FACT PATTER ONE: Organization of a Corporation

Question 1

What is a C-Corp

Answer 1

A corporation that is taxed as an entity distinct from its owners.

The corporate tax rate generally is lower than the personal tax rate

Double taxation: When the corporation makes distributions to shareholders, the distributions are treated as taxable income to the shareholders, even though the corporation has already paid taxes on its profits.

Question 2

What is an S-Corp

Answer 2

Corporations that elect to be taxed like partnerships and yet retain the other advantages of the corporate form.
- They must have no more than 100 shareholders, all of whom are human U.S. citizens or residents
- They must have one class of stock, and
- The stock must not be publicly traded.

Question 3

How to Form a Corporation

Answer 3

To form a corporation, we need a PERSON, a PAPER, and an ACT.

PEOPLE (incorporators):
One or more persons who undertake to form the corporation. They execute the articles of incorporation and deliver them to the Secretary of State. They do not need to be a citizen of the state of incorporation.

PAPER: The articles of incorporation must contain:
(1) The name of the corporation
(2) The name and address of each incorporator, the name of a registered agent (to receive service of process), the street address of the registered office (must be in the state.)
(3) Information regarding the corporation’s stock:
- The authorized stock
- If the company has different classes of stock, the number of shares per class + their distinguishing designations
- Information on the voting rights, preferences, and limitations of each class of stock.

ACT
Incorporators will have notarized articles delivered to the secretary of state and pay required fees. If the secretary of state’s office accepts the articles for filing, that is conclusive proof of valid formation.

Question 4

Rule if a corporation has a limited purpose provision

Answer 4

A corporation has the power to engage in any lawful business. A corporation may limit the types of business it engages in by having a narrow purpose provision in its articles of incorporation. A corporation may not carry on business outside the scope of its stated purpose. Business outside the scope of the stated purpose is said to be ‘ultra vires’

[GO TO ULTRA VIRES DEFINITION]

Question 5

Ultra Vires Definition

Answer 5

[FIRST SEE IF LIMITED PURPOSE PROVISION]

At common law, an ultra vires contract was said to be illegal and unenforceable. Today, ultra vires may be raised only by (i) a shareholder seeking to enjoin a proposed ultra vires action, (ii) the corporation seeking damages against the officers or directors who authorized the ultra vires act, or (iii) the state seeking to dissolve the corporation for engaging in the ultra vires act.

[GO TO APPROPRIATE REMEDY]
- Injunction
- Damages
- Dissolution by State

Question 6

Dissolution by State for an Ultra Vires Act

Answer 6

Usually, the state will seek dissolution of a corporation for an ultra vires act only when the act violates regulatory laws.

Question 7

Injunctions for Ultra Vires Acts

Answer 7

Injunctions are equitable actions, and an equitable court will not enforce an injunction against an innocent third party (e.g., a third party who entered into an ultra vires contract with a corporation not knowing that the contract was ultra vires.)

Question 8

Damages for violating an Ultra Vires action

Answer 8

A shareholder can bring an action against directors for breach of the duty of care for authorizing an ultra vires act. Directors are fiduciaries and owe the corporation the duty to act with the care that an ordinary person would exercise in their own affairs. Taking on business outside the scope of the corporation’s stated purpose violates this duty. The appropriate remedy in this situation would be damages, not an injunction.

Question 9

Authorized Stock

Answer 9

The maximum number of shares the corporation can sell

Question 10

Issued Stock

Answer 10

The number of shares the corporation actually sells

Question 11

Outstanding Stock

Answer 11

Shares that have been issued and not reacquired

Question 12

Optional Contents in the Articles of Incorporation

Answer 12

The articles may also include any other provision regarding operation of the corporation that’s not inconsistent with law.

Question 13

Internal Affairs Doctrine

Answer 13

The internal affairs of a corporation (e.g., the roles and duties of directors, officers, and shareholders) are governed by the law of the state of incorporation.

Question 14

Limited Liability

Answer 14

The corporation (not the directors, officers, and shareholders) is liable for what the entity does.

Shareholders generally can only lose the amount that they invested in the company.

Question 15

De Facto Corporation requirements

Answer 15

• Relevant incorporation statute (there’s an incorporation statute in every state)
• The parties made a good faith, colorable attempt to comply with the statute (they tried and came close to forming a corporation)
• There has been some exercise of corporate privileges (the parties were acting as though they thought there was a corporation.)

