Corporations Flashcards

Question

Limited liability filing | CORPORATE MODEL /corporations

Answer 1

- Any time we have limited liability company, state must accept document for filing (gotta get dat stamp) - (distinct from partnership = doesn’t need that, because not limited liability)

Answer 2

= Money $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$M$$$$$0$$$$$$$$N$$$$$$$$$$E$$$$$$$$$$$$Y$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$

Answer 3

1. Debt financing (loans) | 2. Equity financing (selling ownership interest)

Answer 4

Selling ownership interest

Answer 5

- Bifurcation of ownership/management interest - Board of directors are calling shots that affect the money of shareholders - KEY issue = philanthropic decisions

Answer 6

Law recognizes corporations are members of the community, and as members of the community, can support charitable causes

Answer 7

AKA benefit corporation = For-profit corporation that is expressly committed to benefit society by certain causes EXAMPLE = corporation that manufactures widgets in foreign country, pays foreign workers same wage as U.S. workers (cause is expressly stated, board cannot be sued for wasting shareholders money)

Answer 8

- Development of corporation unlocked economic engines | - Created jobs, spurred innovation, created tax revenue

Answer 9

1. Person (incorporator) 2. Paper (typically articles of incorporation) 3. Acts (delivery, filing by usually Secretary of State)

Answer 10

- Can have more than one incorporator - Usually human being, but doesn’t have to be - Job = execute articles and delivery to state

Answer 11

4 things that must be in the articles 1. Name of corporation 2. Name and address of each incorporator 3. Name of registered agent, address of registered office 4. Information about the stock

Answer 12

Must have one of magic words, spelled out or abbreviated

Answer 13

(required by model act, vary slightly from state to state) 1. Corporation 2. Company 3. Incorporation 4. Limited

Answer 14

Must be in the state of incorporation

Answer 15

Official legal representative of the corporation EXAMPLE = someone who can receive service of process or tax docs

Answer 16

Number of shares available | If having classes of stock, must note this and describe

Answer 17

Some states require article of incorporation to include | Statement of purpose for corporation (can be very general)

Answer 18

1. Exculpation provision | 2. Names/addresses of initial directors

Answer 19

1. Incorporator signs articles 2. Have them notarized 3. Deliver them to secretary of state 4. Have to pay filing fee 5. Secretary stamps and files = corporation forms at this moment

Answer 20

1. Initial directors were named in articles | 2. Initial directors were not named in articles

Answer 21

Named directors hold meeting to 1. Select directors 2. Adopt initial bylaws 3. Conduct other appropriate business, like authorizing issuance of stock

Answer 22

- incorporator(s) holds meeting (doesn’t have to be in person, can be by written consent) to SELECT initial directors - Most states = can also adopt initial bylaws/conduct other biz OR can let initial directors do it

Answer 23

Articles = far more important, actually form corporation when filed with state, public documents, usually very short document, extremely difficult to amend (constitutes “fundamental corporate change”) Bylaws = not filed with state, completely internal, lay out internal rules, easy to amend (most states = shareholders can do it, some state = directors or shareholders can)

Answer 24

- Incorporate in state A (= domestic corporation in state A) | - Qualify to do business in state B (= foreign corporation in state B)

Answer 25

Engaged in the regular course of intrastate business activity = must qualify as foreign corporation (if activity is more sporadic, don’t need to qualify AKA corp doesn’t need to qualify in every single state in which it has ever done a single business)

Answer 26

Must get certificate of authority from state B by showing 1. Content of articles 2. Proof that corporation is in good standing in state A

Answer 27

- Must get registered agent in state B (so somebody there to receive service of process if sued in state B) - Must pay taxes and stuff to state B

Answer 28

- Subject to civil fine | - Cannot assert a claim in state B (until pay fine and get qualified)

Answer 29

Q = what law governs internal affairs? A = internal affairs of a state A incorporation are governed by state A law AKA governing law for internal affairs is state of incorporation EVEN IF corp doesn’t do any business at all in incorporating state

Answer 30

Somebody acts on behalf of corporation that’s not yet formed and enters contract on behalf of that corp WHEN EVERYONE KNOWS THERE’S NO CORPORATION

Answer 31

Person acting on behalf of corporation that’s not yet formed and enters pre-incorporation contracts

Answer 32

- Corporation is never automatically liable on pre-incorporation contract - Not liable UNTIL it adopts the contract

Answer 33

Can be express or implied

Answer 34

Board of directors has meeting and agrees to adopt or something like that

Answer 35

Corporation accepts a benefit under that contract

Answer 36

Promoter is PERSONALLY liable because she is a party to that contract EVEN IF corporation is never formed

Answer 37

Promoter is liable on pre-incorporation contracts until there’s a novation

Answer 38

Agreement between promotor and corporation and lessee that corporation will replace promoter on contract (adoption is not novation = if corp adopts contract, BOTH promoter and corp are liable until novation occurs)

Answer 39

Everyone THINKS there is a corporation but legally there isn’t due to defect in formation (= no de jure corporation)

