Rules

Question 1

Forming corporation

Answer 1

Require person (incorporators who sign articles and deliver to SOS), paper (articles of incorporation), and act (delivery and pay fees)

Question 2

What must the Articles of Incorporation include?

Answer 2

• name of corporation
• number of authorized shares
• name and address of incorporators and registered agent
• maybe clause limiting corporation’s purpose (activities beyond scope are ultra vires and may be enjoined, cause directors to be held liable for authorizing)

Question 3

Promoters (definition)

Answer 3

A promoter is a person who undertakes to procure commitments for a corporation before it is formed.

Question 4

de facto corporation liability

Answer 4

A person who purports to act on behalf of a corporation knowing there is no valid incorporation is personally liable for corporate obligations but no liability if de facto corporation with (1) COLORABLE compliance with incorporation statute and (2) exercise of corporate privileges.

(Only some states recognize this doctrine.)

Question 5

corporation by estoppel

Answer 5

A person who purports to act on behalf of a corporation knowing there is no valid incorporation is personally liable for corporate obligations but no liability if corporation by estoppel applies: people are treating business as valid corporation are estopped from denying corporation’s existence.

(Only some states recognize this doctrine.)

Question 6

Can the corporate veil be pierced?

Answer 6

Court may pierce the corporate veil when:
- corporate formalities have been ignored and injustice has resulted
- corporation was inadequately capitalized or
- it is necessary to prevent fraud

Question 7

alter ego doctrine

Answer 7

Corporate veil may be pierced if shareholders ignore corporate formalities such that the corporation may be considered the “alter ego” or a “mere instrumentality” AND some basic injustice arises. Grounds include:
- owners do not treat corporation as separate entity
- commingle personal and corporate funds
- use corporate assets for personal purposes
- owners do not hold meetings

Question 8

inadequate capitalization at formation

Answer 8

Corporation must start with SUFFICIENT UNENCUMBERED capital to meet its prospective liabilities. Corporate veil may be pierced to reasonably cover prospective liabilities.

Question 9

Perpetuating a fraud

Answer 9

Corporation cannot be formed to avoid EXISTING personal liabilities, but can be formed to avoid FUTURE liabilities.

Fraud requires a misstatement of fact.

Question 10

Who will be liable if court pierces corporate veil?

Answer 10

Generally only active shareholders will be liable and only for tort obligations

Question 11

Capital structure

Answer 11

Debt securities (bonds) create debtor-creditor relationship.

Equity securities (stocks) create ownership interest.

Question 12

Types of shares

Answer 12

• authorized stock: max number of shares
• issued stock: number actually sold to investors
• outstanding stock: shares issued and not reacquired

Question 13

Subscription agreement

Answer 13

Agreements to purchase shares from corporation. Preincorporation subscription agreements are irrevocable for 6 months.

Question 14

Consideration for shares

Answer 14

Under MBCA, any benefit to corporation is acceptable. Traditionally only cash, property, and services already performed.

Under MBCA, amount set by directors and their good faith valuation of consideration is conclusive. Traditionally, shares had par value (min consideration) and could not be sold for less.

Question 15

Closely held corporation

Answer 15

Generally shareholders do not run corporation on day-to-day basis, but closely held corporation may dispense with board by shareholders’ agreement (in articles or bylaws and approved by all shareholders or by unanimous written shareholder agreement) and run corporation through different scheme.

Question 16

Shareholders (authority)

Answer 16

Shareholders indirectly control corporation by
- electing directors
- amending bylaws, and
- approving fundamental changes.

Question 17

Record shareholders

Answer 17

Person shown as owner in corporate record on record date has right to vote. Record date is a voter eligibility cut-off date, may not be more than 70 days before meeting; if not specified, on day notice is mailed.

Question 18

Notice of meetings to shareholders

Answer 18

Notice of date, time, and location at annual meeting and date, time, location, and purpose at special meeting.

If notice is improper, action taken at meeting can be nullified, but shareholders waive improper notice by attending meeting without complaint.

Question 19

Proxies

Answer 19

A proxy is a writing signed by record shareholder, directed to secretary of corporation authorizing another to vote the share. Usually valid for 11 months.

Generally revocable by attendance or later appointment. Irrevocable if (1) it’s stated and (2) proxyholder has some interest in shares other than voting.

