FACT PATTERN TWO: Issuance of Stock Flashcards
What is an “issuance” of stock?
An issuance of stock is when a corporation sells its own stock.
Debt Securities
When the corporation borrows money, it issues a debt security (bond). The bond is a promise that the corporation will repay the loan with interest.
Holders of debt securities do not have an ownership interest in the corporation
Equity Securities
When the investor buys an ownership interest in the corporation, it issues equity securities (stock) to the investor.
The money invested does not create a debt.
What are Subscription
Subscriptions are written offers to buy stock from a corporation. One issue may be whether such an offer can be revoked
Pre-incorporation Subscriptions
MBCA: pre-incorporation subscriptions are irrevocable for six months UNLESS:
- Revocation is provided in the terms of the subscription agreement
- All subscribers consent to revocation.
Payment is due upon demand of the board.
- Demand may not be made in a discriminatory manner.
- A subscriber who fails to pay may be penalized by sale of the shares or forfeiture of the subscription and any amounts paid on the subcription, at the corporation’s option.
Post-incorporation Subscription
Post-incorporation subscriptions are revocable until accepted by the corporation.
The corporation and the subscriber are obligated under a subscription agreement when the board accepts the offer.
Form of Consideration for Stock
MBCA: Stock (or an option to buy stock) may be issued for any tangible or intangible property or benefit to the corporation.
Split of authority over two additional forms:
- Promissory notes to the corporation (Allowed by MBCA)
- Future services to the corporation (Allowed by MBCA)
In states where these forms of consideration are prohibited, using them results in “unpaid stock,” meaning it’s treated as watered stock.
Amount of Consideration for Stock: Traditional View
Traditional View: Par (minimum issuance price)
Stock could not be issued by a corporation for less than the stock’s stated par value, but the corporation can still receive more than the par value amount for the shares.
No par means no minimum issuance price- the board can have the stock issued for any price it sets.
Watered Stock
When par value stock is issued for less than its par value.
Amount of Consideration for Stock: MBCA Approach
The MBCA eliminated the concept of par and allows corporations to issue shares for whatever consideration the directors deem appropriate.
If the corporation issues stock in exchange for consideration other than cash (e.g., for property or past services) the board determines the value of the property or services. The board’s valuation is conclusive if made in good faith.
NOTE: If a corporation’s articles specify a par value and the directors authorize a sale of stock for less, the shares will probably be treated as validly issued but the directors can be held liable for breach of their fiduciary duty.
What is a Preemptive Right
A preemptive right is the right of an existing shareholder of common stock to maintain their percentage of ownership in the company by buying stock whenever there is a new issuance of stock for money (i.e., cash or its equivalent)
MBCA: The articles of incorporation must provide for the right.
HOWEVER, Even if the articles do provide a preemptive right, shareholders generally have no preemptive right in shares issued:
(1) for consideration other than cash,
(2) within six months after incorporation, or
(3) without voting rights but having a distribution preference.
