CORPORATIONS FORMING A CORPORATION File Articles – Must be filed with the Secretary of State 1. Name 2. Purpose clause – Can be general or specific 3. Agent for service of process – Name and address 4. Capitalization – # of shares that can be sold, any more sold are void 5. Execution – Signing the articles Amending the Articles – Board must first vote to amend, then stockholder must approve ULTRA VIRES (Shareholders or A.G. v. BOD) – beyond the purpose (of the corporation) 1. This cause of action can only come about if there is a specific (not general) purpose clause 2. Who can sue? A. Contracting parties usually can not sue for Ultra Vires, we assume the contracting parties have knowledge of the articles B. Stockholders can use UV to sue and get out of a contract, if contract already executed then can sue directors for damages as well C. The Attorney General can sue for Ultra Vires 3. Charitable gifts A. Old days a corp needed to be authorized by the articles to give charitable gifts B. Now corp can give charitable gift unless it is prohibited by articles, gift must be reasonable 4. Fiduciary duty – Breach of duty of due care when directors enter into a contract outside of business purpose. Breach of duty of loyalty if the contract serves personal interests rather than interests of corporation. PRE-INCORP PROMOTER (a person who, acting alone or in conjunction with one or more persons, directly or indirectly takes initiative in founding or organizing the business or enterprise) LIABILITY (3rd party v. Promoters) 1. Promoters are presumed liable. Generally all promoters are liable even if only one signs his name unless there is an indemnification clause. 2. For promoters to avoid liability must do two things before corp is formed: A. Sign in an agency capacity B. It must be clear that the contracting party is looking to the corporation once it is formed for payment (if you pay out of pocket then you do not satisfy this element) 3. If do not do those 2 things, can still avoid liability once the corp is formed if: A. There must be an adoption by the board of directors of the corp (if the board does not act then may be considered acquiescence) – Remember if adopted there may be a cause of action for breach of due care and/or loyalty. B. There must be a written novation (takes 3 parties to make a novation) 3. Plaintiff is contracting party, Defendant is promoter, not corporation DEFECTIVE INCORPORATION – At the time the contract was formed or the tort occurred, did the corporation exist? Plaintiffs can be creditors or tort Ps. Defendants are stockholders. 1
1. MBCA Jurisdiction (D is only active shareholders, remember that in Stat Close Corp all shareholders are active) – The date the articles are stamped is conclusive. A corporation is in legal existence on the date that the articles are stamped. The corporation is De Jure if stamped, it is too defective if not stamped. A. If the contract is entered into prior to articles being stamped, then the stockholders that are more than passive are liable 2. Non MBCA Jurisdiction (D are both active and passive shareholders) – 3 theories to have proper corporation A. De Jure – Substantial compliance with all mandatory conditions precedent. Basically the articles must be “filed/received” with the Sec of State, must have all 5 provisions with no substantial errors and the fee must be mailed. Eg. Zip Code missing is a substantial error. B. De Facto – Use of corporate privilege (sign contracts with only name of corporation), and a good faith attempt to comply with all mandatory conditions precedent. Eg. Zip Code missing is ok, but unsigned articles not ok. C. Corp by Estoppel – Holding out of the corporate form and the third party relying thereon. PIERCING THE CORPORATE VEIL – P is 3rd party, and D is shareholders 1. Elements A. Lack of corporate formalities – 4 positions must be filled (Pres, VP, Sec, Tres) but need only two people (pres, and secretary), keeping corporate books, financial records, ledger, stockholder meetings, director meetings, corporate bank account, stockholders not use corporate property, contracts signed in corporate name B. Lack of adequate capital (adequate insurance in tort action is usually a factor for adequate capital, in NY it is conclusive) i. Type of business – Manufacturing (needs more) v. Service (needs less) ii. Reasonable business expenses iii. Foreseeable risks – Look for yogurt shop next door iv. Look at continuing capital as well 2. Contract v. Torts – In tort cases there is no lasting relationship so there is more leeway. Only need to prove one of the elements 3. Equity – This is an action in equity, even if prove