Question 20

Federal rules re: proxies

Answer 20

• must be fair and full disclosure of material facts regarding any management-submitted proposal upon which shareholders are to vote
• material misstatements, omissions, and fraud in connection with solicitation of proxies prohibited
• management must include certain shareholder proposals on issues other than election of directors and allow proponents to explain position

Question 21

Quorum (for shareholder meetings)

Answer 21

Majority of outstanding voting shares must be present for valid vote. Once quorum is reached, shareholder leaving does not invalidate.

Question 22

Approval at shareholder meeting

Answer 22

MBCA: votes cast in favor > votes cast against
Some states require greater vote for fundamental corporate change

Question 23

Shareholder agreements

Answer 23

• voting trusts: shareholders transfer ownership to trustee who votes shares as agreed (valid for up to ten years but renewable)
• management agreements: agree to run corporation, can even dispense with board
• share transfer restrictions: restricts ownership interests (generally freely transferable); restrictions must reasonable

Question 24

preemptive right

Answer 24

right to purchase shares to maintain proportionate ownership interests. MBCA: exists only if provided for, and does not apply to shares issued as compensation, shares issued within 6 mo of incorporation, and shares issued for consideration other than money, and nonvoting shares with distribution preference.

Question 25

Direct shareholder suits

Answer 25

• direct: to enforce right of shareholder

Question 26

Derivative suit (definition)

Answer 26

brought to enforce right belonging to corporation but corporation is joined as defendant

Question 27

Derivative suit (requirements)

Answer 27

• must have owned shares at time of wrong and maintain ownership throughout suit
• fairly and adequately represent corporation’s interests
• MBCA: written demand on corporation to bring suit (in some states, must wait 90 days unless notification of rejection + irreparable injury; in other states, demand not required if it would be futilie

Question 28

Derivative suit (dismissal)

Answer 28

Parties can settle or dismiss a derivative suit only with court approval.

Dismissal must be based upon independent investigation that suit is not in corporation’s best interests. Court will rule to dismiss if they find (1) recommendation of dismissal was truly INDEPENDENT and (2) they made a REASONABLE investigation

Question 29

Derivative suit (recovery)

Answer 29

Recovery to corporation (shareholder plaintiff may recover costs if they win, but if they lose, they will not recover costs).

Question 30

Directors (authority)

Answer 30

Board of directors must act as a group. Actual authority only arises when:
- Unanimous agreement in writing
- At a meeting, which must satisfy quorum and voting requirement. Notice: not required for regular meetings, at least two days’ notice of date, time, and place required for special meetings. Quorum must be present at time of vote.

Failure to give notice makes decisions voidable unless directors not notified waive the notice defect by writing or by attending the meeting without objecting

Question 31

Director committees

Answer 31

Board may create committees and delegate authority to them. But committees cannot take certain actions (though they can recommend:
- Declare a distribution (dividends)
- Fill a board vacancy
- Recommend a fundamental change to shareholders

Question 32

Business judgment rule

Answer 32

Directors are protected from personal liability to corporation/shareholders if:
- the director acts in GOOD FAITH
- with care that ORDINARY PRUDENT person in like position would exercise,
- in manner REASONABLY BELIEVED to be in the BEST INTERESTS of corporation

Question 33

Duty of loyalty (director)

Answer 33

No SELF-DEALING without disclosure and approval. A transaction between a corporation and director will not be set aside for self-dealing if
- director DISCLOSED all MATERIAL facts AND transaction was approved by DISINTERESTED directors or shareholders, OR
- transaction was FAIR to corporation

Question 34

Corporate opportunity doctrine

Answer 34

Under the duty of loyalty, a director may not DIVERT to himself a business opportunity within corporation’s line of business without first giving corporation opportunity to act (USURPATION)

Remedy: corporation may recover director’s profits or force director to convey opportunity to corporation

Question 35

Director (indemnification)

Answer 35

If director is sued as director and successfully defends, corp must indemnify for expenses. If they are unsuccessful, corporation has discretion to indemnify if they complied with business judgment rule standards.

