Corporations

Question 1

[CORPS] • 1 • Formation • Corporate Formation • Required Formalities •

Answer 1

A corporation is NOT legally formed until the Articles of Incorporation (“AOI”) are filed with the Secretary of State by the incorporators AND the required fee is paid. The AOI must contain: (1) a proper corporate name; (2) a corporate purpose; (3) an agent for service of process; (4) the name and address of each incorporator and director; AND (5) the number of shares allowed to be issued. The corporation’s existence begins upon filing, and filing the AIC with the Secretary of State is deemed conclusive proof of valid formation.

Question 2

[CORPS] • 2 • Formation • De Jure Corporation • •

Answer 2

A legally formed corporation is called a de jure corporation. A corporation is legally formed if: (1) the AOI are filed with the Secretary of State by the incorporators AND(2)the requiredfee is paid. A corporation that is not legally formed cannot enter into contractual obligations, andpersonal liability of the owners will resultunless either the exception of de factor corporation or corporation by estoppel applies.

Question 3

[CORPS] • 2 • Formation • De Facto Corporation • •

Answer 3

A de facto corporation enjoys the same benefits and powers of a properly formed corporation. A de facto corporation exists where the entity: (1) made a good faith attempt to incorporate; (2) is otherwise eligible to incorporate; AND (3) took some action indication that it considered itself a corporation. HOWEVER, only a person who was unaware that the corporation was not properly formed may assert the de facto corporation doctrine.

Question 4

[CORPS] • 3 • Formation • Corporation by Estoppel • •

Answer 4

Under the doctrine of corporation by estoppel, any person or entity that treated a business as a corporation may be estopped from denying that the business is a corporation , even if a valid corporation was not formed. The doctrine of corporation by estoppel applies to BOTH (a) third-parties that treated the business as a corporation, and (b) an entity that held itself out as a corporation and benefited fromt hat claim. HOWEVER, the corporation by estoppel doctrine DOES NOT apply to tort actions .

Question 5

[CORPS] • 3 • Formation • Liability for Pre-Incorporation Contracts • Promoter Liability •

Answer 5

A promoter is a person who acts on behalf of a corporation that has not yet been formed to secure contracts and services for the corporation. A promoter remains personally liable on any pre-incorporation contracts entered into EVEN IF the corporation subsequently adopts the contract. TWO EXCEPTIONS to this rule exist: (1) where there was a subsequent novation (an agreement by all parties to substitute the corporation for the promoter as the contracting party and to relieve the promoter of the contractual obligations); OR (2) if the contract explicitly provides that the promoter has no personal liability on the contract.

Question 6

[CORPS] • 3 • Formation • Liability for Pre-Incorporation Contracts • Corporate Liability •

Answer 6

A corporation is not liable for a pre-incorporation contract entered into by a promoter UNLESS the corporation adopts the contract. A corporation may adopt the contract either (A)expressly, through aboard resolution, OR(B) impliedly, byaccepting or retaining benefits of the contract.

Question 7

[CORPS] • 1 • Corporate Powers • Ultra Vires Acts • •

Answer 7

A corporation may only engage in activities that are within the stated corporate purpose in its AOI. When a corporation’s activities are outside of the scope of the stated corporate purpose, such activities are deemed ultra vires. Under COMMON LAW , a corporation’s ultra vires acts are deemed void and unenforceable. However, under the Revised Model Business Corporation Act ( RMBCA ), ultra vires acts are valid and enforceable, BUT the individual directors and officers who approved that transaction can be held personally liable .

Question 8

[CORPS] • 1 • Officers and Directors • Quorum Requirements for a Board of Directors Meeting • •

Answer 8

Actions by a Board of Directors of a corporation are valid ONLY IF (a) a vote occurs when a quorum exists , OR (b) there is a unanimous written agreement by the entire board. A quorum exists when a majority of the board is present. HOWEVER , a corporations bylaws or Articles of Incorporation may contain a different requirement, but at minimum there needs to be at least one-fifth of the board present for a quorum to exist.

Question 9

[CORPS] • 1 • Officers and Directors • Director Compensation • •

Answer 9

Unless the corporations bylaws or Articles of Incorporation state otherwise, the Board of Directors is allowed to determine their compensation. However, the Board of Directors has the duty to set compensation in accordance with reasonable parameters taking into account the needs of the corporation and ensuring that he does not commit waste of corporate assets.

