Corporations Flashcards
Corporations- Steps After Filing the Articles
- Prepare the Bylaws
- Prepare meeting notices and organizational minutes
- Obtain a corporate seal
- Set up a corporate record book
- Issue stock certificates
- Prepare resolutions for the corporate bank account
- Draft appropriate employment contracts, shareholder agreements, and other documents
- Apply for a taxpayer ID number
- Make necessary tax elections
- Apply for necessary licenses and permits
De Facto Corporation Doctrine
- There must exist a valid law under which the particular corporation could have been lawfully organized;
- There must be an actual attempt to organize under that law;
- There must have been actual use of the corporate franchise, that is, the person claiming corporate treatment must show that the business did hold itself out as and do business as a corporation; and
- All of this must be done in good faith.
Business Judgment Rule
The Business Judgment Rule. The business judgment rule is a standard of judicial review employed by courts when they are asked to evaluate the business decisions made by corporate boards of directors.
As you will learn in the exercises that follow, the business judgment rule is a rebuttable presumption that corporate business decisions are made by disinterested and independent directors, acting on an informed basis, and in the good faith belief that the decisions are in the best interests of the corporation and its shareholders. Unless that presumption can be rebutted successfully, a court will dismiss any lawsuit challenging a board’s business decision.
The business judgment rule is a rebuttable presumption that a board of directors’ business decision was proper and should not be second-guessed by the court. That presumption will be outcome-determinative – a challenger’s law suit will be dismissed – unless the challenger can prove to the court that one or more of the elements of the rule was not satisfied, i.e., that the directors violated their fiduciary duties and are therefore unable to claim the rule’s protection.
Board of Directors Duties
Under state corporate law, the directors of a business corporation are fiduciaries and owe the corporation and its shareholders various duties. Those duties, including the duty of loyalty and the duty of care, are called fiduciary duties.
The duty of loyalty involves the directors’ obligation not to put their own interests ahead of those of the corporation and its shareholders. If directors are disloyal, they need not also violate their duty of care to be in violation of their fiduciary duty.
The duty of care involves the directors’ obligation to apply the appropriate standard of care when making corporate business decisions. This standard is often described as the duty to act in good faith, carefully and on the basis of adequate information as they manage the corporation.
Elements of the BJR
Elements of the Business Judgment Rule. As you have read, the business judgment rule will protect corporate directors’ decisions only when all the elements of the rule are in place. The elements of the business judgment rule are as follows:
(1) there must be a business decision;
(2) the decision must be made by the directors in the good faith belief that it is in the best interests of the corporation and its shareholders;
(3) the decision must be made with due care;
(4) the decision must be made by disinterested and independent directors; and
(5) (in a small number of courts only) the board must have acted without abusing its discretion .
BJR Elements- Business Decision
A business decision. Not surprisingly, the business judgment rule applies only where directors have in fact exercised their business judgment (made a business decision) and acted on that judgment. Put another way, the rule only protects board actions that result from the exercise of business judgment.
This “business decision” element, then, involves two important concepts: (1) the conscious exercise of judgment in making a decision and (2) the requirement that the decision involve the corporation’s lawful business .
Please note: The rule does not protect decisions that involve fraud, illegality or ultra vires acts.
BJR Elements– Good Faith
At the heart of directors’ fiduciary duties is the expectation that directors will act in good faith, in the honest belief that their actions are in the best interests of the corporation and its shareholders. If a director’s actions are motivated by any purpose other than the advancement of the corporation’s best interests, a court may conclude that she is acting in bad faith.
What is bad faith? It is more than bad judgment or carelessness in decision making. Courts have identified as bad faith
(1) directors’ actions primarily motivated by the desire to remain entrenched in their positions of control,
(2) a board’s conscious decision to mislead its shareholders by intentionally withholding material information from them,
(3) an otherwise inexplicable “gross disparity” between the price paid for assets and their fair market value, and
(4) other actions that are “outside the bounds of reasonable judgment – an abuse of discretion perhaps explicable on no other basis [than bad faith]”.
BJR- Elements- Disinterested and Independent Directors
Disinterested and independent directors. In order to qualify for the protection of the business judgment rule, corporate directors must meet the state law requirements of the duty of loyalty – they must be both disinterested and independent.
- By requiring disinterestedness, state law protects the corporation and its shareholders from directors whose business judgment is likely to be distorted by personal financial or other interest in a transaction under consideration.
- Courts will conclude a director is interested in a transaction if she will receive from it a benefit not shared equally by the shareholders of the corporation and is not motivated solely by the desire to advance the best interests of the corporation and its shareholders.
- By requiring independence, state law demands that directors exercise their individual business judgment freely, without being controlled or influenced by considerations other than the best interests of the corporation and its shareholders.
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BJR Elements- Due Care: Exercising Informed Judgment
In order to avoid violating this element of the rule, directors must act not only in good faith, in the reasonable belief that the action is in the best interests of the corporation and its shareholders (see Good Faith), but also on an informed basis. This does not mean that the directors must reach a “right” or profitable decision. The “informed judgment” element of the rule refers to the decision-making process rather than the merits of the decision itself.
- varies from state to state
- generally requires ‘gross negligence’
BJR Elements- No Abuse of Discretion
This element only applies in some states.
A small number of courts have stated that there is an additional element to the business judgment rule – that even if there has been a business decision, in good faith, by disinterested and independent directors acting with due care, that decision only qualifies for business judgment rule protection if it does not amount to an abuse of discretion by the board.
This approach to the business judgment rule authorizes a court to examine the merits of a board’s decision in order to determine whether there has been an abuse of directorial discretion even where the requirements of the business judgment rule have apparently been satisfied. Such a decision has been described as one “so removed from the realm of reason or so unreasonable as to fall outside the permissible bounds of sound discretion, and thus [is] an abuse of discretion.” Obviously, very few board actions will meet this “off-the-wall” test, for example an action based on a completely irrational belief.
BJR- Codification
Although there are many statutes containing provisions codifying the duties of care and loyalty, there are currently no statutory codifications of the business judgment rule.
In 1998, the rule was added to the Model Business Corporation Act.
