Corporations Multiple Choice Flashcards
When is a court most likely to disregard the separate identity of a subsidiary corporation and allow recovery from the parent corporation?
(A) When the parent corporation has greater resources than the subsidiary corporation.
(B) When the parent corporation essentially controls the decisionmaking of the subsidiary corporation by electing its board of directors.
(C) When the parent corporation owns 100% of the stock of the subsidiary corporation.
(D) When the parent corporation has inadequately capitalized the subsidiary without a reasonable expectation that the subsidiary will achieve financial independence.
(D) The mere fact that a parent corporation has greater resources than a subsidiary is not a reason
to disregard their separate identities. In addition, a corporation can hold 100% of the stock of a subsidiary corporation and essentially control that corporation’s decisionmaking by electing its board of directors while still maintaining its own separate corporate existence. However, a subsidiary or affiliated corporation will not be deemed to be a separate corporate entity if the formalities of separate corporate procedures for each corporation are not observed. For example, both corporations must be held out to the public as separate entities; separate meetings of directors
and officers should be held; identical or substantially overlapping directors and officers should be avoided; and corporate policies should be significantly different. It is also generally accepted that shareholders will be personally liable for their corporation’s obligations if at incorporation they fail to provide adequate capitalization. In a parent-subsidiary situation, the court will consider whether the subsidiary may reasonably expect to achieve independent financial stability from its operation.
Which of the following qualities generally is not considered a characteristic of the corporate form? (A) Limited liability for owners. (B) Centralized management. (C) Flow-through taxation. (D) Free transferability of ownership.
(C) Flow-through taxation is not considered a characteristic of the corporate form. Typically, a corporation is taxed as an entity distinct from its owners; i.e., it must pay taxes on any profits that it makes, and the shareholders pay taxes on the corporation’s profits when the profits are distributed. The other answer choices are characteristics of the corporate form, and each can be seen as an advantage over some other forms of business entities. The owners of a corporation generally are not personally liable for the obligations of the corporation. The right to manage a corporation
is not spread out among the shareholders, but rather is centralized in a board of directors, who usually delegate day-to-day management duties to officers. Finally, ownership of a corporation normally is freely transferable; a shareholder can sell his shares to whomever he wants, whenever he wants, at whatever price he wants in most circumstances.
Which of the following people would not be held liable for insider trading under rule 10b-5?
(A) The president of a corporation who knows that the corporation is about to announce the launch of a groundbreaking new product and buys company stock in anticipation of the product’s success.
(B) An accountant who, while acting as an independent contractor, discovers a major financial error in the corporation’s books, and then sells all of his stock in the corpo- ration before revealing the error.
(C) A director who advises his niece to sell all of her stock in the corporation because he has received word that the corporation is about to be named the defendant in a class action lawsuit.
(D) A bartender who sells all of her stock in the corporation after she overhears two of the corporation’s directors discussing the company’s recent financial difficulties over drinks.
(D) A stranger who overhears inside information would not be liable under rule 10b-5.
Anyone who breaches a duty not to use inside information for personal benefit can be held liable under rule 10b-5. Typical securities insiders, such as directors, officers, controlling shareholders, and employees of the issuer are deemed to owe a duty of trust and confidence to their corporation, which is breached by trading on inside information. Constructive insiders, such as a securities issuer’s CPAs, attorneys, and bankers performing services for the issuer, also owe such a duty. In addition, where an insider gives a tip of inside information to someone else who trades on the basis of the inside information, the tipper can be liable under rule 10b-5 if the tip was made for any improper purpose (e.g., in exchange for money or a kickback, as a gift, for a family member’s benefit, for reputational benefit, etc.). The tippee can be held liable derivatively if the tipper breached a duty and the tippee knew that the tipper was breaching the duty.
Which of the following is not a requirement to satisfy a director’s duty of care?
(A) The director must act in good faith.
(B) The director must act with the care that an ordinarily prudent person in a like position would exercise under similar circumstances.
(C) The director must act in a manner the director reasonably believes to be in the best interests of the corporation.
(D) The director must act in reliance on her own business judgment and not in reliance on the opinions of others.