If the de facto corporation doctrine applies, the business is treated as a corporation for all purposes except in an action by the state

LIMITATION: Anyone asserting de facto corporation must be unaware of the failure to form a de jure corporation.

Question 16

Corporation by Estoppel

Answer 16

Common law doctrine

Persons who have dealt with the entity as if it were a corporation will be estopped from denying the corporation’s existence.

Prevents an improperly formed “corporation” from avoiding liability by saying it was not properly formed.

This doctrine applies ONLY in contract cases.

Question 17

Methods of Formation: De Jure v. De Facto v. Estoppel

Answer 17

De Jure: Follow all statutory provisions

De Facto: Colorable compliance with most statutory provisions and exercise of corporate privileges

Estoppel: Parties act as if there is a corporation; no requirement of following statutory provisions

Question 18

Effect on Personal Liability: De Jure v. De Facto v. Estoppel

Answer 18

De Jure: Insulates against personal liability of shareholders

De Facto: Insulates against personal liability of shareholders, but corporation subject to quo warranto proceeding by state

Estoppel: Insulates against personal liability
in contract, but not in tort

Question 19

Today: De Facto Corporation and Corporation by Estoppel

Answer 19

These doctrines are abolished in many states.

On exam: “the doctrine likely doesn’t apply, but if it does, here’s how it would work”

Question 20

What is a Promoter

Answer 20

A promoter is a person acting on behalf of a corporation not yet formed.

Question 21

Promoter’s Relationships with Each Other

Answer 21

Absent an agreement to the contrary, promoters are joint venturers (partners) who have a fiduciary relationship with each other.

If they secretly pursue personal gain at the expense of their fellow promoters, they have breach their fiduciary duties

Question 22

Promoter’s Fiduciary Duty to Corporation: Disclosure

Answer 22

Promoters owe a duty of DISCLOSURE and GOOD FAITH

DISCLOSURE:
UNLESS all material facts of the transaction were disclosed to an independent board, a promoter who profits by selling property to the corporation may be liable for his profit.
- If NOT disclosed to an independent board, the promoter still will not be liable for his profits UNLESS the subscribers did not know of the transaction at the time they subscribed OR unanimously ratified the transaction after full disclosure.

Disclosure must be to all who are contemplated to be part of the initial financing scheme. If the promoters purchase all the stock and subsequently sell their individual shares to outsiders, the promoters cannot be held liable for the profits from the sale of property to the corporation.

Question 23

Promoter’s Fiduciary Duty to Corporation: Fraud

Answer 23

Promoters may always be liable if plaintiffs can show that they were damaged by the promoters’ fraudulent misrepresentations or fraudulent failure to disclose all material facts.

Question 24

Who is liable for pre-incorporation contracts?

Answer 24

MBCA: A promoter is jointly and severally liable for obligations incurred by a corporation prior to its incorporation.
- The promoter’s liability continues after the corporation is formed, even if the corporation adopts the contract and benefits from it.
- The promoter will be released from liability only if there is an express or implied novation (agreement among all three parties to release the promoter from liability and substitute the corporation for the promoter in the contract).

The corporation is not liable UNLESS they expressly or impliedly adopt the contract.
Express adoption: The board takes an action adopting the contract.
Implied adoption: The corporation accepts a benefit of the contract

Question 25

What if the promoter enters into a contract with a third party in which the agreement expressly relieves the promoter of liability?

Answer 25

If the agreement expressly relieves the promoter of liability, there is no contract

This is construed as a revocable offer to the proposed corporation, and the promoter has no rights or liabilities under the agreement.

Question 26

Promoter’s Right to Reimbursement

Answer 26

A promoter who is held personally liable on a pre-incorporation contract may have a right to reimbursement from the corporation to the extent of any benefits received by the corporation.

Question 27

Foreign Corporations

Answer 27

If foreign corporations are transacting business in a state, they must register and pay prescribed fees.

“Transacting business” means the regular course of intrastate business activity. This doesn’t include occasional or sporadic activity in this state, nor does it include simply owning property in this state.

A foreign corporation may not transact business within a state until it has obtained a certificate of authority from the secretary of state.

If the foreign corporation does not register with the state, it will incur a civil fine and will be unable to assert a claim in the state. HOWEVER, the foreign corporation can be sued and can defend the suit in the state.