Financing the Creation, Operation, and Growth of a Business - June 26

Question 1

What are the two types of financial capital? (Epstein)

Answer 1

Debt and equity. (414)

Question 2

What is a security? (Epstein)

Answer 2

“A security is any piece of paper (and now, more often, an electronic record) of a company’s promise to do something tomorrow in exchange for your money today. Stocks and preferred stocks are “equity securities.” Bonds, notes and debentures are “debt securities,” as are commercial paper, mortgage-backed securities and many other forms of debt.” (414)

Question 3

What is debt? (Epstein)

Answer 3

Debt is borrowing (a liability). (416)

Question 4

What is equity? (Epstein)

Answer 4

Equity represents an ownership stake in the business, and is accomplished by selling shares. (416)

Question 5

How are corporations financed? (Q)

Answer 5

Corporations are typically financed by issuing stock to raise capital. The ownership of the corporation is divided into shares of stock that are represented by transferable certificates.

Capital stock is the stock issued by a corporation under its authority.

Question 6

May a business issue stock before it formally incorporates? (Q)

Answer 6

Yes. A business may issue stock before it formally incorporates. A prospective corporation that has not yet incorporated may issue shares of stock through subscriptions. Subscriptions are contractual agreements to purchase newly issued securities as soon as the corporation is formed.

Typically, a pre-incorporation subscription is irrevocable for six months, unless the agreement provides otherwise or all the subscribers agree to revocation. In contrast, a subscription entered into after incorporation is treated like a typical contract.

Question 7

Promoters were in the process of incorporating their new business. The corporation would own and manage a music venue and surrounding restaurants and bars. To secure capital for when the corporation was formed, the promoters issued shares of stock through subscriptions. However, after just three months, the promoters believed that they had undervalued the corporation. The promoters wanted to revoke the subscriptions and reissue the shares at a much higher price. The subscriptions did not address revocation, and the subscribers refused to agree to the revocation.

Are the promoters entitled to revoke the subscriptions? (Q)

Answer 7

No. The promoters may not revoke the subscriptions. A prospective corporation that has not yet incorporated may issue shares of stock through subscriptions. Subscriptions are contractual agreements to purchase newly issued securities as soon as the corporation is formed. Typically, a pre-incorporation subscription is irrevocable for six months, unless the agreement provides otherwise or all the subscribers agree to revocation. In contrast, a subscription entered into after incorporation is treated like a typical contract.

Here, the subscriptions were issued before incorporation. The subscriptions were silent on the issue of revocation, and the subscribers would not agree to revocation. Thus, these pre-incorporation subscriptions are irrevocable for six months, and the promoters are not entitled to revoke the subscriptions after only three months.

Question 8

May a corporate entity issue new stock or repurchase its stock? (Q)

Answer 8

Yes. A corporate entity may periodically issue new stock or repurchase stock. The overall number of shares and types of stock issued must be authorized by the entity’s articles of incorporation or determined by its board of directors with an amendment.

Shares that have been issued are referred to as outstanding shares and remain outstanding until reacquired, redeemed, or cancelled by the corporation.

Question 9

What are the two main types of capital stock? (Q)

Answer 9

The two main types of capital stock are common stock and preferred stock. Common stock is the most common type of stock issued by a corporation, Typically, ownership of common stock entitles a shareholder to receive a share of the entity’s profits through dividends and to vote for directors and on important corporate matters. However, common stockholders do not receive preference regarding the distribution of corporate assets or dividends.

Ownership of preferred stock entitles shareholders to receive a payment of dividends and/or distribution of assets before common stockholders receive theirs. However, preferred stockholders typically do not have voting rights.

Question 10

Typically, does a share of preferred stock entitle the shareholder to receive dividends? (Q)

Answer 10

Yes. Typically, a share of preferred stock entitles the shareholder to:

a share of the company’s profits through dividends and

preference regarding the distribution of both dividends and corporate assets ahead of holders of common stock.

In some situations, this means there may be little or nothing left over for common stockholders after all preferred stockholders receive their portion.

Question 11

Are corporations limited to issuing only common stock and preferred stock? (Q)

Answer 11

No. Corporations are not limited to issuing only common stock and preferred stock. A corporation may issue additional classes of stock with distinguishing features, such as voting rights or priority of distribution.

Typically, at least one class of stock must have the right to receive assets upon the corporation’s dissolution. Additionally, at least one class of stock must have unlimited voting rights.

Question 12

What is treasury stock? (Q)

Answer 12

Treasury stock is previously issued stock that is repurchased by the corporation that issued it. Two common reasons a corporation may choose to reacquire its own previously issued stock, i.e., to increase its treasury stock holdings, are that:

the corporation believes that the shares are undervalued by the market or

the reacquisition is a preliminary step to becoming a private corporation.

Question 13

May a corporation issue stock in exchange for something other than cash? (Q)

Answer 13

Yes. A corporation may issue stock in exchange for something other than cash.