(D) Directors are vested with the duty to manage the corporation to the best of their ability; they are not insurers of corporate success, but rather are merely required to discharge their duties: (i) in good faith; (ii) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and (iii) in a manner the directors reasonably believe to be in the best interests of the corporation. In discharging her duties, a director is entitled to rely on information, opinions, reports, or statements (including financial statements), if prepared or presented by any of the following: (i) corporate officers or employees whom the director reasonably believes to be reliable and competent; (ii) legal counsel, accountants, or other persons as to matters the director reasonably believes are within such person’s professional competence; or (iii) a committee of the board of which the director is not a member, if the director reasonably believes the committee merits confidence.
Which of the following is not a necessary element for a successful cause of action under section 16(b) of the Securities Exchange Act?
(A) An officer, director, or more than 10% shareholder of a corporation made a profit.
(B) The profit was made on the purchase or sale of an equity security.
(C) The profit was made by use of insider information.
(D) The purchase and sale or sale and purchase was within a six-month period.
(C) Section 16(b) of the Securities Exchange Act of 1934 provides that any profit realized by a director, officer, or shareholder owning more than 10% of the outstanding shares of the corporation from any purchase and sale, or sale and purchase, of any equity security of his corporation within a period of less than six months must be returned to the corporation. The purpose of section 16(b) is to prevent unfair use of inside information and internal manipulation of price. This is accomplished by imposing strict liability for covered transactions whether or not there is any material fact that should or could have been disclosed—no proof of use of inside information is required.
Which of these choices outlines the proper steps for adopting a fundamental corporate change?
(A) The board adopts a resolution recommending the change; a notice describing the proposed change is sent to the shareholders; after allowing time for shareholder comments, the change is approved by the board; the change is formalized in articles that are filed with the state.
(B) The board adopts a resolution recommending the change; a notice describing the proposed change is sent to the shareholders; the change is approved by the shareholders; the change is formalized in articles that are filed with the state.
(C) A formal notice describing the proposed change is filed with the state; notice is sent to the shareholders; the change is approved by the shareholders; the change is formal- ized in articles that are filed with the state.
(D) A formal notice describing the proposed change is filed with the state; notice is sent to the shareholders; after allowing time for shareholder comments, the change
is approved by the board; the change is formalized in articles that are filed with the state
(B) The basic procedure for adopting a fundamental corporate change is the same for all fundamental changes: (i) a majority of the board of directors adopts a resolution recommending the fundamental change; (ii) notice of the proposed change is sent to all shareholders (whether or not entitled to vote); (iii) the change is approved by the shareholders; and (iv) the change is formalized in articles (e.g., articles of amendment, articles of merger, etc.), which are filed with the state.
Which of the following statements is true regarding a promoter’s personal liability on a preincorporation contract?
(A) A promoter is personally liable even if the contract expressly states that the promoter is not to be bound.
(B) A promoter remains liable even if the corporation is formed and adopts the contract.
(C) A promoter is acting as an agent for the unformed corporation and is not personally liable.
(D) The corporation, not the promoter, is the intended beneficiary to the contract so the promoter is not personally liable.
(B) As a general rule, if a promoter enters into an agreement with a third party to benefit a planned, but as of yet unformed, corporation, the promoter is personally liable on the agreement, even if the corporation is formed and adopts the contract. If the document between the parties expressly indicates that the promoter is not to be bound, there is no contract, so the promoter is not bound. Such an arrangement may be construed as a revocable offer to the proposed corporation. Since the corporate entity does not exist prior to incorporation, it is not bound on contracts entered into by the promoter in the corporate name, even though the contract is intended to ultimately benefit the corporation. A promoter cannot act as an agent of the corporation prior to incorporation, since an agent cannot bind a nonexistent principal.
Which of the following statements is true if a share has a $5 noncumulative preference?
(A) The share is entitled to a $5 annual pay- ment.
(B) The share is entitled to a $5 payment before a distribution can be made on account of common shares.
(C) The share is entitled to a $5 payment plus the distribution paid on account of a common share whenever a distribution is made on account of common shares.
(D) The share is entitled to a $5 payment
each quarter and any missed preference payments must be paid before a distribution can be made on account of common shares.
(B) Shares that have a specific dollar amount distribution preference must be paid their preference whenever a distribution is declared; a distribution cannot be made on account of common shares unless the preference is paid. (A) is incorrect because such a preference does not entitle a preferred shareholder to the declaration of a distribution—the preference arises only if a distribution is declared. Moreover, distributions are not limited to annual payments (e.g., many companies make quarterly distributions). (C) is incorrect because a preferred share is entitled to the distribution made on account of common shares only if the preferred share is described as “participating.” (D) is incorrect because it describes a cumulative preference, and the question asks about shares with a noncumulative preference.
