Corporations

Question 1

What is a promoter?

Answer 1

The person responsible to solicit investors for a corporation, write the charter, and start the business

Question 2

What duty does a promoter have to the corporation he is forming?

Answer 2

A fiduciary duty – he cannot engage in self-dealing (i.e. profiting at the corporation’s or at shareholders’ expense), and he must turn over any such profits he gains to the corporation

Required to fully disclose his activities to anyone with an interest in the corporation

Question 3

Is a corporation liable for contracts made by the promoter before the corporation comes into existence?

Answer 3

No, since a nonexistent business cannot ratify the contracts

A corporation has the choice of “adopting” the contracts after coming into existence, however

Question 4

What are different ways a corporation can adopt contracts made by its promoter?

Answer 4

(1) state statute – forced by law
(2) express agreement, established after incorporation has taken place
(3) impliedly – accepting a contract’s benefits and thus adopting its liabilities

Question 5

Does a promoter retain any liability if his corporation adopts his contracts?

Answer 5

Yes, he is personally liable unless…

• the contract states that the promoter is not personally liable
• novation occurs, the creditor agreeing to form a new contract with the corporation

Question 6

With what legislative act does the promoter need to comply?

Answer 6

Securities Act of 1933 – requires him to file registration statement with SEC (if securities will be offered in interstate commerce) and to provide possible investors with a prospectus

Question 7

What is the main statutory requirement for creating a corporation?

Answer 7

Executing and filing the articles of incorporation (a.k.a. corporate charter, or certificate of incorporation)

Must be signed by incorporators, who usually are the same people as the promoters

Question 8

What must be included in articles of incorporation?

Answer 8

• corporation name
• purpose
• authorized stock
• location of main office
• number of directors
• address of registered agent for service of process
• capital structure
• duration

Question 9

What do some states further require with the articles of incorporation?

Answer 9

• a minimum capital contribution
• officers elected by the board of directors
• bylaws

Question 10

When does a corporation officially come into existence?

Answer 10

According to common law, not until the state office issues a certificate of incorporation following the articles’ filing

According to modern custom, it begins when the filing occurs

Question 11

What is usually the first thing done after incorporation?

Answer 11

Creating bylaws (if they were not already required to be created)

Except for particular states, they do not need to be filed

Question 12

Who can adopt and revise bylaws?

Answer 12

The incorporators or board of directors can adopt them

The shareholders or board of directors can revise them (unless this power is restricted to shareholders, e.g. by the articles)

Question 13

Which corporations can act without bylaws?

Answer 13

Close corporations, i.e. corporations with a small number of shareholders who usually participate in running the business, and which can decide things without a board meeting

General bylaw info still must be included in articles or in an agreement among shareholders

Question 14

What occurs if a corporation does not follow the proper procedure for incorporation?

Answer 14

Common law used to forbid them the status of corporation

This caused contract problems where third parties could choose not to perform, or could hold the shareholders personally liable – so other laws now deal with defective incorporation

Question 15

What is the difference between a de jure and a de facto corporation?

Answer 15

De jure = the business substantially fulfills the incorporation process

De facto = the business does not substantially fulfill the process, but still can be protected in contracts it enters

Question 16

What are the prerequisites for a de facto corporation?

Answer 16

(1) valid statute by which the business could have been legally incorporated
(2) corporate charter
(3) good faith attempt at incorporation
(4) good faith business dealings

Question 17

What can the state do against a de facto corporation?

Answer 17

Challenge its status as a corporation with a quo warranto proceeding

Quo warranto = “by what warrant?” – questions the corporation’s claim to be a corporation

Question 18

What is corporation by estoppel?

Answer 18

A situation where, if a third party agrees to a contract with a business that he truly believes is a corporation, then he cannot hold the shareholders personally liable (i.e. he must treat the other party as a corporation)

This occurs even if the other business is not a de facto corporation

Question 19

What is a subscription agreement?

