Top MEE Rules Flashcards
What are corporate bylaws and what may they contain? (5.6%)
Corporate bylaws are written rules of conduct that must be initially adopted by the incorporators or board of directors. There is no obligation to file bylaws, but almost every corporation has them.
Generally, bylaws provide for the ordinary business conduct of the corporation (e.g., meeting times and dates, elections of a board and officers, filling vacancies, notices, types of duties of officers, etc.).
Corporate bylaws may contain any provision for managing the business and regulating the affairs of the corporation to the extent that it is consistent with the law and articles of incorporation.
What is a promoter, and when is a promoter personally liable (and not personally liable) for contracts entered into on behalf of the corporation? (5.6%)
A promoter acts on behalf of a corporation that is yet to be formed, usually by assisting in the planning and formation of the new business, as well as entering into contracts securing capital to bring it into existence. The promoter may be, but doesn’t have to be, the same person as the corporation’s incorporator.
A promoter is personally liable for any pre-incorporation contracts entered into on behalf of the corporation—even after the corporation comes into existence—so long as both parties to the transaction know that the corporation has not yet been formed. However, a promoter will NOT be held personally liable if:
(1) There is a novation whereby the parties agree to release the promoter from liability in favor of holding the corporation solely liable;
(2) The promoter is able to obtain indemnity from the corporation (usually requires that the promoter did not violate any fiduciary duties);
(3) The corporation adopts the contract. Adoption of a contract can be express or implied. Adoption takes place when the corporation accepts the benefits of the transaction or gives an express acceptance of liability for the debt, such as through board resolution after incorporation.
When are shareholders liable for the debts of the corporation? (11.1%)
General Rule. Generally, shareholders of a corporation are NOT personally liable for the debts of the corporation. However, the major exception to this rule is the doctrine of piercing the corporate veil.
Piercing the Corporate Veil. Courts will allow a creditor to pierce the corporate veil and hold a shareholder personally liable for the debts of a corporation based on the totality of the circumstances, including the following factors:
[See Under Fabric If Shareholder’s Shady Dealings Are Found]
(1) The shareholder has dominated the corporation to the extent that the corporation may be considered the shareholder’s alter ego (e.g., a shareholder utilizes the corporate form for personal reasons);
(2) The shareholder failed to follow corporate formalities (e.g. not holding annual meetings or holding votes);
(3) The corporation was undercapitalized (i.e., inadequately funded at its inception to cover debts and prospective liabilities); OR
(4) There is illegality or fraud present.
Extra factors from Themis:
(5) Use of corporate assets as a shareholder’s own assets
(6) Self-dealing with the corporation
(7) Siphoning corporate funds
(8) Stripping of assets
Passive Investor Liability. Once the corporate veil has been pierced, courts generally hold ALL the shareholders liable. However, some courts do not extend liability to passive investors.
Exam Tip: On the exam, discuss each fact that supports or negates the contention that the shareholder is abusing the protections of the corporation.
Shareholder meetings (5.6%)
a) Annual and Special Meetings. A corporation must hold an annual meeting of shareholders at a time that is stated or fixed in accordance with the bylaws. Special meetings can generally be called by:
(1) Persons authorized under the articles of incorporation;
(2) A demand from shareholders that accounts for at least 10% of the votes entitled to be cast at the meeting; OR
(3) The board of directors for limited purposes (e.g., dissolution of the corporation).
b) Notice. Generally, shareholders who are entitled to vote must be provided with notice of all annual and special meetings. For special meetings, the notice must:
(1) State the purpose of the meeting; AND
(2) Be provided 10-60 days before the meeting commences (in most states).
c) Quorum. A quorum must be present in order for the shareholders to take action at a meeting. Unless otherwise set forth in the articles of incorporation, a quorum exists when at least a majority of the shares entitled to vote are present.
Vote by proxy and revocation (9.3%)
a) A vote by proxy allows a shareholder to vote without physically attending the shareholder’s meeting by authorizing another person to vote her shares on her behalf. A valid proxy must exist in the form of a verifiable electronic transmission or a signed written appointment form.
b) A proxy is freely revocable by the shareholder UNLESS the recipient of the proxy has an economic interest in the shares.
What are the classes of stock? (9.5%)
Ownership:
Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders have the lowest priority in the ownership structure (i.e., in the event of liquidation, common stockholders have rights to company assets only AFTER bond holders, preferred stockholders, and other debt holders have been paid in full.
