Rule Statements

Question 1

Promoters

Answer 1

Promoters are NOT agents of the contemplated corporation.

Promoters have NO power to bind the not-yet-formed corporation.

If there is more than one promoter: there is mutual agency among them. Each promoter would be jointly and severally liable for contracts formed in the scope of promotion.

Question 2

Promoter Liability

Answer 2

In general, promoters are personally liable for contracts they enter into for the benefit of a not-yet-formed corporation.

Exception:

• the pre-incorporation contract specifically disclaims personal liability of the promoter; or
• a court may still determine that the intent of the parties was to hold only the corporation, once formed, liable on the contract.

Question 3

Corporation’s Liability on a Pre-incorporation Contract

Answer 3

A corporation is NOT liable on any pre-incorporation agreements its promoters entered on its behalf unless, after formed, the corporation assumes liability through adoption or novation.

Question 4

Adoption

Answer 4

If a corporation adopts the contract of the promoter, the promoter will remain liable on the contract to the third party, but will be entitled to indemnification from the newly created corporation.

Adoption can be:

(1) Express: generally occurs when the board passes a resolution stating the corporation adopts the contract; or
(2) Implied: where the corporation accepts or acknowledges the benefits of the contract in some manner.

Question 5

Novation

Answer 5

Novation occurs when the promoter, the corporation, and the third party agree to substitution of the corporation as a party to the contract in place of the promoter.

Through novation, the promoters are released from all personal liability on the pre-incorporation contract.

Question 6

Requirements for Incorporation

Answer 6

Incorporation requires the proper execution and filing of articles of incorporation.

• Execution: The articles of incorporation must be prepared and signed by an incorporator (or incorporators) and set forth the following:
  
  • the name and address of each incorporator;
  • the address of the corporation’s initial registered office and name of its initial registered agent at this office;
  • the number of shares the corporation is authorized to issue; and
  • a corporate name that includes: “corporation,” “incorporated,” “company,” or “limited,” “corp.,” “inc.,” “co.,” or “ltd.”

Filing: The articles of incorporation must be delivered by an incorporator to the secretary of state’s office for filing; and its delivery should be accompanied by payment of the appropriate filing fee.

The effective date of incorporation is the date of filing unless the articles set forth a delayed effective date that is not more than 90 days after the date of filing.

Corporate existence begins at the moment of incorporation, and the secretary of state’s filing of the articles is generally conclusive proof that all conditions precedent to incorporation have been satisfied.

Question 7

Organization

Answer 7

After incorporation, a corporation must be properly organized.

Failure to properly organize may expose shareholders to personal liability for corporate debt and obligations.

The organization of a corporation is completed at an organizational meeting that is called by the incorporators or initial directors if named in the articles.

Completing the organization requires:

• The naming or election of directors;
• The appointing of officers;
• The adopting of by-laws

Question 8

Bylaws

Answer 8

The internal rules enacted by the corporation to govern its actions and relations to its shareholders, directors, and officers.

Cannot be inconsistent with law or articles of incorporation.

Bylaws often specify:

• the time and place for annual shareholder meetings;
• the record date for determining the shareholders entitled to vote at meetings or to receive dividends;
• the number of shareholders necessary to constitute a quorum;
• the percentage of votes necessary to authorize corporate action; and
• any restrictions on transferability of shares.

Question 9

Corporation by Estoppel

Answer 9

When a contractual dispute arises between a third party and an entity believed to be a corporation, a court may estop:

• the third party from alleging that the corporation is defectively incorporated if that would unjustly expose the corporate principals to liability; or
• the business entity from alleging that it is not legally a corporation liable on the contract as a corporation if that would unjustly deprive the third party of relief from injury.

Question 10

Power of Directors

Answer 10

Subject to any limitation set forth in the articles of incorporation, (default) the management of the corporation’s business and the exercise of corporate power must be by or under the direction of the corporation’s board of directors.

Unless otherwise authorized by the articles or prior board decisions, (default) individual directors do not have the power to set corporation policy or even to act as its agent when entering into contracts.

Subject to restrictions in the articles, the board generally has discretion to decide whether and when to declare a dividend; the board may legitimately decide to retain corporate earnings to expand the business.

Question 11

Act of the Board

Answer 11

All board action requires the participation of a quorum of the board.

A quorum is a majority of directors (articles or bylaws can change this).

Once a quorum is present, an act requires the affirmative vote of a majority of directors present (articles or bylaws can require more).