Answer 40

``` PIC = everyone knows the corp doesn’t exist DI = everyone believes the corp does exist ```

Answer 41

No formation of de jure corporation BUT if defective incorporators are acting together, probably formed partnership = personally liable (by rules of partnership)

Answer 42

= under these common law doctrines, treated as corporation = not personally liable 1. De facto corporation (DFC) 2. Corporation by estoppel (CBE)

Answer 43

Must be unaware of failure (defect) to form a corporation

Answer 44

Must show that 1. There is relevant incorporation statute (met in every state) 2. Parties made good faith, colorable (you were soooo close) attempt to comply with statute 3. Some exercise of corporate privilege (AKA acting as though corporation existed) = de facto corporation doctrine applies, court treats as if corporation was actually formed

Answer 45

- Parties not personally liable - Applies in BOTH for contracts and in tort BUT state can still enforce penalties/action for failure to incorporate (= still liable to state)

Answer 46

Still liable to state for failure to incorporate correctly

Answer 47

1. If parties treats business as incorporation and act under that belief, 3P can be estopped from denying the corporation's existence (AKA estopped from claiming the entity is not a corporation) 2. Used as defense by defective incorporation to prevent 3P from suing them individually

Answer 48

- Very narrow doctrine (narrower than DFC) | - Applies only in contract (not tort)

Answer 49

- Common law doctrines - All over the map - Some states abolished both, some follow one, some follow both - NOTE WHAT PROFESSOR THINKS RE: WHETHER GOOD LAW

Answer 50

people who act behalf of corporation KNOWING that it doesn’t exist/wasn’t formed = personally liable

Answer 51

- Some think it implies CBE and DFC are abolished - Some think that lack of knowledge means that you can use CBE and DFC - NOTE WHICH PROFESSOR THINKS

Answer 52

Fancy word for money

Answer 53

1. Debt financing 2. Equity financing (usually raise capital using both)

Answer 54

Borrow money

Answer 55

Allow investors to buy ownership interest in the business

Answer 56

- Gives money to corporation to loan for interest (debt financing) - Payment from corporation does not vary with profits/losses of corporation - Riskier for the business

Answer 57

- Gives money to corporation to buy for ownership (equity financing) - Payment from corporation varies with profits/losses of corporation - Riskier for the investor

Answer 58

By issuing securities

Answer 59

Fancy word for sell

Answer 60

Fancy word for investment

Answer 61

- Security issued by corporation to lender (creditor) | - With debt financing

Answer 62

- Loan to corporation, repayment of which is not secured by corporate assets - Form of debt financing

Answer 63

- Security of ownership interest issued by corporation to investor - With equity financing

Answer 64

Corporation is selling its own stock

Answer 65

- Maximum number of shares corporation may sell | - Always set out in the article (cannot sell more unless amend articles)

Answer 66

Number of shares corporation actually does sell

Answer 67

Number of shares corporation has sold and has not reacquired | if issued and bought back, no longer outstanding

Answer 68

When corporation is selling its own stock, must abide by 2 rules 1. Must be for a proper form of consideration 2. Must be for a proper amount of consideration

Answer 69

- Historically = couldn’t do promissory notes and promise for future services - Modern view = buyer may pay for an issuance with any tangible or intangible property or benefit to corporation (AKA pretty much any consideration)

Answer 70

Corporation has to get at least par value

Answer 71

= minimum issuance price Completely arbitrary, has no relationship with actual value of stock (key word = minimum, can be more)

Answer 72

- Not required | - Set up by the articles

Answer 73

- No minimum issuance price | - Board can set whatever price it wants

Answer 74

- ONLY applies when corporation sells its own stock | - Don’t apply to regular people selling the corporation’s stock

Answer 75

When stock is listed for less than par value | Difference btwn par value and selling price = water

Answer 76

AKA what happens when stock is listed for less than par value = corporations sue for payment of water - Directors who approve the issuance of watered stock = liable for the water - Buyer of watered stock = liable for the water charged with notice of par value (can’t use ignorance of par value as defense) - 3P to whom buyer transfers watered stock = not liable for the water if didn’t know about the water

Answer 77

Term of art | = Payment by corporation to its shareholders

Answer 78

1. Dividends 2. Repurchase 3. Redemption

Answer 79

= where corporation is paying the shareholders - Corporation is doing well, making money = can choose to put that back into corporation OR to pay dividends - Some corporations never pay dividends

Answer 80

= corporation buys stock back from shareholder

Answer 81

= corporation forces shareholder to sell back her stock, pays her for it (redeemed stock) - Fairly rare - MUST be set up in the articles of incorporation

Answer 82

- No, shareholder’s don’t have rights to distribution - Payment of distribution is left entirely to discretion of the board (if shareholder sues, very hard to win, must show bad faith and stuff)

Answer 83

Paid pro rata per each share (unless articles say otherwise)

Answer 84

- Preferred = pay first (NOT pay more = might get more, might get less) - Articles will set up classes - Articles will set up preferred amount

Answer 85

- Law imposes restrictions on when corporation can make distribution - 2 schools of thought

Answer 86

1. historical/fund approach | 2. Modern approach (majority approach)

Answer 87

Must know about 3 types of funds in life of corporation

Answer 88

1. Earned surplus 2. Stated capital 3. Capital surplus

Answer 89

= profits corporation earned by doing well on market (making more than it spends) - Proper source (fund) for distribution AKA may pay distribution from earned surplus

Answer 90

= par value of a par issuance (at board’s discretion with no-par balance) - Related to corporation’s raising money by issuing stock (rather than profiting from business) - Can NEVER be used to pay distribution

Answer 91

= excess over par value (at board’s discretion with no-par balance) - Related to corporation’s raising money by issuing stock (rather than profiting from business) - CAN be used to pay distribution

Answer 92

Corporation can make a distribution UNLESS 1. Corporation is insolvent OR 2. The distribution would render it insolvent Looks at insolvency, not the type of funds

Answer 93

Company is insolvent if 1. Unable to pay its debts as they come due 2. Corporation’s assets are less than its liability These are ALTERNATIVE tests = if corporation meets either, it is insolvent Model act section 6.40(c)(1) and (2)

Answer 94

Liabilities INCLUDE preferential liquidation rights | = must be taken into account when testing for insolvency

Answer 95

- Class of stock with liquidation preference (analogous to dividend preference) - Comes up when company dissolves (rather than during distribution) = distributed first to those with liquidation preferences

Answer 96