Preferred stock is a security that represents ownership in a corporation. Preferred stock does NOT always have voting rights. Shares of stock are preferred if their holders are entitled to receive payment of dividends — or, in the event of liquidation or dissolution, to receive any payments or distributions — BEFORE another class of stockholders (e.g., common stockholders).
Other:
Authorized shares are the maximum number of shares that a corporation is legally permitted to issue under its articles of incorporation. In order to increase the amount of authorized shares, the articles of incorporation must be amended with a majority vote from the directors and shareholders.
Outstanding shares are the total number of shares issued by the corporation and held by the shareholders. Generally, each outstanding share is entitled to one vote (regardless of class), UNLESS otherwise provided in the articles of incorporation.
Treasury stock consists of shares that a company issued and subsequently reacquired. Shares that the corporation reacquired are NOT considered outstanding and CANNOT be counted in a shareholder vote.
Options for the Purchase of Shares. A corporation may issue options for the purchase of its shares on certain specified terms that are determined by the corporation’s board of directors (e.g., how the options are issued, the consideration required for issuance, etc.).
Inspection of books and records; purpose and requirements (5.6%)
a) Proper Purpose. A shareholder possesses the right to inspect corporate books and records so long as the purpose for the inspection is proper. In order to be proper, the purpose for the inspection must be reasonably related to a person’s interest as a shareholder. However, a shareholder may inspect the articles of incorporation and bylaws without providing a proper purpose.
b) Procedural Requirements. Generally, a shareholder must:
(1) Make a written demand to inspect corporate books and records and allow the corporation a reasonable amount of time to respond (usually 5 days); AND
(2) Conduct the inspection during regular business hours at the corporation’s principal office.
Fiduciary duty of care (18.5%)
Directors and officers owe the corporation a fiduciary duty of care. This duty includes:
(1) The duty to take reasonable steps to monitor the corporation’s management (duty to investigate and ask questions);
(2) The duty to be satisfied that proposals are in the corporation’s best interests;
(3) The duty to disclose material information to the board; AND
(4) The duty to make reasonably informed decisions. (In making such decisions, directors and officers may rely on information from others whom they reasonably believe are reliable.)
Exam Tip: After discussing whether the director met the duty of care, discuss the business judgment rule.
A “controlling” shareholder—one who owns more than 50% of a corporation or otherwise controls voting power—has a [fiduciary] duty to not abuse their power to disadvantage minority shareholders.
Business judgment rule (18.5%)
In suits alleging that a director, officer, or controlling shareholder [D/O/CS] violated his duty of care owed to the corporation (or in the case of a CS, in examining any dealings that do not involve self-dealing), courts will apply the business judgment rule. This rule establishes a rebuttable presumption that a D/O/CS reasonably believed his actions were in the best interest of the corporation. It protects a D/O/CS from liability for breaching the duty of care UNLESS it can be shown that they: [Good Instincts Or It’s Over]
a) did not act in good faith;
b) was not informed to the extent reasonably necessary;
c) did not show objectivity and had a material interest in the decision;
d) failed to timely investigate after being alerted to a significant matter; OR
e) otherwise failed to act as a reasonable director.
Protected Decisions. A typical decision protected by the business judgment rule includes whether to declare a dividend and the amount of any dividend.
Liability. If a D/O/CS breaches the duty of care, he may be held personally liable for damages. A corporation’s articles of incorporation may reasonably limit the liability of directors and officers for bad judgment, but NOT for bad faith misconduct.
Duty of loyalty (20.4%)
The duty of loyalty stands for the principle that directors and officers of a corporation, in all decisions in their capacities as corporate fiduciaries, must act without personal economic conflict. The duty of loyalty can be breached either by making a self-interested transaction or taking a corporate opportunity.
Note: In a partnership, each partner’s fiduciary duty of loyalty to the partnership and other partners requires that the partner:
(1) Act in good faith and fairly toward the other partners;
(2) Account for any property, profit, or benefit derived by the partner from the partnership business or property; AND
(3) REFRAIN from:
(a) Competing with the partnership within the scope of the business (even during dissolution); AND
(b) Usurping a business opportunity that properly belongs to the partnership (OK if partnership declines it).
(c) Themis: Advancing an interest adverse to the partnership.
