The Nature of the Corporation

Question 1

What is a Promoter and what are they tasked with?

Answer 1

• Promoter = Person who identifies a business opportunity and puts together a deal, forming corporation as a vehicle for investment by other people.
  
  • Has an idea for a business, but no interest in running it.
  • The promoter is considered an agent of the soon-to-be formed corporation and owes fiduciary duties.
  • Tasked with:
    
    • Discovery
      
      • Discover or identify need for certain product/service
    • Investigation
      
      • Investigate more seriously, run numbers, determine if the corporation is an economically feasible venture
    • Assembly
      
      • Bring together the appropriate personnel, property, and capital required to bring the corporation together.

Question 2

What is needed to incorporate, and what is specifically unique to Delaware?

Answer 2

• Decide where
• File Articles of Incorporation – Contract between corporation, state, and shareholders. Binding document. Changes may only be made with approval of shareholders and the State. State sets forth required elements; usually:
  
  • Name
  • Number of shares to issue
  • Address of registered agent
  • Name and address of each incorporator
  • FOR DELAWARE:
    
    • Nature of business or purpose
    • Name and address of directors until first annual meeting
    • ** Certificate of incorporation may also contain a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director; cannot eliminate liability for breach of loyalty, knowing violation of law, or acts not in good faith.
• Cases – SOUTHERN GULF = once you contract with and acknowledge what you believe to be a corporation, you are estopped from denying its existence, especially when it serves only your interests.

Question 3

Who do shareholders elect?

Answer 3

Board of Directors

Question 4

What are the types of securities? What are their differences?

Answer 4

1. Equity Securities
   
   • Common Stock = voting rights and beneficiary of fiduciary duties. MOST risk.
   • Preferred Stock = entitled to preferred dividends before common stockholders. No voting. Less risk.
2. Debt Securities

• Loan or promise to pay back the purchase price + interest rate.
• Owners of debt securities are paid off before both the common and preferred stockholders, but have No right to vote on corporate matters.
• Not a principal; no benefit of fiduciary duties.

Question 5

What are the three theoriesof liability under which shareholders may be personally liable for corporate action?

Answer 5

1. Enterprise Entity Theory
2. Piercing the Corporate Veil
3. Agency Theory

Question 6

What is Enterprise Entity Theory?

Answer 6

• Theory of liability where a litigant may seek to hold a number of distinct corporate entities liable for the actions of a single such corporation in the event that the distinct corporations are each part of one large corporate enterprise. (i.e., the entire enterprise is liable for the actions of any constituent corporate entity).
• Vertical wall.

Question 7

What is Piercing the Corporate Veil?

Answer 7

• Involves trying to break through the barrier between shareholders, officers, or directors, and the corporation to hold them personally liable by showing that they deserve to be liable for the debts and obligations of the corporation. Horizontal wall.
  
  • Two Part Test:
    
    • One must show unity of interest and ownership between the shareholder and corporation by 4 factors:

1. Failure to observe corporate formalities and/or records (big factor for contract cases)
2. Commingling of personal and corporate funds
3. Undercapitalization (big factor in tort cases) and
4. Sharing of assets between corporation

• Avoid a result that promotes Fraud or Injustice
  
  • An unsatisfied judgment (an inability for the ∆ to pay the π) is not enough
  • Keep in mind that there is also an assumption of risk, which is determined at the point of contracting
    
    • In a tort claim, there is no opportunity to negotiate
    • In a contracts claim, there is an opportunity to negotiate
  • There needs to be some “wrong” beyond a creditor’s inability to collect.
• Note:
  
  • Harder to pierce in K cases; easier in Tort because it is involuntary

Question 8

What is the Agency Theory of shareholder liability?

Answer 8

• Must prove:
  
  • i.Control
  • ii.Consent
  • iii.Acting on behalf of
• A court will look to whether a parent and subsidiary corporation have common directors, or officers, etc.

Question 9

How can you find unity of ownership using the substantial domination test? What do you look for?