After incorporation, a corporation’s board of directors has the discretion to issue additional shares of stock in exchange for consideration that consists of any tangible or intangible property or other benefit to the corporation (e.g. cash, promissory notes, service contracts, or other corporate securities). Some states limit the types of consideration that may be exchanged for stock.

Question 14

What is par value? (Q)

Answer 14

Par value is a monetary value established in some states below which a corporation’s newly issued stock may not be sold. In states that require the use of par value, sometimes referred to as par-value states, corporations are compelled to set a par value that will serve as the minimum price of any newly issued stock.

Question 15

If a corporation is issuing new stock, may it set the value of that stock below par value? (Q)

Answer 15

No. If a corporation is issuing new stock, it may not set the value of that stock below whatever monetary value has been set as par value.

This restriction applies only to issuing new stock; it does not apply to selling treasury stock or any shares that are resold after issuance.

Question 16

What is watered stock? (Q)

Answer 16

Watered stock is stock that was sold for less than par value. Someone who purchases watered stock may be liable for the difference between the stock’s par value and what was actually paid for the stock.

Question 17

A board of directors was interested in issuing additional shares of a corporation. A local investor was interested in acquiring 1,000 shares for $50,000. Under the proposed note, the investor would make payments for two years until the $50,000 was repaid. The board wanted to accept the investor’s offer. However, one board member was unsure whether the board could accept an unsecured promissory note instead of cash for the shares.

Can the board accept the investor’s offer? (Q)

Answer 17

Yes. The board can accept the investor’s offer. After incorporation, a corporation’s board of directors has the discretion to issue additional shares of stock in exchange for consideration consisting of any tangible or intangible property or other benefit to the corporation. Thus, the board may choose to accept cash, unsecured promissory notes, service contracts, or other corporate securities in exchange for the corporation’s stock.

Here, the board received an offer to issue 1,000 additional shares in exchange for an unsecured promissory note for $50,000. This promissory note is property. Thus, the board has the authority to decide that this is appropriate consideration for the corporation’s stock and accept the offer.

Question 18

A corporation wished to hire a famous artist to paint a number of murals in its new offices. The artist was willing to paint the murals for $50,000. The corporation did not have the necessary funds available in cash. A director suggested paying the artist $25,000 and issuing the artist 1,000 shares of the corporation, valued at $30 per share. The artist agreed to do the work for these terms.

Can the board of directors issue 1,000 of the corporation’s shares to the artist as partial payment for the artist’s services? (Q)

Answer 18

Yes. The board of directors may issue 1,000 of the corporation’s shares to the artist as partial payment for the artist’s services. After incorporation, a corporation’s board of directors has the discretion to issue additional shares of stock in exchange for consideration consisting of any tangible or intangible property or other benefit to the corporation. The board may choose to accept cash, unsecured promissory notes, service contracts, or other corporate securities in exchange for the corporation’s stock.

In this case, the board is planning to issue 1,000 of the corporation’s shares in exchange for a contract for future services. A contract for future services provides a benefit to the corporation. Thus, the board is authorized to make an issuance for this consideration.

Question 19

A corporation was incorporated in a par-value state and set a par value for its stock. When first incorporated, the board of directors set par value at $20 per share. A few years after incorporating, the majority shareholder was experiencing financial distress, and the corporation agreed to repurchase all her shares. Shortly thereafter, the corporation encountered an unexpected liquidity crisis and needed to resell most of these shares. A new investor approached the board and offered to purchase 10,000 shares for $18 per share.

Can the board accept this offer? (Q)

Answer 19

Yes. The board may accept the offer. In par-value states, if a corporation is issuing new stock, it may not set the value of that stock below whatever monetary value has been set as par value. In those states, par value serve as the minimum price for any newly issued stock. However, this par-value restriction does not apply to selling treasury stock, previously issued stock that has been repurchased by the corporation.

Here, the new investor is offering to buy stock that was originally sold to another shareholder and later repurchased by the board. This means the investor is offering to buy treasury stock. The par-value restriction requiring a board to issue stock for at least par value does not apply to sales of treasury stock. Accordingly, even though the investor is offering less than par value for the treasury stock, the board may accept the offer.

Question 20

What is a preemptive right? (Q)

Answer 20

A preemptive right is a right granted by a corporation’s articles of incorporation to particular shareholders entitling them to purchase newly issued shares of stock in proportion to their existing holdings before the corporation makes a public offering of the stock.

For a corporation to grant preemptive rights to certain shareholders, the corporation must expressly grant those preemptive rights in its articles of incorporation.

Question 21

What is the purpose of preemptive rights? (Q)

Answer 21

The purpose of preemptive rights is to allow shareholders to maintain their overall ownership percentage even if new shares are offered to the public.

Typically, preemptive rights are intended to prevent the board of directors from diluting a shareholder’s ownership interest or seizing majority control of the corporation by issuing new shares.