Question 10

[CORPS] • 1 • Officers and Directors • Election of Directors • •

Answer 10

Shareholders elect directors at the corporations annual shareholders meeting. An agreement that prohibits shareholders from electing directors is contrary to public policy and unenforceable.

Question 11

[CORPS] • 2 • Officers and Directors • Removal of a Director • •

Answer 11

A director may be removed from a corporations Board of Directors by a vote of the majority of the shareholders for cause or without cause UNLESS the Articles of Incorporation set forth that a director may only be removed for cause. An agreement that prohibits shareholders from removing directors is contrary to public policy and unenforceable.

Question 12

[CORPS] • 1 • Officers and Directors • Powers of Corporate Officers • •

Answer 12

An officer of the corporation has authority to bind the corporation under the general principles of agency. Proper authority exists where the officer has actual authority (express or implied) or apparent authority (based upon the officers title or position). An officer generally has implied or inherent powers that are necessary to perform the functions of his position.

Question 13

[CORPS] • 2 • Officers and Directors • Delegation of Corporate Responsibilities • •

Answer 13

The Board of Directors may delegate certain responsibilities to a committee of at least two directors UNLESS the bylaws or Articles of Incorporation state otherwise. A director may rely on the reports of officers, committees, or other directors assigned to perform a certain role. However, directors MAY NOT delegate their duty to make independent decisions OR delegate all their duties to a committee and simply affirm the committees decision.

Question 14

[CORPS] • 6 • Officers and Directors • Director Duties • Duty of Care and Business Judgement Rule •

Answer 14

The duty of care requires that a director act: (1) in good faith ; (2) with a degree of care that a prudent person would exercise under the circumstances; AND (3) in the best interests of the corporation according to the directors reasonable belief. If this three-part test is satisfied, then a director will not be liable for corporate decisions that resulted in adverse consequences to the corporation. Under the common law, the above test was known as the business judgment rule.

Question 15

[CORPS] • 5 • Officers and Directors • Director Duties • Duty of Loyalty • Fiduciary Duty Owed

Answer 15

A director owes the corporation the fiduciary duty of loyalty and therefore must act in the corporations best interest. The duty of loyalty prohibits a director from engaging in self-dealing or usurping a corporate opportunity. Self-dealing is a transaction that benefits the director or a directors family member.

Question 16

[CORPS] • 5 • Officers and Directors • Director Duties • Duty of Loyalty • Conflicting Interest Transactions

Answer 16

A conflict of interest transaction is a transaction with the corporation wherein a director has a direct or indirect interest. A conflict of interest occurs where the director or directors family member either: (a) is a party to the transaction ; (b) has a beneficial interest in the transaction or is so closely linked to the transaction that the directors judgment may reasonably be effected; OR (c) is involved with another entity (director, employee, owner, etc.) that is conducting business with the corporation and that transaction would normally be bought before the board because of its importance to the corporation.

A conflict of interest transaction may be upheld where the transaction: (a) was approved by a majority of the uninterested directors after full disclosure of all material facts; (b) was approved by a majority of the disinterested shares entitled to vote after full disclosure of all material facts; OR (c) was fair to the corporation under the circumstances at the time of the transaction.

Question 17

[CORPS] • 5 • Officers and Directors • Director Duties • Duty of Loyalty • Usurping a Corporate Opportunity

Answer 17

A corporate opportunity is one in which the corporation has a business interest in OR reasonably expects in its line of business. A director MAY ONLY pursue a corporate opportunity if he: (1) first presents it to the corporations Board of Directors; AND (2) the corporations board decides not to pursue the opportunity. Modern authorities construe a business opportunity broadly to include those outside the corporations traditional line of business. It is NOT a defense to show that the corporation would not have been able to take the opportunity.

Question 18

[CORPS] • 1 • Shareholders • Shareholder Voting • Fundamental Changes to a Coporation •

Answer 18

A fundamental change MUST be approved by a majority of the total votes entitled to be cast for the corporation , not just a majority of votes present at the meeting. A fundamental change includes a merger, consolidation, amendment of the Articles of Incorporation, sale of all or substantially all of the corporations assets, or dissolution. A corporation MUST hold a special meeting when a fundamental change is proposed. A special meeting requires notice to be mailed to the shareholders, which must include the reason for the meeting and the date, time, and place of the meeting. Business that is not included in the notice may not be discussed at the special meeting.

