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