Default Exception:

• the board can transact business in the absence of a meeting so long as there is written consent to an action that is signed by all members of the board.

Question 12

Duly Held Meeting of the Board

Answer 12

(Default) Regular meetings may be held without notice of date, time, place, or purpose of the meeting (articles or bylaws can provide otherwise).

(Default) Special meetings require two days’ notice for date, time, and place of meeting, NOT purpose (articles or bylaws can require shorter).

Removal of directors: must have notice.

Waiver of notice:

can occur before or after the date and time stated in the notice by means of a signed writing by the director entitled to the notice

or
by a director’s attendance or participation in a meeting when the director makes no prompt objection to the meeting or the transaction of business at the meeting.

NOTE: Even if timely objection is made at the beginning of a directors’ meeting, if the objecting director thereafter votes and assents to action taken at the meeting, the notice requirement will be deemed to have been waived.

Question 13

Authority of Corporate Officers

Answer 13

The powers of a corporate officer are the powers of an agent.

A corporate officer or agent may enter into any transaction for which they have been expressly or implicitly authorized under the articles or certificate of incorporation, the bylaws, an employment contract, or a board resolution.

Corporate officers have the implied authority to enter into transactions that are reasonably related to performing the duties for which they are responsible.

If a corporate officer who acts without or beyond their actual authority, consider whether the officer had apparent authority to act or whether the officer’s actions were later ratified by the board.

Question 14

Ultra Vires Doctrine

Answer 14

A corporation cannot undertake a contract or activity that is beyond the scope of its powers, as described in the articles of incorporation or bylaws.

Under the MBCA, the limits of a corporation’s authority may be challenged in the following instances:

• In a proceeding by a shareholder to enjoin the act;
• In a proceeding by the corporation (directly, derivatively, or through a representative) against a current or former director, officer, employee, or agent of the corporation; and
• In a proceeding by the attorney general based on the grounds that:
  
  • the corporation obtained its articles through fraud; or
  • the corporation has continued to exceed or abuse the authority conferred upon it by law.

Question 15

Duty of Care

Answer 15

Directors and Officers must discharge their duties:

(1) In good faith;
(2) same care of an ordinary and prudent person in a like position in similar circumstances;
(3) in a manner they reasonably believe to be in the best interests of the corporation.

Directors and Officers may rely on: information, reports, records, and financial data by those deemed reliable and competent by the board for that matter.

Question 16

Business Judgement Rule

Answer 16

Creates a rebuttable presumption (burden on plaintiff to show otherwise) that, when making a business decision, directors and officers have acted:

• on an informed basis;
• in good faith; and
• with honest belief that their decision was in the corporation’s best interest.

A director CANNOT act in good faith when committing or allowing the corporation to commit illegal acts, even when doing so is profitable for the corporation.

Question 17

Duty of Loyalty

Answer 17

The fiduciary duty of officers, directors, and employees requires that they be loyal to the corporation and not promote their own interests in a manner injurious to it.

Conflicts of interest typically arise when directors or officers:

(1) transact business with the corporation (self-dealing);
(2) usurp a corporate opportunity; or
(3) directly compete with the corporation.

Question 18

Self-Dealing

Answer 18

When a director or officer is involved in a “conflict of interest transaction,” the duty of loyalty requires the director or officer to notify the other directors, officers, or shareholders of all of the material facts regarding the conflict.

Such transactions are voidable unless:

the material facts of the conflict were disclosed and fully described to the board, and the transaction was validly approved by a majority of disinterested directors or shareholders; or

a court determines the transaction was fair and reasonable to the corporation.

In an action claiming violation of a duty of loyalty: the allegedly disloyal director or officer carries the burden of proving that the transaction was in fact fair to the corporation.

Question 19

Usurping Corporate Opportunity

Answer 19

The duty of loyalty prohibits directors and officers (and sometimes employees) from usurping for their own benefit any business opportunity that properly belongs to the corporation.

In determining whether an opportunity belongs to the corporation, courts will consider the following:

(1) Whether the business constituting the opportunity is closely related to that of the corporation;
(2) whether the board had expressed an interest in acquiring that type of business;
(3) whether the individual became aware of the opportunity while acting in his capacity as a director or officer; and
(4) whether he used any corporate funds or facilities in discovering or developing the opportunity.

Even if an “opportunity” is determined to belong to the corporation, there is no usurpation of a corporate opportunity if after full disclosure:

(1) the corporation was given the opportunity to first pursue it and declined to do so; or
(2) was otherwise unable to take advantage of the opportunity.

