FACT PATTERN TWO— ISSUANCE OF STOCK

Question 1

ISSUANCE OF STOCK
4.1 BACKGROUND

Answer 1

• To start & operate a corporation, we need money
  (capital).
• Corp can either borrow money/raise it by selling stock (or both).
• Either way, corp will issue a security to investor.
• Security is a fancy word for investment.

Question 2

Debt Securities

Answer 2

• When corp borrows money, it issues a debt
  security, which is usually called a bond.
• Bond: promise that corp will repay loan w/ interest.
• If loan is unsecured by corporate assets, it may be called a debenture.
• Importantly, holder of debt securities is a creditor, but not an owner, of corp.

Question 3

Terminology

Answer 3

• Debt obligations may be payable either to holder of bond (a bearer/coupon bond) or to owner registered
  on corp’s records (a registered bond).
• A debt obligation may also have special features; ex, it may provide that it is convertible into equity securities at the option of holder, or it might provide that corp may redeem the obligation at a specified price before obligation matures.

Question 4

Equity Securities

Answer 4

• When investor buys an ownership interest in corp,
  it issues equity securities, which is stock (investor
  holds shares of stock).
• Importantly, the money invested does not create a debt.
• The shareholder is an owner, but not a creditor, of corp

Question 5

Terminology

Answer 5

• Remember that shares described in corp’s AOI are authorized shares.
• Those shares that have been sold are issued & outstanding.
• Shares that have been reacquired by corp through repurchase/redemption are authorized but unissued
• These are sometimes referred to as treasury shares
• Shares may be certificated (represented by a
  certificate) or uncertificated.

Question 6

Classification of Shares

Answer 6

• A corp may choose to issue only one type of share,
  giving each shareholder an equal ownership right (in which case the shares are generally called “common shares”).
• Alternatively, ownership rights may be varied if articles provide that the corp’s stock is to be divided into classes/series w/in a class.
• Recall that if shares are to be divided into classes/ series w/in a class, articles must include info such as # of shares of each class.

Question 7

Share Options

Answer 7

• Corp may issue share options.
• An option is right to purchase shares in the future
• Options may be offered in exchange for any type of consideration, including future services.

Question 8

Issuance

Answer 8

• An issuance of stock is when a corp sells its own
  stock.
• It’s important to remember that the rules in this fact
  pattern apply only when there is an issuance, meaning, when corp is selling its own stock.

Question 9

SUBSCRIPTIONS

Answer 9

• Subscriptions are written offers to buy stock from a corp.
• One issue may be whether such an offer may be
  revoked.

Question 10

Preincorporation Subscription

Answer 10

• MBCA: preincorporation subscriptions are irrevocable for 6 months unless otherwise provided in terms of subscription agreement/UNLESS all subscribers consent to revocation.

Question 11

Payment

Answer 11

• Unless otherwise provided, payment is due upon demand of the board.
• Demand may not be made in a discriminatory manner.
• A subscriber who fails to pay may be penalized by
  sale of the shares/forfeiture of subscription & any
  amounts paid on subscription, at corp’s option.

Question 12

Postincorporation Subscription

Answer 12

• Postincorporation subscriptions are revocable until accepted by corp
• Corp & subscriber are obligated under a subscription agreement when board accepts offer.

Question 13

CONSIDERATION

Answer 13

What must the corporation receive when it issues stock?

Question 14

Form of Consideration

Answer 14

• :MBCA: stock (or an option to buy stock) may be
  issued for any tangible/intangible property/benefit
  to corp.
• This includes money (cash/check), property, services already performed for the corp, & discharge of a debt.
• Also includes promissory notes to corp & future services to corp.

Question 15

Tip

Answer 15

MBCA greatly expanded what is acceptable consideration for issuance of shares. Older statutes did not allow shares to be issued for promissory notes/promises of future work. These forms of consideration are acceptable under MBCA. Similarly, a promise to convey property in the future would also be acceptable. Watch for exam questions that test on this dramatic change.

Question 16

Amount of Consideration
a. Traditional View—Par

Answer 16

• Par means minimum issuance price.
• Traditionally, stock could not be issued by a corp for less than stock’s stated par value, & consideration received for par value stock had to be held in a certain account containing at least aggregate par value of outstanding par value shares.
• Correspondingly, no par means no minimum issuance price.
• That means the board can have the stock issued for any price it sets.

Watered Stock
- On bar, if you’re given par stock, watch for watered stock, which can occur when par value stock is issued for less than its par value.

Question 17

MBCA Approach—Board Determines Value

Answer 17

• MBCA generally has eliminated the concept of par &
  allows corps to issue shares for whatever consideration directors deem appropriate
• Consideration received for issuance of stock need not be placed in any special account.
• If corp issues stock in exchange for consideration other than cash, such as for property/past services, board determines value of property/ services.
• Board’s valuation is conclusive if made in good
  faith.
• Stock is considered fully paid & nonassessable
  as soon as corp receives consideration for which board authorized issuance.
• Of course, a shareholder who fails to pay full amount agreed upon can be held liable for any sums remaining unpaid.

Question 18

Tip

Answer 18

While the concept of par value is mostly dead
under the MBCA, a corporation’s articles can still
specify a par value for stock. In which case, if the
directors authorize a sale of stock for less than the stated
par value, the shares will probably be treated as validly
issued, but the directors who authorized the issuance can
be held liable for breach of their fiduciary duty. The MBCA
itself provides no clear guidelines on this issue.

Question 19

PREEMPTIVE RIGHTS
4.4.1 Right to Maintain Percentage of Ownership

Answer 19

Preemptive right: right of an existing shareholder of common stock to maintain her percentage of ownership in the company by buying stock whenever there is a new issuance of stock for money (meaning cash/equivalent, like a check).

Question 20

Right Must Be Stated in Articles

Answer 20

• MBCA: shareholders do not have a preemptive right to purchase newly issued shares to maintain their proportional ownership interest unless AOI provides the right.
• So if articles are silent on this issue, we do not have preemptive rights.

Question 21

Limitations

Answer 21

• Even if articles do provide a preemptive right, shareholders generally have no preemptive right in shares issued:
  (1) for consideration other than cash (ex. for services
  of an employee),
  (2) w/in 6 months after incorporation, or
  (3) w/o voting rights but having a distribution preference.