elements judge look at equity A. Parent/Subsidiary relationship – Parent company is stockholder, so if you pierce the veil you get to business assets B. Stockholder/Company – Stockholders are people, so if you pierce the veil you get to personal assets C. Enterprise liability – Separate companies that are run by the same person CAPITALIZATION -- SHAREHOLDERS RIGHTS 1. Typical right of Shareholder A. Voting right B. Dividend right C. Liquidation right INADEQUATE CONSIDERATION – Proper consideration for stocks; Plaintiff is stockholders (protect from dilution of interests) or creditors (protect because they are relying on capital of corp); Defendant is BOD, Remedy is to have the proper consideration paid or cancel the shares. 1. Qualitative test – What kind/type of consideration can we have? 2
a. Cash b. Services Rendered – promoters render services to the JV not the corporation c. Property – can be a note but must be secured, if it is an invention it must be patented 2. Quantitative test – Amount of consideration must equal # of shares issued X par value or no par stated value a. Good Faith Jurisdiction – Services rendered or property must be valued by BOD. If they make a mistake in good faith you still pass the test. b. True Value Jurisdiction – If there is a mistake, even one penny lower, then do not pass the test. 3. Name that stock a. Not valid type of consideration – Bonus Stock b. Not enough cash – Discount Stock c. Not enough property or services rendered – Watered Stock 4. Exception – Recycled stock – This stuff only applies to original issuance. § 5 SEC act of 1933: Requires the filing of a registration statement of all securities being placed in the hands of the public for the first time. If you meet the requirements, at the time of offering you must have either filed a registration statement or have found an exception. o Exception: 4.2 – If all offerees of a publicly held corp. are key employees then no need to register. Unclear if closely held corp. must register at all. INVESTMENT CONTRACT (Scheme Victim v. The person or entity that sold the K) 1. Elements a. Must have an investment of some kind off legal consideration b. For Profit c. Two or more investors in a common enterprise d. You must be a passive investor (were you relying on the managerial efforts or others)? – How did you expect to get your return, are you doing the real work? 2. COA – Rescission of K, if you can prove it was an investment K, and the promoter did not register with the SEC and did not have an exemption at the time he offered the K, then you can get a rescission under § 5. a. Exemption – Only selling to small number of investors in a closely held corp (key employees in public corp) NON-PAYMENT OF DIVIDENDS a. Closely held corp (Minority v. BOD) – Must show Bad Faith: Policy of directors dictated by their personal interests rather than corporate welfare i. Hostility – Pattern of behavior over a long time period; and ii. The majority shareholders are getting money from the corp. in other ways b. Publicly held corp (Shareholders v. BOD) – Must show lack of business purpose STATUTORY CLOSELY HELD CORP – The stockholders are allowed to manage the company, no need for independent officers and BOD 3
1. Two additional provisions in the articles of incorp a. “This is a close corp” b. “No more than 35 stockholders” If shares are restricted, if 36 shareholder gets in, his shares are void. If shares are not restricted, if 36 shareholder gets in, no longer a statclose corp. SHAREHOLDER’S RIGHTS A. Generally a. Voting b. Dividend i. No automatic dividends, BOD must meet and declare dividends c. Liquidation i. Creditors first, stockholders next. B. Special rights per AOI a. Dividend i. Preference – If declared, then take preference first ii. Cumulative – If declared and not paid, then rolls over iii. Mandatory – Must be paid unless can not meet legality test, then it rolls over like cumulative b. Pre-emption rights – see below c. Convertibility – Can be converted from one class to another d. Redemption – Can force a repurchase, this is usually at option of corp. but can also be at option of shareholder. Also see below for legality test. e. Voting shift – “In the event of two consecutive years of non-payment of dividends, voting rights would be given to the preferred stockholders” SHAREHOLDER ACTIONS (affected party v. corp.) A. Types 1. Straight Voting – majority rules of every director on the board a. Classified board means that each class is responsible for voting on certain directors 2. Cumulative Voting – gives hope to the minority a. In CA there is mandatory cumulative voting b. In DEL the corp. chooses B. Ways to hold election 1. All members of BOD at the same time 2. Staggered – Member of BOD come up for vote at different times a. In mandatory cumulative jurisdictions min of 2 or 3 (depends on jurisdiction) board members up for vote each time C. Pooling Agreement 1. Only requirement for a pooling agreement to be valid is that the stockholders are voting for a proper matter. 2. Can be written or oral. D. Voting Trust 1. Separation of legal title – Must give share to the trustee, he becomes the record owner. The others are beneficial owners. 2. The agreement must be written and open for inspection by other investors 4
