Corps & LLCs

Question 1

When is a corporation formed?

Answer 1

Generally, a corporation is formed when the articles of incorporation are filed with the secretary of state (unless the articles specify a delayed effective date).

Question 2

What are required in the articles of incorporation?

Answer 2

The articles of incorporation MUST set forth the following:

1. The name of the corporation;
2. The maximum number of shares the corporation is authorized to issue; AND
3. The names and addresses of:
   a. The first board of directors;
   b. The incorporators executing the articles of incorporation; AND
   c. The initial registered agent.

Question 3

The articles of incorporation may be amended if…?
What about minor amendments?

Answer 3

…there is a majority vote from the directors AND shareholders.
However, minor amendments may be made by the board of directors without shareholder approval.

Question 4

Corporate bylaws are…

Answer 4

… written rules of conduct that must be initially adopted by the incorporators or board of directors. Generally, bylaws provide for the ordinary business conduct of the corporation (e.g., meeting times and dates, elections of a board and officers, filling vacancies, notices, types of duties of officers, etc.).

Question 5

Corporate bylaws may contain any provision for…

Answer 5

… managing the business and regulating the affairs of the corporation to the extent that it is consistent with the law and articles of incorporation.

Question 6

If there is a conflict between the bylaws and articles of incorporation…

Answer 6

…the articles of incorporation govern.

Question 7

The bylaws may be amended or repealed by who?

Answer 7

… the corporation’s shareholders. The board of directors may also amend or repeal the bylaws UNLESS the shareholders expressly specify otherwise.

Question 8

What is a corporate promoter?

Answer 8

A promoter acts on behalf of a corporation that is yet to be formed (usually assists in the planning and formation of the new business).

Question 9

A promoter is personally liable for…

Answer 9

…any contracts entered into on behalf of the corporation so long as both parties to the transaction know that the corporation has not yet been formed.

However, a promoter will NOT be held personally liable if:
1. There is a novation where the parties agree to release the promoter from liability in favor of holding the corporation solely liable; OR
2. The promoter is able to obtain indemnity from the corporation (usually requires that the promoter did not violate any fiduciary duties).

Question 10

A corporation is NOT bound by any pre-incorporation contracts that were…

Answer 10

…entered into by promoters UNLESS the corporation adopts such contracts.

Question 11

An adoption of pre-incorporation contracts entered into by promoters can be…

Answer 11

…express or implied from the actions of the corporation or its agents (e.g., accepting the benefits of a known pre-incorporation contract).

Question 12

Are shareholders of a corporation personally liable for debts of the corporation?

Answer 12

Generally NO, shareholders of a corporation are NOT personally liable for the debts of the corporation. However, the major exception to this rule is the doctrine of piercing the corporate veil.

Question 13

What is the doctrine of piercing the corporate veil?

Answer 13

Piercing the Corporate Veil: Courts will allow a creditor to pierce the corporate veil and hold a shareholder personally liable for the debts of a corporation when:
1. The shareholder has dominated the corporation to the extent that the corporation may be considered the shareholder’s alter ego (e.g., a shareholder utilizes the corporate form for personal reasons);
2. The shareholder failed to follow corporate formalities;
The corporation was undercapitalized (i.e., inadequately funded at its inception to cover debts and prospective liabilities); OR
3. There is fraud or illegality present.

Question 14

Define Passive Investor Liability.

Answer 14

Once the corporate veil has been pierced, courts generally hold ALL the shareholders liable. However, some courts do not extend liability to passive investors.

Question 15

Common Stock.

Answer 15

Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy.

Question 16

What priority in the ownership structure to common stockholders have?

Answer 16

Common stockholders have the lowest priority in the ownership structure (i.e., in the event of liquidation, common stockholders have rights to company assets only AFTER bond holders, preferred stockholders, and other debt holders have been paid in full.)

Question 17

Preferred Stock.

Answer 17

Preferred stock is a security that represents ownership in a corporation. Preferred stock does NOT always have voting rights.

