Corporations 1 Formation Requirements (1) Incorporators: must have at least one person or entity; must sign & file AoI. (2) Articles of Incorporation: articles are a contract between (i) Corporation & Shareholders and (ii) between Corporation and State. o Information required in Articles: (i) Names and addresses of Corporation (Corp, Company, Incorporated, Limited) (ii) Names and addresses of each Incorporator SPLIT: some states require names and addresses of initial directors. (iii) Statement of Duration (required only if less than perpetual existence). (iv) Statement of Purpose General Statement of Purpose is ok (i.e. ―to engage in any lawful activity") Ultra Vires= when corporation acts beyond the cope of the articles. o Today; Ultra Vire contacts are valid; but Shareholders can seek an injunction and officers, directors, & employees are liable to Corporation for Ultra Vires losses. (v) Stock Authorized Stock- maximum # of shares the corporation can sell. Issued Stock- number of shares the corporation actually sells Outstanding Stock- shares that have been issued and not reacquired by the corporation. Articles must include: Authorized stock, number of shares per class and information on par value, voting rights and preferences of each class. (3) Filing and Fee o Incorporators must file articles with Secretary of State and pay required fee. Acceptance by Secretary of State is conclusive proof of valid formation. (In some states, Secretary’s issuance of certificate of incorporation is conclusive proof of valid formation.) o This creates a DE JURE CORPORATION. Legal Significance of Formation of Corporation Internal Affairs of Corporation: roles and duties of directors, officers, and shareholders are governed by the law of the state of incorporation. Limited Liability: shareholders (owners) are not personally liable for debts of corporation. This is the principle of ―limited liability,‖ which means that shareholders generally are liable only for the price of their stock. Separate Legal Person: A corporation is a separate legal person. It can sue and be sued, it can hold property, it can be a partner in a partnership, it can make charitable contributions, it must pay income taxes as an entity. Defective Corporation De Facto Corporation: o (a) there is a relevant incorporation statute; (b) the parties made a good faith, colorable attempt to comply with it; and (c) some exercise of corporate privileges. o Example: Incorporators draft and sing articles and mail them to Secretary of State. They think they formed a corporation, but the articles were lost in the mail. o If applicable, treated as corporation for all purposes EXCEPT in an action by the state for exceeding its powers (called Quo Warranto). Corporation by Estoppel
Corporations 2 o One dealing with a business as a corporation, treating it as a corporation may be estopped from denying the business’ corporate status. o Can be invoked against (1) the corporation from avoiding an obligation; (2) those who dealt with the corporation. Status of the 2 doctrines: Abolished in many states.
Bylaws = for internal governance- e.g. lay out responsibilities, set regular meeting times and places, prescribe methods of giving notice. Who adopts? Board of Directors @ the organizational meeting. Who can amend/repeal? Generally, only the shareholders can amend/repeal the bylaws (some states the Board of Directors). In most states, adoption of bylaws is not a condition precedent to formation of a corporation. Promoter Liability & Pre-Incorporation Contracts A promoter is a person acting on behalf of a corporation not yet formed. Liability on Pre-Incorporation Contracts o Rule: A corporation is not liable on preincorporation contracts until it ADOPTS the contract. o Adoption: 1 of 2 ways: (1) Express: Board of Directors act to adopt the contract (2) Implied: Corporation accepts a benefit of the K. Adoption does not relieve the promoter from liability. Only Novation does. Liability of the Promoter on Pre-Incorporation Contracts o Unless the contract clearly provides otherwise, the promoter remains liable on preincorporation contracts until there has been a Novation. Novation= an agreement of the promoter, the corporation, and the other contracting party that the corporation will replace the promoter under the contract. Secret Profit Rule o = promoter cannot make a secret profit on her dealings with the corporation. o What promoter paid is irrelevant, all we care about is Price Paid by Corporation and Fair Market Value. o Promoter is only liable if the profit is SECRET. Not a problem if Corp. knew. Foreign Corporations Foreign Corporation= incorporated outside this state. Foreign Corporations transacting in this state must qualify by getting a ―certificate of authority‖ from Secretary of State. Transacting= regular course of intrastate business activity. Not occasional or sporadic activity. Consequences of foreign corp. transacting without qualifying= civil fine and corp cannot sue in the state. ISSUANCE OF STOCK Issuance of stock occurs when a corporation sells or trades its own stock. It is a way to raise capital for the corporation. (these rules don’t apply to random shareholders) Subscriptions= written offers to buy stock from corporation o Revocable until acceptance. Corporation and subscriber become obligated when the board accepts the offer. At that point, the subscriber is obligated to buy the stock and the corporation is obligated to sell to her.