Answer 19

A contract to purchase shares at a given price

Question 20

What is the problem with people who subscribe before incorporation?

Answer 20

There is essentially a contract without two parties, which is thus unenforceable

Question 21

What are the different ways around the problem of pre-incorporation subscriptions?

Answer 21

(1) if individuals depend on others’ subscriptions as a basis for their own subscriptions, then they are enforceable among the subscribers
(2) the Model Business Corporation Act (MBCA) requires pre-incorporation subscriptions to be treated as irrevocable offers for six months

Question 22

Can subscriptions be conditional?

Answer 22

They can be conditional on anything, but all subscriptions are implicitly conditional upon (a) the business being a de jure corporation and (b) the corporation fulfilling all relevant laws

Question 23

For states that have minimum capital requirements (i.e. which require a certain amount of contributed capital), how is this determined?

Answer 23

By the fair market value of the capital

This is relevant because contributed capital can be in the form of property or services, not just money

Question 24

What is treasury stock?

Answer 24

Stock that has been issued but then reacquired by the corporation – can be cancelled by the corporation, in which case the shares are treated as unissued

Does not include voting or dividend rights

Question 25

What is watered stock?

Answer 25

Stock issued for less than par value

Question 26

To what is a common stockholder entitled?

Answer 26

- dividends - assets (in the event of liquidation) - voting rights (sometimes)

Question 27

To what is a preferred stockholder entitled?

Answer 27

- assets (for par value before common stockholders in the event of liquidation) - fixed dividends (before common stockholders) - voting rights (sometimes) - various others, depending on the preferred stock

Question 28

What are different kinds of preferred stock?

Answer 28

(1) convertible = can be changed to common stock (2) cumulative = entitled to fixed dividend payments each year; this accrues if dividends are not paid for a given year (3) participating = share in any profit distribution given to common stockholders (4) unspecified = entitled to fixed dividends (which do NOT accumulate), but no other profits

Question 29

What is a stock's par value?

Answer 29

The nominal value stated on the stock certificate -- but stocks can be sold for any amount over par value Par value for stocks is accounted for in the capital account (e.g. "Common Stock"), while any extra is accounted for in an Additional Paid-in Capital account

Question 30

What is legal capital?

Answer 30

Issued shares x par value This account is useful for paying creditors if liquidation occurs

Question 31

What is the surplus of a company?

Answer 31

Earned surplus (i.e. retained earnings) + paid-in surplus (i.e. APIC) Also equal to (net assets) - (legal capital)

Question 32

Can corporations accept past services as consideration for issued stock?

Answer 32

Yes

Question 33

How can stocks be transferred?

Answer 33

By endorsement and delivery If endorsed in blank, delivery is sufficient to transfer stocks

Question 34

Can corporations restrict the ways in which stock can be transferred?

Answer 34

Yes -- e.g. a stockholder can be required to offer the corporation to repurchase the stock first before offering it to someone else To be enforceable, these restrictions must be reasonable and overtly presented on the stock certificate

Question 35

Under what circumstances would a stockholder recognize a taxable gain/loss from his purchase of stock?

Answer 35

If, after purchasing, he owns less than 80% of the total stock This applies to groups of stockholders as well

Question 36

How is the taxable gain/loss calculated for a non-controlling stockholder (i.e. <80%)?

Answer 36

Taxable gain/loss = FMV of stock - tax basis of money/property exchanged

Question 37

Do corporations recognize taxable gains/losses for money or property contributed?

Answer 37

No The new tax basis is the FMV of the property contributed

Question 38

What is the difference between a domestic corporation and a foreign corporation?

Answer 38

Domestic = does business only in the state where it's incorporated Foreign = does business outside the state of incorporation

Question 39

What is a professional corporation?

Answer 39

A corporation whose shareholders are all professionals (e.g. lawyers, doctors), who usually assume personal liability for their professional activity

Question 40

Do insiders for a corporation (officers and directors) have a fiduciary duty towards stockholders?