Question 22

If a shareholder has a preemptive right to buy additional shares of a corporation before new shares are offered to the public, may the shareholder waive that preemptive right without receiving any consideration? (Q)

Answer 22

Yes. If a shareholder has a preemptive right to buy additional shares of a corporation before new shares are offered to the public, the shareholder may waive that preemptive right without receiving any consideration.

As long as the shareholder waives a preemptive right in writing, the waiver will be irrevocable even if there was no consideration exchanged for the waiver.

Question 23

The board of directors of a corporation had continuing, significant disagreements with a group of disgruntled shareholders. The corporation had 100,000 outstanding common shares. The board voted to issue 25,000 additional common shares to a new investor. The disgruntled shareholders believed that the new issuance was an attempt to dilute and diminish their voting influence within the corporation. To avoid this dilution, each of the disgruntled shareholders wanted to exercise a preemptive right to purchase some of the 25,000 new shares in proportion to the shareholder’s current holdings. The articles of incorporation did not address the issue of preemptive rights.

Do the disgruntled shareholders have preemptive rights to purchase a proportional amount of the new issuance? (Q)

Answer 23

No. The disgruntled shareholders do not have any preemptive rights to purchase a proportional amount of the new issuance. If a shareholder has a preemptive right, the shareholder is entitled to purchase newly issued shares in proportion to the shareholder’s existing holdings before the corporation offers those new shares to the public. However, not all shareholders have preemptive rights. Shareholders have preemptive rights only if the corporation expressly granted the rights in its articles of incorporation.

Here, the corporation’s articles of incorporation do not even address the issue of preemptive rights, let alone grant any to the shareholders. Thus, none of the disgruntled shareholders have a preemptive right to purchase any portion of the 25,000 new shares.

Question 24

When a corporation was initially formed, its articles of incorporation gave its shareholders preemptive rights. However, the corporation’s board later decided to eliminate those rights. The board argued that the rights were delaying the corporation’s efforts to issue shares and suppressing share value. The board sent each shareholder a proposed agreement waiving the shareholder’s preemptive rights. However, the shareholders were not offered any consideration in exchange for signing the waiver agreement. Even without consideration, convinced by the board’s argument, all shareholders signed the waiver agreement.

Do the corporation’s shareholders still have any preemptive rights? (Q)

Answer 24

No. The corporation’s shareholders no longer have any preemptive rights. A corporation may expressly grant a preemptive right to certain shareholders in its articles of incorporation. Shareholders with preemptive rights are entitled to purchase a portion of any newly issued shares in proportion to their existing holdings before the corporation offers those new shares to the public. However, shareholders may waive their preemptive rights. A shareholder’s waiver of preemptive rights is valid even if there is no consideration for it, as long as the waiver is in writing.

Here, the shareholders gave up their valuable preemptive without receiving anything in return. However, even though the waiver agreement was not supported by any consideration, it was in writing. Thus, the waiver is valid, and the shareholders no longer have any preemptive rights.

Question 25

What is a corporate distribution? (Q)

Answer 25

A corporate distribution is:

a corporation’s direct or indirect transfer of money or other property (except its own shares) or

acquisition of debt
to or for the benefit of its shareholders.

Corporations make distributions to shareholders as a way of sharing profits.

Question 26

What are dividends? (Q)

Answer 26

Dividends are a portion of the corporation’s net profits to which shareholders are entitled. Dividends may be distributed in the form of cash, additional shares, or property.

Typically, dividends are distributed periodically (e.g., quarterly) as a set amount per share or a percentage of par value, with preferred shareholders receiving their dividends before common shareholders. The decision of whether to distribute dividends is typically within the discretion of the board of directors.

Question 27

Must a corporate distribution always be in the form of a dividend? (Q)

Answer 27

No. A corporate distribution need not always be in the form of a dividend, although a dividend is a common form of distribution. A distribution may be in the form of:

a declaration or payment of a dividend;

a purchase, redemption, or
other acquisition of shares;

a distribution of indebtedness; or

some other form.

Question 28

May a corporation make distributions to its shareholders if, after the distribution, the corporation’s total assets will be less than its total liabilities? (Q)

Answer 28

No. A corporation may not make any distribution to it shareholders if, after the distribution, either:

the corporation would be unable to pay its debts in the usual course of business, or

the corporation’s total assets would be less than its total liabilities.

In addition to these two restrictions, a corporation’s articles of incorporation may also place restrictions on the corporation’s ability to make distributions to its shareholders.

Question 29

A corporation had been struggling to pay its bills and had defaulted on several already. To try to signal strength to the market, the corporation entered into a share-repurchase agreement for the repurchase of 10,000 shares of its own common stock. Some of the corporation’s creditors objected to this course of action.