Corporation may purchase liability insurance to cover directors even if they would not otherwise be entitled to indemnification

Question 36

Fundamental corporate changes

Answer 36

• amendments to articles
• mergers
• consolidations
• share exchanges
• dispositions of substantially all assets outside of regular course of business

Question 37

Fundamental corporate changes (procedure)

Answer 37

• board resolution
• notice to shareholders
• shareholder approval
• articles of change filed with state

merger must be approved by directors and shareholders of both corporations

Question 38

Fundamental corporate changes (dissenters’ remedy)

Answer 38

Shareholders who do not like a fundamental corporate change may force corporation to purchase their shares at a FAIR price if they:
- give corporation NOTICE of intent to demand APPRAISAL RIGHTS before vote is taken
- do not vote in favor of change
- demand payment after change is approved

Question 39

Dissolution

Answer 39

• voluntary dissolution: after shares have been issued, corporation by dissolve by fundamental corporate change procedure
• administrative dissolution: state may bring action for failure to pay fees or penalties, failure to file annual report, and failure to maintain registered agent
• judicial dissolution: AG may seek judicial dissolution if fraudulently obtained articles or corporation is exceeding or abusing authority. Shareholders and creditors may also seek judicial dissolution

Question 40

Rule 10b-5

Answer 40

Rule 10b-5 makes frauds in connection with the purchase and sale of a security unlawful.

A prima facie case for breach of the rule requires proof of:
- fraudulent conduct
- in connection with the purchase or sale of a security
- use of a means of interstate commerce
- for a private cause of action, reliance and damages

A fact will be considered material if a reasonable investor would consider it important when making an investment decision.

Conduct is only fraudulent on proof of scienter (intent to deceive, recklessness).

Question 41

Section 16(b)

Answer 41

Section 16(b) of the Securities Exchange Act of 1934 provides that
- any profit realized by a director, officer, or shareholder owning more than 10 percent of the outstanding shares of the corporation
- from any purchase and sale or sale and purchase, of any equity security of his corporation
- within a period of less than six months must be returned the corporation.

The applies to publicly held corporations whose shares are traded on a national exchange or have at least 2,000 shareholders (or 500 nonaccredited shareholders) and more than 10 million in assets.

profit determined by matching highest sales price against lowest purchase price for any six month period.

Question 42

Sarbanes Oxley Act of 2002 (SOX)

Answer 42

applies to publicly held companies; requires covered companies to establish audit committee of board members to oversee work performed registered public accounting firm and establishes internal procedures for receiving and handling complaints about company’s accounting, internal accounting controls, and auditing procedures

Question 43

Corporations are (hint: compared to shareholders)

Answer 43

Corporations are legal entities separate and apart from their shareholders.

Question 44

Corporation’s liability for pre-incorporation contracts

Answer 44

Corporations are not liable for contracts made prior to incorporation. (generally only promoters are liable on preincorporation contracts.)

Corporation may become liable on a preincorporation contract only if it adopts the contract. Adoption might be: explicit (e.g. by resolution of board) or implicit (e.g. by accepting the terms of the contract).

Question 45

How can shareholders become creditors?

Answer 45

Shareholders become creditors of the corporation by lending the corporation money.

Question 46

Promoters’ liability

Answer 46

Promoters are liable on a preincorporation contract unless:
- the contract expressly indicates the promoter is not to be bound, in which case the agreement is construed as revocable offer to the proposed corporation, or
- all parties have agreed to a novation (an agreement among parties releasing the promoter and substituting the corporation)

Liability continues even after corporation is formed absent a valid novation.

Question 47

Directors; fiduciary duties

Answer 47

Directors are fiduciaries of the corporation and they owe the corporation a duty of care and a duty of loyalty.

Question 48

Shareholders’ liability

Answer 48

Generally, shareholders in a properly formed corporation are not personally liable for the corporation’s obligations.

Question 49

Corporate officers’ fiduciary duties

Answer 49

Corporate officers are fiduciaries and owe their corporation the duty to act in its best interests and not for personal gain.

Question 50

Corporate officers, inside info

Answer 50

A corporate officer who has inside info has a duty to disclose that information to the shareholder with whom he deals or refrain from trading (disclose or abstain)

Question 51

Declaring dividends

Answer 51

Absent a provision otherwise in a corporation’s articles of incorporation or bylaws, the declaration of a dividend is left to the discretion of the board of directors.

A strong case is required to convince a court of equity to order directors to declare a dividend.

Question 52

misrepresentation (common law)

Answer 52

to make out a claim, plaintiff must show:
- misrepresentation of fact by the defendant,
- scienter (intent to deceive)
- an intent to induce the plaintiffs’ reliance on the misrepresentation
- causation
- justifiable reliance by the plaintiff on the misrepresentation
- damages

Question 53

Director’s reliance on others

Answer 53

In discharging their duty of care and loyalty, directors are entitled to rely on the reports and opinions of other directors, officers, employees, and outside persons who are reporting on matters within their competence.