- Directors who approved the distribution = usually liable to the extent that distribution was improper (some states = strict liability, some states require breach of duty of care) - Shareholders who received distribution = liable ONLY if knew distribution was improper AT TIME IT WAS RECEIVED

Answer 97

Either named in articles or elected by incorporators

Answer 98

Elected by shareholders every year at annual meeting

Answer 99

- Need only one - Model act = can be enumerated in articles OR bylaws (varies by state)

Answer 100

- Nope | - Has to been an adult human being

Answer 101

- Nope | - No authority to bind the corporation

Answer 102

- Smaller companies = day-to-day operations | - Large companies = oversee management, but officers undertake actual management

Answer 103

- Held by the board of directors - Directors can 1. Set management policy 2. Make big decisions - NOT the shareholders

Answer 104

- Not only a director but also employed full-time by the corporation (as officer) - Sometimes called management director

Answer 105

Someone whose day job is not within the corporation

Answer 106

- Required, shareholders must hold it to elect directors | - If late, directors will be holdover directors until successor is appointed

Answer 107

- Up for election every year | - Sometimes can be longer in staggered boards

Answer 108

- divided into halves or thirds | - half/third of board is elected each year

Answer 109

- Can remove a director before term is up - With or without cause (some states = if staggered board, must have cause)

Answer 110

- Majority = shareholder or remaining directors can fill that position - Majority = if shareholders created the vacancy, shareholders should select replacement

Answer 111

Must act as a group

Answer 112

1. Unanimous written agreement (generally includes email) | 2. Meetings

Answer 113

1. Regular | 2. Special

Answer 114

Corporation does not have to give notice to shareholders | time/date/frequency is usually set up in the bylaws

Answer 115

Corporation MUST give notice to directors

Answer 116

- Must state time and place of meeting - Does not have to state the purpose of the meeting - Model act 8.22(b) requires notice be given at least two days before meeting - Details of how to give notice = statutes usually vague, often put in bylaws

Answer 117

Any action taken by board at that meeting may be voided | UNLESS those not given notice waive the defect

Answer 118

1. May do this in writing at any time | 2. May do this by attending the meeting without objecting at the outset of the meeting

Answer 119

Every decision board makes comes to board as resolution to be passed or not Key Q = does it have a quorum

Answer 120

Majority of the directors (unless bylaws say otherwise)

Answer 121

Once have a quorum, just need positive/affirmative vote from majority of those in attendance

Answer 122

If director leaves meeting (even for short bit) and majority is not longer present = quorum is broken, board cannot act

Answer 123

- Directors don’t have to be in the same place or see each other - TEST = directors merely have to hear each other live - Everyone participating is considered present

Answer 124

- Can vote by proxy | - Can enter voting agreements

Answer 125

voting proxies/agreements = void by public policy | directors owe nondelegable fiduciary duties to corporation

Answer 126

Every director present is PRESUMED to have concurred with whatever action board took UNLESS dissent or abstention is noted in writing

Answer 127

- In the minutes OR - Deliver in writing to presiding officer in the meeting OR - Filed written dissent with the corporation immediately after the meeting

Answer 128

Liable UNLESS the dissent or abstention is noted in writing in 1 of 3 permitted ways (usually in the minutes)

Answer 129

You can create a shell LLC with no assets and merge with the corporation with the LLC being the survivor

Answer 130

Corporation = Formalities required. Partnership = Can be informal.

Answer 131

Corporation = Yes. Partnership = Depends on type.

Answer 132

Corporation = Easier. Partnership = More difficult.

Answer 133

Corporation = Default infinite. Partnership = Default at will.

Answer 134

Corporation = Yes. Partnership = No.

Answer 135

Corporation = Lawyer, filing fees, etc. Partnership = Zero for GP.

Answer 136

Corporation = More extensive. Partnership = Extensive.

Answer 137

Corporation = Easier to understand and high prestige. Partnership = Hard to understand and low prestige.

Answer 138

Corporation = More limited. Partnership = High.

Answer 139

Corporation = Double. Partnership = Single. Pass though.

Answer 140

(Courts says you must have 3 out of 4) 1. Limited L 2. Unlimited Duration 3. Centralized management, and 4. Freely transferable interest

Answer 141

- Legal personality: a corporation is a legal entity distinct from its owners; - More freely transferable ownership interest (Liquidity) - Flexible capital structure - Infinite duration - Limited liability

Answer 142

Centralized corporate management = - the right to manage the corporation is not spread out among the shareholders - but rather is centralized in a board of directors, who usually delegates day-to-day management duties to officers

Answer 143

a shareholder can sell his shares to whomever he wants, whenever he wants in most circumstances

Answer 144

Corporations are taxed twice: 1. Corporation is taxed as an entity, and 2. Taxed when corporation pays out dividends to shareholders

Answer 145

Stock: an equity security is an instrument representing an investment in the corporation whereby its holder become a part owner of the business

Answer 146

- Bonds: set return, interest. Debt gets paid first if company goes bankrupt. - A debt security represents a creditor/debtor relationship with the corporation, whereby the corporation has borrowed funds from an outside creditor and promised to repay the creditor - A bond holder has no ownership interest in the business

Answer 147

May be amended at any time by a three step process: 1. The Board recommends amendment to the shareholders 2. Shareholders must approve the amendment, AND 3. Amendment must be field with the secretary of state’s office

Answer 148

- May not be same or confusingly similar to that of another corporation incorporated or qualified to do business in the state of incorporation - The name must also include some word or abbreviation indicating that the business is incorporated such as corporation, company, Inc, or the like

Answer 149

The articles must state the maximum number of shares the corporation is authorized to issue

Answer 150

- The articles must state the name of the corporation’s registered agent and the address of its registered office - The registered office must be located within the state of incorporation - The registered agent receives service of process when the corporation is sued

Answer 151

- The articles must state the name and address of each incorporator - Traditionally needed 3, but today you only need 1

Answer 152

1. Statement of Purpose 2. Classes and Series of Shares 3. Director and Officer Indemnification and Liability Limitation

Answer 153

The articles may state the nature of the corporation’s business or the purpose for which it was formed

Answer 154

