Corporations, Partnership & Agency

Question 1

Definition of Corporation

Answer 1

A corporation is a legal entity that exists separate from its owners, thus shielding the owners and managers from liability.

Question 2

Formation of a Corporation

Answer 2

A corporation’s existence begins on the date the Articles of Incorporation are filed with the Secretary of State. The Articles of Incorporation MUST contain:

(1) the corporate name; (2) the number of shares the corporation is authorized to issue; (3) the address of the corporation’s initial registered office and the name of its initial registered agent at that office; AND (4) the name and address of each incorporator.

Question 3

De Jure Corporation (DJC)

Answer 3

When incorporators comply with all statutory requirements to file articles of incorporation with the Secretary of State, they create a de jure corporation.

Question 4

De Facto Corporation

Answer 4

When efforts to comply with incorporation requirements are unsuccessful, persons associated with the corporation may escape liability for obligations the corporation incurs if a de facto corporation exists from:

(1) a statute under which the entity can validly incorporate, (2) colorable compliance with the statute and a good faith attempt to comply, and (3) conduct of business in the corporate name and the exercise of corporate privileges.

Question 5

Pre-Incorporation Promotor Liability

Answer 5

A Promoter is a person who acts on behalf of corporation that hasn’t yet been formed. Promotor’s are personally liable for pre-incorporation contracts unless (1) there is a subsequent novation, or (2) the contract explicitly provides there is no promoter liability.

Question 6

Corporate Liability for Pre-Incorporation Contract’s

Answer 6

A corporation is not liable for a pre-incorporation contracts unless the corporation expressly or impliedly (knows material terms and accepts the benefits of) adopts the contract. If the corporation accepts the benefit of the contract, it may be adopted, and while it doesn’t relieve the promotor of liability, it offers the creditor an alternative avenue to seek reimbursement against the Corp also.

Question 7

Business Judgment Rule & Corporate Fiduciary Duties

Answer 7

Directors and officers are fiduciaries of a corporation, and as such owe a duty of care to the corporation. This means that they must discharge their duties: (1) in good faith; (2) in a manner the Director reasonably believes to be in the best interests of the corporation; AND (3) with the care that a person in a like position would reasonably believe appropriate under similar circumstances. If this three-prong test is satisfied, then a Director will NOT be liable for corporate decisions resulted in adverse consequences under the Business Judgment Rule. Courts won’t disturb decisions subject to the Business Judgment standard if a rational business purpose exists. Business Judgment Rule DOES NOT APPLY or protect Directors financially interested in a transaction, not acting in good faith, or engaged in fraud or illegality.

Question 8

Duty of Loyalty: Fiduciary Duty Owed

Answer 8

A Director (or Officer) owes the corporation a fiduciary duty of loyalty, which means that the Director, in his dealings with the corporation, must act in the best interests of the corporation and without personal conflict.

Duty of loyalty forbids Directors from: (a) entering into conflicting interest transactions; (b) usurping a corporate opportunity; (c) competing with the corporation; OR (d) trading on inside information.

Question 9

Duty of Loyalty

Conflicting Interest Transactions

Answer 9

A conflicting interest transaction with the corporation is a breach of duty of loyalty UNLESS the Director shows that: (a) it was approved by a majority of disinterested Directors after full disclosure of all relevant material facts; (b) it was approved by a majority of disinterested Shareholders after full disclosure of all relevant material facts; OR (c) the transaction as a whole was fair to the corporation at the time it was entered into (fair price, beneficial to corp and fair dealing).

Question 10

Duty of Loyalty

Usurping a Corporate Opportunity

Answer 10

A corporate opportunity is any opportunity that: (a) the corporation has an interest/expectancy in; OR (b) is in the corporation’s line of business. A director / officer MAY ONLY pursue a corporate opportunity if he: (1) first presents it to the corporation’s Board of Director’s; AND (2) the Board decides not to pursue the opportunity.

Question 11

Shareholder Litigation

Direct Action

Answer 11

Dirct Action involves an injury or breach of duty owed to a shareholder or corporation. The damages awarded in a direct action will be paid directly to the shareholder or member.

Question 12

Shareholder Litigation

Derivative Action

Answer 12

In a Derivative Action, a shareholder is suing to enforce the corporation’s claim, not his own personal claim. The damages awarded in a derivative action will be paid to the corporation (not the shareholder), but the shareholder may recover the reasonable costs of the litigation.

In order to initiate a derivative suit, the Plaintiff-shareholder must (1) be a shareholder at the time of the act or omission; (2) remain a shareholder through entry of judgment; (3) must fairly and adequately represent the interests of the corporation; AND (4) he must make a written demand upon the corporation to take suitable action.