Question 18

Shares of stock are preferred if their holders are…

Answer 18

1. Entitled to receive payment of dividends BEFORE any payment of dividends to another class of stockholders (e.g., common stockholders); OR
2. Entitled, in the event of liquidation or dissolution, to receive any payments or distributions BEFORE another class of stockholders (e.g., common stockholders).

Question 19

What are authorized shares?

Answer 19

Authorized shares are the maximum number of shares that a corporation is legally permitted to issue under its articles of incorporation.

Question 20

How can a corp increase authorized shares?

Answer 20

In order to increase the amount of authorized shares, the articles of incorporation must be amended with a majority vote from the directors and shareholders.

Question 21

Outstanding shares are…

Answer 21

…the total number of shares issued by the corporation and held by the shareholders. Generally, each outstanding share is entitled to one vote (regardless of class), UNLESS otherwise provided in the articles of incorporation.

Question 22

Treasury stock consists of shares that…

Answer 22

…a company issued and subsequently reacquired.

Shares that the corporation reacquired are NOT considered outstanding and CANNOT be counted in a shareholder vote

Question 23

How may a corporation issue options for the purchases of its shares?

Answer 23

A corporation may issue options for the purchase of its shares on certain specified terms that are determined by the corporation’s board of directors (e.g., how the options are issued, the consideration required for issuance, etc.).

Question 24

As to shares within the same class…

Answer 24

ALL shares within a class of stock MUST have identical rights and preferences UNLESS the shares within a class are divided into separate series.

Question 25

A preemptive right is…

Answer 25

… a right of a current shareholder to purchase additional shares in the corporation before outsiders are permitted to do so in order to maintain their percentage of ownership in the corporation.

Question 26

In most states, how does a corp create preemptive rights?

Answer 26

In most states, a corporation must “opt in” to create preemptive rights by expressly including such rights in the corporation’s articles of incorporation. However, in some states, preemptive rights are presumed to exist unless the corporation “opts out” by expressly barring such rights in the corporation’s articles of incorporation.

MOST STATES = CORP MUST OPT-IN IN AOI
SOME STATES = CORP MUST OPT-OUT IN AOI

Question 27

Unless otherwise set forth in the articles, preemptive rights do NOT exist for…

Answer 27

1. Preferred shares that CANNOT be converted to common stock;
2. Shares sold for a consideration other than cash; OR
3. Shares issued by majority shareholder vote to directors, officers, or employees.

Question 28

WHO HAS THE DISCRETION TO PAY DIVIDENDS/DISTRIBUTIONS?

Answer 28

BOARD OF DIRECTORS.
Unless otherwise set forth in the articles of incorporation, a shareholder does NOT have any right to receive distributions (whether in the form of dividends or otherwise) from the corporation. Dividends and distributions are generally paid to shareholders at the full discretion of the board of directors.

Question 29

If the board of directors refuses to issue distributions in bad faith, but not necessarily in bad judgment, the shareholders may…

Answer 29

… be able to compel distribution.

Question 30

As to consideration for shares, the board of directors may authorize issuance of shares for…

Answer 30

… consideration of ANY tangible or intangible property or benefit to the corporation (e.g., cash, promissory notes, services performed, contracts for services performed, etc.).

Question 31

Absent fraud or bad faith, the judgment of the board of directors as to the consideration received for the shares issues is…

Answer 31

…conclusive.

Question 32

Reasons judgment of BOD as to consideration received for shares may not be considered conclusive?

Answer 32

Fraud or bad faith.

Question 33

Annual and Special Meetings requirements

Answer 33

A corporation must hold an annual meeting of shareholders at a time that is stated or fixed in accordance with the bylaws.

Question 34

Special meetings can generally be called by:

Answer 34

1. Persons authorized under the articles of incorporation;
2. A demand from shareholders that accounts for at least 10% of the votes entitled to be cast at the meeting; OR
3. The board of directors for limited purposes (e.g., dissolution of the corporation).