Question 20

Competition with the Corporation

Answer 20

Competition by a director or officer will NOT necessarily be a breach of fiduciary duty if he or she acts in good faith.

As a general rule, directors and officers may engage in independent business, but if the independent business competes with the corporation, equitable limitations will apply.

In the absence of any contrary agreement or understanding, corporate officers are not precluded, upon the termination of their employment, from entering into competition with their corporate employer, or from using the intangible knowledge and skill they acquired while employed.

Covenants not to compete, however, will be enforced if they are reasonable as to time and area of application.

Question 21

General Shareholder Power

Answer 21

Shareholders in their collective capacity have the power to:

(1) Elect Directors;
(2) Remove directors with or without cause;
(3) Amend bylaws; and
(4) Approve fundamental changes such as: amendments to the articles, merger, dissolution, and the sale of all or substantially all corporate assets.

Question 22

Shareholder Meetings

Answer 22

To ensure that the collective power of shareholders is not interfered with, watered down or otherwise manipulated, each shareholder of record must be provided with timely written notice of each annual and special shareholder meeting 10 to 60 days prior to the meeting date.

For annual meetings, proper notice will state the place, date, and hour of the shareholder meeting.

For special meetings, proper notice will state the place, date, hour, and PURPOSE of the shareholder meeting.

Quorum rules apply.

Question 23

Shareholder Resolutions

Answer 23

The MBCA does not specifically permit the submission of shareholder resolutions for shareholder action at shareholders’ meetings. Nonetheless, the practice is widespread and generally accepted under common law principles as a fundamental right.

Generally, a shareholder resolution is acceptable if the proposal is a recommendation or request that the corporation or board of directors take a specified action; conversely, resolutions seeking to mandate or bind the corporation or the board are not considered proper.

Question 24

Straight vs. Cumulative Voting

Answer 24

When electing directors (typically at the annual shareholder meeting) each shareholder gets a number of votes equal to the number of shares they own multiplied by the number of seats up for election.

“straight” or “statutory” voting, shareholders may not give more than one vote per share to any single nominee.

In cumulative voting, shareholders may allocate all of their votes to any candidate when there are multiple openings on the board.

Question 25

Removal

Answer 25

If a corporation has straight voting, and unless otherwise provided in the articles of incorporation, the entire board of directors, or any individual directors, can be removed, with or without cause, by a majority of the shares entitled to vote in the election of such directors.

If a corporation has cumulative voting a director cannot be removed if the number of votes cast against his removal is equal to or more than the minimum number of votes necessary to guarantee election in the original election.

Question 26

Approval of Proposals for Fundamental Changes

Answer 26

Amendments to the articles are proposed by the board and submitted to the shareholders for approval (Notice: must indicate the purpose and copy of proposed amendment).

A plan for merger or share exchange must be adopted by the board and then submitted for shareholder approval (Notice: purpose for the meeting is to consider the merger, and IF the corporation is NOT the surviving entity, a copy or summary of the surviving corporation’s articles).

Disposition of substantially all of a corporation’s assets (outside the regular course of its business) does require shareholder approval if it would leave the corporation without a significant continuing business activity (less than 25% of assets and income from that year).

Quorum requirements apply for approvals.

Question 27

Exceptions to the Approval Requirement

Answer 27

Approvals will not be required if:

In a merger: the corporation will survive the merger or be the acquiring corporation in the share exchange;

the merger or share exchange will not itself affect a change in the number of outstanding shares held by the corporation’s shareholders; or

affect a change to the preferences, limitations, or relative rights of those shares; AND

the issuance of shares as part of the merger or share exchange does not otherwise require shareholder approval.

In the case of mergers involving subsidiaries does NOT require approval of the subsidiary board or shareholders if the parent company owns at least 90% of the voting power in the subsidiary

Question 28

Voting Rights of Shareholders

Answer 28

(1) Unless otherwise provided, each share is entitled to one vote.
(2) Only shareholders of record on the record date are eligible to vote.
(3) Shareholders are entitled to vote by proxy.

Question 29

Proxy Voting

Answer 29

A valid proxy agreement requires: the shareholder providing the proxy with either a written, signed authorization or an electronically transmitted authorization.

A proxy will expire in 11 months unless otherwise provided in the proxy agreement.