Corporations 3 Consideration= what the corporation must receive when it issues stock o Traditional Rule: (1) money (cash or check), (2) tangible or intangible property, or (3) services already performed for the corporation. o Modern Trend: (1), (2), (3), (4) future services; (5) promissory notes. o Amount of Consideration: Par Value (minimum issuance price) if Corporation sets one. If No Part Value, Board of Directors sets a price. Treasury Stock= stock that was previously issued and has been reacquired by the corporation. The corporation can then resell it. **For Treasury Stock- no PAR value. Corp can sell it for anything. Watered Stock= If Corporation Issues par stock for less than par value The Directors AND the BUYER are liable for watered stock, if they have notice. (notice or not, directors are liable) Preemptive Rights= the right of an existing shareholder to maintain her % of ownership by buying stock whenever there is a new issuance of stock for money (cash and equivalent). o Some states do not consider treasury stock or un-issued shares for preemptive rights. o ***Preemptive Rights exist only if it is $. If it is property, do not exist.
DIRECTORS & OFFICERS Statutory Requirements o Number- 1 or more adult human beings o Election- shareholders elect directors (at the annual meeting). Can elect the entire board or can stagger the board by halves or thirds (―staggered terms‖). ―Classified board‖= directors are grouped into different classes and each class is elected by a designated class of shares. o Removal: Shareholders can remove directors before their terms expire WITH OR WITHOUT CAUSE. Requires the vote a of a majority of shares entitled to vote. Court may remove a director for fraud or gross abuse (most likely in a closed corporation). Generally, the Board fills the vacancy on the Board. o Board Action: There are ONLY two ways the board can take a valid act. (1) unanimous written consent to act without a meeting, or (2) a meeting that satisfies QUORUM and VOTING REQUIREMENTS. A conference call qualifies as a meeting- just so all directors can hear each other simultaneously. If neither (1) nor (2) is met, the act is VOID unless later ratified by a valid corporate act. Notice is not required, unless it is for a special meeting. No Proxies or Voting agreements allowed for Director voting. (against Public Policy) Quorum= must have a majority of all directors to do business (unless a different % is required in bylaws). If a quorum is present at a meeting, however, passing a resolution (which is how the Board takes an act at a meeting) requires only a majority vote of those present. (9 directors, need 5 for a quorum. Need 3 for a resolution). Quorum of Board can be ―broken‖ if people leave. Role of Directors o The directors have access to corporate records so they can discharge their responsibilities. o Committees: Board delegates substantial management functions to a committee, but a committee cannot amend bylaws, declare dividends or recommend a fundamental corporate change to shareholders.
