OTHER FORMATION ISSUES

Question 1

CONSEQUENCES OF FORMING A
CORPORATION

Answer 1

Now that we’ve formed a corporation—with a person, a
paper, and an act—why does it matter? Let’s look at several
important consequences that follow from formation.

Question 2

Internal Affairs Doctrine

Answer 2

• Internal affairs doctrine: internal affairs of a corp are governed by law of state of incorporation

Question 3

Entity Status

Answer 3

• Upon formation, a corp has entity status, meaning
  it’s a legal person.
• Corp can sue & be sued, hold property, be a partner in a partnership, invest in other companies/ commodities, & so on

Question 4

Benefit Corporations

Answer 4

• Benefit corp (B Corp.) is one formed for profit & also to benefit to a broader social policy cause.
• Things work as w/ a regular corp, but articles must say it’s a “benefit corporation.”
• Corp also files an annual benefit report explaining how it pursued its stated social mission.
• Decisionmakers must consider impact of decisions not only on shareholders, but also on broader community/environment.
• Managers should not be liable for failing to maximize profits alone; the company has a broader purpose than that.

Question 5

Limited Liability

Answer 5

• Generally, shareholders are liable only to pay for their stock, not for corporate debts.

Question 6

DEFECTIVE INCORPORATION (WE
WRONGLY THOUGHT THERE WAS A
CORPORATION)

Answer 6

• One of the main reasons to incorporate is to avoid personal liability for obligations the corp incurs.
• If incorporators thought they formed a corporation, but they failed to do so, they’d be personally liable for business debts.
• (Basically, the would-be incorporators have formed
  a partnership instead, & partners are liable for business debts.)
• But 2 doctrines may still allow incorporators to
  escape liability: (1) de facto corp & (2) corp by estoppel.
• In other words, the veil of protection may be applied where a de jure corp has not been formed.
• One important characteristic of both of these doctrines is that anyone asserting either doctrine must be UNAWARE of failure to form a de jure corp.

Question 7

De Facto Corporation
a. Characteristics and Requirements

Answer 7

De facto corp requirements:
(1) Must be a relevant incorporation statute. (On exam, it will always be met, b/c there’s an incorporation statute in every state)
(2) Parties made a good faith attempt to
comply w/ statute (parties tried & came close to forming a corp); and
(3) There has been some exercise of corporate privileges (parties were acting as though they thought there was a corp).
- If de facto corp doctrine applies, the business is
treated as a corp for all purposes except in an action
by the state (called a “quo warranto” action).

Question 8

Limitation

Answer 8

• De facto doctrine can be raised as a defense to personal liability only by a person who is unaware there was no valid incorporation.
• Persons who act on behalf of a corp knowing there was no incorporation are jointly & severally liable for all liabilities created in so acting.

Question 9

Corporation by Estoppel

Answer 9

• Under CL doctrine of corp by estoppel, persons who have dealt w/ the entity as if it were a corp will be estopped from denying corp’s existence.
• Applies inK to prevent “corporate” entity, & parties who have dealt w/ entity as if it were a corp, from backing out of their Ks.
• Also prevents improperly formed “corp” from avoiding liability by saying it was not properly formed.
• Note: Corp by estoppel applies only in K cases. Not to tort vics.

Question 10

Application of Doctrines

Answer 10

• Generally, if a de facto corp is found, it is treated like
  any other corp for all purposes, except that state may seek dissolution in a quo warranto proceeding.
• Estoppel applies only on a case-by-case basis.
• De facto doctrine applies equally in K & tort situations, but estoppel generally is applied only in K cases
• If there is no valid incorporation & facts do not support de facto/estoppel argument, generally, cts will hold only active business members personally liable, & their liability is joint & several.

Question 11

Status of Doctrines

Answer 11

• These doctrines are abolished in many states.
• However, if one/both of the doctrines is relevant to an essay, you should still raise them in your answer w/ this caveat (doctrine likely doesn’t apply, but if it does, here’s how it would work).

Question 12

.