Self-dealing/Conflicting interest transactions; duty, exceptions, remedies (13%)
As part of their duty of loyalty, directors and officers have a duty to avoid implicating their personal conflicting interests in making business decisions for the corporation (“self-dealing”). A director/officer has a conflicting interest in a transaction when the director/officer or a family member either:
(1) Is a party to the transaction (includes transactions with another business entity that the director is associated with); OR
(2) Has a beneficial financial interest in the transaction that would reasonably be expected to exert an influence on the director/officer’s judgment if called upon to vote on the transaction.
Safe Harbors. A director/officer that enters into a conflicting interest transaction may be protected from liability if:
(1) A majority of disinterested shareholders approves the transaction;
(2) A majority of disinterested board members authorizes the conflicting interest transaction; OR
(3) The transaction, judged according to the circumstances at the time of commitment, is established to have been fair to the corporation.
Remedies. The transaction can be enjoined or rescinded and the corporation can seek damages from the interested director/officer.
Corporate opportunity doctrine (7.4%)
As part of their duty of loyalty, directors/officers are prohibited from usurping, for their own benefit, business opportunities that rightfully belong to the corporation.
If the corporation would be interested in an opportunity, directors/officers must present and offer it to the corporation first before taking it themsevles. If the corporation declines the opportunity, the director may take it without violating the duty of loyalty.
In determining whether the opportunity is one that must first be offered to the corporation, courts have applied the “interest or expectancy” test or the “line of business” test.
(a) 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. An expectancy can also exist when the corporation is actively seeking a similar opportunity.
(b) Under the broader “line of business” test, the key is whether the opportunity is within the corporation’s current or prospective line of business. Whether an opportunity satisfies this test frequently turns on how expansively the corporation’s line of business is characterized.
How do mergers and consolidations occur? What rights do dissenters have? (11.1%)
A merger occurs when one of two existing corporations is absorbed by the other corporation.
A consolidation occurs when two existing corporations combine into one new corporation.
A merger or consolidation both require:
(1) The recommendation of an absolute majority of the board of directors; AND
(2) The agreement of each corporation by an absolute majority of shareholders.
Exception: Short-Form Mergers. In many states, if a parent corporation owns at least 90% of the stock of a subsidiary, the subsidiary may be merged into the parent without approval from the shareholders of either corporation.
After a merger or consolidation takes place, dissenting shareholders opposed to the merger or consolidation may either:
(1) Challenge the action; OR
(2) Receive payment determined at the fair market value of their shares immediately before the merger/consolidation took effect (and lose the right to challenge the action absent a showing of fraud).
Sales of Substantially All Corporate Assets (5.6%)
Shareholder approval is required for the corporation to sell, lease, exchange, or otherwise dispose of all, or substantially all, of its property if the disposal is NOT in the corporation’s usual and regular course of business.
However, if the disposal of assets is in the corporation’s usual and regular course of business, shareholder approval is NOT required (unless otherwise set forth in the articles of incorporation).
Derivative claims; definition, standing, key requirement, outcomes (14.8%)
A derivative claim is a lawsuit brought by a shareholder, usually against a director or officer, on behalf of the corporation for a harm to the corporation (e.g. bad business decisions, disloyalty). The shareholder is suing to enforce the corporation’s rights when the corporation has a valid cause of action, but has failed to pursue it. This often occurs when the defendant in the suit is someone close to the corporation (e.g., a director or officer).
Standing. A derivative action may be brought by any person who is a shareholder at the time of the bad act or omission (and at the time the action is filed).
Board dismissal—can bring motion if the action is not in the corporation’s best interest. Can be challenged if board was not disinterested or not acting in good faith
Demand. Generally, before commencing a derivative action, a shareholder must make a written demand on the board to bring the lawsuit in the corporation’s name. Then the shareholder must wait 90 days to file the derivative action, UNLESS the board rejects the demand during the 90-day period, or irreparable harm would occur.
Futility exception (some jurisdictions): Plaintiff shareholder is NOT required to make a demand if it would be futile to do so (e.g., the board is interested in the transaction being challenged; if the shareholder is accusing the board of directors of wrongdoing, it would be futile to demand that the board bring a suit against itself).
Damages. If a derivative claim is successful, the proceeds go to the corporation, not the shareholder who brought the action. However, if the award to the corporation benefits the defendants, the court may order that damages be paid directly to the shareholder (and plaintiff’s attorneys entitled to have fees paid by the corporation).
