect successor Ds
3. Oppression doctrine—doctrine of SH oppression protects minority from oppressive majority control; statutory provisions regarding involuntary dissolution are interpreted to protect the reasonable expectations of SHs

Question 31

Special Types of Corporations

Answer 31

A. Closely held and close corporations—only a few SHs; stock not publicly traded; more relaxed style of governance

B. Foreign corporation—incorporated in another state; must register and seek a certificate of authority from the current state

C. Professional corporation—the purpose is statutorily limited to the rendering of a professional service

D. S corporation—C avoids double taxation by passing income and expenses through to its SHs, who are then taxed directly

E. Benefit corporation—for profit; corporate purpose is creating social/environmental benefit rather than maximizing shareholder profit

Question 32

Limited Liability Company

Answer 32

—enjoys the pass-through tax advantage of a partnership and the limited liability of a corporation

Question 33

LLC Creation

Answer 33

created by filing articles of organization with the state, including the LLC’s name, mailing address, and, if there are no members upon filing, a statement to that effect; does not come into existence until it has at least one member; some states apply doctrines of de facto corporation and corporation by estoppel if there was a good-faith effort to create an LLC

1. Operating agreement—the articles of organization only reflect an LLC’s existence, but an LLC may also adopt an operating agreement to govern business; agreement can be oral, in a record, or implied by conduct; statutory default provisions apply when the operating agreement is silent; default management arrangement is member-manager
2. Membership—minimum one member, no maximum; to become a new member requires the consent of all other LLC members (a transfer of a membership interest also requires the consent of all members)
   * Transfer of membership—the transferee only acquires the transferor’s right to share in the LLC’s profits and losses, not a right to participate in the LLC’s management
   * Termination of membership—does not automatically trigger a dissolution of the LLC; LLC may elect to liquidate the fair value of that person’s interests
   * Allocation of profits and losses—unless determined by an operating agreement, allocations are made according to each member’s contributions to the LLC
   * Inspection rights—LLC members generally have inspection rights similar to SHs of Cs

Question 34

LLC Management

Answer 34

can be direct (by members) or centralized (by one or more managers who need not be members)

Question 35

LLC Management Liabilities

Answer 35

• Members are generally not liable for the LLC’s obligations; managers are not personally liable for obligations incurred on behalf of the LLC
• Piercing the veil—members may be liable if the veil is pierced due to undercapitalization, commingling of assets, confusion of business affairs, or deception of creditors
  o Mere instrumentality test—(i) members dominated the entity such that the LLC had no will of its own, (ii) members used that domination to commit a fraud or wrong, and (iii) the control and wrongful action proximately caused an injury
  o Unity of interest and ownership test—the LLC did not have an existence independent of the members because there was such a unity of interest and ownership between the entity and the members that the failure to pierce the veil would be unjust or inequitable
• Creditors can obtain a charging order (judgment lien) against a member’s LLC interest, requiring the LLC to pay to the judgment debtor distributions that otherwise would be paid to the member; the operating agreement cannot alter this rule to the prejudice of third parties

Question 36

LLC Management Duties

Answer 36

—members of member-managed LLC and managers of manager-managed LLC owe duties of loyalty and care to the LLC and members * Must account to the LLC for any benefit derived by the member related to the LLC’s business, refrain from dealing with the LLC on behalf of one having an adverse interest, and refrain from competing with the LLC

• Duty of care to LLC is subject to BJR; not liable for simple negligence
• Fiduciary waivers are recognized in LLCs; may agree to specific activities that do not violate the duty of loyalty, as long as the agreement is not manifestly unreasonable

Question 37

LLC Management Authority to Bind

Answer 37

—managers have authority to bind the LLC

Question 38

LLC Dissociation

Answer 38

• Member can withdraw at any time for any reason without written notice
• Withdrawal does not necessarily trigger dissolution and winding up

Question 39

LLC Direct and Derivative Suits

Answer 39

1. Direct—an action to enforce a member’s rights as a member under the operating agreement and the state LLC statute; there must be an actual or threatened injury that is not just a result of an LLC injury
2. Derivative—an action by a member on behalf of the LLC to enforce the rights of the LLC; must show that a demand was made or that demand would be futile

Question 40

LLC Dissolution

Answer 40

an LLC may merge with another LLC or other business entity; may dissolve upon the occurrence of various events (mutual consent of members, lack of members for 90 consecutive days, court order, or events provided in the operating agreement)

1. Member may seek involuntary dissolution if a controlling member acts in a way that is oppressive and directly harmful to the member seeking the order; action must action violate member’s reasonable expectations
2. Winding up—the LLC must (i) discharge the LLC’s debts, obligations, or other liabilities; and (ii) settle and close the LLC’s activities, and marshal and distribute the LLC’s assets; may perform acts necessary or appropriate to the winding up