A 3% shareholder of a corporation purchases an additional 11% of the company’s stock. Two months later, he sells all his stock to fund his retirement overseas. Is the shareholder liable under section 16(b) of the Securities Exchange Act of 1934 for the profits he made on the sale?
(A) Yes, as a holder of more than 10% of the corporation’s stock he is strictly liable for any profits made within a six month period.
(B) Yes, because he sold more than 10% of the company’s stock within two months of purchasing it.
(C) No, section 16(b) would not be triggered because he was not a 10% shareholder at the time he purchased the additional 11% of the stock.
(D) No, because he sold his stock to fund his retirement, not on the basis of any insider information.
(C) Section 16(b) of the Securities Exchange Act of 1934 would not be triggered because he was not a 10% shareholder at the time he purchased the additional 11% of the stock. Section 16(b) provides that any profit realized by a director, officer, or shareholder owning more than 10% of the outstanding shares of the corporation from any purchase and sale, or sale and purchase, of any equity security of his corporation within a period of less than six months must be returned to the corporation. For the purposes of section 16(b), a person is a more than 10% shareholder if he directly or indirectly owns more than 10% of any class of equity security of the corporation at the time immediately before both the purchase and the sale. The purchase that brings a shareholder over the 10% threshold is not within the scope of section 16(b).
In which of these situations is a court least likely to pierce the corporate veil?
(A) When corporate formalities are ignored and injustice results.
(B) When the corporation was inadequately capitalized at the outset.
(C) When the corporation becomes insolvent due to poor management.
(D) When necessary to prevent fraud on creditors.
(C) A de jure corporation will be treated as a legal entity distinct from its owners until sufficient reason to the contrary appears. Each case is different, but there are three recurring situations in which the corporate veil is often pierced: (i) when corporate formalities are ignored and injus- tice results; (ii) when the corporation is inadequately capitalized at the outset; and (iii) to prevent fraud. Insolvency of the corporation due to poor management generally would not be a reason to pierce the veil, although insolvency that occurs soon after incorporation might indicate that there was undercapitalization at the outset.
Which of the following statements regarding shareholder lawsuits is most accurate?
(A) All shareholder suits against their corporation are known as derivative actions because they all derive from the shareholder’s relationship to the corporation.
(B) Since shareholders are technically the owners of a corporation, they cannot bring any lawsuit against the corporation because to do so would be the equivalent of suing themselves.
(C) Shareholders can bring direct actions against their corporation to enforce their own rights and any recovery will be for their own benefit; shareholders can sometimes bring derivative actions to enforce the rights of the corporation, but in those cases recovery generally goes to the corporation and the shareholders bringing the action can only recover their reasonable expenses.
(D) Shareholders have the right to bring lawsuits against their corporation at any time, but their fiduciary duty to their fellow shareholders requires that any recovery be shared by all the shareholders in proportion to the amount of shares held.
(C) Shareholders are entitled to enforce their own claims against the corporation, officers, directors, or majority shareholders by direct action. In such a case, any recovery is for the benefit of the individual shareholder, or, if the action was a class action, for the benefit of the class. There is no fiduciary duty to share the recovery. Shareholders also may sue derivatively to enforce a corporate cause of action, as long as they meet the requirements specified by law and they have made necessary demands on the corporation or the directors to enforce the cause of action. In a derivative action, the recovery generally goes to the corporation rather than to the shareholders bringing the action, but the shareholders can recover reasonable expenses (including attorneys’ fees). In either capacity, direct or derivative action, the shareholder may sue for herself and for others similarly situated.
For a private plaintiff to recover damages under rule 10b-5, the plaintiff must show all of the following except:
(A) The defendant engaged in fraudulent conduct.
(B) The defendant purchased or sold securities.
(C) The defendant’s conduct involved the use of some means of interstate commerce.
(D) The defendant’s actions caused the plaintiff damages.