Answer 12

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Question 13

PRE-INCORPORATION CONTRACTS (WE
KNEW THERE WAS NOT A CORPORATION)

Answer 13

• Promoter is a person acting on behalf corp not yet formed.
• Before a corp is formed, promoters obtain commitments for capital & other instrumentalities
  that will be used by corp after its formation.

Question 14

Promoters’ Relationship with Each Other

Answer 14

• Absent an agreement to the contrary, promoters are joint venturers (partners) who have a fiduciary relationship w/ each other.
• They will breach their fiduciary duty if they secretly
  pursue personal gain at expense of fellow promoters.

Question 15

Promoters’ Relationship with Corporation
.

Answer 15

• Promoter’s fiduciary duty to corp: fair disclosure & good faith

Question 16

Breach of Fiduciary Duty Arising from Sales to the
Corporation

Answer 16

• Promoter who profits by selling property to corp
  may be liable for his profit unless all material facts of transaction were disclosed.
• If transaction is disclosed to an independent board of directors & approved, promoter has met his duty & will not be liable for his profits.
• If board is not completely independent, promoter still will not be liable for his profits if subscribers
  knew of transaction at the time they subscribed/ unanimously ratified the transaction after full disclosure.
• Disclosure must be to all who are contemplated to be part of initial financing scheme.
• If promoters purchase all the stock & subsequently sell their individual shares to outsiders, promoters cannot be held liable for the profits from the sale
  of property to the corp.

Question 17

Fraud

Answer 17

• Promoters may always be liable if Ps can show that
  they were damaged by promoters’ fraudulent misreps/fraudulent failure to disclose all material facts.

Question 18

Promoters’ Relationship with Third Parties—

Answer 18

Preincorporation Agreements
- Promoter may enter into Ks on behalf of a corp not yet formed.
- Our key question is who bears liability on these preincorporation Ks?

Question 19

Corporation’s Liability

Answer 19

• Not bound on Ks entered into by promoter in the corporate name prior to incorporation.
• Corp may become liable only if it expressly/impliedly adopts promoter’s K.

Question 20

Promoter’s Liability

Answer 20

• Under MBCA, anyone who acts on behalf of a corp
  knowing that it is not in existence is jointly & severally
  liable for obligations incurred.
• Thus, if a promoter enters into an agreement w/ 3rd party on behalf of a planned but unformed corporation, promoter is personally liable on K.
• Promoter’s liability continues after corp is formed, even if corp adopts K & benefits from it.
• Promoter will be released from liability only if there is an express/implied novation (agreement among all 3 parties to release promoter from liability & substitute corp for promoter in K).

Question 21

Exception—Agreement Expressly Relieves Promoter
of Liability

Answer 21

• If agreement expressly relieves promoter of liability, there is no K; promoter has no rights/liabilities under agreement.

Question 22

Tip

Answer 22

Questions may require you to discuss whether promoter will be liable on a preincorporation K. If you keep in mind that promoters are forming a corp, these questions should be fairly easy to answer. For there to be a valid K, someone must be bound w/ 3rd party. It can’t be the corp since it does not exist; therefore, promoter is liable even though she was acting on behalf of the corp to be formed. (If the agreement expressly relieves promoter of liability, it will be treated as an offer to the corp.)

Question 23

Promoter’s Right to Reimbursement

Answer 23

• Promoter who is held personally liable on a preincorporation K may have a right to reimbursement from corp to extent of any benefits
  received by corp.

Question 24

FOREIGN CORPORATIONS

Answer 24

• Foreign corps transacting business in a state must register & pay fees.

Question 25

Transacting Business

Answer 25

• Transacting business means regular course of intrastate (not interstate) business activity.
• So, it doesn’t include occasional/sporadic activity in this state, nor does it include simply owning property in this state.

Question 26

Registering as a Foreign Corporation

Answer 26

• Foreign corp must register w/ secretary of state in each state in which it wishes to transact business.
• Corp has to provide info about its articles & prove good standing in its home state.