Question 35

Notice requirements for shareholder annual meetings

Answer 35

Notice. Generally, shareholders who are entitled to vote must be provided with notice of all annual and special meetings.

Question 36

Notice requirements for SH special meetings

Answer 36

For special meetings, the notice must:
1. State the purpose of the meeting; AND
2. Be provided 10-60 days before the meeting commences (in most states).

Question 37

Quorum requirements.

Answer 37

A quorum must be present in order for the shareholders to take action at a meeting. Unless otherwise set forth in the articles of incorporation, a quorum exists when at least a majority of the shares entitled to vote are present.

Question 38

What are Non-Voting Shares?

Answer 38

The articles of incorporation may provide that holders of certain types of shares cannot vote unless specific conditions are satisfied. However, such shareholders are still entitled to receive notice even though their shares have non- voting status.

Question 39

What is the weight of each SH vote? Does stock class matter?

Answer 39

Unless otherwise provided by law or the articles of incorporation, all shareholders’ votes are counted equally, regardless of class.

Question 40

As to voting rights, what is the record date requirement?

Answer 40

Record Date. A shareholder is only entitled to vote if she acquired voting shares before a designated record date. Generally, the record date may be designated in the bylaws no more than 70 days prior to the shareholder meeting.

Question 41

How can SH’s elect directors?

Answer 41

Shareholders elect directors either directly (each share equals one vote) or cumulatively.

Question 42

Cumulative voting is…

Answer 42

… usually a more favorable method to represent the interests of minority shareholders.
In cumulative voting, voters cast as many votes as there are seats, but voters are not limited to giving only one vote to a candidate. Instead, they can put multiple votes on one or more candidates.

Question 43

What is a vote by proxy?

Answer 43

A vote by proxy allows a shareholder to vote without physically attending the shareholder’s meeting by authorizing another person to vote her shares on her behalf.

Question 44

How does one issue a valid proxy?

Answer 44

A valid proxy must exist in the form of a verifiable electronic transmission or a signed written appointment form.

Question 45

Are proxies revocable?

Answer 45

A proxy is freely revocable by the shareholder UNLESS the recipient of the proxy has an economic interest in the shares.

Question 46

As to corp books and reocrds, A shareholder possesses the right…

Answer 46

… to inspect corporate books and records so long as the purpose for the inspection is proper.
In order to be proper, the purpose for the inspection must be reasonably related to a person’s interest as a shareholder.

eg, , “such as a desire . . . to determine whether improper transactions have occurred.” or “economic risks” to the company

Question 47

What limiations are placed on SH’s right to inspect docs?

Answer 47

The MBCA allows a shareholder to inspect “only relevant excerpts of [board] minutes . . . directly connected with the shareholder’s purpose.”
The MBCA also allows inspection of
“accounting records,” although this category is not as broad as the “books and records” category found in other corporate statutes. According to the Official Comment, accounting records are “records that permit financial statements to be prepared which fairly present the financial position and transactions of the corporation.”

Question 48

Does a SH need a proper purpose to inspect shareholder minutes?

Answer 48

No, a shareholder may inspect the SH minutes without providing a proper purpose.

Question 49

Does a SH need a proper purpose to inspect AOI and bylaws?

Answer 49

No, a shareholder may inspect the articles of incorporation and bylaws without providing a proper purpose.

Question 50

A shareholder seeking inspection of corporate documents must offer credible evidence that…

Answer 50

… there was mismanagement or other improper conduct.

Burden on SH to show this.
a news story by a leading publication would likely be enough of a showing to warrant inspection (see MEE Feburary 2017)

Question 51

What are the procedural req’s for a SH to inspect books/records?

Answer 51

Procedural Requirements. Generally, a shareholder must:

1. Make a written demand to inspect corporate books and records and allow the corporation a reasonable amount of time to respond (usually 5 days); AND
2. Conduct the inspection during regular business hours at the corporation’s principal office.