Question 13

Election of Corporate Directors

Answer 13

Shareholders elect directors at the annual shareholder meetings. Shareholders may remove directors with or without cause. Primary Officers are appointed by the board, who determine their salary.

Question 14

Removal of Directors & Officers

Answer 14

Removal of Directors: A director may be removed from a corp board by a vote of the majority of the shareholders for cause or without cause UNLESS the Articles state that a director may only be removed for cause.

Removal of Officers: An Officer may be removed at any time with or without cause by: (a) the BOD; (b) the Officer who appointed such Officer; OR (c) any other Officer (if authorized).

Question 15

Compensation of Directors & Officers

Answer 15

Unless the corp bylaws or Articles state otherwise, the BOD is allowed to determine the compensation of directors and officers. However, they have a duty to set compensation in accordance with reasonable parameters, taking into account the needs of the corporation and ensuring they don’t commit waste of corporate assets.

Question 16

Board Meetings

Answer 16

The board can only act if a quorum is present. A majority of the Board is necessary to form a quorum, unless the Articles state a higher or lower number. At least 1/3 of directors are required to form a quorum.

Question 17

DIRECTOR or OFFICER Authority TEMPLATE

Answer 17

[Party Name]’s authority to [insert facts on what the person did (i.e. sign a contract)] arose from his/her role as [Company, director and officer title].

Question 18

Director or Board of Director’s Authority

Answer 18

A board of directors may act by (1) meeting or (2) unanimous written consent.

Question 19

Authority of Corp. Officers:

Actual Authority

Answer 19

An officer has Actual Authority to act consistently with their duties: (a) as outlined in the Bylaws; OR, (b) as provided by the Board of Directors.

Actual authority may be Express or Implied.

Express Actual Authority manifests from (1) oral and written words, (2) direct and definite language, or (3) specific instructions. The corp bylaws define actual express authority for an officer.

Implied Actual Authority allows an agent to take actions necessary to achieve the principal’s objectives based on the agent’s reasonable understanding of the objectives. An officer has implied authority to perform tasks necessary to carry out the officer’s duties by virtue of the position

Question 20

Authority of Corp. Officers:

Apparent Authority

Answer 20

An agent derives apparent authority from a principal’s manifestations which cause a third party to reasonably believe the agent has authority even though the agent has neither express nor implied authority.

An officer has apparent authority if the corporation holds the officer out to third parties as having authority to bind the corporation.

Question 21

Authority of Corp. Officers:

Ratification

Answer 21

A principal can ratify (approve an unauthorized act (no actual or apparent authority) an agent performed, and agree to be bound, as if the agent performed with authority. NOTE:If the person did not have authority, analyze if the board of directors held a meeting to ratify the person’s act.

Question 22

Piercing the Corporate Veil & Shareholder Liability

Answer 22

Generally, shareholders are not personally liable for corporate debts. But, Courts or creditors may disregard the corporate entity and pierce the corporate veil by holding active shareholders personally liable for corporate debts when under the (1) totality of the circumstances, (2) limited liability is unfair.

Question 23

Factors to Consider to Pierce the Corporate Veil

Answer 23

Factors courts consider when piercing the corporate veil:

(1) undercapitalization,

(2) alter ego,

(3) Fraud,

(4) Enterprise Liability,

(5) “Deep Rock” doctrine,

AND (6) Limited Liability is Unfair.

Question 24

Pierce Factor #1: Undercapitalization

Answer 24

Undercapitalization looks at whether the corporation has adequate funds to cover potential liabilities at the time of formation.

Question 25

Pierce Factor #2: Alter Ego

Answer 25

The shareholder (1) failure to respect the corporate entity must (2) adversely affect a third party ‘s ability to recover from the corporation.

Question 26

Pierce Factor #3: Fraud

Answer 26

Intentional misrepresentation (fraud) requires: (1) false representation, (2) scienter, (3) intent, (4) causation, (5) justifiable reliance, and (6) damages.

Question 27

Pierce Factor #4: Enterprise Liability

Answer 27

When the same shareholders own the stock of two corporations engaged in the same enterprise, one corporation’s creditor can reach the other corporation’s assets to satisfy the debt.

Question 28

Pierce Factor #5: “Deep Rock” Doctrine

Answer 28

When a corporation is insolvent and equity requires (i.e., fraud, gross mismanagement, bad faith), controlling shareholders’ claims as creditors, may be subordinated to outside creditors’ claims.

Question 29

Pierce Factor #6: Limited Liability is Unfair

Answer 29

The corporate veil is often pierced in tort, not contract cases. Parties who contract with a corporation have a chance to investigate its financial conditions.

