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| ORGANIZATION: A corporation is a legal entity separate from its owners and may be created only by filing certain documents with the State. The State of incorporation governs the internal affairs of the corporation (e.g. roles and duties of directors, officers, & SH). |
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| People: must have one or more, called incorporators. Incorporators execute and file the articles of incorporation. |
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Paper: the Articles of Incorporation are a contract between the corporation and shareholders, and the Corp. and State. Besides the corporate name, address, statement of duration, there must be a specific statement of purpose in articles. If the corporation acts beyond the scope of the statement of purpose, it is called an ultra vires act, in which:
a. shareholders can seek an injunction to halt the ultra vires act; and
b. responsible officers and directors are liable to the corporation for ultra vires losses
i. Definitions of Capital Structure (stock):
1. authorized stock: maximum number of shares the corporation can sell
2. issued stock: number of shares the corporation actually sells
3. outstanding stock: shares that have been issued and not reaquired by the corporation
4. treasury stock: stock that was previously issued and is reaquired by the corporation
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Term
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Definition
Act: file the articles with the Secretary of State and pay the fee. Acceptance by Sec. of State concludes a valid formation. This is also called a De Jure (means “lawful” or “by right”) Corp. There are two other methods of formation:
a. De Facto: requires (1) a relevant incorporation statute; (2) a good faith colorable attempt to comply with incorporation statute; and (3) conduct business in the corporate name and exercise corporate privileges
b. Corporation by Estoppel: says that persons who have dealt with an entity as if it were a Corp. will be estopped from denying the corporation’s existence. Available in contract, not tort cases. “status of these two doctrines have been abolished in many states..”
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| Legal Significance of Incorporation |
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Definition
Legal Significance of Formation of Corp: a corporation is a separate legal person. It can sue and be sued, hold property, be a partner in a partnership, make charitable contributions, and must pay income taxes as an entity.
1. Liability: generally, officers and directors are not personally liable for what the entity does. Generally, shareholders (owners) are not personally liable for debts of the entity. (So if a de jure corporation is not formed, they will be liable.)
2. Liability of pre-incorporation contracts: “a promoter is a person acting on behalf of a corporation not yet formed”
a. corporation’s liability: a corporation is not liable on pre-incorporation contracts until it adopts the contract
b. promoter’s liability: generally, unless the contract provides otherwise, the promoter remains liable on preincorp. Ks until there has been a novation (an agreement of the promoter, corporation, and other contracting party that the corporation will replace the promoter on the contract)
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| Bylaws: adopting bylaws is not required for formation, but most have them. Provide internal governance – lay out responsibilities, set meeting times and places, prescribe method of notice. Adopted by board and repealed by shareholders. If bylaws conflict with articles, the articles control. Bylaws are an internal document, not filed with a state agency. |
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| Foreign Corporations: “foreign corporations transacting business in this state must qualify.” Transacting business = regular course of interstate business, more than sporadic. Qualify = getting certificate of authority from Secretary of State. Apply by giving information from articles, certificate of good standing from home state, pay fee. If don’t, can be fined and can’t sue. |
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| ISSUANCE OF STOCK: occurs when a corporation sells or trades its own stock. It is a way to raise capital for the corporation. |
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| subscription agreement: a written offer to buy stock (note: pre-incorporation subscription agreement is not revocable for 6 months unless it provides otherwise or all subscribers agree—this is so the corporation doesn’t get hung out to dry) |
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consideration: a corporation must receive consideration when it issues stock 1. form of consideration: the traditional rule allowed anything (e.g. cash, checks, tangible or intangible property, services already performed) except promissory notes and future services; however, the modern trend even allows those two. 2. amount: par means “minimum issuance price.” A corporation may sell for more than par, but not less. a. stated capital: this is generated by issuing stock at par value. That is, on a par issuance, the par value goes to the stated capital, and any excess goes to capital surplus. (e.g. Corp. issues 10,000 shares of $2 par stock for $50,000. Of that, $20,000 goes to stated capital, and $30,000 goes to capital surplus.) 3. Consequences for issuing par stock less than part value (i.e. watered stock) -- Directors and person who purchased stock are liable for the difference if they had knowledge. 3rd party purchaser in good faith is not liable. |
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Definition
| preemptive right: only applies to newly issued stock that is sold for cash. It is the right of an existing shareholder (SH) to maintain his percentage of ownership by buying stock whenever there is a new issuance. |
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| Federal Securities law regarding the sale and purchase of stock: Rule 10b-5, §16B, and SOX |
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| Rule 10b-5: this law prohibits fraud and misrepresentation (or nondisclosure) in connection with the purchase or sale of any security (security may be in equity [stock ownership], or debt where an investor lends capital to the corporation to be repaid, making lender a creditor, not a SH). 10b-5 also prohibits most instances of trading securities on the basis of insider information (i.e. information not disclosed to the public that an investor would think is important when deciding whether to invest in a security), or tipping (i.e. passing along material inside information for a wrongful purpose). |
