Corporations Rules Flashcards

Question

DIRECTOR DUTIES & LIABILITY

Answer 1

**DUTY TO MANAGE**: Directors have a duty to manage the corporation. This does include delegating management functions to committees that recommend actions for the Board to take. **BUSINESS JUDGMENT RULE**: A presumption that directors manage a corporation in good faith and in the best interest of both the corporation and its shareholders. **FIDUCIARIES**: Directors are fiduciaries and owe the corporation duties of care and loyalty. **DUTY OF CARE**: A director owes the corporation a duty of care - act with the care that a prudent person would use with regard to her own business (unless the Articles of Incorporation have limited this duty). **DUTY TO DISCLOSE**: Directors have a duty to disclose material corporate information to other members of the board. **DOCTRINE OF WASTE**: Directors have a duty not to waste corporate assets by overpaying for property or employment services. **DUTY OF LOYALTY**: A director owes the corporation a duty of loyalty. A director may not receive an unfair benefit to the detriment of the corporation or its shareholders, unless there has been: o Material disclosure; and o Independent ratification.

Answer 2

**_MATERIAL DISCLOSURE_** o The transaction must be approved by a majority of the directors (at least two) without a conflicting interest after all the material facts have been disclosed to the board. **_INDEPENDENT RATIFICATION_**: Directors may defend a claim by obtaining independent ratification through: o A majority vote of independent directors; o Majority vote of a committee of at least 2 independent directors; or o Majority vote of shares held by independent owners of those shares.

Answer 3

Determined by the by-laws. o **Duties of Care and Loyalty**: Officers owe the same duties of care and loyalty as directors. o **Agents**: Officers are agents of the corporation, and their authorized activities can bind the corporation. o **Mandatory Positions**: Corporations must have a President, Secretary and Treasurer. o **Power**: Directors have great discretion to select or remove officers, but the corporation will be liable for any breach of contract (if a contract exists).

Answer 4

A corporation may indemnify a director for reasonable expenses incurred in unsuccessfully defending a suit brought against the director for reasonable expenses incurred in connection with the proceeding, limited by the following rules: 1. **THE CORPORATION MAY NEVER INDEMNIFY A DIRECTOR WHO IS HELD LIABLE TO HIS OR HER OWN CORPORATION**: Or if a director received an improper benefit 2. **THE CORPORATION MUST ALWAYS INDEMNIFY THE DIRECTOR IF S/HE WINS A LAWSUIT AGAINST ANY PARTY**: Such as for Attorney’s fees. 3. **SITUATIONS WHERE A CORPORATION MAY PAY THE DIRECTOR**: o Liability to third-parties or settlement with a corporation. o Director or officer shows that his or her actions were in good faith, and s/he believed his or her conduct to be in the corporation’s best interest. o Director’s conduct was not unlawful (brought forth in a criminal proceeding). 4. **GRANTING PERMISSIVE INDEMNITY**: Officers are generally indemnified to the same extent as the director. o Approval by a majority of independent directors o Approval by a majority of a committee consisting of at least two independent directors o Approval by a majority of shares held by independent shareholders

Answer 5

**POWER TO MANAGE THE CORPORATION: ** o The power to manage a corporation is generally vested in directors. o Shareholders have no direct control over the management of the corporation. However, they have indirect control, because shareholders have the power to elect the board (of course, check with by-laws and Articles of Incorporation for any unique rules). **SHAREHOLDER INSPECTION RIGHTS**: Shareholders may inspect the corporation’s books, papers, accounting records, shareholder records, etc., upon five days written notice stating a proper purpose for the inspection.

Answer 6

**Shareholders** have indirect power through their voting power by which they elect officers, modify by-laws and approve fundamental changes in the corporate structure. o **Annual Meeting**: Every corporation must have an annual meeting where at least one director slot is open for election. o **Specially Noticed Meeting**: Meeting of the shareholders to vote on a proposal or a fundamental corporate change. Can be called by the Board, president or 10% voting-shareholders. • Notice must contain the time + place + special purpose for the meeting because nothing else can be addressed in the meeting that is not in the notice or else it is void. o **Location of Meetings**: May be held within or outside the state. o **Notice**: Shareholders must be notified of meetings not less than 10 or more than 60 days before the meeting. Notice must state the place, day and hour of the meeting, and for special meetings, as stated, the purpose. Notice may be waived in writing or by attendance

Answer 7

**DERIVATIVE SUIT**: A direct suit may be brought for a breach of fiduciary duty owed to the shareholder by an officer or director. Any recovery here is for the benefit of the individual shareholder. A shareholder is suing to enforce the corporation’s OWN cause of action. o The corporation, rather than the shareholder bringing the action, is entitled to recovery. Nevertheless, the corporation is named as defendant. **REQUIREMENTS FOR A DERIVATIVE SUIT**: o **Contemporaneous stock ownership / Standing**: Shareholder must own at least one share of stock when the claim arose and throughout the entire litigation. A shareholder must have been a shareholder at the time of the act complained of or must have become a shareholder through transfer by operation of law from one who was a shareholder at that time (Standing). o **Demand**: The Shareholder Demand must be made and: o Rejected by the Board; OR o At least 90 days must have passed since the demand was made.