Question 30

Dividends & Distributions to Shareholders

Answer 30

Decisions to declare dividends or make distributions to shareholders are within the discretion of the Board of Directors and are normally protected under the business judgment rule. Only the BOD has the power to issue dividends (an Officer cannot). Once a distribution is declared, the shareholder affected has a legal right to that distributions.

Question 31

Shareholder’s Cannot Compel Dividends

Answer 31

Generally, a shareholder DOES NOT have the right to compel a corporation to issue a distribution (whether in the form of a dividend or otherwise), UNLESS such right is expressly granted in the Articles of Incorporation.

But, a court will interfere and order a dividend/distribution upon a showing: (1) of bad faith or dishonest purpose; AND (2) that the funds were available for the dividend / distribution.

Question 32

Shareholder Voting Agreements

Answer 32

Shareholders may sign an agreement providing how they will vote their shares. A voting agreement is specifically enforceable, and a claim for breach of contract may be brought to enforce this right. It must be in writing and signed by all parties, and has no durational limit.

Question 33

Fundamental Changes to A Corporation

Answer 33

Generally, a fundamental change MUST be approved by a majority of the total votes entitled to be cast for the corporation, not just a majority of votes present at the meeting.

Fundamental changes include merger, consolidation, amendment of the Articles of Incorporation, sale of all or substantially all of the corporation’s assets or dissolution. A corporation must hold a special meeting when a fundamental change is proposed. A special meeting requires notice to be mailed to the shareholders, including date, time and place. Business that is not included in the notice may not be discussed at the special meeting.

Question 34

DISSOLUTION: Distribution of Corporate Assets

Answer 34

Upon dissolution, corporate assets are converted to cash and then distributed in the following order:

(1) outside creditors (which includes promissory note holders and those without equity interest in the company);

(2) inside creditors (Shareholders who made loans to the corporation);

and (3) the remaining assets are distributed to the shareholders according to their share of ownership.

Question 35

DISSOLUTION: BK, Equitable Subordination, Deep Rock Doctrine

Answer 35

In Bankruptcy under equitable subordination, all unsecured creditors will be treated the same and collect their debt from the corporation equally.

However, under Deep Rock Doctrine, the claim of a shareholder (especially one with a controlling interest) who makes a loan to the corporation will be subordinated to the claims of outside creditors if: (a) the corporation was undercapitalized; OR (b) if the shareholder acted wrongfully.

Question 36

Federal Securities Law - Rule 10b5

Answer 36

Prohibits the use of any means or instrumentality of interstate commerce in any scheme to defraud, make material misrepresentations or omissions, or in any other way to use fraud in the purchase or sale of securities.

For Plaintiff to prevail, he must show the Defendant (1) engaged in a fraudulent scheme or device which was; (2) relied upon; (3) in connection with the purchase or sale of a security; (4) acted with scienter (mental state involving intent to deceive, defraud or manipulate); (5) used some means of interstate commerce; AND (6) caused damages. Note: a fraudulent scheme or device includes: (a) a misrepresentation of material fact (or disseminating such information); (b) insider trading; OR (c) tipping.

Question 37

CREATION OF AGENCY RELATIONSHIP

Answer 37

An agent is a person or entity that acts on behalf of another – the principal.

Agency is a fiduciary relationship, and exists if there is: (1) assent/consent (a formal agreement between the principal and the agent); (2) benefit (the agent’s conduct on behalf of the principal primarily benefits the principal); AND (3) control (the principal has the right to control the agent by being able to supervise the agent’s performance the degree of control does not need to be significant).

Question 38

Actual Authority (Contractual LIability of Principal & Agent)

Slightly different than for Corporation

Answer 38

A principal is bound to contracts entered into by an agent if the agent has actual authority. Actual authority may be express or implied.

Question 39

Actual Authority

EXPRESS vs. IMPLIED

Answer 39

EXPRESS ACTUAL AUTHORITY occurs when the principal has explicitly told the agent (either orally or in writing) that he is entitled to act on the principal’s behalf.

IMPLIED ACTUAL AUTHORITY occurs when either (a) the agent believes the action taken is required by their duties; (b) they have acted the same previously; OR (c) it is customary for agents in that position to act in that way.

Question 40

Apparent Authority

Answer 40

Under Apparent Authority, A principal is bound to contracts entered into by its agent if the agent has apparent authority.

Apparent authority arises where: (1) the principal holds out another as having authority; AND (2) the third-party reasonably relies on that authority.

Question 41

Ratification of Agent’s Contract by Principal

Answer 41

A principal is liable for contracts entered into by an agent without authority when they have knowledge of all material facts/terms; and manifest assent to the agent’s actions through words or conduct.