Question 52

What authority does the BOD have over the affairs of the corporation?

Answer 52

Subject to any limitation imposed by law or the articles of incorporation, the board of directors has full control over the affairs of the corporation.

Question 53

As to the authority of directs, a quorum must be present…

Answer 53

A quorum must be present in order for the directors to take action or vote.
Unless otherwise set forth in the articles of incorporation, a quorum exists when at least a majority of the directors are present.
Directors are considered present so long as all of the directors participating can simultaneously hear each other (e.g., conference calls).

Question 54

Is a quorom of BOD’s required for informal actions?

Answer 54

No, Informal action by the board may be taken without a quorum present so long as the board has unanimously consented to the action in writing.
So don’t have to be present.

Question 55

What is the notice requirement for BOD regular meetings? Special meetings?

Answer 55

It is presumed that directors have notice of regular meetings. However, for special meetings, directors must be given 2 days notice, which includes information about the time, location, and date of the meeting. However, such notice is NOT required to provide the purpose of the special meeting.

Question 56

Who has the authority to conduct the day-to-day affairs of corporation?

Answer 56

The board of directors generally delegates day-to-day management of the corporation’s business to officers elected by the board (CEO, CFO, president, etc.).

Question 57

The board may remove officers…

Answer 57

… at any time with or without cause. However, such removal may result in a breach of contract action if the board is violating an employment agreement.

Question 58

What duties are owed by directors and officers to the corporation?

Answer 58

duty of care and
duty of loyalty.

Question 59

What duty of care is owed to a corporation (and its shareholders) by directors and officers?

Answer 59

Duty of care includes:
1. The duty to take reasonable steps to monitor the corporation’s management;
2. The duty to be satisfied that proposals are in the corporation’s best interests;
3. The duty to disclose material information to the board; AND
4. The duty to make reasonably informed decisions.

Question 60

In terms of duty to make reasonably informed decision, on whom may BOD/officers rely?

Answer 60

In making such decisions, directors and officers may rely on information from others whom they reasonably believe are reliable.

Question 61

What is the business judgment rule?

Answer 61

In suits alleging that a director or officer violated his duty of care owed to the corporation, courts will apply the business judgment rule.

Under this rule, a court will NOT second guess the decisions of a director/officer so long as the decisions are made:
1. In good faith;
2. With the care an ordinarily prudent person in a like position would exercise under similar circumstances; AND
3. In a manner the director/officer reasonably believes to be in the best interests of the corporation.

Question 62

Directors breach their fiduciary duties—and the business judgment rule provides no protection—
when they…

Answer 62

…approve illegal business operations (or refuse to investigate alleged illegal business
activities), even though the illegal business may be profitable to the corporation.

Question 63

Liability. If a director or officer breaches the duty of care…

Answer 63

…he may be held personally liable for damages.

Question 64

May a corp’s AOI limit BOD/officer liability?

Answer 64

A corporation’s articles of incorporation may reasonably limit the liability of directors and officers for bad judgment, but NOT for bad faith misconduct.

for bad judgment = YES
for bad faith = NO

Question 65

What is the duty of loyalty owed by BOD/officers to corp/SH’s when there is a conflicting interest transaction?

Answer 65

Directors and officers have a duty to avoid implicating their personal conflicting interests in making business decisions for the corporation.

Question 66

A director/officer has a conflicting interest in a transaction when…

Answer 66

…the director/officer or a family member either:
1. Is a party to the transaction; OR
2. Has a beneficial financial interest in the transaction of such significance to the director/officer that the interest would reasonably be expected to exert an influence on the director/officer’s judgment if called upon to vote on the transaction.

Question 67

What safe harbors are available to director/officers who enter into a conflicting interest transaction?

Answer 67

A director/officer that enters into a conflicting interest transaction may be protected from liability if:

1. Disinterested shareholders approve the conflicting interest transaction;
2. The non-interested members of the board authorize the conflicting interest transaction; OR
3. The transaction, judged according to the circumstances at the time of commitment, is established to have been fair to the corporation.