- Corporate stocks may be separated into multiple classes and series - If the corporation wishes to do so, the articles must identify the different classes and the number of shares of each class the corporation is authorized to issue - Where one or more classes of shares have certain preferential rights over other classes, those rights must be spelled out in this part

Answer 155

Most corporate statutes now permit the articles to include provisions limiting the scope of a director’s liability and/or permitting indemnification of directors

Answer 156

= the rules the Corporations Adopts to Govern Internal Affairs - Binding contracts between directors, officers and shareholders - May contain any provision, not inconsistent with the law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers, or employees - Stockholders are put on notice of bylaws upon the purchase of stock

Answer 157

- Bylaws tend to be far more detailed than the articles of incorporation for these reasons 1. Bylaws need not be filed with the state government, so they are not part of any public record 2. Bylaws are more easily amended than articles of incorporation 3. Officers and directors tend to be more familiar with bylaws than with the articles, which makes them a ready repository for organizational rules. - Articles control over bylaws

Answer 158

- A contractual provision in which the parties establish the place (such as the country, state, or type of court) for a specified litigation between them - Cuts down on a corporation’s litigation because cases from different states can be consolidated - The only requirement is that it must be internal business for it to be subject to the forum selection clause

Answer 159

Re: Forum Selection Clause 1. Under Delaware law, forum selection bylaws adopted pursuant to articles of incorporation w/o a vote by stockholders are not facially invalid. 2. Shareholders can bring direct and derivative actions. 3. Stockholders have the power to adopt, amend, or repeal bylaws, but a corporation may confer this power upon the directors (but this never divests this power from the stockholders). 4. When challenging the contractual validity of the bylaws: Burden is a difficult one – must show that bylaws cannot operate lawfully or equitable under any circumstances.

Answer 160

1. C-Corporations 2. Close Corporations 3. De Facto Corporation 4. Corporation by Estoppel

Answer 161

Public v. Private - Most common formation - Taxation: it pays income taxes on any profits that it makes, and generally shareholders do not have to pay income tax on the corporation’s profits until the profits are distributed. Double taxation

Answer 162

50% of the company’s stocks are in the hands of 5 or fewer people

Answer 163

- This is a corporation in fact - This doctrine provides that a defectively formed corporation (that is one that fails to meet the technical requirements for forming a de jure corporation) may attain the legal status of a de facto corporation if certain elements are met - Elements = instantly comes into being when 1. Proceeding in good faith (a good faith attempt to comply) 2. Using a valid LLC/Corporation statute 3. For an authorized/permitted purposes, AND 4. Have executing and acknowledged articles of association pursuant to that purpose 5. Cannot have a true corporation until that state says you are (must complete all requirements, paperwork, etc.) (However, if a state has not done what it is supposed to do, it can still be recognized as a corporation because courts look to substance over form)

Answer 164

- A person who treats an entity as a corporation will be estopped from later claiming that the entity was not a corporation - This is an equitable remedy, the purpose of which is to prevent one who contracts with a corporation from later denying its existence in order to hold the individual officers or partners liable - Court applies this doctrine to LLCs because the corporate structure has little impact on the equitable principles at stake, there is no reason to draw a distinction, and it can coexist with an LLC like it coexists with the BCA

Answer 165

The courts will disregard the corporate form, or pierce the corporate veil whenever necessary to prevent fraud or to achieve equity (would promote injustice or fraud) (This is the opposite of de facto and estoppel argument because here, a valid corporate existence is ignored in equity to make individuals personally liable)

Answer 166

Veil will be pierced when corporate formalities are ignored (when the corporation is the alter ego or mere instrumentality of another corporation)

Answer 167

= corporation is dummy for its individual stockholders who are actually carrying on business in their person capacities; the stockholder would be personally liable - Alter ego results in basic injustice - When a company’s owner does not take care to observe the formal separation between himself and his business, the business creditors can collect their debts directly from him

Answer 168

= the plaintiff must allege that a shareholder used the corporate form to conduct business in his individual capacity and further his own business interests’ rather than the corporations: - He will be liable for the corporation’s acts upon the principle of Respondeat superior applicable even where the agent is a natural person - This liability extends even to the corporation’s negligent acts as well

Answer 169

= Corporation is a fragment of a larger corporation which actually conducts business; only larger corporate entity financially responsible - If one corporation owns all the shares of common stock of another corporation - A showing of substantial domination is required 1. First company (owner of shares) is generally the parent corporation 2. The second company is generally the subsidiary - Like an individual shareholder; however a corporate shareholder must be aware of the danger that if it is not careful, the creditors of the subsidiary may be able to pierce the corporate veil of the subsidiary - The parent must also be careful to not become directly liable by virtue of its participation in the activities of the subsidiary

Answer 170

1. The failure to maintain adequate corporate records or to comply with corporate formalities 2. The comingling of funds or assets 3. Undercapitalization 4. One corporation treating the assets of another corporation as its own

Answer 171

- Daily operation of the two corporations is not kept separate - Subsidiary does not observe basic corporate formalities, such as keeping separate books and records and holding shareholders and board meetings (This was the most important factor In Re Silicone)

Answer 172

- Parent and subsidiary file consolidated financial statements and tax returns - Parent finances subsidiary

Answer 173

- Subsidiary operate with grossly inadequate capital

Answer 174

- Parent and subsidiary have common directors or officers; - Parent and subsidiary have common business departments - Parent causes the incorporation of the subsidiary - Parent pays the salaries and other expenses of the subsidiary - Parent uses subsidiary’s property as its own

Answer 175

1. When the corporation is inadequately capitalized at the outset 2. To prevent fraud - Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice (must allege more than simply a promotion of injustice because that would be an issue in every case and too general; some element of unfairness, something akin to fraud, deception, or the existence of a compelling pubic interest must present in order to disregard the corporate fiction 3. The corporate veil of limited liability does not protect from criminal liability - A corporation is an agent of human action so if a corporation injures someone an individual authorizing such action may/can be liable - This does not happen often

