Corporations/Business Entities Big Picture Outline

Six Major Fact Patterns:
  • Organization of the Corporation
  • Issuance if Stock
  • Action by & Liability of Directors & Officers
  • Rights of Shareholders
  • Fundamental Corporate Changes
1. Organization of the Corporation

A. Specific statement of purpose Ultra Vires Rule (beyond the scope of the articles/ activities)
B. Legal Significance of the Formation of the Corporation

  • Corp is a separate legal person
  • B/c corp is a separate entity, the people who run it and own it usually are not liable for the debt it incurs
  • Limited Liability

C. Pre-incorporation Contracts

  • Liability of the corporation
  • Generally, unless the K says otherwise, the promotor remains liable on pre-incorporation contracts until there has been novation, i.e. an agreement of the promotor, the corporation, and the other contracting party that the corporation will replace the promotor under the K

When the Corporation is not Properly Formed [discussion of de jure, de facto, and corporation by estoppel concepts.]
Pierce “Corporate Veil” [Fraud, Undercapitalization, and Alter Ego Theories].
Unpaid Stock
Watered Stock

2. Issuance of Stock

Subscription Agreements (revocability)
Consideration- What must the corp. receive when it issues stock? [There is a split in jurisdictions]

  • Board’s valuation conclusive it is made in good faith
  • Consequences of issuing par stock for less than par value; i.e. “watered stock”
  • What if X transfers the stock to A? A is not liable if she acted in good faith [did not know about the “water”]
  • You cannot have promissory notes for Consideration [some say it is okay if secured].
  • Cannot have future services for consideration
    Redemptions and Repurchases of Stock
3. Directors & Officers

Meetings– Unless all directors consent in writing to act without a meeting, a meeting is required. A conference telephone call is a “meeting”- just so the directors can hear all the participating directors simultaneously; no notices needed for regular meetings.

 

Rule of Directors– the Board can delegate substantial management functions to a committee of one [some states say two] or more directors. Some states require that the power to delegate be established in the articles; others assume the power exists unless it is taken away by the articles or bylaws; either wat, a committee generally cannot declare dividends, amend bylaws, recommend fundamental corporate change, or fill a Board vacancy.

 

Effective Board Action

  •  Need quorum
  • Majority of quorum wins
  • Voting agreement is not allowed; no proxies 

Board Vacancy 

  • May be filled by other directors or shareholders 

Director Duties 

  • Duty of Care [most important]
    •  A director owes the corporation a duty of care. This means that she must act as a prudent person would with respect to her own business affairs.
    • She is liable only if her breach caused loss to the corporation [this standard is very tough to show].

 Misfeasance– when the director does something that causes harm to the corporation. 

  • Where the directors action caused a loss to the corporation, they are not liable if they meet the Business Judgement Rule (BJR). BJR goes back to being prudent- did they do their appropriate homework, analyze, inquire, etc. A ct will not second=guess a business decision if it was made in good faith, was reasonably informed, and had a rational basis

Duty of Loyalty [burden is on the D] 

  • A director owes the corporation a duty of loyalty. She must act in good faith in a manner she reasonably believes to be in the corporations’ best interest.
    • Insider Trading
    • Self-Dealing (“interested director” transaction, I.E. any deal between the corporation and one of its directors or a director’s close relative, or another business of the director)
    • A director may not self-deal and is liable for damages unless the interested director can show:
      • the deal is fair or
      • the interest is disclosed or known [full disclosure of the material facts] and approved by a majority of the disinterested directors or a majority of disinterested shares.
      • Remedy is rescission
    • Compensation to the director must be reasonable
    • Fiduciary director cannot compete directly with his corporation [remedy = constructive trust on profits and maybe damages as well]
    • Director cannot usurp corporate opportunity

 Which Directors are Liable? 

General Rule: A director is presumed to have concurred with Board action unless her dissent or abstention is noted in writing in corporate records. 

Exception: Good Faith reliance on financial statements prepared by auditors, book value of assets, or on the opinion of a competent employee or professional.

Corporate Opportunity Doctrine: a director cannot usurp or engage in a business opportunity belonging to the corporation. The opportunity must be necessary to the corporation.

Remedies are:

  • Damages
  • Constructive Trust
  • Corporation gets opportunity at cost

Compete with Corporation

Remedies are:

  • Damages
  • Injunctive relief

Officers: agents of the corporation who run the day-to-day operations (President, Secretary, Etc).