Answer 8

Distributions can take the form of dividends, redemptions of shares, and repurchases of shares. **RIGHT TO DISTRIBUTION**: The right to distribution is usually discretionary, with the exception that at least one class of stock must have a right to receive the corporation’s net assets upon dissolution. Declared in Board’s discretion, unless the corporation is insolvent or would be rendered insolvent by the dividend, or the articles limit distribution. **RIGHT TO RECEIVE DISTRIBUTIONS / DIVIDENDS**: Declaration of dividends is within the discretion of the board of directors and a strong case is required to induce a court of equity to order the directors to declare a dividend. **PRIORITY OF DISTRIBUTION**: Shares may be divided into classes with varying rights. o **Preferred Shares**: Have a right to receive dividends BEFORE common shareholders may receive dividends. o **Participating Shares**: Get paid twice – as preferred shares, and then also participate as if common shares. First, as preferred shares, but also get to participate as if they were also common shares. o **Cumulative Shares**: Shares that have the right to be paid not just for current year, but past years that are unpaid

Answer 9

**LIABILITY FOR UNLAWFUL DISTRIBUTIONS**: Directors are personally liable to a corporation if they vote for a distribution that violates any of the above rules. That liability extends to the amount of the distribution that is in excess of what could have been properly distributed. o **EXCEPTION**- A director is not liable for distributions approved in good faith: o Based on financial statements prepared in accordance to reasonable accounting practices; or from relying on information from other officers, employees or accountants. **CONTRIBUTION FOR UNLAWFUL DISTRIBUTION**: A director who is held liable for an unlawful distribution is entitled to contribution from: o Every other director who could be held liable for the distribution; and o Each shareholder for the amount s/he accepted while knowing the distribution was improper

Answer 10

In a closely-held corporation, there is only a primary market, meaning the only sales that are going to be made by the corporation are sales from the corporation to potential shareholders. (This is predominant in SMALL businesses taking on a corporate form). **Requirements**: 1. Unanimous Shareholder election (choice) evidenced in the Articles, By-laws or a filed agreement. 2. Reasonable Share Transfer Restriction. 3. If the corporation has both: a. No piercing allowed even if the corporation failed to follow formalities; b. Possible subchapter S-Corp status, meaning the corporation will be taxed as a partnership

Answer 11

The tax laws permit certain corporations to elect to be taxed like partnerships and yet retain the other advantages of the corporate form. Such corporations are called S-Corps. **Requirement**: 1. Cannot have more than 100 Shareholders who are: a. Individuals; b. Living in America; and c. There is only one class of stock. .

Answer 12

Shareholders are not liable for the corporation’s obligations. In general, Shareholders have no fiduciary duties to the corporation or their fellow shareholders. * *EXCEPTIONS**: 1. Piercing the corporate veil to render a shareholder liable; 2. Controlling shareholders owe a fiduciary duty to minority shareholders; and 3. Controlling shareholders are liable for selling the corporation to a party who loots the corporation, unless reasonable measures were taken to investigate the buyer’s reputation and plans for the corporation.

Answer 13

Require the approval by a majority of all votes entitled to be cast – not just those cast at a meeting. **TYPES OF CHANGES:** o **Merger**: A merger involves the blending of one or more corporations into another corporation, and the latter corporation survives while the merging corporations cease to exist following the merger. o **Consolidation**: A and B become C o **Share Exchange**: One corporation purchasing all of the outstanding shares of one or more classes or series of another corporation. o **Sale of a corporation** o **Conversion**: Involves one business entity changing its form to another business entity (i.e. a corporation changing to an LLC). o **Dissolution**: A dissolves

Answer 14

1. Directors must submit a resolution at a valid shareholders meeting; 2. Notice of special meeting; and 3. Approval by a majority of all shares entitled to vote, and by a majority of any voting group adversely affected by the change. 4. _EXCEPTION_: This does not apply for short form merges where a parent company merges with a subsidiary (parent corporation must own more than 90% of the stock of the subsidiary). o **Dissenting Shareholder Appraisal Remedy**: If a corporation approves a fundamental change, shareholders who dissent may have the right to have the corporation purchase their shares at fair value. **In order to achieve this, a dissenting shareholder must:** 1. File a written notice of objection and intent to demand payment before the shareholders vote; 2. Not vote in favor of the proposed change; and 3. Make prompt written demand to be bought out.

Answer 15

BY **THE DIRECTORS**: Directors may dissolve the corporation by filing with the state in which the corporation incorporated articles of dissolution. This can only be done if shares have not yet been issued or business has not yet commenced. o **Must occur before dissolution**: All corporate debts must be paid, and if shares have been issued, any assets remaining after winding up must be distributed to the shareholders. BY **CORPORATE ACT**: The corporation may dissolve by a corporate act approved under the fundamental change procedure.