Answer 176

pulling corporate assets on a personal suit by claiming an individual was acting as an agent for the corporation

Answer 177

- If shareholders respect the requirements of a corporation then they are relieved of personal liability - See Netjets for an example of what NOT respecting the existence of shareholders and a corporation looks like

Answer 178

- Who suffered the alleged harm (corporation or suing shareholders individually)? - Who would receive the benefit of any recovery or other remedy (corporation or shareholders individually)

Answer 179

1. Class action: - E.g. directors reconfigured Shareholder rights to harm preferred shareholders 2. Direct individual action: - E.g. director reconfigured bylaws to squeeze out a particular shareholder 3. Generally: - A breach of fiduciary duty owed to the shareholder by an officer or a director of a corporation - Brought by shareholder in his own name - Cause of action belongs to shareholder in his individual capacity - Arises from an injury directly to the shareholder - Often brought as a class action 4. Recovery goes to the shareholder

Answer 180

1. Suit brought by the shareholders, not in their name, but in the name of the corporation enforcing the rights of the corporation 2. Arises out of an injury to the corporation as an entity 3. Asking the court to declare that under the circumstances they should be allowed to step into the shoes of the directors and take action 4. Ex. CEO is messing with the corporation’s money a. If you go to the CEO he will likely do nothing b. If you go to the board they will likely not do anything either 5. A shareholder fails to state a cause of action unless it alleges that a corporation’s directors’ conduct was causing financial loss to the shareholder AND was based upon fraud, illegality, or conflict of interest a. A shareholder’s derivative suit can only be based on conduct by the directors, which borders on fraud, illegality, or conflict of interest

Answer 181

- In Delaware, creditors may only bring derivative actions if the corporation is insolvent - In a minority of jurisdictions, creditors can only bring derivative actions if the corporation is insolvent or in the zone of insolvency

Answer 182

(either universal demand juris or can’t skip b/c can’t meet qualifications) - Prohibited from filing a suit within 90 days of the issuance of a demand to the corporation unless rejected earlier except - Shareholder may file prior to the expiration of the 90-day period, but only if they can show that the corporation would suffer irreparable injury as a result - Board of corporation rejected the pre-suit demand made by SHs that board assert the corporate claim - SH can drop the claims or abandon suit OR File suit that rejection was wrongful (in universal demand jurisdiction this is the SH’s only option)

Answer 183

(Demand futility) (NY, DE, TN) You can go straight to court w/o making a demand if: - Action occurs and you plead with particularity that reasonable doubt exists that: 1. Board lacks independence 2. Decision was not protected by BJR - Director Oversight cases where inaction/failure to act (In Re China Agrotech) - You do this by showing: 1. Majority of board has material familial or financial interest 2. Majority of board is incapable of acting independently 3. Underlying transaction is not the product of valid business judgement

Answer 184

1. Grimes/Aronson Test | 2. Rales Test

Answer 185

use if challenging an action made by a majority of current directors TEST: must plead particularized facts that lead to reasonable doubt that 1. Disinterested or independent directors - Majority of the board has material financial or familial interest - Majority of the board lacks independence 2. Whether the director exercised valid business judgment in the actions being challenged in the proposed law suit OR underlying transaction is not a product of Business Judgement Rule - This is a disjunctive test: if the first rule applies, you don’t have to move the second step 3. Once director interest is established, the Business Judgment Rule is inapplicable and demand is excused

Answer 186

= applies where the subject of the derivative suit is not a business decision of the board (when the plaintiff alleges a Caremark violation by the board for failing its oversight duties, there is no business decision) AKA there is no action, simply inaction This rule is in place for the common sense reason that a board facing liability likely would not admit any wrongdoing or change its course of action upon receiving such a demand 1. Comes into play when the Business Judgement Rule is inapplicable because there has not been an action OR 2. Involves board members that were not directors at the time of the underlying transactions, because we are worried that they are not disinterested because of the control of the board majority TEST: must plead particularized facts that, if true, raise reasonable doubt as to, - Director disinterest or independence/impartiality (E.g. when directors “consciously disregarded their duties” and acted in bad faith, and thus face a substantial likelihood of liability) Generally: a sustained or systematic failure of the board to exercise oversight will establish the lack of good faith that is a necessary condition to director liability

Answer 187

- A special litigation committee’s determination forecloses further inquiry into a matter, provided the investigation is bona fide. - A director’s lack of independence turns on whether the director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind - Special Litigation Committees are subject to heightened scrutiny – has to be bulletproof

Answer 188

If demand is sought The Court looks to see if the Board’s decision falls within the Business Judgment Rule - If it does, there is no judicial review - If not, use the 2 step test from Zapata Corp. v. Maldonado 1. Inquire into the independence and good faith of the committee and the bases supporting its conclusions - If not satisfied, deny motion to dismiss - If satisfied, go to step 2 2. The court should determine, apply its own independent business judgement, whether the motion to dismiss should be granted

Answer 189

(from In Re Oracle Corp.) = Whether the director is, for any substantial reason, incapable of making a decision with only the best interest of the corporation in mind

Answer 190

1. Most powerful group. Meet once a month generally (on an as-needed basis) 2. Responsible for the management of the business and affairs of the corporation 3. May be removed by shareholders with or without cause 4. May delegate authority to committees, made up of two or more members of the board

Answer 191

1. The C-Suite: CEO, COO, CFO 2. Officers have whatever duties the board prescribed 3. The board remains responsible for supervision of the officers despite the delegation of a duty 4. Some officers may also be directors: - Officers who sit on the Board are called inside directors - The majority of directors must be “independent” rather than inside directors

Answer 192