Answer 40

They did not under common law -- they were not required to disclose inside info except in face-to-face interaction Now, insiders' obligations are regulated by SEC Rules 10b-5 and 16b

Question 41

What does SEC Rule 10b-5 forbid?

Answer 41

It forbids fraud, deceit, and material omissions of fact that make statements misleading

Question 42

What does SEC Rule 16b forbid?

Answer 42

It forbids officers, directors, and >10% stockholders to buy and sell stock for a profit within a six-month period

Question 43

What are the corporation's express and implied powers?

Answer 43

Express = whatever it is authorized to do by state law, articles of incorporation, or bylaws Implied = whatever is reasonably necessary to execute express powers

Question 44

What powers are NOT able to be implied powers for a corporation?

Answer 44

(1) giving away assets at shareholders' expense (2) entering into a partnership (3) lending money -- though it can act as a surety if it promotes the corporation's interests (2) and (3) can be permitted by charter or statute

Question 45

Why are corporations ordinarily prohibited from entering into partnerships?

Answer 45

Because the partners who could control the corporation are not its elected officers (or agents)

Question 46

Who has the right to manage a corporation's affairs?

Answer 46

The board of directors Original directors are named in articles of incorporation; later ones are elected at shareholder meetings

Question 47

How can vacant director positions be filled in between shareholder meetings?

Answer 47

The board can select someone to fill the position

Question 48

Do directors need to manage the corporation along with shareholder influence?

Answer 48

No, they have a right to manage it without direct shareholder involvement, and they need not be shareholders themselves

Question 49

What is the minimum number of directors a corporation must have?

Answer 49

Used to be three, but now there is no minimum (besides one)

Question 50

How does an inside director differ from an outside director?

Answer 50

An inside director is an employee, officer, or shareholder who is also a director

Question 51

What is a corporation's audit committee?

Answer 51

An independent committee responsible for the corporation's audit work, both in appointing and overseeing any auditors -- must approve all services (auditing or not) provided by an auditing firm Must include at least one financial expert

Question 52

In what ways must an audit committee be independent of the corporation?

Answer 52

Each member must be independent in the sense (1) that he is unaffiliated with the company and (2) that he does not receive payment for consulting, advisory, or other services Audit committee members can still serve on other committees, however

Question 53

What does an audit committee do besides oversee external auditors?

Answer 53

It oversees the whole financial reporting process, including internal control policies and accounting policies and principles

Question 54

How can directors be removed from their office before their term ends?

Answer 54

Older common law forbade their removal except for some good cause, e.g. fraud, but now a director can be removed at any time by shareholder vote

Question 55

Does a board meeting require the presence of all directors to make binding decisions?

Answer 55

No, only a simple majority (>50%) need to be there Furthermore, unless the articles say otherwise, a vote of a simple majority of the directors present makes a decision binding

Question 56

Can binding decisions be made by directors without a meeting?

Answer 56

Only in some states -- the directors must consent in writing and have the documents filed with the corporation's minutes

Question 57

Can a board of directors delegate their duties to another committee?

Answer 57

Yes, they can delegate some (but not all) duties to an executive committee, though this committee must also be composed of directors Examples of non-delegable duties: changing bylaws, declaring dividends

Question 58

Are directors personally liable for dividends that are wrongly paid out?

Answer 58

Yes, unless they acted responsibly upon the info they had

Question 59

Does a director have rights to be compensated for services he provides to the corporation?

Answer 59

Only if the bylaws specifically authorize it

Question 60

What is included in a director's duty of due care to his corporation?

Answer 60

Must act with the care and skill of a prudent person in the circumstances, or else he can be held liable for negligence

Question 61

What is the business judgment rule?

Answer 61

Relates to the director's duty of due care: reduces the liability of a director for negligence in matters of judgment, so long as he acted in good faith and did not commit "clear and gross negligence"

Question 62

What is included in a director's duty of loyalty to his corporation?