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| Section 16B: this law provides recovery by the corporation of “profits” gained by certain insiders from buying and selling the company’s stock. It imposes strict liability whenever any profit is realized by any director, officer, or shareholder owning more than 10% of a class of the corporation’s stock from the purchase and sale, or sale and purchase, of any equity security within a 6 month period. (i.e. If, within 6 months before or after any sale, there was a purchase at a lower price, the largest number of shares both bought and sold will be recoverable by the corporation.) E.g. D is a director of Acme, Inc. In 2003, D bought 700 shares of Acme stock for $10/share. In Jan. 2005, D sold 700 shares for $6/share. In March 2005, D bought 200 shares for $1/share. The “profit” is $5/share because D bought at a lower price within 6 months of selling at a higher price. You multiply $5 by 200, because 200 is the number common to the shares both bought and sold (700 shares @ $10/share were outside the 6 month window). |
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Term
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Definition
| Sarbanes-Oxley Act (SOX): this law provides an oversight board to register public accounting firms that prepare audit reports for companies registered under the 1934 Act. The board will establish rules for auditing, quality control, ethics, and independence relating to preparation of audit reports. It also prohibits most loans to executives in registered corps. |
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Definition
| Directors: shareholders elect and remove directors with or without cause regardless of term expiration. Directors have a duty of care and a duty of loyalty to the corporation. |
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| Board of Directors Actions |
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Definition
| Board of Directors Actions: two ways to make a valid act: (1) unanimous written consent to act without a meeting; or (2) a meeting that satisfies the quorum and voting requirements. a. quorum for meetings: must have a majority of all directors to do business. If a quorum is present at a meeting, however, passing a resolution (which is how the board acts) requires a majority of only those present. b. voting: voting by proxy and voting agreements are void as against public policy |
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| Duty of Care: burden is on the plaintiff to establish a breach. The standard is: A director owes the corporation a duty of care. He must do what a prudent person would do with regard to his own business. 1. Duty of care can be breached by nonfeasance(director does nothing) [must show causation] or misfeasance (action that hurts the Corp.) 2. Business Judgment Rule (BJR): a court will not second-guess a business decision if it was made in good faith, was informed, and had a rational basis. |
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| Director's Duty of Loyalty |
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Definition
Duty of Loyalty: burden is on defendant to prove no breach, because BJR does not apply in cases involving conflict of interest. Standard: A director owes the corporation a duty of loyalty. He must act in good faith and with a reasonable belief that what he does is in the corporation’s best interest.
1. Interested Director Transaction: any deal between the corporation and one of its directors. Deal will be set aside unless: (1) it was fair to the corporation, or (2) director’s interest and relevant facts were disclosed and the deal was approved by either a majority of the disinterested directors or disinterested shareholders
2. Competing ventures: a director cannot compete directly with his own corporation
3. Corporate Opportunity: a director cannot usurp (take) a corporate opportunity, unless he (1) tells the board, and (2) waits for the board to reject the opportunity
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Term
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Definition
| Director liability: a director is presumed to have agreed with board action unless his dissent or abstention is noted in writing in the corporate records. Note: absent directors, or those placing a good faith reliance on info. are not liable |
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Term
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Definition
| Officers: officers are agents of the corporation. They can set bind the corporation by acts for which they have authority. Officers are selected and removed by the board of directors, and the directors set officer compensation. Officers owe the same duties of care and loyalty to the corporation as directors. |
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Term
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Definition
| SHAREHOLDERS: generally, the board of directors manages a corporation. Shareholders can manage a corporation directly only in a close corporation (one that has few shareholders and the stock is not publicly traded) or where the corporation’s articles or a shareholder agreement provide otherwise. Note: shareholders can also eliminate the board of directors and run the corporation. If they do, the managing shareholders owe the duties of care and loyalty. SH in close corp. owe fiduciary duty. |
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Definition
Shareholder liability (Piercing the Corporate Veil): generally, a shareholder is not liable for the acts or debts of a corporation. But a court might “pierce the corporate veil” (PCV), which means the court will hold shareholders personally liable for what the corporation did. To do this requires (1) that the SHs have abused the privilege of incorporating, and (2) fairness requires it. Note: piercing the corporate veil has only been used in close corporations. Usually occurs in two areas:
1. alter ego (identity of interests): this is when a SH treats the corporation as his alter ego by treating the corporation and personal assets as interchangeable (e.g. commingling personal/corporate funds; using the corporate car as his own; using the corporate credit card to pay for personal purchases)
2. undercapitalization: this is when shareholders failed to invest enough to cover prospective liabilities.
