R6 - M5 - Business Structures Part 2

Question 1

Who is liable for a corporations obligations?

Answer 1

The corporation is a sperate legal entity from its shareholders. That means that generally, shareholders and others are not liable for the debts and lawsuits.

Now if a shareholder was directly involved in a tort, then then they are personally liable. Other shareholders will not be impacted by the one shareholder that committed the tort.

You really just lose your investment.

Question 2

Is a C corp subject to double taxation?

Answer 2

Yes, through the profits.

Question 3

Do shareholders run the business, or is it directors and officers that run?

Answer 3

Normally shareholders hire those officers and directors to run the business.

Unless a closely held corporation.

Question 4

What are the pros to an S or C copr, over an LLC?

Answer 4

Corps normally have a perpetual life. You do not need to dissolve if a shareholder leaves.

You can transfer your ownership freely, without consent of other shareholders. Unless otherwise agreed.

Question 5

Where do you file to form a Corporation?

Answer 5

You file under the state you want to incorporate in. Most states follow the revised model business corporation act.

Question 6

What is a promoter in a corporation?

Answer 6

Their job is to secure capital commitments and loans to form a corporation.

They normally do this before the corporation is formed, so they are bound to those contracts that they make. The corporation then makes a novation to replace the promoter for those loans and capital contributions.

Question 7

What form must the corporation file?

Answer 7

Its called the articles of incorporation, and they must disclose the name of the corp, name and address of registered agent, and the name and address of each incorporators. Also the share of stock they will authorize.

Director and officer’s name is not required.

Question 8

What are the type of stock C corporations can issue? Also what is the order of payment for liquidation?

Answer 8

Preferred stockholders and common stockholders.

In liquidation, first creditors, then preferred stockholders, and lastly common shareholders.

Question 9

What is the ultra vires clause?

Answer 9

Under the articles of incorporation, they can disclose the purpose of their business if they want.

This basically says that the corporation will operate in a very narrow line of business, and if the officer or director operates outside of that, they can be liable for damages.

Question 10

What are they Bylaws for a corporation?

Answer 10

These are addition to the articles where they have rules on how to run the corporation.

They are created by the board of incorporators, but they can be modified by the board with no approval.

They do not have to be filed with the state.

Question 11

What is piercing the corporate vail?

Answer 11

This is when the courts determine that shareholders, officers, or directors are going to be held liable because the privilege of conducting business practices is being abused.

Normally happens in three situations:

Shareholder is commingle personal funds and business funds, or use of corporate assets for personal use.

Not enough capital to start the business, they need to make sure they have enough.

Corporation was formed to commit fraud against creditors.

Question 12

How do corporations raise capital?

Answer 12

Normally through the sell of equity obligations (stock) or debt obligations (bonds).

Debt securities increases return on equity since there are less owners, return on equity decreases as there are more owners.

Question 13

What are some of the characteristics of equity securities for a C Corporation?

Answer 13

Corporations may only issue one class of stock, or two.

Preferred stock is nonvoting, and assumes less risk. Common stock assume more risk and get paid last in liquidation.

The board can choose what the stock issuance price is. Stock can be paid via property or other value other than cash.

Question 14

Shareholders have voting rights. What are the things that they can vote on?

Answer 14

They can vote to elect or remove directors and

whether to approve fundamental changes to the corporation, such as dissolution.

Question 15

The general rule is one share one vote, what is the exception to this rule?

Answer 15

Normally it is one share one vote, unless articles of incorporation state otherwise.

The exception is cumulative voting for directors:

If you are voting for five director positions, you normally have one vote per each position, since you only have one share. Instead of voting for each position, you can accumulated your votes and put 5 votes for one candidate.

Question 16

Once the board declares a dividend, are the shareholders treated as unsecured creditors?

Answer 16

Yes, until paid, they are treated as unsecured creditors.

Debit RE, Credit Div Payable

Question 17

What is the difference between noncumulative and cumulative preferred shares?

Answer 17

Preferred shareholders get paid before common shareholders, but there are two types.

Noncumulative - These are shareholders that do not get paid for past declarations not made. For example, if a company you hold shares in declared a dividend in 2024 but not 2023, you only get the 2024 amount.

Cumulative - You get paid dividends for all the years where dividends were not declared. So in this example, you would get the 2023 amount and the 2024 amount.

Question 18

When a corporation issues a stock dividend are those taxable?

Answer 18

Once it is issued, you are not taxed on it. Once you sell it you are.

Question 19

Can shareholders inspect the books and records?

Answer 19

Yes, as long as it is for proper purpose and gives a written notice. Not improper purpose.

Shareholder could also send an attorney, accountant, or other agent to inspect the books and records.

Question 20

What are preemptive rights?

Answer 20

This is when a corporation decides to issue additional shares of stock, and current shareholders want to purchase it so they can keep their voting strength.

Common law grants this, but under RMBCA, these rights do not exist unless the articles or incorporation include them.

Question 21

What is a derivative action?

Answer 21

This is when a corporation has legal cause of action against someone but does not bring the action. The shareholders can bring that action instead of the corporation for the corporation. Directors, officers, or outsiders.

Whatever damages they won, they have to give that to the corporation.

Question 22

What is a direct action?

Answer 22

This is when the shareholders seek action against the corporation, and the corporation is the defendant.

This time, shareholders would receive the damages.

Question 23

What are the directors rights, duties, obligations, and authority?

Answer 23

They are not agents, but still owe fiduciary duties to the corporation.

The directors can, elect, remove, and supervise the officers

adopt, amend, and repeal the bylaws. Remember articles of incorporation require more approval.

