FACT PATTERN TWO— ISSUANCE OF STOCK Flashcards
ISSUANCE OF STOCK
4.1 BACKGROUND
- 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.
Debt Securities
- 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.
Terminology
- 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.
Equity Securities
- 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
Terminology
- 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.
Classification of Shares
- 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.
Share Options
- 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.
Issuance
- 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.
SUBSCRIPTIONS
- Subscriptions are written offers to buy stock from a corp.
- One issue may be whether such an offer may be
revoked.
Preincorporation Subscription
- MBCA: preincorporation subscriptions are irrevocable for 6 months unless otherwise provided in terms of subscription agreement/UNLESS all subscribers consent to revocation.
Payment
- 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.
Postincorporation Subscription
- Postincorporation subscriptions are revocable until accepted by corp
- Corp & subscriber are obligated under a subscription agreement when board accepts offer.
CONSIDERATION
What must the corporation receive when it issues stock?
Form of Consideration
- :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.
Tip
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.
Amount of Consideration
a. Traditional View—Par
- 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.
MBCA Approach—Board Determines Value
- 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.
Tip
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.
PREEMPTIVE RIGHTS
4.4.1 Right to Maintain Percentage of Ownership
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).
Right Must Be Stated in Articles
- 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.
Limitations
- 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.