Is the share repurchase permissible? (Q)

Answer 29

No. The share repurchase is not permissible because the corporation is unable to repay it debts. A corporation may acquire and reissue its own shares. However, the acquisition of shares requires paying money out to shareholders and is a type of distribution. A corporation may not make any distribution to it shareholders if, after the distribution, either:

the corporation would be unable to pay its debts in the usual course of business, or
the corporation’s total assets would be less than its total liabilities.
In this case, the corporation is already unable to pay its debts in the usual course of business. Distributing more cash to shareholders to buy back stock would only make it even harder for the corporation to pay its debts. Thus, the corporation is prohibited from repurchasing its common stock.

Question 30

Generally, may a corporation may reacquire its own previously issued stock? (Q)

Answer 30

Yes. Generally, a corporation may reacquire its own previously-issued stock. The corporation is then allowed to reissue that same stock. These shares are often referred to as treasury shares after reacquisition. Typically, the shareholder and corporation will enter into a share-repurchase agreement for the reacquisition.

This is the general rule. However, this ability may be restricted by statute. Also, a corporation’s articles of incorporation may directly or indirectly restrict the corporation’s ability to repurchase and reissue of shares of stock.

Question 31

What are shareholder appraisal rights? (Q)

Answer 31

An appraisal right entitles a shareholder to request the repurchase of his or her stock at fair market value (i.e., an appraisal). Generally, a shareholder has a right to appraisal if the shareholder is opposing or dissenting from an extraordinary corporate action involving his or her shares, such as if the corporation is:

merging or exchanging shares,
disposing of assets,

amending its articles of incorporation to reduce the quantity of the shareholder’s shares,

being domesticated (i.e., transferred to another state), or

being converted from one type to another.

However, a corporation’s articles of incorporation may limit or eliminate its shareholders’ appraisal rights.

Question 32

What types of corporate actions may trigger a shareholder’s ability to exercise an appraisal right? (Q)

Answer 32

Generally, a shareholder has a right to appraisal if the shareholder is opposing or dissenting from an extraordinary corporate action involving his or her shares, such as:

a merger to which the corporation is a party;

a share exchange to which the corporation is a party;

the corporation’s disposition of assets;

an amendment to the articles of incorporation that reduces the number of shares owned by the shareholder;

a domestication of the corporation (i.e., transferring the corporation to another state);

a conversion of the corporation from one type to another; or

any other corporate action to the extent provided by the articles of incorporation, bylaws, or board of directors.

The corporation must notify its shareholders of their appraisal rights if it proposes one of these actions.

Question 33

If a shareholder exercises an appraisal right, does the shareholder receive a predetermined value for the shareholder’s shares? (Q)

Answer 33

No. If a shareholder exercises an appraisal right, the shareholder does not receive a predetermined value for the shares. Rather, the shareholder will receive the shares’ fair market value.

Question 34

What two actions must a shareholder take to exercise her appraisal rights? (Q)

Answer 34

To exercise appraisal rights, a shareholder must:

deliver written notice of her intent to demand payment for her shares before the vote on the proposed objectionable action and

not vote any shares in favor of the proposed objectionable action.

Once a shareholder submits the required written appraisal form, the corporation must pay the fair market value of the shares to the shareholder within 30 days and in cash. If a shareholder’s demand for payment remains unsettled, the corporation may commence a judicial proceeding to determine the fair market value of the shares. The shareholder may become a party to that proceeding.

Question 35

Almost all of a corporation’s shareholders voted to change the corporation’s state of incorporation from Delaware to Nevada. A few shareholders voted against the change, arguing that Delaware case law was more developed and favorable to the corporation. The articles of incorporation and bylaws were silent on the issue of appraisal rights.

Can this group of dissenting shareholders exercise its appraisal rights? (Q)

Answer 35

Yes. These shareholders may exercise their appraisal rights. Unless otherwise eliminated, a shareholder has a right to request an appraisal, i.e., a repurchase of his or her stock at fair market value, if the shareholder is opposing or dissenting from an extraordinary corporate action involving his or her shares, such as if the corporation is:

merging or exchanging shares,
disposing of assets,

amending its articles of incorporation to reduce the quantity of the shareholder’s shares,

being domesticated (i.e., transferred to another state), or

being converted from one type to another.

Here, the transfer from Delaware to Nevada is a domestication. This is an extraordinary corporate action giving rise to the right of appraisal. This right has not been otherwise eliminated. Thus, the dissenting shareholders may exercise their appraisal rights to have their shares’ repurchased at fair market value.

Question 36

Do shareholders have any rights as a result of owning corporate stock? (Q)

Answer 36

Yes. As a result of owning corporate stock, shareholders have the right to:

vote at meetings,

elect and remove directors,

receive dividends,

bring shareholder derivative suits,

inspect and copy corporate records (the right of inspection), and

enter into shareholder agreements that govern their relationship with the corporation.

Shareholders dissenting to a merger also hold appraisal rights, i.e., the right to receive fair value for their shares after a valuation by the court.