3. By law it can be no more than 10 years 4. Must be voting on a proper matter i. Statutory Close Corp. – Stockholders can vote on everything ii. Non-Stat Close Corp. – Stockholders can only vote on extra-ordinary matters (dissolution, amend by laws or AOI, mergers, voting for directors, filling vacancies, removing directors). Can not vote on salary, dividends, officers. If voting trust or pooling agreement not legal, then what was voted on by them will be void. E. Requirements for a formal stockholder meeting 1. Notice of meeting – Directors must give notice of not less than 10 days and not more than 60 days. 2. Record date – Must set a record date not less than 10 days, and not more than 60 days. The stockholders of record on that date will be the ones who can vote. If anyone becomes stockholder after that date they should get a proxy to vote. Proxy is signed by the record owner. 3. Quorum – A majority of the outstanding voting shares must vote 4. Valid vote – Can be a majority of those who vote, or supermajority. 5. There can be no substantial harm to another class If one of the requirements is not met, then just like vote never occurred F. Requirements for valid vote by Written Consent 1. Voting on proper matter 2. Majority of outstanding voting shares must approve (sign) it 3. There can be no substantial harm to another class Voting by Written Consent for directors must be unanimous
LEGALITY OF DISTRIBUTION – Sue the Directors (SH or Creditors v. BOD) 1. Dividends A. Proper Source – Are the dividends being paid from a proper source? i. Capital Surplus/Paid-in Surplus – Amount of money from selling stock above par value; OR ii. Earned Surplus/Retained Surplus – Money from retaining earnings B. Solvency – The corp. must also be solvent i. Balance Sheet Test – Assets must be greater than liabilities; and ii. Cash Flow Test – The corp. must be paying debts as they come due 2. Redemption – First of all must be in the AOI A. Proper Source – Are the dividends being paid from a proper source? i. Capital Surplus/Paid-in Surplus – Amount of money from selling stock above par value; OR ii. Earned Surplus/Retained Surplus – Money from retaining earnings; OR iii. Stated Capital (GUTS) can be used to pass proper source test only to pay arrearages (cumulative dividends piling up) and the corp. is in financial hardship B. Solvency – The corp. must also be solvent i. Balance Sheet Test – Assets must be greater than liabilities; and ii. Cash Flow Test – The corp. must be paying debts as they come due 3. Repurchase – This is a voluntary act on the part of corp. and shareholder
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RESTRICTIONS – Restrict transfer of stock, Only for Close Corp. (Corp v. Transferee) 1. Must be conspicuous as to form and content (exception is when the transferee has actual knowledge a. Form – There should be some kind of notice on the front (reasonable person standard). b. Content – Should be clear as to what the restrictions are. Can reference another document, as long as the other document is clear. 2. Restrictions must be reasonable. The triggering events that cause restrictions can be death, incapacity, divorce, bankruptcy, or sale 3. There must be notice given to the corp. in a reasonable time. If any one of the test not met, then the restriction is not valid and the transfer is good. DIRECTOR ACTIONS 1. Formal Meeting a. Notice – Must simply be reasonable notice (24 hours). Can be waived if all directors waive it b. Quorum – Majority of the authorized # of directors must vote. The exception is when it is impossible to make quorum, then majority available must show, then majority of those vote for new directors, no other actions can take place until all directors spots filled. c. Valid Vote – Usually majority of those who vote 2. Written Consent a. Votes by written consent must be unanimous 3. Telephonic Conference – Same requirements are formal meeting 4. One director binding the corp.? – Only for Close Corp. (MICKSHAW) a. Only if he goes back to the board and gets acquiescence from all other board members, and the board has full knowledge when they acquiesce. OFFICER ACTIONS (Parties) 1. Express Authority – An officer can get a certified (by the secretary) board resolution, stamped and signed. 