Question 19

[CORPS] • 1 • Shareholders • Shareholder Voting • Proxy Voting and Revocation of a Proxy •

Answer 19

A shareholder may vote her shares at a shareholders meeting without physically attending the meeting through the use of a proxy. A proxy MUST : (1) be in writing ; (2) signed by the shareholder ; (3) addressed and delivered to the corporations secretary ; AND (4) authorize another to vote the shareholders shares. An individual who is granted the power to vote another’s shares by a proxy must act in accordance with any agreement between the parties. If the shareholder directs that the proxy holder vote a certain way, then the proxy holder must do so. A shareholder may also grant a proxy holder the ability to vote shares as the proxy holder deems appropriate. A proxy is valid for 11 months UNLESS the proxy provides otherwise. Proxy agreements are freely revocable by the shareholder, even if the proxy states that it is irrevocable. One exception to this rule is a proxy coupled with an interest or legal right , which is irrevocable if the proxy expressly states that it is irrevocable.

Question 20

[CORPS] • 2 • Shareholders • Shareholder Voting • Shareholder Voting Agreements •

Answer 20

Generally, shareholders may enter into agreements regarding their rights and obligations including an agreement to vote their shares together. A shareholder voting agreement MUST be in writing and signed by all parties. A shareholder voting agreement has no durational limit. It is governed by contract principles and is not revocable unless it would be under prevailing contract law. A shareholder voting agreement is distinguishable from a voting trust in that a voting trust is more formal, in that legal ownership of the shares are transferred to the trust, the shareholders must provide the trust agreement to the secretary of the corporation, and it only lasts 10 years.

Question 21

[CORPS] • 2 • Federal Securities Law • Rule 10b-5 • •

Answer 21

Rule 10b-5 prohibits the use of any means or instrumentality of interstate commerce in any scheme to defraud, make material misrepresentations or omissions, or in any other way to use fraud in the purchase or sale of securities.

In order for a plaintiff to prevail under a Rule 10b-5 claim, he must show that the defendant : (1) engaged in a fraudulent scheme or device which was; (2) relied upon; (3) in connection with the purchase or sale of a security; (4) acted with scienter ; (5) used some means of interstate commerce ; AND (6) caused damages.

A fraudulent scheme or device includes (i) misrepresentations of material facts , (ii) insider trading (trading securities on the basis of inside information), OR (iii) tipping (trading on material information received from an insider). An insider is a person that discloses non-public information that a reasonable trader would want to know before buying or selling stock or abstains from trading. One who receives insider information is only liable if he knows that an insider is giving him non-public information for an improper purpose. Reliance is presumed if a material omission is made. Material is defined as a statement or omission that has a substantial likelihood that a reasonable investor would consider it important. Scienter exists when a person acts with at least recklessness. The plaintiff can only be the Securities and Exchange Commission (SEC) or be connected to the purchase or sale of the securities in issue. Non-trading defendants may also be held liable if fraud based on misleading information can be proven.

Question 22

[CORPS] • 2 • Federal Securities Law • Section 16(b) • •

Answer 22

Section 16(b) requires that a director, officer, or shareholder owning more than 10% of a corporation MUST surrender any profit realized to the corporation from the sale or purchase of equity securities within a 6-month period when the corporation: (a) is publicly traded on a national stock exchange; OR (b) has more than $10 million in assets AND at least 2,000 shareholders. Strict liability is imposed for any covered transaction. The corporation is entitled to recover the maximum difference between any sale and purchase price during the 6-month period.

Question 23

[CORPS] • 4 • Shareholder Liability and Disregard of the Corporate Entity • Piercing the Corporate Veil • •

Answer 23

Generally, a shareholder is not personally liable for the debts of the corporation. However, a court will hold shareholders personally liable by piercing the corporate veil in the following situations: (a) the corporation is acting as the alter ego of the shareholders; (b) where the shareholders failed to follow corporate formalities ; (c) a corporation was inadequately capitalized at its inception to cover debts and liability; OR (d) to prevent fraud. A court is more likely to pierce the corporate veil for tort actions rather than contract disputes.

Question 24

[CORPS] • 1 • Dissolution • Distribution of Corporate Assets • •

Answer 24

Courts generally require outside creditors (which includes promissory note holders and those without an equity interest in the corporation) to be satisfied first with the assets of the corporation. Then, if sufficient assets remain, inside creditors (shareholders who made loans to the corporation) will be required to be satisfied. Lastly, the remaining assets, if any, will be distributed to the shareholders according to their share of ownership.