Note: courts are generally more willing to PCV for a tort victim than for a contract claimant (say this on the exam)
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Term
| Shareholder Derivitive Suits |
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Definition
Shareholder Derivative Suits (SH as plaintiff): in a derivative suit, a SH is suing to enforce the corporation’s claim, not a personal claim. Generally, the recovery of any successful derivative suit goes to the corporation—the SH gets attorney’s fees. The requirements for a derivative suit are: 1. stock ownership: the person suing must have owned stock at the time the claim arose or have gotten it by an operation of law (e.g. inheritance or divorce decree) from someone who did own stock at the time the claim arose. 2. must show that the SH will adequately represent the interest of the corporation 3. must make a written demand on the directors that the corporation bring suit (unless demand would be futile—it would be futile if the directors were going to be the defendants) 4. must plead with particularity 5. the corporation can move to dismiss the derivative suit based on findings by disinterested directors that suit is not in the corporation’s best interest (e.g. low chance of success or cost of litigation would exceed recovery). Need court approval. |
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Definition
| Shareholder Voting: the general rule is that a record shareholder as of record date has the right to vote. Written notice must be given to every shareholder entitled to vote not less than 10 or more than 60 days before a meeting. |
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| SH Voting -- Proxy Agreement |
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Definition
| proxy agreement: a signed writing by a record shareholder authorizing someone else to vote. The agreement is good up to 11 months. If the SH who gave proxy was a record SH on the record date, the record date requirement doesn’t apply. |
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| SH Voting -- Voting Trust |
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Definition
| voting trust: requires the corporation to have a copy of the agreement, the trustee has legal title to the shares, and is limited to a 10 year maximum. A trust allows SHs to increase their influence by “block voting” (voting alike). |
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| SH Voting -- Corporate Action |
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Definition
| Corporate action: two ways shareholders can make a valid corporate act: (1) unanimous written consent of the holders of all voting shares, or (2) a meeting that satisfies quorum and voting rules. |
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Term
| SH Voting -- Quorum Requirement |
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Definition
| Quorum requirement: there must be a quorum represented at the meeting. Generally, it requires a majority of outstanding shares, not shareholders. Acceptance of a proposal requires approval of majority of quorum shares. |
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| SH Voting -- Cumulative Voting |
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Definition
| Cumulative voting: this is available only in voting for directors. It is a device to give small shareholders a better chance of electing someone to the board. Your number of votes is: your shares times the number of directors to be elected. |
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| Stock Tranfer Restrictions |
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Definition
| Stock Transfer Restrictions: will be upheld provided they are reasonable under circumstances. i.e. reasonable price. |
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| SH Right to Inspect Books |
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Definition
| Right of SH to Inspect Books of Corporation: any SH can demand access. Must give written demand stating a proper purpose. |
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| Distributions: these are payments to SHs, and can be (1) a dividend, (dividends are paid in descending order to: Preferred, Participating, Cumulative, and Common shareholders), (2) to repurchase a shareholder’s stock, or (3) to redeem stock (redemption is a forced sale to corporation at a price set in the articles. Directors decide on distributions. |
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| Fundamental Corporate Changes |
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Definition
FUNDAMENTAL CORPORATE CHANGES: these are unusual occurrences, (e.g. merger, amendment of articles, dissolution, transfer of substantially all assets, and transfer of shares in a share exchange) so require board of director action and approval by a majority of shares entitled to vote. Note: SHs right of appraisal: the right to force the corporation to buy his shares at FMV is triggered.
A. Effect of merger or consolidation: the surviving company succeeds to all rights and liabilities of the constituent companies
B. Involuntary (by court order) Dissolution: a shareholder can petition because of (1) director abuse, waste of assets, misconduct; (2) director deadlock that harms the company; or (3) shareholder deadlock and failure for at least two annual meetings to fill a vacant board position. (note: an alternative to dissolution might be that the court orders the corporation or majority shareholders to buy the stock of the complaining shareholder)
C. After filing articles of voluntary dissolution or a court orders involuntary dissolution, the corp. stays in existence to wind up.
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