Answer 16

**BY THE SHAREHOLDERS**: Shareholders may seek judicial dissolution on any of following grounds: o Directors are deadlocked in the management of corporate affairs, and the shareholders are unable to break the deadlock; o Directors have acted or will act in a manner that is illegal, oppressive or fraudulent; o Shareholders are deadlocked in voting power and failed to elect one or more directors, for a period that includes at least 2 consecutive meeting dates; or o Corporate Assets are being wasted, misapplied. **ATTORNEY GENERAL**: May seek judicial dissolution on the ground the corporation fraudulently obtained its articles or is abusing its authority

Answer 17

A corporation that has been dissolved has effectively ended its corporate existence, and is not allowed to carry on any business except that which is appropriate to winding up the affairs.

Answer 18

A foreign corporation may not transact business within a state until it has obtained a certificate of authority from the secretary of state. A foreign corporation may not be denied a certificate of authority merely because the laws of its state of incorporation governing its organization and internal affairs differ from the host jurisdiction. If a foreign corporation is doing business in a state and has not obtained a certificate of authority to do business, it generally cannot bring suit in the foreign state, although it can defend suits. However, failure to obtain a certificate does not usually impair the validity of any contract or corporate act.

Answer 19

Makes it a crime for any person to use any means or instrumentality of interstate commerce to employ any scheme to defraud, make an untrue statement of material fact, or engage in any practice that operates as a fraud in connection with the purchase of sale of any security. **_ELEMENTS FOR A CAUSE OF ACTION:_** 1. **Fraudulent Conduct** - Plaintiff must show that the defendant engaged in some fraudulent conduct shown by: o **Scienter**: The conduct complained of must have been undertaken with intent to deceive, manipulate or defraud. D must also have recklessness as to truth. o **Materiality**: A statement or omission made with a substantial likelihood that a reasonable investor would consider it important in making an investment decision. A misrepresentation can also be found for failure to disclose a material fact in breach of a fiduciary duty. 2. **In Connection with Purchase or Sale of a Security by Plaintiff**: This EXCLUDES potential purchasers who do not buy and people who already own shares and refrain from selling.

Answer 20

Rule 10b-5 prohibits insider trading securities on the basis of inside information not disclosed to the public, that an investor would find useful in decisions to invest. **_Liability For:_** o **Misappropriator**: Person who breaches a duty of trust and confidence owed to the source of the information and trades on the market; o **Tipper**: Person who tips inside information for any form of personal benefit (does not have to be sharing in profits) to another who trades on it; or o **Tippee**: Person who receives inside information and trades on it knowing the information was disclosed in breach of the tipper’s fiduciary duty AND that the tipper did in fact breach that duty. **_Investors in a private action for damages must also prove:_** o **Reliance**: Must be proven by some financial loss. Show that they relied on the fraud, or that the fraud impacted the market. o **Loss Causation**: The fraud provoked the sale or purchase, and caused the financial loss. o **Damages**

Answer 21

Purpose is to prevent unfair use of inside information and internal manipulation of price. **_SCENARIOS_**: 1. A corporation will have purchased and sold, or sold and purchased stock within a six month period; and 2. They owned more than 10% of a corporation stock BEFORE the purchase or sale of the stock! **_SITUATIONS WHEN THE RULE APPLIES:_** 1. Big Corporations: Reporting corporations - (1) listed on a national exchange or (2) at least 500 shareholders and 10 million in assets. 2. Certain Corporation Individuals: Officers, directors, or shareholders w/ more than 10%. 3. Type of Transaction: Where the corporation buys or sells stock WITHIN A SIX MONTH PERIOD (called short-swing trading). **APPLICATION**: All profits from such “short-swing” trading are recoverable by the corporation. If, within 6 months before or after any sale, there was a purchase at a lower price than the sale price, there is a profit.

Answer 22

* *_ELEMENTS:_** a. Applies to reporting corporations. b. CEO and CFO must certify that based on the Officer’s knowledge, reports filed with the SEC: i. Do not contain material misrepresentations or omission; and ii. Fairly present the financial position of the company. c. Penalties for willfully certifying a false report can include harsh fines and jail time. d. A corporation may recover an officer’s profits made within a 12-month period surrounding the false filings if the filings have to be restated. Additionally, the corporation may recover any incentive-based compensation during that time. e. **Blackout Periods**: Corporations can recover any profits made by officers that resulted from trading corporation’s stock during blackout periods of at least three days, when at least half of the employees were prohibited from trading in their retirement plan’s securities.

Answer 23

Licensed professionals (lawyers, accountants, medical professionals) may incorporate as a Professional Corporation (PC). However, each professional will be personally liable for his or her own malpractice. Organizers must file Articles with name designated “Professional Corporation” and shareholders must all be licensed professionals. The corporation is only allowed to practice one selected profession.