2. Implied Authority a. President – Implied authority for ordinary, regular, day-to-day actions (hiring and firing of employees, short term loans (1 year) with a reasonable percentage rate). b. VP – has president power on if president is incapacitated c. Secretary d. Treasurer VACANCIES 1. Directors or stockholders can remove directors. Look to bylaws. 2. Can remove with cause (egregious conduct) or without cause. a. With cause is typically because of a loyalty problem b. If trying to remove a director that was voted in by cumulative voting without cause, then the minority shareholders have an opportunity to cumulate votes against removal. 3. If vacancy look to bylaws to see who fills. 4. If directors are trying to fill vacancy 6
a. Director meeting with quorum b. No other matter may be decided at the meeting INVALID PROXY COA – A valid proxy is signed by the record owner and lists the name of the person voting. 1. Proxys are revocable upon: a. Notice of attendance of record owner at annual meeting, notice is given by going to the inspectors of the election and letting them know you are there b. Notice of death (notice given to secretary or inspector of election) of record owner c. Notice of incapacity of record owner 2. Proxy not revocable if consideration given. Rule 14A comes into play when (1) there is a solicitation and (2) it involves a public company. a. To be public, must be traded on NYSE or AMEX, or have 10 mil in assets and 500 or more stockholders in a voting class. 14(a)(9) – Shareholders or SEC v. BOD or anyone who makes statement False or misleading statement or omission that is material in connection with a proxy solicitation. 1. Material means that there is a substantial likelihood that a Rx person would find it important 2. The level of culpability is simple negligence 3. There also must be some sort of loss (monetary or goodwill) 4. Essential Link Test – Was minority vote needed to pass? Remedies include rescinding actions, or if merger then too hard to rescind, so damages 14(a)(8) – Shareholders v. BOD Shareholders go to BOD and ask for a proposal for the stockholders to vote on. Shareholder must be record or beneficial owner of either 1% or $2,000 of the corp’s VOTING
stock AND must have owned this amount for at least one year prior to the meeting
BOD can exclude it if: 1. It relates to an ordinary matter (unless social policy implicated) 2. It relates to a matter that management has a specific proposal on (counter to the management) 3. It relates to an election 4. It is Ultra Vires BREACH OF DUE CARE (Shareholders v. BOD) Key Defense is the 6th provision in the AOI – BOD not liable for due care causes of actions for damages 1. Stockholder must show that the directors did not meet standard of duty to be fully informed (reasonable prudent person in similar circumstances) a. Key is to be informed, if there is a merger must get a fairness opinion from an investment banker, if regarding compensation there should be an independent fairness committee b. If director has specialized knowledge then will be held to higher standard 2. Stockholder must show breach of duty rose to level of Gross Negligence 7
a. For Compensation Analysis i. Closely held corp. – salaries must be unreasonable ii. Publicly held corp. – salaries must amount to waste 3. Causation – But for test 4. Losses – This can be monetary or loss of goodwill Defenses: I abstained from voting, I wasn’t there when they voted for it, etc. BREACH OF LOYALTY – SELF-DEALING (Shareholders/Creditors? v. Director involved) Burden of proof on Director because no BJR because not BOD decision 1. Impartial Board Approval with Full Knowledge – Member with interest can not vote, can count towards quorum, but not vote. 2. Impartial Stockholder Approval with Full Knowledge – Stockholder with interest can not vote, but can count towards quorum. 3. Prove that the transaction was fair – If don’t have one of the first two, then prove that the transactions was fair in court. Look for compensation issues
