Rule Statements Flashcards
Promoter Liability
A promoter is personally liable for acting on behalf of a corporation before incorporation, and is jointly and severally liable for all liabilities created while so acting, even after the corporation comes into existence, unless a subsequent novation releases the promoter from liability. The corporation is not liable for pre- incorporation transactions even if for the benefit of the corporation. However, a corporation is liable if it expressly or impliedly adopts a contract by accepting benefits of the transaction or gives an express acceptance of liability for debt.
Articles of Incorporation
The articles of incorporation must include the corporate name, a statement of C’s legal purpose, may enumerate powers that the corporation possesses or limit its duration, and must be filed with the state.
Ultra Vires Actions
When a corporation that has stated a narrow business purpose in its articles of incorporation subsequently engages in activities outside that stated purpose, the corporation has engaged in an ultra vires act. A corporation may only engage in activities that fall within the stated business purpose in its articles of incorporation. When a corporation that has stated a narrow business purpose in its articles of incorporation subsequently engages in activities outside that stated purpose, the corporation has engaged in an ultra vires act. The corporation can take action against a director, officer, or employee of the corporation who engages in such action.
When a third party enters into a transaction with the corporation that constitutes an ultra vires act for the corporation, the third party generally cannot assert that the corporation has acted outside those powers in order to escape liability.
Sale of Securities - Rule 10b-5 Action
To maintain a Rule 10b-5 action, a plaintiff must either purchase or sell the security through the use of interstate commerce. There must be fraudulent or deceptive conduct, such as untrue statements of material fact, failure to prevent misleading statements, or insider trading. The defendant’s statement must be material, such that a reasonable investor would find the fact important in deciding whether to purchase/sell a security. Finally, the defendant must make the statement intentionally or recklessly, and the plaintiff must rely on defendant’s fraudulent conduct and be harmed by it.
Sale of Securities - Rule 16(b) Action
A corporate insider can be forced to return short-swing profits to the corporation through a Section 16(b) action. To maintain this action, the corporations must have securities traded on a national securities exchange, or have assets of more than $10 million and more than 500 shareholders. Only corporate directors, officers, and shareholders who hold more than 10% of any class of stock are subject to a Section 16(b) action. During any six-month period, a corporate insider who both buys and sells his corporation’s stock is liable to the corporation for any profits made.
Direct Actions
A shareholder may sue the corporation for breach of a fiduciary duty owed to the shareholder by a director or an officer. A shareholder may also sue the corporation on grounds that do not arise from the shareholder’s status as a shareholder.
Derivative Actions
In a derivative action, a shareholder is suing on behalf of the corporation for a harm suffered by the corporation, and recovery generally goes to the corporation. To have standing, a plaintiff must have been a shareholder at the time of the wrong, or at the time the action is filed, and must continue to be a shareholder during litigation. Written demand upon the board must be made unless it would be futile, and rejection of the demand is tested against the business judgment rule. Finally, the plaintiff can seek reimbursement from the corporation for reasonable litigation expenses.
Shareholder Liability - Piercing the Corporate Veil
If a plaintiff is able to “pierce the corporate veil,” a corporation’s existence is ignored, and the shareholders of the corporation are held personally liable. Some factors considered by the courts when piercing the corporate veil include undercapitalization, disregard for corporate formalities, using the corporation’s assets as the shareholder’s own assets, self-dealing, or the siphoning of a corporation’s funds.
NOTE: Usually a shareholder that is uninvolved with the daily operations of the company will not be held liable as a result of veil piercing.
Controlling Shareholder’s Fiduciary Duties
A controlling shareholder may owe a fiduciary duty to minority shareholders in two circumstances. A controlling shareholder may be liable for damages caused to other shareholders when he sells stock to an outsider if the stock was sold to an outsider intent on looting or destroying the company. Also, a controlling shareholder who receives a special distribution or otherwise conducts major business transactions to his own benefit owes a duty of loyalty.
Directors - Duty of Care
Directors have a duty to act with the care of an ordinarily prudent person in a like position and similar circumstances. As an objective standard, the director is presumed to have the knowledge and skills of an ordinarily prudent person.
In deciding how to act, the director is also required to use any additional knowledge or special skills that he possesses. However, a director can rely on information and opinions of officers, employees, attorneys, accountants, or other experts if the director reasonably believes them to be reliable or competent.
Business Judgment Rule
The business judgment rule (BJR) is a rebuttable presumption that a director reasonably believed his actions were in the best interest of the corporation. The BJR doesn’t apply when a director engages in a conflict-of-interest transaction with the corporation.
The BJR can be overcome if the director didn’t act in good faith, wasn’t informed to the extent he reasonably believed was necessary, had material interests in the challenged conduct and wasn’t objective, failed to devote attention corporate affairs, failed to timely investigate matters of material concern, or received undue financial benefits.
Directors - Duty of Loyalty
The duty of loyalty requires a director to act in a manner that the director reasonably believes is in the best interest of the corporation. Typically, a director breaches this duty by placing his own interests before those of the corporation.
Directors - Self-Dealing
A director who engages in a conflict-of-interest transaction with his own corporation has violated the duty of loyalty, unless the transaction is protected under the safe harbor rule. In these situations, the director cannot profit at the corporation’s expenses.
A conflict-of-interest transaction is one that would normally require approval of the board and is of such financial significance to the director that it would reasonably be expected to influence the director’s vote on the transaction.
Directors - Usurpation of Corporate Opportunity
A director may violate his duty of loyalty by usurping a corporate opportunity rather than first offering the opportunity to the corporation. In determining whether the opportunity is one that must first be offered to the corporation, courts have applied two tests.
Under the “interest or expectancy” test, the key is whether the corporation has an existing interest or an expectancy arising from an existing right in the opportunity. Under the broader “line of business” test, the key is whether the opportunity is within the corporation’s current or prospective line of business.
Officers - Actual Authority
Actual authority wielded by an officer is defined by the corporate bylaws or set by the board of directors.