Answer 62

He can have transactions with the corporation, so long as they are fully disclosed to (and approved by) other directors Also must be unobjectionable to courts, or else the contract can be rescinded and the director held liable for any harms

Question 63

What is the corporate opportunity doctrine?

Answer 63

Relates to the director's duty of loyalty: forbids a director from taking for himself a business opportunity that the corporation could take (not without giving the corporation a chance to act first)

Question 64

Do officers need to be distinct from the board of directors?

Answer 64

No -- though they are appointed by the board, officers can also be directors

Question 65

How can officers act on behalf of their corporation?

Answer 65

Officers have an express power of binding the corporation to contracts, and otherwise they act as agents (with all the ordinary rules applying)

Question 66

How do the fiduciary duties of officers and directors compare?

Answer 66

They are the same

Question 67

What does the Sarbanes-Oxley Act require of officers?

Answer 67

(1) the CEO and CFO (or equivalent persons) must certify the annual and quarterly reports submitted to the SEC -- and they must be free of fraud/falsity (2) executive officers (for an issuing corporation) must have no incentive-based pay from selling stock in the 12 months before an earnings restatement

Question 68

Does respondeat superior apply to corporations?

Answer 68

Yes, they are liable for torts committed by employees within their employed activities

Question 69

What does "ultra vires" mean?

Answer 69

"Beyond the powers" -- refers to acts done by a corporation which are unauthorized Ultra vires acts are not illegal but are considered void or unenforceable

Question 70

Can a corporation or a third party claim the ultra vires doctrine in order to negate a contract?

Answer 70

No, it can be asserted only by the corporation's shareholders, who can then (along with the state) sue the corporation for any harms caused

Question 71

What does it mean to "pierce the corporate veil"?

Answer 71

To hold shareholders personally liable for corporate debts Arises due to fraud that implicates the shareholders, often because the corporation was formed for some fraudulent or harmful purpose

Question 72

What factors does a court consider when determining whether to pierce the corporate veil?

Answer 72

- whether the corporation has a bona fide business purpose - whether corporate funds and shareholder funds are duly segregated - whether the procedures for corporations have been followed (e.g. board meetings)

Question 73

What is another situation which might cause a court to determine whether to pierce the corporate veil?

Answer 73

If there is insufficient capital invested to meet the minimum thresholds

Question 74

Under what circumstances might a court hold a parent corporation liable for the debts of its subsidiary?

Answer 74

If... (a) the subsidiary has insufficient capital invested, (b) the sub's activities are unduly mixed with the parent's, or (c) the sub exists solely for the parent's sake

Question 75

What can occur if shareholders seek to make loans to a corporation when it is coming into existence?

Answer 75

If the corporation is bankrupt (or insufficiently capitalized), the shareholders are not entitled to the increased creditor rights they would have hoped to achieve -- instead, insider loans will be treated as capital contributions or made a lower priority than outsider loans

Question 76

Regarding shareholders, what are direct actions and derivative actions?

Answer 76

Direct = lawsuits for the shareholder's benefit Derivative = lawsuits for the corporation's benefit (e.g. against a fraudster director)

Question 77

How does straight voting differ from cumulative voting?

Answer 77

Straight = shareholders receive one vote per share (this can also be weighted to give multiple votes for certain types of shares) Cumulative = used when electing directors; shareholders' votes are multiplied by the number of directors to be elected and can be used however they want (e.g. all for one candidate)

Question 78

Do shareholders have a right to inspect corporate records?

Answer 78

Yes, so long as the shareholder can prove that such inspection is related to his interest as a shareholder

Question 79

What are preemptive rights for shareholders?

Answer 79

Shareholders with these rights are entitled to purchase any stock that is newly issued before others have the opportunity -- though this is done in proportion with their current stock ownership

Question 80

Do stockholders have the right to cause dividends to be declared?

Answer 80

Ordinarily no -- they can do so only if they can prove to a court that directors have wrongly or arbitrarily refused to declare them

Question 81

Out of what accounts can a corporation pay out dividends?