BREACH OF LOYALTY – USURPATION OF CORPORATE OPPORTUNITY (Shareholders/Creditors? v. Director involved) Burden on director to show that it was not a corporate opportunity. 1. Not in the current line of business or future expected line of business 2. The opportunity was U.V. 3. The opportunity was offered only to the board member, not to the corp. 4. The opportunity was illegal (anti-trust issues) 5. Corp. doesn’t have the resources (very weak) 6. Estoppel – BOD knew about opportunity and did nothing Remedies: Disgorgement BREACH OF LOYALTY – PARENT/SUB NON-MERGER SITUATION (Minority shareholders of sub v. BOD of parent) 1. Minority shareholders of the sub must first show that parent received some benefit to the exclusion and detriment of the minority shareholders a. If minority received any benefit then the C.O.A. is dead 2. Then the burden shifts to the BOD of parent to prove that deal was fair (long term benefit) BREACH OF LOYALTY – PARENT/SUB CASH-OUT MERGER (Minority shareholders of sub v. BOD of parent) Make sure there is a valid approval by BOD and shareholders of parent AND sub. 1. Minority shareholders must show lack of fair dealing (look to see if a true negotiation took place, was there an independent merger and acquisition committee?); and 2. Minority shareholders must show lack of fair price
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Remedy: Minority shareholders are paid the difference between what they were paid and what they should have been paid (appraisal) absent the breach of loyalty. Defenses by BOD: The deal was fair BREACH OF LOYALTY – TARGET DECISION TO DEFEND (Shareholders of the target corp v. BOD of the target corp) BRJ does not lock on because it is presumed the BOD is acting to save their own jobs 1. The BOD must prove there was an actual or perceived threat of a bust up merger a. Actual – Acquirer just tells you b. Perceived – Duty to do a reasonable investigation, look to see if the target has cash lying around, look to the history of the acquirer 2. The BOD must prove that the defense mechanism was reasonable a. Poison Pill (The option to buy more stock is given to current S.H.’s) is reasonable b. Golden parachute (immense compensation packages given to high level execs if there is a takeover) is reasonable or not depending on the size of compensation c. Scorched Earth (the company just guts itself) is not reasonable. d. Porcupine Provisions are reasonable. Staggered boards are reasonable as long as more than one comes up for election at a time. Super-majority provision are reasonable as long as less than 85% e. Shark Repellant (if the target runs into court and grabs a control share acquisition statute) is always reasonable f. Pac-Man (turn around and make offer on the acquiring company) depends, here is depends on the terms. g. Selling Crown Jewel is not usually reasonable h. Self-Tender offer depends i. White Knight is where the target seeks another acquirer, it depends. j. Tin Parachutes are never reasonable (huge severance given to all employees) k. Declaring a dividend depends l. Any kind of tactic that makes the target unattractive, depends BREACH OF LOYALTY – DUTY TO AUCTION (Shareholders of target v. BOD of target) Merger situation where one public company with widely dispersed ownership is being targeted by another company with primarily one controlling shareholder If Duty is triggered, then the BOD must: 1. Take away all defensive mechanisms in the target 2. Open up the bidding process, give all bidder the same info 3. Get the best value for the stockholders NOW
INSIDER TRADING 10(b)(5) (Actual Purchaser or seller or SEC v. Insider) Anyone who is an insider has a duty to disclose material info or abstain from tipping or trading. 1. Self-Trader a. Must be an insider i. Traditional – executive officer 9
ii. Constructive – someone in a position of trust or confidence with the corporation b. Must personally benefit i. Financially ii. Non-financially 2. Tipper a. Must be an insider b. Must personally benefit 3. Tippee (receive info from tipper and must trade on info) a. Tipper must be an insider b. Tippee should have known that the tipper was betraying a relationship of trust (intentionally tells tippee) c. Tipper personally benefits The information must be material – a substantial likelihood that a reasonable person would find the fact important Scienter – Must be intent to defraud Reliance – Reliance is presumed based on fraud on the market Causation – Knowing possession satisfies causation
Defenses: Disclosure (disclosed to a wide audience and market had time to react [15 min]), didn’t have scienter (best chance is when you are a tippee and your tipper is constructive insider) If can not get under traditional theory of insider trading go to misappropriation theory (Sec v. X): 1. Fiduciary Relationship – Put someone in a position of trust or confidence (family relationship alone does not create this duty) 2. That person deceptively trades on confidential information Defenses: Disclosure
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