1. Individuals who have residual interest in the company 2. Shareholders have indirect control over the corporation through the power to elect directors, amend the bylaws, and approve fundamental changes to the corporation 3. Annual meetings to vote on directors 4. Notice of meetings to shareholders entitled to vote: 10-60 days before the meeting

Answer 193

- Doctrine relieving corporate directors and/or officers from liability for decisions honestly and rationally made in the corporation’s best interest - This broad protection/immunity from their decisions that directors/officers receive that protects them even when they lose lots of company money

Answer 194

- A class of stock representing the corporation’s ownership, the holders of which are entitled to dividends only after the holders of preferred stock are paid - Shares entitling their holder to dividends that vary in amount and may even be missed, depending upon the fortunes of the company (risky); these shareholders typically want more control

Answer 195

The payment of earning to a corporation’s shareholders in proportion to the number of shares held

Answer 196

- Stock that entitled the holder to a fixed dividend, whose payment takes priority over that of common stock dividends (it accumulates) - Hybrid between debt and equity - When company goes belly-up, these get paid first

Answer 197

Stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually any time after a pre-determined date

Answer 198

- Businesses that trade to tackle social problems, improve communities, people’s life chances or the environment - They make their money from selling goods and services in the open market, but they invest their profits back into the business or the local community - Benefit corporations: pushback on cases like Dodge and eBay that push corporations too far towards shareholders - Low-profit LLC

Answer 199

1. Donation to Princeton University 2. A corporation may make reasonable charitable contributions, even in the absence of express statutory provisions. - Must be SOME benefit to the corporation - Some jurisdictions place cap on % of earnings

Answer 200

1. A corporation’s primary purpose is to provide profits for its stockholders. 2. Although a corporation’s directors have discretion in the means they choose to make products and earn a profit, the directors may not reduce profits or withhold dividends from the corporation’s shareholders in order to benefit the public.

Answer 201

- Directors have gathered information and thought about the problem - Corporate decision-making is, by nature, largely discretionary - We do not want courts substituting their judgment for that of the directors, we only want courts stepping in when the directors act in an illegal manner - This is about balancing between allowing corporations to be run by Boards and the interests of the public and shareholders in being protected from stupid imprudent decisions by the board - A director/officer must act: 1. In good faith 2. In a manner the director reasonably believes in the best interest of the corporation; 3. With the care that a person in a like position would reasonably believe appropriate under similar circumstances

Answer 202

- Directors must make a wise choice if delegating duties and must closely monitor persons making decisions on the corporation’s behalf - Directors are only liable if their actions were illegal or unconscionable - Policy: 1. If a director were open to liability for his uncompromised decisions, few people would seek out or accept a position on the Board 2. Directors must often make quick decisions with huge impacts 3. Directors must trust that if their decision looks poor in hindsight, they cannot be sued if they made their best efforts to understand the factors relating to the issue - The issue of director liability can be difficult when a director shrinks his duties and allows a third party to act on behalf of the corporation, particularly if the third party’s actions are not closely monitored

Answer 203

- Officer duties are similar to directors, although the law is less well settled for officers - Standard of Conduct for Officers: = an officer shall act: 1. In good faith 2. Care of a reasonable person (in similar circumstances); AND 3. Reasonably believes to be in the best interest of the corporation - Inform superior officer or board directors of information that is: 1. Within officer’s scope and material to the superior, 2. Actual or probable violation of the law, and 3. Breach of duty

Answer 204

(from Smith v. Van Gorkom) - Presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action was taken in the best interest of the company. - Requires more than imprudence or mistaken judgment to overcome this presumption. - Whether directors have informed themselves “prior to making a business decision, of all material information reasonably available to them - Gross negligence standard (can’t just close eyes to the problem) - Courts will generally not second guess the BJR unless P shows: Fraud, illegality, bad faith, self-dealing/conflict of interest, or gross negligence.

Answer 205

- Does NOT apply if: (a) waste, or (b) no decision - Policy: 1. Encourages Board service and risk taking (and potential reward) 2. Courts recognize that directors are generally better suited to make business decisions than judges 3. Courts also recognize the statutory regime provides responsibility for managing the corporation to directors, not shareholders 4. Courts recognize that unhappy shareholders can always vote the directors out of office

Answer 206

- Directors have avoided conflicts of interest or negligence (includes obligation of good faith) - A director, officer, and sometimes a dominant shareholder’s “duty to not engage in self-dealing, or otherwise use his or her position to further personal interests rather than those of the beneficiary” - Duty as director is to the shareholders

Answer 207

Directors may engage in interested transactions with the corporation, with certain protections: - If a majority of disinterested directors approve the transaction • Were all material facts disclosed? • Were independent directors really independent or were they dominated or controlled by the interested party - Disinterested shareholders may ratify the transaction - Entire fairness: if approval cannot be had, director can show that the deal is fair to the company, or similar to an arm’s length deal - Courts look to the terms of the transaction and ask if it is similar to a deal with a third party?

Answer 208

Re: duty of loyalty - A director does NOT breach his fiduciary duty by approving a radio advertising program in which the wife of the corporate president, who was also a member of the Board of Directors, was one of the featured performers. - B/c the program’s purpose was not to enhance the wife’s career or to give her any financial benefit as she was only one of many performers on the campaign and her wages were comparable to that of other performers.

Answer 209

- Delaware General Corporation Law § 144 provides a safe harbor for interested transactions if the material facts as to the director’s relationship or interests as to the K or transaction are disclosed or are known to the Board, and the Board in good faith still authorizes the K or transaction by the affirmative votes of a majority of disinterested directors. - If committee members are disinterested in independent, the business judgment rule will shield the committee’s decision