Question 37

Are corporations required to hold shareholders’ meetings? (Q)

Answer 37

Yes. Every corporation is required to hold an annual shareholders’ meeting at a place and time in accordance with the applicable bylaws. At each shareholder’s meeting, a chair, appointed by the bylaws or board of directors, will preside, determine the order of business, and establish fair rules for the conduct of the meeting. Typically, shareholders elect directors and discuss other corporate business at the annual meeting.

There also may be special meetings called by the board of directors or other authorized persons for a vote on some extraordinary measure. A court can order meetings upon a shareholder’s application, such as when the corporation fails to hold an annual meeting.

Question 38

May shareholders consent to act without a meeting? (Q)

Answer 38

Yes. Shareholders may consent to forego the formality of a meeting and take an action permitted to be taken at a meeting so long as that consent is memorialized in a signed writing. The articles of incorporation can limit the actions that can be taken without a meeting.

Question 39

Are shareholders entitled to advance notice of shareholders’ meetings? (Q)

Answer 39

Yes. Shareholders are entitled to advance notice of the date, time, and place of annual and special shareholders’ meetings between 10 and 60 days before the meeting date. Typically, the notice for a special meeting must also indicate the meeting’s purpose.

A corporation is required to notify only those shareholders who are entitled to vote at the meeting. A shareholder may waive the required notice in a signed writing or by attending the meeting without objection.

Question 40

Corporations must give notice of special and annual shareholders’ meetings to which shareholders? (Q)

Answer 40

Corporations must give proper notice of special and annual shareholders’ meetings to all shareholders with a right to vote at the meetings.

Proper notice means giving the shareholders notice of the date, time, and place of the meeting between 10 and 60 days before the annual or special meeting date. A notice for a special meeting must also indicate the meeting’s purpose.

Question 41

What are the two ways that a shareholder may waive a corporation’s failure to properly provide notice of a shareholders’ meeting? (Q)

Answer 41

A shareholder may waive a corporation’s failure to provide the required notice of a shareholders’ meeting either by:

waiving the lack of notice in a signed writing or

attending the meeting without objection.

However, a shareholder may attend a meeting without waiving the right to receive proper notice if, at the meeting’s beginning, the shareholder states his or her objections to the meeting.

Question 42

A corporation’s shareholder received notice of an upcoming special shareholders’ meeting. The shareholder attended the meeting, said nothing, and voted on all matters. However, the shareholder was outvoted on some key issues. The following week, the shareholder realized that the meeting’s notice had not been timely.

Can the shareholder now challenge the validity of the actions taken at the meeting because the meeting was defectively noticed? (Q)

Answer 42

No. The shareholder has waived any right to use the defective notice to challenge the meeting’s validity. Shareholders are entitled to receive between 10 and 60 days of advance notice of the date, time, and place of each annual and special shareholders’ meeting. A shareholder may waive a corporation’s failure to provide the required notice by waiving the lack of notice in a signed writing or attending the meeting without objection. A shareholder may attend a meeting without waiving the right to receive proper notice if, at the beginning, the shareholder states his or her objections to the meeting.

Here, even though the special meeting’s notice was deficient, the shareholder attended the meeting without objection. Thus, the shareholder waived the required notice and may not use the defective notice as a basis for challenging the validity of the actions taken at the meeting.

Question 43

Must a shareholder hold a corporation’s shares as of the record date to be entitled to vote at a shareholders’ meeting? (Q)

Answer 43

Yes. At a shareholders’ meeting, only the shareholders who held shares as of the record date are entitled to vote. The record date must be determined by the bylaws or board of directors before a shareholders’ meeting. The record date may not be more than 70 days before the meeting. The corporation must also prepare a list of shareholders who are entitled to vote as of the record date.

Question 44

In the context of a shareholders’ meeting, what is quorum? (Q)

Answer 44

In the context of a shareholders’ meeting, a quorum is the number of shareholders that must be present to conduct corporate business at the meeting.

Typically, there is quorum of shareholders if the holders of a majority of outstanding shares are present at a meeting. Quorum is determined by presence, not by the number of shareholders who actually cast votes. Thus, whether a shareholder abstains from voting does not affect whether a quorum exists. Generally, shareholders must elect a director by a plurality of the votes cast during a meeting in which quorum is present.

Question 45

What is straight voting? (Q)

Answer 45

Straight voting is a voting system in which shareholders and the corporation are permitted one vote per share on each matter. Straight voting requires a quorum of shareholders.

Question 46

In the context of shareholders voting for directors, what is cumulative voting? (Q)

Answer 46

In the context of shareholders voting for directors, cumulative voting means the shareholders have a right to multiply their allotted number of votes by the number of directors for whom they are entitled to vote in the election. The cumulative or total number of votes may then be cast for a single candidate or distributed among two or more candidates (e.g., a shareholder with 100 shares who is voting on three director positions has 300 cumulative votes that may be distributed among one, two, or three candidates).