Answer 9

• What is the relationship between the parent and the subsidiary?
• How much control is exerted?
• Look For:
  
  • i.Common directors/officers
  • ii.Common business departments
  • iii.Consolidated financial statements
  • iv.The parent finances and subsidiary
  • v.Subsidiary operates with grossly inadequate capital
  • vi.Parent pays salaries and other expenses of subsidiary
  • vii.Parent uses subsidiary’s property as own
  • viii.Daily operations are not kept separate
  • ix.The subsidiary does not observe corporate formalities.

Question 10

Limited Partnerships ** - Partner Liability**

Answer 10

• Limited partners enjoy the same status as shareholders, take on less risk, and have limited liability. (i.e. a limited partner is not personally liable solely by reason of being a limited partner).
  
  • Limited partners exercise NO control over partnership. IF THEY DO, then they may be deemed a General Partner.
    
    • A General Partner is liable jointly and severally for all obligations of the partnership.
    • HOWEVER, LP may exert control if they are a director/officer/shareholder of a corporation’s general partner. [Frigidaire case]

Question 11

What is a Shareholder Derivative action?

Answer 11

• The shareholder has the right to bring an equitable action in the name of the corporation to recover for injury to the corporation. If the suit is successful, recovery goes to corporation.
  
  • Chief regulator of corporate management. It is a remedy available when there are abuses to hold the corporation and directors accountable.
  • If substantially benefits corporation, court may make corp pay π’s expenses; if π’s a douche and court find there was no reasonable cause or an improper purpose, then π may have to pay ∆’s expenses.
  • Only court can terminate.

Question 12

What is a Shareholder Direct suit?

Answer 12

When the shareholders are individually being harmed.

Question 13

Shareholder Derivative Actions - Indemnification - Delaware vs. MBCA

Answer 13

• Most jurisdictions permit the corporation to indemnify a director for legal expense if he conducted himself in good faith pursuant to his business judgment. In Delaware, no indemnification for any claim, issue or matter on which the individual is found to be liable to the corporation. However, a corporation must indemnify a director for reasonable expenses incurred in successfully defending himself in his corporate capacity.
  
  • Delaware: To the extent that a former directors or officer has been successful on the merits or otherwise (so broader)
  • MBCA: wholly successful on the merits
  • But for both if they win or settle = corporation will indemnify the directors or officers.
  • It’s just Delaware defines as successful on the merits or otherwise and do not require the directors to be wholly successful

Question 14

What are some obstacles to a shareholder suit?

Answer 14

1. Posting Securities
2. Demand Requirement
3. Special Litigation Committees

Question 15

Obstacles to Suit - Posting Securities

Answer 15

To limit strike suits, most corporation statutes limit the shareholders who may bring derivative suits and enacted statutes that require the π-shareholder in a derivative suit to post a bond or other security to indemnify the corporation against litigation expenses in the event the π loses.

Question 16

Obstacles to Suit - Demand Requirement

Answer 16

• MBCA = a shareholder may not commence a derivative suit unless he has made a written demand upon the corporation to take suitable action and 90 days have expired since such demand was made.
  
  • Must be in writing.
• Delaware, California, New York =
  
  • Demand Futility Rule= allows π-shareholder to dispense with demand when doing so would be futile from the perspective of the reasonable person.
  • Demand excused when:
    
    1. Majority of board has financial or familial interest
    2. Majority of board is incapable of acting independently
    3. Transaction is not a product of a valid exercise of business judgment.

Question 17

Obstacles to Suit - Special Litigation Committees

Answer 17

• Corporation may form an SLC who has the power to take a serious look at the shareholders claim and determine if the corporation should move forward.
• SLC consists of disinterested and indepenedent directors and will decide whether to go forward with litigation or to suggest that the court dismiss it.
• Court looks at whether the SLC:
  
  • Acted independently,
  • Conducted s_ufficient and reasonable inquiry_ into the claim, AND
  • Acted in good faith.
• Jx:
  
  • CA and NY: Court only looks at procedural factors of the SLC and affords the deference to the SLC< so long as there is sufficient/reasonable investigation made by independent directors in good faith.
  • Delaware: Two-prong Test
    
    1. Court looks into the SLC’s procedure, but also applies its own independent business judgment to determine whether the litigation is meritorious (substance).
    2. If court decides that shareholder has acclaim and bad board, then the court will deny the SLC’s motion to dismiss derivative claim.