(B) Under rule 10b-5, it is unlawful for any person, directly or indirectly, by the use of any means
or instrumentality of interstate commerce or the mails, or of any facility of any national securities exchange, in connection with the purchase or sale of any security, to: (i) employ any device, scheme, or artifice to defraud; (ii) make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (iii) engage in any act, practice, or course of business that operates or would operate as a fraud or a deceit upon any person, in connection with the purchase or sale of any security. A violation of the rule can result in a private suit for damages, an SEC suit for injunctive relief, or criminal prosecution. To recover damages under rule 10b-5,
a private plaintiff must show that: (i) the defendant engaged in some fraudulent conduct; (ii) the fraudulent conduct was in connection with the purchase or sale of a security by the plaintiff; (iii) the fraudulent conduct involved the use of some means of interstate commerce; (iv) the plaintiff relied on the fraudulent conduct (although this can be presumed based on the fraud on the market theory); and (v) the defendant’s fraud caused the plaintiff damages. The focus is on a sale or purchase by the plaintiff; the defendant need not have purchased or sold any securities. Thus, a non-trading defendant, such as a company that intentionally publishes a misleading press release, can be held liable to a person who purchased or sold securities on the market on the basis of the press release.
When is a corporation liable for a pre-incorporation contract that a promoter signed on behalf of the corporation?
(A) Never, a corporation cannot be held liable on a contract that was formed before its existence.
(B) As soon as the corporation is formed, because a promoter serves as the agent of a corporation prior to its existence.
(C) When the corporation expressly or impliedly adopts the contract as its own.
(D) Only when there is a novation formally releasing the promoter of liability and substituting the corporation.
(C) Since the corporate entity does not exist prior to incorporation, it is not bound on contracts entered into by the promoter in the corporate name. A promoter cannot act as an agent of the corporation prior to incorporation, since an agent cannot bind a nonexistent principal. The corpo- ration may become bound on promoter contracts by adopting them. Adoption may be express or implied. The effect of an adoption is to make the corporation a party to the contract at the time it adopts, although adoption of the contract by the corporation does not of itself relieve the promoter of his liability. A novation is required to release the promoter from liability.
Which of the following statements regarding the president of a corporation is true?
(A) The president of a corporation only has the authority that is expressly granted in the corporation’s articles of incorporation.
(B) The president of a corporation has implied authority to enter into contracts on behalf of the corporation in the ordinary course of corporate affairs.
(C) The president of a corporation has no authority to bind the corporation without the express approval of the corporation’s board of directors.
(D) The president of a corporation has absolute authority to run the corporation in any reasonable manner she sees fit under the business judgment rule.
(B) The president of a corporation has implied authority to enter into contracts on behalf of the corporation in the ordinary course of corporate affairs. As an officer of the corporation, the president is an agent of the corporation and receives her power to manage from the directors. The president’s authority may be actual or apparent. If authority exists, actions taken by a corporate officer (such as entering into contracts) bind the corporation. An officer’s actual authority includes not only the authority expressly granted to the officer by the directors, the bylaws, the articles, and statutes, but also any authority that may be implied by the express grant. The business judgment rule protects directors whose reasonable decisions turn out to be poor or erroneous in hindsight. It does not give authority to a corporation’s president to run the corporation in any manner she sees fit.
Which of these alone is not an adequate reason for upholding a transaction in which a director has a conflicting personal interest?
(A) The transaction, judged according to circumstances at the time of the commitment, was fair to the corporation.
(B) The transaction will result in any tangible or intangible benefit to the corporation.
(C) The transaction was approved by a majority of the votes entitled to be cast by shareholders without a conflicting interest in the transaction after all material facts have been disclosed to the shareholders.
(D) The transaction was approved by a majority of the directors (but at least two) without a conflicting interest after all material facts have been disclosed to the board.
(B) A conflicting interest transaction can be upheld if: (i) the transaction was approved by a majority of the directors (but at least two) without a conflicting interest after all material facts have been disclosed to the board; (ii) the transaction was approved by a majority of the votes entitled to be cast by shareholders without a conflicting interest in the transaction after all material facts have been disclosed to the shareholders (notice of the meeting must describe the conflicting interest transaction); or (iii) the transaction, judged according to circumstances at the time of commit- ment, was fair to the corporation. Under the RMBCA, any tangible or intangible property or benefit to the corporation can serve as consideration for shares, but this is not the standard that is used to judge a conflicting interest transaction. A transaction might offer some benefit to a corporation, but still be unfair at the time of the commitment.