Question 68

What is the corporate opportunity doctrine?

Answer 68

The corporate opportunity doctrine prohibits directors and officers from usurping business opportunities that rightfully belong to the corporation for their own benefit.

Question 69

What is a merger?

Answer 69

A merger occurs when one of two existing corporations is absorbed by the other corporation.

Question 70

What is a consolidation?

Answer 70

A consolidation occurs when two existing corporations combine into one new corporation.

Question 71

A merger or consolidation both require…

Answer 71

1. The recommendation of an absolute majority of the board of directors; AND
2. The agreement of each corporation by an absolute majority of shareholders.

Question 72

Are there any exceptions for merger/consolidation requirements for short-form mergers?

Answer 72

Short-Form Mergers. In many states, if a parent corporation owns at least 90% of the stock of a subsidiary, the subsidiary may be merged into the parent without approval from the shareholders of either corporation.

Question 73

After a merger or consolidation takes place, dissenting shareholders opposed to the merger or consolidation may…

Answer 73

… either:
1. Challenge the action; OR

2. Receive payment determined at the fair market value of their shares immediately before the merger/consolidation took effect.

Question 74

What happens to a dissenting shareholders right to challenge an action when they receive fair market value for their shares?

Answer 74

They lose this right, absent a showing of fraud.

A dissenting shareholder who opts to receive fair market value for their shares loses the right to challenge the action absent a showing of fraud.

Question 75

A derivative claim is…?

In what context does this often occur?

Answer 75

… a lawsuit brought by a shareholder on behalf of the corporation. The shareholder is suing to enforce the corporation’s rights when the corporation has a valid cause of action, but has failed to pursue it.

This often occurs when the defendant in the suit is someone close to the corporation (e.g., a director or officer).

Question 76

Before making a derivate action, SH must…

Answer 76

Demand. Generally, a shareholder must make a written demand on the board before commencing a derivative action. After submitting the written demand, the shareholder must wait 90 days to file the derivative action, UNLESS the board rejects the demand during the 90-day period.

However, under the common law, and in some jurisdictions today, the plaintiff shareholder does NOT have to make a demand on the board if it would be futile to do so (e.g., the board is interested in the transaction being challenged).

Question 77

W’hen can the board seek dismissal of the SH’s derivative action?

Answer 77

Under the MBCA, the board can seek dismissal of the shareholder’s derivative action if a majority of the board’s “qualified directors”—those directors who do not have a material interest in the derivative action—determine in good faith, after conducting a
reasonable inquiry upon which its conclusions are based, that continuance would be contrary to the corporation’s best interests. Although the Official Comment to
MBCA § 7.44 suggests that a full-blown board investigation is not necessary, the board’s request for dismissal must have “some support in the findings of the inquiry.”

Question 78

Failure by the board to investigate credible allegations of corporate illegality constitutes…

Answer 78

a lack of “good faith.”

Note: even when bribes are widespread, approving such bribes violates duty of good faith.

Question 79

, the duty to act in good faith requires corporate directors to establish…

Answer 79

…procedures to
ensure the corporation’s compliance with legal norms.
Thus, courts have required corporate directors to establish “[corporate] information and reporting
systems” that provide “timely, accurate information . . . concerning both the corporation’s
compliance with law and its business performance.”

Question 80

As to damages, what happens if a derivative claim is successful?

Answer 80

If a derivative claim is successful, the proceeds go to the corporation, not the shareholder who brought the action. However, if the award to the corporation benefits the defendants, the court may order that damages be paid directly to the shareholder.

Question 81

Directors breach their fiduciary duties by failing to…

Answer 81

…act upon “red flags” or “obvious danger signs” of corporate illegality.

Question 82

What is a direct claim made by a SH?

Answer 82

A direct claim is a lawsuit brought by a shareholder to enforce his OWN rights.

Question 83

What must SH prove in a direct claim?