Question 42

Formation of a Partnership

Answer 42

A partnership is two or more persons associating as business co-owners for profit. A written agreement is not necessary to form a partnership. But if no formal agreement, a partnership is presumed if there is agreement to share profits equally. Absent an agreement to contrary, each partner has an equal vote; profits shared equally; and losses are shared equally. [DISCUSS LP, LLP or GENERAL].

Question 43

Formation of General Partnership

Answer 43

A General Partnership is created with (1) two or more persons, (2) as co-owners, (3) carry on a business for profit. No written agreement or formalities are required. A partnership is presumed if there is an agreement to share profits equally. Absent an agreement to the contrary, each partner has an equal vote; profits are shared equally; and losses are shared the same as profits are shared.

Question 44

Formation of a Limited Partnership (LP)

Answer 44

A limited partnership (LP) forms when (1) two or more persons, at least one general partner and at least one limited partner, (2) file a limited partnership certificate with the Secretary of State. A limited partner’s liability for partnership debts is limited to the amount of the capital contribution to the partnership.

Question 45

General Partnership - Liability to Third Parties

Answer 45

General partners are personally, jointly and severally, liable to third parties for all partnership debts.

Incoming Partners admitted into an existing partnership are NOT liable for obligations incurred prior to their admission.

Generally a judgment creditor CANNOT levy execution of the judgment against a partner’s personal assets for a partnership debt UNLESS: (1) judgment was rendered against the partner; AND (2) the partnership assets have been exhausted or are insufficient.

Question 46

Failure of Limited Partnership to File LP Certificate

Answer 46

A person, who contributes to a purported limited partnership and believes in good faith s/he is a limited partner, may still be personally liable to a third party who transacts with the purported limited partnership, if a limited partnership certificate is not field with the Sec. of State.

Question 47

Limited Partnership (LP) Liabilities

Answer 47

The LP’s General Partner is personally, jointly, and severally liable for all partnership debts unless otherwise agreed.

A Limited Partner in a LP is personally liable when a third party actually believes in good faith the person is a general partner at the time of a transaction.

Question 48

Fiduciary Duties Owed By Partners

Answer 48

A partnership may maintain an action against a partner for the resulting loss when the partner violates a partnership duty.

Question 49

Partner-Duty of Loyalty (fiduciary duty sub-category to discuss)

Answer 49

Under the duty of loyalty, a partner CANNOT: (a) engage in self-dealing, (b) usurp business opportunities, OR (c) compete against the partnership. Where a partner breaches the duty of loyalty, profits may be disgorged and any contracts may be revoked or rescinded.

Question 50

Partner-Duty of Care (fiduciary duty sub-category to discuss)

Answer 50

Each partner is to refrain from engaging in grossly negligent, reckless, or knowing unlawful acts, or intentional misconduct; OR a knowing violation of law.

Question 51

Asset Distribution at DISSOLUTION of Partnership

Answer 51

Upon dissolution, partnership assets are distributed in this order:

(1) creditors,

(2) partners and former partners for accrued unpaid distributions,

(3) partners for contributions return,

and (4) partners in the proportion in which they share distributions.

Question 52

PARTNER AUTHORITY

Answer 52

Each partner has equal partnership management rights. A partner is a partnership agent and can bind the partnership (including entering contracts) when the partner acts with:

(1) Actual (Express & Implied),

(2) Apparent, or

(3) Ratification.

Question 53

Partner Authority - ACTUAL

Answer 53

Actual authority may be (1) express or (2) implied.

EXPRESS: Express authority manifests from (1) a partnership agreement, (2) an authorization of the partners, or (3) a statement of authority filed with the Secretary of State.

IMPLIED: Implied authority is based on a partner’s reasonable belief that an action is necessary to carry out an express authority

Question 54

Partner Authority - APPARENT AUTH.

Answer 54

An unauthorized partner’s act may bind the partnership if the act is performed in the ordinary course of apparently carrying on (1) the partnership busines or (2) business of a kind carried on by the partnership. A third party cannot hold a partnership liable where the person knows or receives notice a partner lacks authority.

Question 55

FORMATION OF LIMITED LIABILITY PARTNERSHIP (LLP)

Answer 55

A limited liability partnership (LLP) forms when a statement of qualification is filed with the Secretary of State to notify third parties their sources for loss recovery is limited. It is composed of general and limited partners, and MUST have at least one general partner.

Question 56

LIMITED LIABILITY PARTNERSHIP (LLP) LIABILITY OF PARTNERS TO 3rd PARTIES

Answer 56

An obligation incurred by a Limited Liability Partnership (LLP) is solely the obligation of the LLP. Under RUPA, a partner in an LLP is NOT liable for partnership obligations.

Exceptions are:

(1) partners are ALWAYS liable for their own misconduct or when they sign a personal guarantee.

(2) even if not liable, he is at risk of losing any capital contributions.