A cumulative-voting system protects minority shareholders by providing those with fewer shares the opportunity to elect at least one director.

Question 47

What are the requirements for cumulative voting? (Q)

Answer 47

For a shareholder to be able to vote cumulatively at a particular meeting, the articles of incorporation must provide shareholders a general right to vote cumulatively for directors. In addition, either:

the meeting notice must state conspicuously that cumulative voting is authorized at the meeting or

a shareholder must give advance notice to the corporation of the shareholder’s intent to vote cumulatively at the meeting.

If these requirements are not met, shareholders must use a straight-voting system and each shareholder may cast no more than his total shares for any given director candidate.

Question 48

How many votes per share are shareholders permitted? (Q)

Answer 48

Shareholders are permitted one vote per share on each matter when a quorum is present at the meeting, unless the articles of incorporation have provided for cumulative voting. The corporation is also entitled to one vote per share.

Question 49

Some shareholders of a corporation wished to vote cumulatively to elect directors at the annual shareholders’ meeting. The articles of incorporation did not provide for cumulative voting. However, the shareholders gave the corporation notice of their intent to vote cumulatively, and the meeting notice stated that shareholders would be voting cumulatively.

May the corporation’s shareholders vote cumulatively at the annual shareholders’ meeting? (Q)

Answer 49

No. The corporation’s shareholders may not vote cumulatively at the meeting. Shareholders have the right to vote cumulatively at a particular meeting only if the articles of incorporation provide a general right to vote cumulatively for directors and either:

the meeting notice states conspicuously that cumulative voting is authorized at the meeting or

a shareholder gives advance notice to the corporation of the shareholder’s intent to vote cumulatively at the meeting.

Here, the notice requirement has been met in two ways, which is more than necessary. However, the articles of incorporation do not give shareholders the right to vote cumulatively. Thus, even with the extra notice, without a general right in the articles of incorporation, cumulative voting is not allowed.

Question 50

What is a voting trust? (Q)

Answer 50

If one or more shareholders sign an agreement to create a voting trust, the shareholders are giving the trustee the right to vote for any shares in the trust. The voting-trust agreement:

transfers the shareholders’ ownership of their shares to the trust and

gives the trustee the right to vote at shareholders’ meetings and otherwise act on the shareholders’ behalf.

The shareholders may continue to receive dividends and other distributions from the corporation.

Question 51

What is a voting agreement? (Q)

Answer 51

A voting agreement is an agreement between two or more shareholders in which the shareholders all agree to vote their shares in a specific manner. If a shareholder later changes his mind, a valid voting agreement may be enforced against the shareholder to force compliance.

Question 52

What is a voting proxy? (Q)

Answer 52

A voting proxy is a person appointed by a shareholder to cast her vote at a shareholders’ meeting. The appointment may be written or electronically transmitted by the shareholder or the shareholder’s agent or attorney-in-fact. Typically, a proxy appointment is valid for 11 months and is revocable, unless the appointment expressly states otherwise.

Question 53

What is a proxy contest? (Q)

Answer 53

A proxy contest is a challenge to corporate action or management accomplished by soliciting proxy votes from other shareholders. Typically, a proxy contest involves solicitation of shareholders and/or their proxies by incumbents and opponents who seek to gain control of the corporation by gathering votes in their favor for an upcoming election.

Directors may incur reasonable and proper expenses in good faith for the solicitation of proxy votes in a proxy contest, and shareholders may reimburse the successful proxy contestants for these expenses.

Question 54

Does a shareholder have a right to inspect and copy the corporation’s official records at its principal office? (Q)

Answer 54

Yes. A shareholder has a right to inspect and copy the corporation’s official records at its principal office, during regular business hours with advance notice. To exercise this right, the shareholder must give the corporation a signed written notice of his demand at least five business days before the date on which he wishes to inspect and copy.

Question 55

Does a shareholder have a right to inspect and copy corporate records that are not kept at the corporation’s principal office? (Q)

Answer 55

Yes. A shareholder has a right to inspect and copy corporate records that are not kept at the corporation’s principal office. However, this right is more limited than a shareholder’s right to inspect and copy the official corporate records that are kept at the corporation’s principal office.

A shareholder may inspect and copy corporate records that are not kept at a corporation’s principal office only if:

the demand is made in good faith and for a proper purpose,

the shareholder describes the purpose and desired records with reasonable particularity, and

the desired records are directly connected to the purpose.

Question 56

May a corporation’s articles of incorporation or bylaws abolish its shareholders’ right to inspect and copy the corporation’s official records? (Q)

Answer 56

No. A corporation’s articles of incorporation and bylaws may not abolish or even limit its shareholders’ right to inspect and copy the corporation’s official records. If a corporation does not allow a shareholder to exercise the shareholder’s right to inspect and copy the corporation’s official records, then the shareholder may request a court-ordered inspection.