Question 18

What is Corporate Philanthropy?

Answer 18

social responsibility, corporate charity, corporate contributions, whether this is good, bad, or permissible. Charity amount must be reasonable—is the corporation donation reasonable in light of corporate earnings, profits, and corporation goals.

Question 19

What is the rule for Corporate Philanthropy?

Answer 19

• Corporate gift-giving is an allowable method of increasing goodwill, but the gift should be less than 1% of capital and surplus and
• directed to an institution owning no more than 10% of the company stock.
• No pet charities.

Question 20

**Arguments in favor of Corporate Philanthropy: **

Answer 20

Wealthy has moved over the years from individuals to corporate institutions, who have an ongoing “duty” to meet certain social needs; corporations are in the best position to fill those gaps; corporate PR function, tax benefits/ deductions; long-term profitability

Question 21

**Arguments Against Corporate Philanthropy: **

Answer 21

tendency to give to certain charities and not others (risk of unfairness); using shareholder money and profits to give to charity; Some would argue this is essentially theft; sense that corporate funds are being used to advance directors into certain social circles (price of social admission); donations often made to organizations with politicized associations (sometimes shareholder don’t approve of the message politically)

Question 22

What is Ultra Vires and how are things currently?

Answer 22

• Ultra Vires: beyond the power of the corporation (outside the scope of corp. power).
  
  • Certain activities are invalid because they are outside managerial power. Used early on when the articles of incorporation had very narrow purposes
  • Now, state legislatures enacted statutes that gave authority to corporations to engage in any lawful business.
    
    • New York = In taking action, action which may involve or relate to a change or potential change in the control of the corporation, a director shall be entitled to consider without limitation:
      
      • (1) both the long-term and short-term interest of the company and its shareholders, and
      • (2) the effects that the corporation’s actions may have in the short-term or in the long-term upon any of the following:
        
        • The prospects of potential growth, development, productivity, and profitability of the corporation;
        • Current employees
        • Customers and creditors
        • The ability of the corporation to prove as a going concern, goods, services, employment opportunities and employment benefits and otherwise contribute to the communities in which it does business
  • Example: Oil companies were in Burma building and turned blind eye to civil rights violations. Money that the corporations bring in are not going to the people.
  • Legislatures of some states have developed corporate constituencies statutes (written in permissive form so the Board may consider all of these interests…)

Question 23

What is the Abberation on the Law of Dividends?

Answer 23

Generally it is the board’s decision to award dividends and generally a court will defer to the board’s decision. But here, Court found that the purpose of the corporation is to make money for the shareholders and Ford had to issue the dividends.

Question 24

What is California’s position on Corporate Philanthropy?

Answer 24

California Corporations Code 207(e): Corporations can give irrespective of specific corporate benefit. Suggesting there should be a general benefit. Gives corporations the power to “make donations, regardless of specific corporate benefit for the public welfare or for community fund, hospital, charitable, educational, scientific, civic, or similar purposes.

Question 25

What is the IRS Fed Income Tax Law on deductions?

Answer 25

They are limited to 10% of taxable income.

Question 26

Pandora’s Box Article:

Answer 26

• Good:
  
  1. Individuals no longer have the capacity to remedy society’s ills. Now wealth sits with corporations, so not as much money for individuals to give, so want to encourage corporations to give
  2. Corporation is streamlined and efficient, faster than government, they can redirect the funds to the right place
  3. Economic arguments: Form of advertising for corporation, creates good will, good image among customers, build morale among employees—“good corporate citizen”—benefits the corporation in the long run
  4. Corporations don’t have to go through red tape to spend money (unlike the gov’t)
• Bad:
  
  1. No oversight on corporate contributions
  2. With no shareholder approval
  3. Corporate managers have immense discretion on spending shareholder money to redress societal ills (that maybe the shareholders don’t want their money going their)
  4. A way to gain the social latter “elephant bumping”
  5. Corporate managers are using their philanthropic contributions in order to gain admission into these societal groups (elite group)