Corporations 4 o A committee is made up of 1 or more directors. DUTY OF CARE o A director owes the corporation a duty of care. She must act in good faith and do what a prudent person would do with regard to her own business. Causation Required- must show the Directors’ breach caused a loss to the corporation. o Misfeasance: the board does something that hurts the corporation. o Business Judgment Rule: A Director is not liable if he meets the BJR: act in GOOD FAITH, was INFORMED, and had a RATIONAL BASIS. Only in trouble if irrational or grossly negligent. DUTY OF LOYALTY o A director owes the corporation a duty of loyalty. She must act in good faith and with a reasonable belief that what she does is in the corporation’s best interest. o Interested Director Transaction: any deal between the corporation and one of its directors or another business of the director’s. Rule: interested director transactions will be set aside UNLESS the director shows: (1) the deal was fair to the corporation when entered, OR (2) her interest and the relevant facts were disclosed or known and the deal was approved by either a majority of the disinterested directors OR majority of the disinterested shares. Special Quorum rules- interested directors might count toward quorum o Competing Ventures: Director cannot compete directly with the corporation. o Corporate Opportunity (Expectancy): Director cannot USURP a corporate opportunity. That means the director cannot take it until he (1) tells the board and (2) waits for the board to reject the opportunity. Corporate Opportunity = anything the corporation has an interest or expectancy Company’s financial inability to pay for the opportunity is not a defense. Remedy= Constructive Trust Other Basis of director Liability o Ultra Vires Act: Responsible officers and directors are liable for ultra vires losses. o Improper Loans: Sarbanes-Oxley Act prohibits most loans to executives in registered publicly traded corporations. o Improper Distributions o Securities Liabilities- 10b-5 Presumption of Director Liability o General Rule: a director is presumed to have concurred with Board action unless her dissent or abstention is noted in writing in corporate records. That means (1) in the minutes or (2) in writing to the corporate secretary or registered letter to the corporate secretary immediately after the meeting. (Point*= an oral dissent is ineffective). o Exceptions: (1) absent voters are not liable; (2) good faith reliance.
OFFICERS Owe the same DUTIES OF CARE & LOYALTY as the directors. Status: Officers are agents of the corporation. They can bind the corporation by acts for which they have authority to bind it. Types of Authority: o (1) Actual: given by articles, bylaws, or board act o (2) Apparent: when corporation holds the officer out as having authority to bind it, so 3 rd parties rely on it. o (3) Inherent (Implied): which is by virtue of office held (i.e. President has inherent authority to enter contracts binding on the corporation in ordinary course of business.
Corporations 5 Removal: Officers are selected by and removed by the Directors. Directors also set officer compensation. Shareholders DO NOT hire and fire officers (only directors). Indemnification of Directors and Officers o Person sued in capacity as officer or director has incurred costs, attorney’s fees, maybe even fines, a judgment or settlement; seeks reimbursement from the corporation. No Indemnification: corporation cannot indemnify if the person is held liable to the corporation or is held to have received an improper personal benefit. Mandatory Indemnification: corporation is required to pay if person was ―wholly successful‖ in defending the action. Permissive Indemnification: settlement. Corporation is permitted to indemnify. ***Articles can provide for limitation or elimination of liability for damages, but not for breach of the duty of loyalty, intentional misconduct or wrongful personal benefit.
SHAREHOLDERS Shareholder Liability o General Rule: A shareholder is not liable for the acts or debts of a corporation. o Exception: Pierce the Corporate Veil A court will PIERCE THE CORPORATE VEIL if: (1) Alter Ego: (identity of interests)- commingled funds (2) Undercapitalization: if the corporation was undercapitalized when formed! o Courts are generally more willing to Pierce the Corporate Veil for a TORT victim than for a Contract Claimant. Shareholder Management o General Rule: BoD, not shareholders manage the corporation. o Shareholders Manage Directly: There must be a Unanimous shareholder agreement that provides for shareholder management (close corporation) o Managing Shareholders owe a duty of care and a duty of loyalty (In a Close Corp). A court may be willing to help the minority shareholder, since there is no public market for the shares. Shareholder Derivative Suit o = shareholder suing to enforce the corporation’s claim, not his own personal claim. Occurs mostly when Directors or Officers breach their fiduciary duties. o Consequences of a Successful Derivative Suit= recovery goes to the corporation*** Shareholder can receive Costs and Attorney’s Fees Sometimes, a court might allow a shareholder to recover directly if a recovery byt the corporation would simply return money to the bad guys. o Consequences of an Unsuccessful Derivative Suit= shareholder is liable for attonreys’ fees and cots if he sued without reasonable cause. (Other shareholders cannot later sue on the same transaction—res judicata) o Requirements of Bringing a Shareholder Derivative Suit (1) Stock Ownership at time the claim arose (must own throughout litigation) (2) Must adequately represent interest of the corporation. (3) must make a written demand on directors that the corporation bring suit UNLESS demand would be futile. (4) Plead with particularity (usually) (5) Post Bond for costs – to avoid strike suits (some state only) o The corporation can move to dismiss the derivative suit if disinterested directors find it is not in the corporation’s best interest. (low chance of success or cost of litigation would