Question 57

A shareholder wanted to review the minutes from a corporation’s last three shareholders’ meetings. The shareholder made an official, written request to the administrative assistant to the board of directors to inspect the documents in three weeks. However, the corporation’s articles of incorporation state that shareholders do not have the right to inspect corporate records. The assistant told the shareholder that he was not allowed to view the minutes.

Is the shareholder entitled to inspect the corporation’s minutes of the shareholders’ meetings? (Q)

Answer 57

Yes. The shareholder is entitled to inspect the corporation’s minutes. A shareholder has a right to inspect and copy the corporation’s official records at its principal office. A corporation is required to keep copies of minutes of its shareholders’ meetings at its principal office. To exercise a right of inspection, the shareholder must make a signed written demand at least five business days in advance. A corporation’s articles of incorporation and bylaws may not limit or abolish a shareholder’s right to inspect and copy corporate records.

Here, because he gave proper advance notice, the shareholder has a right to inspect records in the corporation’s principal office, including the requested minutes. Although the articles of incorporation attempt abolish this inspection right, that attempt is invalid and unenforceable. Thus, the shareholder is still entitled to inspect the minutes.

Question 58

What are shareholder agreements? (Q)

Answer 58

Shareholder agreements are effective binding agreements between shareholders in the same corporation that generally take precedence over inconsistent statutory law provisions.

Typically, a shareholder agreement governs the exercise of corporate powers or the management of the business and affairs of the corporation, as well as the relationship among the corporation, shareholders, and directors.

Question 59

What are the two methods for forming shareholder agreements? (Q)

Answer 59

Shareholder agreements may be formed by being:

included in the articles of incorporation or bylaws and approved by all shareholders at the time of the agreement or

set forth in a written agreement that is signed by all shareholders at the time of the agreement and made known to the corporation.

Unless provided otherwise, a shareholder agreement is valid for 10 years and subject to amendment by all shareholders.

Question 60

Must a shareholder agreement be noted conspicuously on either a share’s certificate or its information statement? (Q)

Answer 60

Yes. A shareholder agreement must be noted conspicuously on either a share’s certificate or its information statement. However, the failure to properly and conspicuously note the shareholder agreement’s existence does not affect the validity of the agreement or any action taken pursuant to it. Rather, if a shareholder is affected by an agreement that is not properly noted, the shareholder has the right to demand a rescission of the share purchase.

Question 61

Are there any limitations on the subjects that shareholder agreements may address? (Q)

Answer 61

Yes. Shareholder agreement are typically limited in what subjects they may address. They may:

eliminate or restrict the board of directors’ powers and transfer those powers and liabilities to other persons;

govern the authorization or making of corporate distributions;

establish the corporation’s directors and officers, including their terms of office and manner of selection and removal;

govern the exercise of voting power by the directors and shareholders;

establish the terms of an agreement between the corporation and its members about property or services;

transfer the authority to create corporate powers or manage corporate business to shareholders or others; or

require corporate dissolution upon shareholder request or other event.

Other shareholder agreements may be valid if they are not contrary to public policy.

Question 62

A corporation was planning to offer its stock for sale to investors. The corporation asked its in-house counsel to determine whether the upcoming stock offering must comply with federal securities law.

Which of the following additional facts would most likely require that the offering comply with federal securities law? (Q)

Answer 62

The corporation is offering the stock for sale to the public. State statutes govern most aspects of corporate law. However, if a corporation decides to offer its stock to the public using a stock exchange or other form of interstate commerce, then federal law applies. See generally Del. Code. Ann. Title 8; 15 U.S.C. § 77a, et seq. Specifically, the Securities Act of 1933 imposes special disclosure and registration requirements that must be satisfied before a corporation makes a public stock offering. See 15 U.S.C. § 77a, et seq.

Question 63

An investor signed a written subscription agreement to buy stock in a corporation. The corporation had not yet incorporated. The investor then changed her mind and wanted to revoke the subscription.

Are there any circumstances in which the investor may revoke this subscription? (Q)

Answer 63

Yes, because subscription agreements may be revocable by their own terms, after a fixed period of time, or with the consent of the corporation or the other subscribers. A subscription agreement is an offer to buy stock in a corporation. See Model Bus. Corp. Act § 6.20 (2016). A subscription agreement may be entered either before or after the corporation is officially incorporated. The default rule is that pre-incorporation subscription agreements are generally irrevocable for a period of time (e.g., three or six months). However, the terms of the subscription agreement itself may provide for revocation in certain circumstances. Additionally, a subscription agreement may be revocable if the corporation or all other subscribers agree to allow the revocation, depending on the laws of the governing state. See, e.g., Model Bus. Corp. Act § 6.20; N.Y. Bus. Corp. Law § 503. Therefore, here, the investor may be able to revoke this pre-incorporation subscription agreement in certain circumstances. For example, the investor may be able to revoke the subscription after a period of time set by the state laws governing the agreement. Alternatively, the investor may be able to revoke the subscription if she gets the consent of the other subscribers or the corporation.