  • Chosen by the Directors
  • May be removed without cause
  • Corporation is not liable for contracts made by officers without actual, inherent or apparent authority to enter into the contract for the corporation
  • Entitled to reasonable and fair compensation and reimbursement for corporate expenses
  • Duty of Care

 

4. Shareholders
  • General Rule: A shareholder is not liable for the debts of a corporation. However, a court might “pierce the corporate veil” [PCV] and hold the shareholders liable personally if they have abused the privilege of incorporating and limited liability would be inequitable.

Shareholder Management of a Corporation– shareholders can run a close corporation. [same duties of care and loyalty but they are heightened]

Shareholder Inspection Rights

  • May only inspect records, books, shareholder lists, etc., i.e. what’s on paper [as compared to inspecting factory]
  • Need a proper purpose

 

Shareholder Derivative Suites

  • In a derivative, a shareholder is going to enforce the corporation claim [ask, could the corporation had brought this suit? If so, it is probably a derivative suite].
  • Almost all derivative suits involve a breach of the duty of care or loyalty.
    • Requirements to bring an SDS:
      • Must be a shareholder at the time when the suit was brought
      • Prior demand on the board of the directors unless this would be totally futile
      • Bond
      • Stock ownership
      • Written demand
      • Complaint, etc. etc. etc.
      • No dismissal without court approval
      • If the suit is successful, the recovery goes to the corporation and the individual is reimbursed for litigation costs

Distinguish from a Shareholder Direct Suit

Controlling Shareholder’s Relation to Minority Shareholders

  • Is fiduciary to other shareholders and the corporation

 

Voting

  • SH elects the directors and may remove them
  • Only SH as of record date can vote
  • SH decides major changes and decisions

Proxies – biggest exception

  • Must be written
  • Must be signed
  • Expiration-11 months unless noted otherwise
  • Revocation- easily revocable unless coupled with an interest

Meetings

  • There must be an annual meeting and may have a special meeting
  • SH quorum required (Majority); there can be action without a meeting if there is written consent (in some states)
  • Notice Requirement [contents of Notice: must always state when and where the meeting is and the purpose of said meeting. The statement of purpose is important, as it limits what can be done.]
    • Notice must be given at least 10 days prior to the meeting and no more than 60 days before the meeting
    • Special Meeting requires a 2-day notice
    • Notice can be waived by express waiver or attending the meeting

Effective Shareholder Action

  •  Quorum Necessary
  • Majority Quorum Wins
  • Cumulative Voting [for directors only

Shareholder Agreements to Control Voting

  • Pooling Agreements
  • Voting Trusts
  • On file
  • Expired in 10 years
  • Stock transfers restriction agreements [must be reasonable restriction].

Preemptive Rights – only applicable to

  • Newly authorized stock
  • Sold for cash

Dividends

  • No right to them
  • Irrevocable once declared
    • Insolvency exception
  •  Payable out of:
    • Earned surplus- always
    • Stated Capital- never
    • Other surplus accounts- maybe, depending on the state

Distributions– payments to shareholders can be divided or payments to repurchase shares or to redeem shares [forced sale to corporation at the price set in the articles].

  • Shareholders have no right to a distribution until it is declare
  • Corporation can make distributions if it is insolvent or if the distribution would render it insolvent.
    • Insolvent = unable to pay debts as the come due OR assets are less than the liabilities.
    • Good Faith Defense = remember that the directors can always raise the important defense of GF reliance
5. Fundamental Corporate Change

Mergers- A corp and B corp form A corp

  • Directors and shareholders of both corporations must approve, the latter by majority of shares entitled to vote.
  • Appraisal Rights of Dissenting Shareholder
    • Requirements:
      • Written objection before meeting
      • Vote against merger or abstain from voting
      • File written claim

Consolidation- A corp and B inc. form C corp

General Rule: Buying a corporation does not succeed to the liabilities of the seller corporation unless the agreement provides otherwise, or the company buying the assets is a “mere continuation” of the selling company.

Sale of Assets

  • Majority of directors and majority of shares entitled to vote must approve
  • Appraisal rights
    • May be treated as “de facto Merger”. If so, merge rules approve.

Amendment of Articles

  • Majority of directors and majority of shares entitled to vote must approve [no quorum concept]
    Dissolution- Involuntary- shareholders petition because of director abuse, etc.
  • Majority of directors and majority of shares entitled to vote must approve [no quorum concept]
  • If liquidation, pay outside creditors first

 

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