Corporations 6 exceed recovery) Court can scrutinize whether the directors are making the recommendation are truly disinterested. Shareholder Voting o General Rule: record shareholder as of record date has the right to vote. Record shareholder is the person shown as the owner in the corporate records. Record Date is a vote eligibility cut-off. Exceptions: (1) a corporation does not vote TREASURY STOCK. (2) Death of shareholder (3) PROXIES= writing signed by record shareholder directed to secretary of corporation authorizing another to vote the shares. o Proxies are REVOCABLE Unless (1) states it is irrevocable & (2) coupled with an interest (4) Voting Trusts: written trust agreement controlling how the shares will be voted. Shareholders retain all shareholder rights except for voting. 10 YEAR maximum. Must give a copy to the corporation. (5) Voting Agreements: signed writing. Split authority as to whether they are specifically enforceable. Some states say yes. Some say no. o Notice: must give written notice to every shareholder entitled to vote, for every meeting. Otherwise, action taken at the meeting is VOID unless Waiver. Notice must tell them purpose of the meeting- these are the only things that can be voted on. o Quorum: there must be a quorum represented at the meeting. **Shareholder quorum is not lost if people leave the meeting (opposite of Board Meeting). Traditionally, you needed a majority of the shares present. Modern trend is you need a majority of the shares that voted on the particular purpose. Stock Transfer Restrictions o Stock transfer restrictions will be upheld if they are Reasonable Under the Circumstances, which means not an Undue Restraint on Alienation. The right of first refusal is ok, assuming the corporation offers a reasonable price. INSPECTION RIGHTS o Traditional View: must have owned stocks at least 6 months AND onw at least 5% of outstanding shares. o Modern Trend: any shareholder. o Procedure: make a written demand stating a proper purpose. Distributions o = payments to shareholders- can be dividend or can be to repurchase shareholder’s stock or to redeem stock (force sale to corporation at price set in articles.) o General Rule: Distributions are declared in the board’s discretion. An action to force declaration of a distribution is tough to win. Can win ONLY on a VERY strong showing of abuse of discretion. (Example: corp consistently makes profits and the board refuses to declare a dividend while paying themselves a bonus.) o Preferred, Participating, Cumulative, & Common Common Stock Preferred= pay first (can be less amount than common stock) Participating Preferred= pay first, and pay when pay common stock Cumulative= owed every year. If not paid, it accrues to the next year til finally paid. Dividends cannot be issued until cumulative preferred get theirs o What can & cannot be used for a Dividend? Can= Earned Surplus; Capital Surplus ($ generated by issued stock above PAR)
Corporations 7 Cannot= Stated Capital (PAR generated by issuing stock) o Nimble Dividend: one paid out of current earnings when there is not sufficient surplus for a dividend. Many states do not allow this. o ***Corporation can make distribution even though it lost money last year. BUT, cannot make distribution if it is (1) insolvent; or (2) if the distribution will leave the corporation unable to pay debts as they come due. Fundamental Corporate Change Characteristics of Fundamnetal Change o = extraordinary occurrences (amendment of the Articles, Merger, Consolidations, Dissolution, Sale of Assets) that require Board of Director action and o When the Board is making a major change, you need a MAJORITY OF SHARE ENTITLED (not present, not voting) TO VOTE. Right of Appraisal = the right of a dissenting shareholder to force the corporation to buy her shares at fair value. Actions by corporation to trigger right: o (1) merger or consolidation; (2) transfer of substantially all assets not in the ordinary course of business; (3) transfer of shares in a share exchange. Actions by shareholder to perfect right: o (1) before shareholder vote, file with the corporation written notice of objection and intent to demand payment; (2) abstain or vote against the proposed change; and (3) after the vote, make written demand to be brought out. Amendment of the Articles: o Requirements: BoD action, Notice to Shareholders, and Shareholder approval. o No dissenting shareholder rght of appraisal. Mergers & Consolidation: o Requirements: BoD action & notice to shareholders; and shareholder approval. o ***There is a dissenting Shareholder right of appraisal. o Effect of merger or consolidation: the surviving company succeeds to all rights and liabilities of the constituent companies. So a creditor of that corporation can sue the survivor. o Consolidation= A corp and B corp form C corp. One Company Acquires All the Stock of Another o There are only fundamental corporate chages for the transferring corporation only. They are not fundamental corporate changes for the buying corporation. o Requirements: BoD action & notice to shareholders; and shareholder approval. o ***There is a dissenting Shareholder right of appraisal. Dissolution o Voluntary: need board of directors resolution and approval by a majority of the shares entitled to vote. (In some states, you need unanimous written shareholder agreement) o Involuntary (by court order): shareholder can petition because of (1) director abuse, waste of assets, misconduct; OR (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. Creditor can petition because the corp’s insolvent and the creditor has either an unsatisfied judgment against the corporation or the corporation admits the debt in writing.