Question 64

The founder and sole owner of a business wanted to incorporate the business and raise capital by offering stock to outside investors. However, the founder also wanted to retain a majority interest in the corporation for himself.

Assuming the jurisdiction applies the Model Business Corporation Act, which of the following actions will best protect the founder from having his ownership interest diluted by future issuances of additional corporate stock? (Q)

Answer 64

Filing articles of incorporation that specify the existence of preemptive rights. Preemptive rights guarantee a shareholder the right to purchase sufficient shares to maintain that shareholder’s percentage of ownership whenever the corporation issues new common stock for money. See Model Bus. Corp. Act § 6.30 (2016). Other investors may purchase the new shares only after the shareholder either exercises the preemptive right to buy a portion of those shares or declines the opportunity. This ability to exercise preemptive rights protects a shareholder from having the shareholder’s ownership interest in a corporation diluted by the issuance of additional shares. Under the Model Business Corporation Act, shareholders typically do not have preemptive rights unless the articles of incorporation specifically create preemptive rights. Id.

Here, the founder wants to protect his proportionate interest as the majority shareholder in the corporation. To do that, the founder must file articles of incorporation that specify the existence of preemptive rights. Then, if the corporation issues any additional shares for money at some point in the future, the founder will have the preemptive right to purchase enough of those additional shares to maintain his majority interest before other investors are allowed the opportunity to purchase any of the additional shares.

Question 65

A corporation sold par value stock to an investor for $100 per share. The stock’s listed par value was $75 per share, but the corporation had determined internally that it would accept as low as $65 per share. Several months later, the investor sought to sell the shares to a bank.

May the investor sell the shares for less than $75? (Q)

Answer 65

Yes, because a stock’s par value is not relevant when the stock is sold again after issuance. A corporation may, but is not required to, list a par value for some or all of its stock in its certificate of incorporation. Par value is the minimum price at which the company may sell stock. See generally Model Business Corporation Act § 6.21 Official Comment (2016). Stock for which no par value has been assigned may be sold at any price. A stock’s par value is only relevant when the company is issuing the stock. A purchaser of par value stock may sell the stock at any price she deems acceptable.

Here, the investor is reselling par value stock and is free to accept any price she deems fit. The par value was only relevant when the corporation initially issued the stock and sold it to the investor. Answer options C and D are necessarily incorrect for these same reasons.

Question 66

A paint corporation had issued all of the stock defined in its certificate of incorporation. The corporation’s offering had not produced sufficient capital to operate the business. The corporation’s articles of incorporation did not mention other financing methods.

May the paint corporation seek other sources of capital? (Q)

Answer 66

Yes, because at least bonds and debentures are available to the corporation. Issuing stock is not the only way a corporation may raise capital. For example, a corporation may issue bonds, which are essentially loans given to the corporation by investors in exchange for a security interest in corporate assets. Black’s Law Dictionary, bond (11th ed. 2019). Corporations may also use debentures, which are unsecured loans given by creditors to the corporation. Black’s Law Dictionary, debenture (11th ed. 2019).

Here, therefore, the corporation may pursue other sources of financing, including bonds and debentures, to raise additional capital beyond its issuance of stock.

Question 67

A prospective shareholder of a corporation that was formed under and governed by the Model Business Corporation Act (MBCA) inquired what consideration the corporation would accept in exchange for its shares of stock.

Under the MBCA, which of the following may the corporation accept in exchange for its shares of stock? (Q)

Answer 67

Any benefit to the corporation that is acceptable to the board of directors. Although some states limit the types of consideration that a corporation may accept for stock, the MBCA and most states give corporate directors wide latitude to accept money, tangible property, intangible property, or any other benefit to the corporation as consideration for stock. See, e.g., Model Bus. Corp. Act § 6.21 (2016); Del. Code Ann. § 152. Therefore, here, the corporation may accept any benefit to the corporation that is acceptable to the board of directors.

Question 68

A new corporation that was formed under and governed by the Model Business Corporation Act (MBCA) sought to issue authorized shares of stock pursuant to the corporation’s certificate of incorporation.

Under the MBCA, which of the following is required for the corporation’s issuance of its authorized shares of stock? (Q)

Answer 68

There must be at least one class of stock that has unlimited voting rights. A corporation may issue as many shares of as many classes and series of stock as are authorized in the corporation’s certificate of incorporation. See Model Bus. Corp. Act § 6.03. These are called authorized shares. Id. Under the MBCA, at least one class of authorized shares must have unlimited voting rights, and at least one class, which may be the same class as the class with unlimited voting rights, must have a right to share in the company’s assets upon dissolution. See id. § 6.01. Therefore, here, the corporation must ensure that at least one class of its authorized stock has unlimited voting rights.