Law: #21

Question 1

Who are the three basic players in the operation of a corporation?

Answer 1

1) board of directors
2) officers
3) shareholders

Question 2

What are the two places that the number of directors on a board can be specified?

Answer 2

1) articles of incorporation

2) bylaws of the corporation

Question 3

What type of directors are specified in the articles of incorporation?

Answer 3

Original directors

Question 4

What are bylaws? How do they come about?

Answer 4

They are rules that are adopted by the board of directors.

Question 5

What rule is a directors conduct judged by?

Answer 5

By the business judgment rule

Question 6

What are the three things a director has the fiduciary duty to do?

Answer 6

1) act in good faith
2) exercise ordinary care (with the care of an ordinary prudent person in a like position would exercies under similar circumstances)
3) be loyal (cant compete with the corporation)

Question 7

Who appoints corporation officers?

Answer 7

The board of directors

Question 8

How is a bond defined in the lesson?

Answer 8

The contractual obligation of a corporation to repay borrowed money.

Question 9

Who controls major financial decisions in a corporation?

Answer 9

The board of directors

Question 10

Who usually determines the organizational structure of the corp.?

Answer 10

The President/CEO and his subordinates

Question 11

Who usually determines the number and description of employee’s (not including CEO)?

Answer 11

The CEO/President and his subordinates

Question 12

Who owns a corporation?

Answer 12

Shareholders

Question 13

Why would a corporation choose to designate the number of directors in by-laws rather than the articles of incorporation?

Answer 13

Having this in the by-laws makes it easier to change in the future.

Question 14

What are some of the items frequently found in bylaws? (4 mentioned in lesson)

Answer 14

1) Officers duties and authority
2) Meetings of shareholders
3) Directors number and terms of office
4) Elections of directors

Question 15

What are the two methods of voting for directors are there? How do they work?

Answer 15

1) Straight Voting:
- each shareholder votes the number of share he owns for as many candidates as he wants. (A majority holder could vote in as many directors as he wanted)
- “winner takes all”, the majority of shareholders may elect all of the directors. Elected by plurality of the votes cast by shares entitled to vote.

2) Cumulative Voting:
- Given a block of votes based on shares owned, and then can put all towards one candidate, or distribute them (allows minority shareholders to have a voice).
- Proportionate representation on the board in which majority and minority shareholders each elect directors according to the number of shares they control.

Question 16

If in a cumulative voting situation the majority is often still able to vote in more directors why is it important to elect minority directors that will still be out voted? (2 reasons given in lesson)

Answer 16

1) The minority directors can still participate in the discussion and may be able to alter the decisions of the board and
2) they can keep minority share holders informed.

Question 17

What is the business judgment rule?

Answer 17

the presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.

Question 18

There are many different ways for a company to generate investment money. There are so many that it is hard to remember the names of all of them. However, like how the word dog includes Great Danes’ and Chihuahuas’, there is a word that includes all these different investment methods. What is it?

Answer 18

Securities

Question 19

What is a preorganization/subscription agreement? Who can usually enforce the agreement?

Answer 19

This is a type of security in which investors promise to invest certain amounts of stock before a corporation is formed so long as others commit to do this as well.

-This is enforceable by the corporation usually

Question 20

What is the default amount of time that a preorganization/subscription agreement shares are irrevocable?

Answer 20

6 months, unless a longer or shorter time is specified in the agreement.

Question 21

If there is only one type of stock issued by a corporation what is it generally referred to as?

Answer 21

Common Stock

Question 22

How is the value of common stock determined?

Answer 22

It is simply the amount the company is worth divided by the number of shares.

Question 23

What is par value? Where is par value stated? Why is par value stated?

Answer 23

• It is the minimum price a corp can sell its common stock for
• The amount is stated in the articles of incorporation
• This is done to protect early investors.

Question 24

What is normally paid for first between a bond and stock?

Answer 24

a bond is usually paid for first

Question 25

What are the advantages and disadvantages between buying a bond versus stock?

Answer 25

Advantage: A bond is usually paid for before stock
Disadvantage: A bond usually pays a relatively low (fixed) rate of interest.

Question 26

What are the three-fold duties of a director, and which of those three does Ms. McMullin (in the McMullin v. Beran case) claim that the directors violated?

Answer 26

A director must (1) act in good faith, (2) act with ordinary care, and (3) be loyal. Ms. Mullin claims, in effect, that the directors did not do their homework to determine the correct value of the stock. Thus, the directors violated item #2 because they did not act “with the care an ordinarily prudent person in a like position would exercise under similar circumstances.”)

Question 27

How many directors must a corporation have?

Answer 27

There is no fixed number of directors except that the corporation must have as many directors as the minimum required by state law. The board determines the number of directors and it is their decision as long as there is a legitimate business reason for their decision.