Answer 210

Duty of care or duty of loyalty 1. If duty of care is properly alleged, the burden is on the plaintiff 2. If duty of loyalty is properly alleged, the burden is on the defendant to show intrinsic fairness, unless the defendant ratifies the transaction according to DGCL § 144(a)(1) or § 144(a)(2) - If properly ratified, the burden shifts back to the plaintiff

Answer 211

- There is a duty to deter appropriateness of business prospects “belonging to” the corporation - Factors for Corporate Opportunity (Broz): this test is used for guidance only, the court does not necessarily require all four factors: 1. The corporation is financially able to take the opportunity; 3. The opportunity is in the corporation’s line of business; 4. The corporation has an interest or expectancy in the opportunity; AND 5. By embracing the opportunity, the officer or director would create a conflict between his or her self-interest and that of the corporation

Answer 212

- The rule that a corporation’s directors, officer’s, and employees are precluded from using information gained in corporate capacity to take personal advantage of any business opportunity that the corporation has an expectancy right or property interest in, or that in fairness should otherwise belong to the corporation - Opportunity must be integral to the business

Answer 213

1. Generally, shareholders do not owe a fiduciary duty to other shareholders, however, dominant shareholders owe a fiduciary duty to minority shareholders not to take advantage 2. One must show self-dealing in order to shift the burden to the dominant shareholders, and then the burden is on the dominant shareholders to show intrinsic fairness 3. Shareholders have no reciprocal duties to the corporation, unless they are dominant shareholders (partners always owe a duty) - Being a dominant or “controlling” shareholder puts you in a position of determining who will be on the board - Here, the liability shifts from the directors to the people who are really calling the shots - HOWEVER, the court makes it clear that when a majority shareholder votes PURELY in his capacity as shareholder (and not as a director), he may vote with only his self-interest in mind, at the expense of minority shareholders, without violating any fiduciary duties (otherwise there would be little value in being a controlling shareholder)

Answer 214

A defense to a claim that a director engaged in an interested director transaction by showing the transaction’s fairness to the corporation

Answer 215

Duty of Candor = Idea that when you ask shareholders to take an action, then the Board has the duty to provide them w/ all material information related to that decision or action.

Answer 216

- If material information was withheld from the stockholders before their ratification of the action and the withheld information may have had an effect on the stockholder’s decision, then the decision was not informed and will not validate the interested transaction - If there is a ratification by a majority of shareholders, the burden is on the shareholders to prove unfairness

Answer 217

1. The Court reads into the statute to require a majority vote of the disinterested shareholders in a voidable transaction 2. A “void” transaction cannot be ratified: examples of waste (like a gift of company assets or a transaction no reasonable shareholder would have approved of), ultra vires, fraudulent transactions, and illegal transactions 3. A shareholder could argue that this was a “void” not just a voidable and fair transaction. This is likely a losing argument, because here the Board demonstrated fairness

Answer 218

- These are always going to be subjected to scrutiny - The general rule in shareholder derivative suits involving interested director or officer transactions is that the burden of proof is on the defendant director/officer to prove the transaction was intrinsically unfair

Answer 219

- Ratification of an “interested transaction” by a majority of independent, fully informed shareholders shifts the burden of proof to the objecting shareholder to demonstrate that the terms of the transaction are so unequal as to amount to a gift or corporate waste of corporate assets. - A majority of disinterested shareholders must ratify corporate transactions w/ an interested director. • This rule is meant to protect against invalidation of an action solely b/c a director is involved, not to provide a means for interested shareholders to approve actions in their own personal interests.

Answer 220

Interested transaction between corp. and directors - Will not be voidable if approved in good faith by a majority of disinterested shareholders. Approval by fully informed, disinterested shareholders pursuant to § 144 invokes the Business Judgment Rule and limits judicial review to issues of gift or waste with the burden on the plaintiff Transaction between corp. and its controlling shareholder - In a parent/sub merger, the standard of review is ordinarily intrinsic fairness, with the directors having the burden of proving that the merger was entirely fair - But where the merger is conditioned upon approval by a majority of the minority shareholders, the standard of review remains entire fairness, but with the burden of demonstrating that the merger was unfair shifting to the plaintiff - Here, a speedy decision is not sufficient evidence to support a contention that the board’s decision was not informed.

Answer 221

1. Good Faith 2. Loyalty; and 3. Due care

Answer 222

- This is a subsidiary element, a condition of the duty of loyalty - A state of mind consisting of: 1. Honesty in belief or purpose 2. Faithfulness to one’s duty; 3. Observance of reasonable commercial standards of fair dealings or 4. Absence of intent to defraud or to seek unconscionable advantage - The law presumes good faith - The business judgement rule applies if the directors were acting in good faith

Answer 223

Can run the gamut from 1. Subjective bad faith (fiduciary conduct motivated by an actual intent to do harm) 2. Intentional dereliction of duty (conscious disregard for one’s responsibilities); AND 3. Lack of due care (fiduciary action taken solely by reason of gross negligence; but without any malevolent intent Failure to act in the face of a known duty to act; must be more than merely gross negligence

Answer 224

The law presumes that in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action was taken in the best interests of the company

Answer 225

= necessary conditions predicate for Director Oversight Liability - This is when the directors are accused of failure to provide adequate oversight  The board never met,  Discrepancies in financial reporting  Complaint supports allegations with references to books and records 1. The directors utterly failed to implement any reporting or information system or controls, OR 2. Having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention - Note: in either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations - Remedy: damages, an injunction, or handing over the ill-gotten gains; here the business judgment rule does not apply

Answer 226

- Cases involving oversight failures almost never reach merits of claims - Typically dismissed for failure to comply with the Delaware Rules of Civil Procedure - Typically issued in a case: whether demand was excused as futile - No board action