Answer 81

Out of retained earnings (earned surplus) and, in some states, additional paid-in capital (paid-in surplus)

Question 82

What is an absolute majority vote?

Answer 82

A vote greater than 50% of all the voters in that class, not merely of all the voters present for a particular meeting

Question 83

Which corporate actions require an absolute majority vote of shareholders?

Answer 83

Large changes like a large sale of assets, merger, dissolution, or revision of the articles The articles can sometimes require a greater proportion than an absolute majority, but that is the default requirement

Question 84

Under what other circumstances is an absolute majority vote needed?

Answer 84

An absolute majority of a class of shareholders is needed to modify the rights of that class

Question 85

What is a voting trust?

Answer 85

An arrangement where shareholders give their voting rights (but not dividend rights) to a trustee, who has title to the stock and votes in their stead Requires a trust agreement that must be filed with the corporation, and a copy given to the trustee Cannot be for longer than ten years

Question 86

What is a pooling agreement?

Answer 86

An arrangement where shareholders agree to vote in a particular way This agreement must be signed and in writing

Question 87

What is proxy?

Answer 87

An authorization by a shareholder for someone else (an agent) to vote in his stead Can be revocable or irrevocable, depending on whether the proxy also has a property or secured interest

Question 88

Does a shareholder have a fiduciary duty towards his corporation?

Answer 88

No, he can act primarily in his self-interest Exception: majority shareholders have a duty towards minority shareholders not to harm them

Question 89

What liabilities does a shareholder bear to his corporation?

Answer 89

Besides limited liability, a shareholder can be liable for... (1) watered stock -- liable for the difference between what was paid and par value (2) unpaid portions of a subscription contract (3) repaying dividends that were wrongly doled out, even if the shareholder did not know

Question 90

What is the difference between a merger and a consolidation?

Answer 90

In both reorganizations, two or more companies become one, but in a merger, one company retains its corporate identity -- a consolidation involves the creation of a new corporation

Question 91

What is the required process for a reorganization to occur?

Answer 91

(1) directors approve plan (2) shareholders approve plan (many states require 2/3 absolute majority) (3) plan is filed with state (4) state issues certificate

Question 92

What occurs if a shareholder dissents from a reorganization?

Answer 92

Statutes provide a process by which he could be entitled to payment for his shares

Question 93

What is a short-form merger?

Answer 93

A merger of a substantially owned subsidiary into its parent company -- and thus also called a parent-subsidiary merger The Revised Model Business Corporation Act (RMBCA) provides a simpler process for this kind of merger

Question 94

For a parent-subsidiary merger, what qualifies as "substantially owned"?

Answer 94

If the parent has at least 90% of the outstanding stock for each class of stock

Question 95

How is the process for a short-form merger simplified?

Answer 95

The plan needs to be approved only by the parent's directors -- not by any shareholders or the sub's directors Shareholders can still dissent, however

Question 96

What is a quasi-reorganization?

Answer 96

Changing a corporation's capital structure but not its legal status Done to remove an accumulated deficit (so it can pay dividends) without the cost of legally reorganizing

Question 97

What are the steps of a quasi-reorganization?

Answer 97

(1) revaluing assets at NRV, applying any increase against the deficit (2) applying the paid-in capital account directly against the deficit (3) increasing the PIC account through donation or through reducing stocks' par value

Question 98

How does a voluntary dissolution of a corporation occur, if not by expiration of a time period?

Answer 98

(1) vote by directors (2) vote by shareholders (need absolute majority) (3) filing a certificate of dissolution with the state court

Question 99

How might an involuntary dissolution of a corporation occur?

Answer 99

(1) quo warranto -- if the business does not achieve the state requirements for a corporation, the state can act against it to revoke this (2) shareholders can act for dissolution if the directors commit fraud or harm, or if the corporation cannot be run in the shareholders' interest (e.g. if the directors are at a standstill on important decisions)