Fix management compensation.

Initiate fundamental changes to the corporates structure. Then the shareholders would vote on that.

Question 24

Who has the power to declare a distribution (dividend)?

Answer 24

The board of directors normally do it, shareholders normally have no power to do so.

Now if a director declares a dividend that is illegal, then they can be held personally liable. So, they declare a dividend that is so large, the corp can not pay their other debts. Stuff like that.

If the shareholder knows that the dividend was illegal or too large, they have to give that money back to the corporation.

Question 25

If the director makes a bad decision, and it hurts the corporation, what is their best defense? This is also called the business judgment rule.

Answer 25

That they acted in good faith on the best interest of the business. Directors are still fiduciaries of the corporation. Or if someone in the same position would have done the same thing.

Directors are only liable for negligent acts or omissions.

Same rules apply for officers.

Question 26

For the business judgment rule, what can the director do to avoid bad decisions?

Answer 26

Right to rely - Rely on others, reports, statements.

You can rely on people inside the corporation and outside the corporation such as accountants and lawyers.

Question 27

Do the directors owe the corporation a duty of loyalty?

Answer 27

Yes, that is the L in LORA.

They have to owe the corporation their best interest and loyalty, and they cannot compete with the corporation.

Question 28

If the director has a conflict of interest, how can that conflict of interest be upheld?

Answer 28

Full disclosure of the transaction, approved by the majority of the BOD and shareholders.

Transaction is fair and reasonable. (The BOD also can set their own wages, which is another conflict of interest)

Question 29

What is indemnification on behalf of directors?

Answer 29

Basically if there is a lawsuit against a director, the corporation will pay the lawyer the legal costs to protect that director. There scenarios where this will not occur.

If the director acted in bad faith, or when the shareholders sue the director on behalf of the corporation (derivative).

This same rule applies for officers.

Question 30

What are the duties of an officer?

Answer 30

They are agents on behalf of the corporation. They also have a fiduciary duty to act on the corporations best interests.

They conduct day to day operations.

They can bind the corporation to contracts through either apparent or actual authority.

Question 31

How are officers selected and removed? What is their authority?

Answer 31

They are selected and removed by the board of directors with or without cause.

They have both apparent and actual authority. If you want to limit apparent authority, you have to let third parties know.

Question 32

Can officers server as a board of director? Do they have to be shareholders?

Answer 32

They can server on the board, and they do not have to be shareholders.

Question 33

What are fundamental changes? What is the DAMS acronym?

Answer 33

These would change the nature of the corporation (DAMS).

D - Dissolution

A - Amendments, these are changes to the article of incorporation that will adversely affect share holders rights.

M - Mergers, consolidations, and compulsory share exchanges.

S - Sale of most of the corporates assets outside the regular course of business.

These require both board and shareholder approval through a special procedure.

Question 34

What are the steps for making these fundamental changes?

Answer 34

First the board must adopt a resolution setting forth the proposed changes, and submit it for the vote of the shareholders to approve.

Then, the corp must notify all the shareholders of this possible change.

Majority of the shareholders must approve this change.

Lastly, the change is executed by the corp and filed by the state.

Question 35

What are some of the things the corporation can amend in the articles of incorporation?

Answer 35

They can really change whatever, as long as it is deemed lawful.

Normally the amend to start or stop preemptive rights, or change the purpose clause.

Question 36

What is merger?

Answer 36

This is where corporations are joining together. This is when one company does not exist, but the other company keeps going.

A good example of this is A company merges with B, but B ceases to exist. Even though A has all of B’s assets, A is the new company.

The same steps for making fundamental changes apply to mergers. Board resolution, notice, approval of majority of shareholders, and filing.)

Question 37

What is a consolidation?

Answer 37

This is when two or more companies merge to form a brand new company. You get all the assets of the old corporations, but you also get all the debt of the old corporations.

The same steps for making fundamental changes apply to consolidation. Board resolution, notice, approval of majority of shareholders, and filing.)

Question 38

What is a share exchange?

Answer 38

Transaction where one corporation acquires all of the outstanding shares of another corporation.

Both corporations continue to exist as separate entities.

The same steps for making fundamental changes apply to share exchange, but only for the corp being acquired. Board resolution, notice, approval of majority of shareholders, and filing.)

Question 39

What is a Short-From Mergers?

Answer 39

This is the exception to the general rule for mergers.

This is when the parent corp owns more than 90% of the subsidiary corporation, so no approval of the shareholders is needed. Just need approval from the parents board.

Question 40

How do you prevent an unwanted takeover attempt?

Answer 40

You can do things a number of ways:

Persuade the the shareholders to reject the offer

Sue the person doing the takeover if they are doing something illegal.

Merge with a white knight - company you want to merge with

Make a self tender - try and acquire stock from own stockholders and retain control so fend off takeover.

Greenmail - Pay the takeover company to go away.

Lock up the crown jewels - Give the third party an option to purchase the most valuable assets.

Scorched earth policy - Sell off your assets, or take out loans that would make you less financially attractive.

Shark repellent - amended the articles of incorporation to make takeover more difficult.

Question 41

D in DAMS, Dissolution, what is the process for dissolution?

Answer 41

You liquidate, first you sell the corporate assets, pay the expenses incurred to sell those assets, pay creditors, pay preferred shareholders, then common shareholders.

Question 42

What is a foreign corporation?

Answer 42

Corporation that does not do business in that state. So you incorporated in New York, but want to do business in Ohio. You are foreign to Ohio. You need a certificate to do business there.

Having a bank account, collecting debt, hiring employees, are not examples of this.