Answer 227

re: oversight > derivative aspects > no board action - Under Delaware law, a sustained or systematic failure of the Board of Directors to exercise oversight establishes the lack of good faith that is a necessary condition to Board L. - In a derivative suit that involves something other than a business decision of the Board (i.e. failure to exercise oversight) a litigation demand is futile when directors would face a substantial likelihood of L if the suit were filed. - This rule is in place for the common-sense reason that a Board facing L likely would not admit any wrongdoing or change its course of action upon receiving such a demand.

Answer 228

1. Does complaint create reasonable doubt that directors could have exercised independent judgment in responding to a demand - Substantial risk of monetary liability (Under Delaware law, 102(b)(7) - Risk of liability analysis depends on whether your state has a 102(b)(7) law 2. If it does, there is an absolute affirmative defense as long as you can prove that you haven’t violated the statute 3. If so, is there a reason to believe the plaintiff can show breach of loyalty or bad faith - Burden of proof is on the defendant because 102 is an affirmative defense - If only a Caremark claim, 102 precludes liability and demand required - In the real world, the plaintiff would probably go away - If the defendant cannot prove that he or she was not acting in bad faith or loyalty, liability cannot be exculpated 4. Is the liability risk high enough to excuse demand? - We care about this even with directors not there at the time, because to the extent that their liability risk is too high, they are always going to say no always

Answer 229

1. Direct or derivative? 2. If derivative - demand excused or required? - complaint creates reasonable doubt that directors could have exercised independent judgment in responding to a demand (substantial risk of monetary liability) 3. Risk of liability analysis depends on whether 102(b)(7) clause is present 4. If so, is there reason to believe P can show loyalty or bad faith? - burden of proof likely on D b/c 102(b)(7) is an affirmative defense 5. If only care claim, 102(b)(7) precludes liability and demand required - In real world, P probably goes away 6. If bad faith or loyalty, liability cannot be exculpated 7. Liability risk high enough to excuse demand?

Answer 230

1. Corporations may provide public benefit, but it has limitations and must have some benefit to the corporation (depending on jurisdiction) 2. Corporations will typically be able to make decisions regarding operations and dividends, subject to the business judgment rule, unless such decisions seem to provide no benefit to shareholders 3. LLC liability principles are similar to corporate law principles; de facto corporations and corporation by estoppel theories apply to LLC 4. Operating Agreement is a contract between members and the company, therefore a forum selection clause was binding (because it was not prohibited by law)

Answer 231

1. Fiduciary duties apply to LLC members similarly to directors and partners, subject to terms of an LLC agreement in which the parties can agree otherwise 2. Limitations of liability will be applied similarly as to corporations 3. Directors must abide by a duty of care and duty of loyalty to have the benefit of the business judgment rule - -- Duty of care is not breached so long as the decision is considered in good faith based on reliable information - -- Duty of care may be breached if directors fail to inform themselves of relevant information, including through review of reports, pricing information, and value the company 4. Even if business judgment rule does not apply, a transaction may nevertheless be saved if the deal can be deemed to be entirely fair for the company

Answer 232

1. Directors may owe a duty to creditors in special situations, including a duty not to make themselves aware or informed 2. If a conflict of interest exists, directors owe a duty of loyalty and thus must disclose the conflict and take such action to ensure fairness in the deal 3. Directors may owe a duty to creditors in special situations, including a duty not to make themselves aware or informed

Answer 233

1. Directors owe a duty to account for profits obtained personally in connection with transactions related to his or her company 2. 2 Standards of Review application for Parent-Subsidiary relationships --- Intrinsic Fairness – ------ Used when parent has received a benefit to the exclusion of the minority shareholders of the subsidiary and at the expense of the minority shareholders of the subsidiary ------ Burden of Proof is on defendant to show transaction is fair to corporation --- Business Judgment Rule – ------ Used when minority shareholders have received the same benefit of the subsidiary ------ Burden of Proof is on plaintiff to rebut presumption 3. When fiduciary duties conflict, directors should protect the interests of the investors bearing the greatest risk - see Zhan 4. Transactions that were a product of corporation and interested directors, or a product of a corporation and interested/majority shareholders, may be ratified by a majority vote of disinterested shareholders or proof of intrinsic fairness 5. “To act in good faith, a director must act at all times with an honesty of purpose and in the best interests and welfare of the corporation...a true faithfulness and devotion to the interests of the corporation and its shareholders...”

Answer 234

1. Good faith is not a separate claim, but part of duty of loyalty and is brought as part of that 2. Caremark rule requires that boards implement compliance plans when they have already had an issue or know an issue could come up 3. Different tests may apply for demand excused depending on whether the claim is an oversight claim or whether directors were directors at the time of the underlying action

Answer 235

1. There is a distinction between direct actions (actions harming only an individual or a group of individuals) and derivative actions (actions harming the corporation) and establishment of the type of claim is necessary 2. Most states have requirements that a shareholder must make a demand to the corporation that it take the case, which demand can be approved or rejected - -- If rejected, shareholder can only proceed if rejection was wrongful 3. Can file without demand, if demand would be futile or excused, but subject to certain pleading requirements 4. Special Committees of disinterested directors may request dismissal of derivative suits, but subject to specific tests established under state law

Answer 236

1. Close corporation is one in which stock is held by only a few people or families that is often not dealt in by buying or selling - -- There are certain statutes that will enable anyone to create a statutory close corporation 2. Vote Pooling Agreement and Shareholder Voting Agreements are permitted to enable minority shareholders to pool together their shares to protect their interests 3. For a vote pooling agreement to elect officers to be valid, the directors need to be able to retain an ability to exercise their fiduciary duty 4. The rule in McQuade is limited to situations in which there are not minority shareholders to protect

Corporations Flashcards

(262 cards)