Proxy agreements are freely revocable by:

(1) a writing delivered to the corporation;
(2) a subsequently executed proxy present at a shareholder meeting; or
(3) an in-person appearance and vote at a meeting by the original shareholder.

EXCEPTION: proxys are irrevocable during their term if the agreement explicitly provides that it is irrevocable and the proxy must be coupled with an interest (i.e. loan or sale of stock).

Question 30

Consolidating Voting Power

Answer 30

Shareholders can arrange to vote their shares in concert with another by means of a voting agreement or voting trust.

(1) Voting trusts involve a transfer of legal title and are more strictly regulated than voting agreements.
(2) Voting agreements are contracts whereby shareholders bind each other to vote a certain way on particular issues.

Question 31

Shareholder Right to Information and Inspection

Answer 31

Shareholders have a right to information, such as annual financial statements, that are important to a shareholder’s voting and investing decisions.

Shareholders have an unqualified right to examine the articles, bylaws, minutes of a shareholders’ meeting, and list of shareholders of record.

Shareholders also have a qualified right to inspect (and make copies of) accounting books and the records and minutes of director meetings upon a good faith demand made for a proper purpose and with specificity as to that purpose and the items sought to be inspected.

Good Faith: requires evidence establishing credible basis for the belief of possible wrongdoing (mere suspicion is not enough).

Proper Purpose: any purpose reasonably relevant to a shareholder’s interest as a shareholder.

Question 32

Appraisal Rights of Dissenting Shareholders

Answer 32

In general, where a fundamental change has been put to a vote of the shareholders, dissenting shareholders have the right to obtain payment of the fair value of that shareholder’s shares.

Question 33

Direct Suits by Shareholders

Answer 33

Direct suits are brought when the wrong or harm is direct to the shareholder (i.e. compelling payment of dividends).

To compel payment of dividends: a shareholder needs to prove that the director’s refusal to declare a dividend amounted to fraud, bad faith, or an abuse of discretion.

Motivating factors court will examine:

(1) intense hostility of the controlling faction against the minority;
(2) exclusion of the minority from employment by the corporation;
(3) high salaries, bonuses, or corporate loans made to the officers in control;
(4) the fact that the majority group may be subject to high personal income taxes if substantial dividends are paid; and
(5) the existence of a desire by the controlling directors to acquire the minority stock interests as cheaply as possible.

Question 34

Derivative Suits by Shareholders

Answer 34

A derivative suit is an equitable action brought by a shareholder on behalf of the corporation and for the corporation’s benefit.

Typically, it involves an alleged breach of fiduciary duty by officers and/or directors, and a request that the court enforce this duty owed to the corporation or redress the injury suffered by the corporation. So to the extent the shareholder is harmed, that harm is derivative of the harm done to the corporation.

To be eligible to bring a derivative suit, the shareholder must have been a shareholder when the transaction complained of occurred.

Prerequisite to bringing a derivative action: The shareholder must:

(1) make written demand upon the corporation; and
(2) allow at least 90 days to pass, unless irreparable injury would result by waiting 90 days.

Dismissal: A board of directors can seek dismissal of a derivative suit when a majority of directors, who do not have a material interest in the derivative action determine, in good faith, and after conducting a reasonable inquiry, that continuance of the suit would not be in the best interests of the corporation.

Question 35

Duties of Controlling Shareholders

Answer 35

Controlling shareholders have a duty of good faith whereby they must refrain from exercising control so as to obtain a benefit from the corporation not shared proportionately with minority shareholders.

Shareholder “oppression” most commonly occurs in a close corporation. In a close corporation, the lack of a public market for the corporation’s shares puts minority shareholders in a potentially vulnerable position since they cannot readily exit and escape mistreatment through the selling of their shares.

Question 36

Shareholder Liability

Answer 36

A corporate entity is distinct from its shareholders. In general, shareholders are not personally liable for the debts of the corporation in which they hold stock.

EXCEPTION: Piercing the Corporate Veil

Common triggers: (1) a close corporation in which corporate formalities are not observed and corporate and personal funds are commingled.

(2) a parent corporation and its subsidiary when there is insufficient segregation of their respective businesses, records, and finances.

A plaintiff seeking to pierce the corporate veil must prove:

(1) shareholder “control” that effectively renders the corporate form a façade (shareholder was the alter ego of the corporation);
(2) use of the corporate form to obtain an improper or fraudulent purpose; and
(3) injury or unjust loss resulting from this wrongful use of the corporate form.