Corporations 8 SECURITIES Terminology o Securities = investments. o Debt= investor lends capital to the corporation, to be repaid (usually with interest). The debtholder is a creditor, not an owner. o Equity= stock, ownership. o Put Option= option to sell securities at a set price. o Call Option= an option to buy securities at a set price Common Law Liabilities o Sale of Controlling Shareholder’s Interest: Control Premium: controlling shareholder can sell its share for more value simply as ownership of that portion of the corporation. Courts impose duties on the controlling shareholder, owed to the corporation and to minority shareholders, especially in these situations: Sale to Looters: Controlling shareholder is liable if he sells to looters without making a reasonable investigation of the buyer. Disguised Sale of Corporate Asset: Buyer pays a premium to the controlling shareholder so she can get her hands on an asset of the corp. Sale of a Board Position: Fiduciary cannot get paid to relinquish her position. Watch for controlling shareholder selling her control shares and then resigning from the board along with her pals. o Controlling Shareholder cannot Subject Minority Shareholders to Detriment Many courts impose upon directors and officers an affirmative duty to disclose ―special facts‖ in a securities transaction with a shareholder (or maybe a nonshareholder). (aka Insider Trading) FEDERAL RULE 10b-5 o (1) Instrumentality of Interstate Commerce (telephone, mail, national exchange) o (2) Possible ∆s Company issues a misleading press release Buyer or Seller of Securities who misrepresents material information Buyer or Seller of Securities who fails to disclose material inside information (when there is a duty to abstain or disclose- comes from relationship of trust and confidence with shareholders of the corporation) Tipper/Tippee Tipper: (1) based inside information in breach of duty to Company; (2) benefited (gift or enhancing reputation is enough). Tippee: (1) traded on tip; (2) knew or should have known that the information was improperly passed. o (3) Possible Plaintiffs SEC Private Buyer or Seller of Securities o (4) Possible “bad acts” by ∆ Misrepresentation of material information Nondisclosure of material misrepresentation when duty to disclose exists (insider cannot trade on secrets) Tipping (passing along material inside information for a wrongful purpose) o (5) Bad Act in connection with Purchase or Sale of Any Security (i.e. Debt, Equity) o (6) Materiality: The misrepresentation or omission must concern a ―material‖ fact- one that a reasonable investor would consider important in making an investment decision.
Corporations 9 o (7) Scienter Intent to deceive, defraud, manipulate. (Negligence does not suffice) o (8) Reliance Presumed in cases of nondisclosure and public misrepresentation FEDERAL RULE 16B o = strict liability (intent/scienter is irrelevant) o Provides for recovery by the corporation [so it could be a derivative suit] of ―profits‖ gained by certain insiders from buying and selling the company’s stock. The theory is that it is bad for market confidence to have these insiders buying and selling their own corporation’s stock. o Type of ∆ Director (either when she bought or sold) or Officer (either when she bought or sold) or Shareholder who owns more than 10% (both when she bought and sold). ***MUST BE ABOVE 10% IMMEDIATELY BEFORE SHE BOUGHT AND SOLD. o Type of Transaction MUST BE WITHIN A SINGLE 6 MONTH PERIOD o ∆ must have bought and sold equity securities (stock)