Answer 83

The shareholder must prove actual injury that is NOT solely the result of an injury suffered by the corporation.

Question 84

Who gets proceeds in direct claim?

Answer 84

If a direct claim is successful, the proceeds go to the shareholder.

Question 85

When is an LLC formed?

Answer 85

Generally, an LLC is formed when the certificate of formation is filed with the secretary of state.

Question 86

What is required in the certificate of certification?

Answer 86

The certificate of formation is analogous to a corporation’s articles of incorporation. Commonly, the certificate of formation must provide:

1. The name and purpose for which the LLC is organized;
2. The address of the principal place of business;
3. The name and address of the registered agent in the state;
4. The initial capital contributions agreed to be made by all members; AND
5. The number of persons, or classes of members, who will manage the LLC, and the names and addresses of the persons or members who will serve as managers.

Question 87

What is the LLC equivalent of corporate bylaws?

Answer 87

The LLC’s operating agreement

Question 88

What does an LLC operating agreement govern?

Answer 88

1. The relations between the members and the LLC;
2. The rights and duties of managers;
3. The activities and affairs of the LLC; AND
4. The conditions, if any, for amending the operating agreement.

Question 89

What is a member-managed LLC?

Answer 89

LLC is managed by its members.
Generally, an LLC is presumed to be member-managed unless the operating agreement provides otherwise.

Question 90

If the operating agreement provides that the LLC will be manager- managed…

Answer 90

…an elected group of managers will run the business analogous to how a board of directors runs a corporation’s business.

Question 91

When in doubt about LLC, apply…

Answer 91

agency rules.

Question 92

When does LLC manager have actual authority?

Answer 92

“each member [in a member-managed LLC] has equal rights in the
management and conduct of the company’s activities,” and unless otherwise specified in the operating agreement, he/she has the actual authority to bind the LLC if acting to carry out the company’s ORDINARY BUSINESS.

Question 93

When does LLC manager have apparent authority?

Answer 93

each member of a member-managed LLC can bind the company to contracts for apparently carrying
on the ordinary business of the company unless the member lacks authority to do so and the
other party to the contract has notice that the member lacks such authority.

eg, 3P who bought farmland from member of a bike shop LLC could not reasonably rely on one member’s offer to sell on behalf of the LLC because selling real estate is outside the ordinary coure of the activities of the company.
3p is not a bona fide purchaser either because he should have had doubts that one LLC member could bind the company in the sale of the land.

Question 94

What happens when member decides to withdraw?

Answer 94

Dissociation

Question 95

What is the result of a dissociation by a member?

Answer 95

dissociation results in (1) loss of his rights to participate in the LLC and (2) still gets rights to distributions (payments by the LLC) only if and when made by the continuing members.

Question 96

When member dissociates, does this result in a dissolution of the LLC?

Answer 96

No. dissociation DOES NOT EQUAL dissolution.

Dissolution requries consent of all members.

Question 97

So does dissociation occurs, does member get payment for his LLC interest?

Answer 97

NOPE. He has no right to payment for his LLC interest, unless the operating
agreement specifies that a withdrawing member has a right to payment upon dissociation, that the remaining members are to agree to have the LLC buy his interest, or that the other members
are to consent to dissolution (and winding up of the business).

Question 98

What is a dissociation similar to?

Answer 98

the rights of a withdrawing LLC member are not like those of a partner in an at-will partnership, but rather more like those of a minority shareholder in a closely held corporation.

Question 99

Partner withdrawal in an at-will partnership, unless agreed otherwise,
causes…

Answer 99

…the dissolution of the partnership and a right to cash payment for the pro rata share of the withdrawing partner’s interest, after satisfying any creditor claims.

Question 100

The withdrawal of a minority
shareholder in a closely held corporation results…

Answer 100

… neither in dissolution of the corporation nor in any right to pro rata payment of the corporation’s net assets. Instead, the minority shareholder remains entitled to dividends and other distributions only if and when the board of directors (majority shareholders) chooses to authorize such payments.