Question 28

Examine the Cumulative Voting Table again. What is the optimal number of directors for which the majority should vote, and what is the optimal number of directors for which the minority should vote?

Answer 28

The optimal number of candidates for whom the majority should vote is four [1,500 votes each] and the optimal number of candidates for whom the majority should vote is two [1,650 votes each]. From the minority perspective, voting for two candidates is optimal because no matter how the majority votes, the two minority candidates will be among the top six in numbers of votes received, and will be elected.

Question 29

Explain the meaning and application of the “business judgment” rule.

Answer 29

The so-called “business judgment” rule asks whether the directors or officers of a corporation have a “legitimate business” reason for their action. In Mullin v. Beran (in this chapter) the court said that “The business judgment rule “is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.” These are different ways of saying the same thing.

Question 30

Suppose that the defendants in the McMullin v. Beran case above talked and orally agreed to start a new company, but did nothing to further their understanding. Have they violated the duty they owe to their employer?

Answer 30

Most courts would hold that the employees have not violated their duty if all they do is talk among themselves, but take no action to further their understanding.

Question 31

Suppose that Kumquat did not sell any stock to Sam Jones. Instead, Kumquat sold Sam an “option” to buy Kumquat Common in 24 months at $13 per share, no matter how much the stock of the corporation had risen on the open market. Is this option a “security”?

Answer 31

Yes, an option to buy stock is a security. The definition of a “security” is intended to be all-inclusive. Thus, with reference to “stock” and other items, the definition of a security includes “any . . . right . . . to purchase any of the foregoing.”

Question 32

Which group establishes broad, general policy for a corporation?

officers

directors

shareholders

Answer 32

b

The board of directors establishes broad, general policy for a corporation.

Question 33

MM Companies, Inc. v. Liquid Audio, Inc. focuses on control of the board of directors of Liquid Audio, Inc. The decision of the appellate court establishes which of the following propositions?

A corporation cannot have more than five directors.

Corporations must have seven directors.

Neither of these is correct.

Answer 33

c

A fixed number of directors is not required and a corporation may have five or seven (or another number) of directors as long as there is a legitimate business reason for the decision.

Question 34

Which of the following is correct concerning “par” value?

Par value applies to the minimum price at which stock will originally be sold by a corporation.

Par value applies to secondary sales of stock on the open market.

Par value applies to both stocks and bonds.

More than one of these is correct.

Answer 34

d

Par value applies to the minimum price at which stock will originally be sold by a corporation.

Question 35

Luke and Owen form a limited liability partnership (LLP). The objective of the business is growing, harvesting and selling kumquats. They sell twenty-seven limited partnership interests to investors who each contribute $10,000 to the enterprise. It is understood that the limited partners will not participate in the management of the LLP. The question comes up whether the limited partnership interests are securities.

Yes, the limited partnership interests are securities.

No, the limited partnership interests are not securities.

Answer 35

a

The definition of a security includes such things as “certificate of interest or participation in any profit-sharing agreement,” “transferable share,” or “investment contract,” and so on. Depending on the language of the documents used in the formation of the LLP, the limited partnership interests are securities.

Question 36

Internal corporation rules are known as which of the following?

statutory rules

director’s rules

bylaws

Answer 36

c

Internal corporation rules are known as bylaws.

Question 37

Assume a corporation with seven directors to be elected and a group of majority shareholders with 100 shares and a group of minority shareholders with 10 shares. With cumulative voting, how many directors can the minority shareholders elect?

zero

one

two

three

Answer 37

a

With 700 votes (7 x 100 = 700) and seven directors, the majority can cast 100 votes for each director. With only 70 total votes (7 x 10 = 70) the minority cannot elect any directors. If, however, the minority had 101 (or more) total votes they could elect at least one director.

Question 38

Corporation officers are selected by which of the following?

the secretary of state in the state of incorporation

the board of directors

the shareholders

Answer 38

b

Corporation officers are selected by the board of directors.

Question 39

When must a corporation issue dividends and how much money must be paid to each shareholder?

The frequency and amount of dividends is established by rules of the Internal Revenue Service. (An example is an S Corporation.)

The frequency and amount of dividends is controlled by the so-called “business judgment” rule.

Shareholders determine the frequency and amount of dividends.

Answer 39

b

The frequency and amount of dividends is controlled by the so-called “business judgment” rule. For example, see Gay v. Gay’s Super Markets, Inc.

Question 40

According to the opinion in McMullin v. Beran, which of the following is not part of the fiduciary duties that members of a board of directors must follow?

loyalty

good faith

due care

all of these are required

Answer 40

d

According to the opinion, board members follow a “triad of fiduciary duties, loyalty, good faith or due care.”

Question 41

How many directors are required for a corporation?

Five directors are required.

Seven directors are required.

Nine directors are required.

Each corporation may decide how many directors it will have.

Answer 41

d

Each corporation specifies how many directors it will have in its articles of incorporation or bylaws.