Corporations 1. Agency 1) Definition 2) Principal’s liability in Tort Must show 2 things: 1) Existence of P/A Relationship 1.Consent by P that A acts on his behalf, 2. Subject to control of P, 3. Agent’s consent – Servant-master? – Respondent Superior? – Independent Contractor? – Its 4 Exceptions? – Franchise agreement? 2) Scope of employment – Frolic or mere detour? 5 factor – Intentional? Not w/I scope of E unless: 1. specifically authorized 2. natural to nature of job: bouncer batters 3. purpose of/ motivated to serve & further M’s buz. 4. M/L: Foreseeability test 3) Principal’s liability in Contract 1) Existence of P/A relationship 2) Authority 1. Actual Express 2. Actual Implied 3. Apparent Authority 4. Authority by Ratification 5. Authority by Estoppel 6. Inherent Authority – Agent’s Liability issue? 4) Duties & obligations of parties 2. Partnership 1- F ormation 1. Definition 2. No formalities – prima facie 3. Partnership vs. Loan or employment agreement? 4. Partnership by Estoppel? 2- L iability to 3 rd Party - Formation issue - Personally, jointly & severally - New P? Dissociating partner? 3- L iability bwtn Parties 1. Fiduciary Duty of Partners 1. No usurping opportunities 2. No self dealing 3. No secret profit 4. Remedies: ONLY accounting for past damages + discourage profit 2. Partnership Property 1. Specific PP partnership’s 2. Share of profit personal 3. Right to C: not transferable 4- D issolution 1. Dissolution by? 2. Consequences: 1. Contribution of asset – what order? 2. Right of parties? - Damages? - Continue? 3. Fiduciary duty 4. Effect of dissolution – liability during winding up Limited Liability Partnership? 3. Corporations 1) Formation of Corporation 1. De Jure 2. De Facto 3. Corporation By Estoppel 4. Piercing Corporate Veil 2) Promoter Transactions 1. P’s relationship w/ each other 2. P’s relationship w/ Corp. 3. P’s relationship w/ 3 rd party – Pre- incorporation agreements: i. Promoter’s liability ii. Corporation’s liability 3) Pre/Post-Incorporation agreements 4) Powers & Management 1. Ultra Vires Transaction 2. Board of Director 3. Officers 4. Shareholders 5) Director’s Duty of Care and Loyalty 1. Prudent Investor Rule 2. Business Judgment Rule 3. Conflict of Interest 4. Interested Director 5. Interlocking Directorate 6. Corporate Opportunity Doctrine 7. Director/Creditor of Corporation 6) Security Exchange Violations 1. Common Law Rule 1
Transcript
Corporations
1. Agency
1) Definition
2) Principal’s liability in Tort Must show 2 things:
1) Existence of P/A Relationship1.Consent by P that A acts on his behalf, 2. Subject to control of P, 3. Agent’s consent
4) Powers & Management 1. Ultra Vires Transaction 2. Board of Director 3. Officers 4. Shareholders
5) Director’s Duty of Care and Loyalty1. Prudent Investor Rule 2. Business Judgment Rule 3. Conflict of Interest4. Interested Director 5. Interlocking Directorate 6. Corporate Opportunity Doctrine7. Director/Creditor of Corporation
6) Security Exchange Violations 1. Common Law Rule
1. Sale of controlling SH interest
2. Fraud 3. Insider Trading -min v maj
– Special fact doctrine4. Disclose to Corporation
2. Federal Liability a. 10b5 – Fraud b. 16b – short Swing Profitsc. 14a – Proxy Rules
7) Closed Corporations 1. Shareholder Agreements2. Fiduciary Duty Owed to
Minority3. Restrictions on Transfer of
Shares
8) Capitalization of Corporation 1. Consideration Paid for Shares – Quality/Quantity2. Underwriting
9) Regulation of Issuance of Securities1. Type of Securities 2. Section 5b(1)3. Section 4(1)4. Section 115. Section 12-12(c)
10) Shares and Dividends 1. Classification 2. Source of Valid Dividends
11) Redemption and Repurchase
12) Fundamental Change in Corporation Structure 1. Merger/Consolidations 2. Appraisal Rights3. Acquisition of Stock 4. Dissolution/ Liquidation 5. Amendment of Articles/
Bylaws
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Agency – Principal-Agent relationship
Framework:
1) Definition
2) Principal’s liability in Tort Must show 2 things:
1) Existence of P/A Relationship1.Consent by P that A acts on his behalf, 2. Subject to control of P, 3. Agent’s consent
2) Scope of employment– Frolic or mere detour? 5 factor– Intentional? Not w/I scope of E
unless: 1. specifically authorized2. natural to nature of job:
bouncer batters 3. purpose of/ motivated to
serve & further M’s buz.4. M/L: Foreseeability test
3) Principal’s liability in Contract 1) Existence of P/A relationship 2) Authority
1. Actual Express2. Actual Implied 3. Apparent Authority4. Authority by Ratification 5. Authority by Estoppel6. Inherent Authority
– Agent’s Liability issue? 4) Duties & obligations of parties
1) Definition
1) Existence of P/A Relation – in tortExistence of principal-agent relationship is a 3-prong test: 1-consent by principal that agent acts on his behalf, 2-subject to principal’s control, 3-agent’s consent. In this case,
Subject to control may be shown by power to supervise, or having control over means and manner of operation vs. end result
Consent is shown by doing the act Agency power to bind P can arise
even absence true mutual consent
Exercising Control i.e., creditor continuously interfered in the internal affairs of X (debtor) to a degree that constituted de facto control.
Agency by permitting someone to use a vehicle: an agency relationship result when a person allows another to act on his behalf and subject to his control. By volunteering his car and express condition that she drives and not saying anything loaning the car, he allowed her to act on his behalf and subject to his control. Thus the driver is an agent of owner. Also there is a presumption that the driver is the owner’s agent.
Gratuitous Agents These are agents who perform their service without gain. Unlike other agents, gratuitous agents cannot be compelled to perform the duty the have undertaken. The principal is nevertheless liable for the torts of gratuitous agents.
Whether an agency relationship is created does not depend on the intent of the parties involved. An agency relationship can arise even if the parties do not intend to be agent and principal to each other. Similarly, agency relationship may not arise even if the parties so intended if certain conditions are not met. The formation of an agency relationship depends on the existence of certain factual elements.
- In CA, doctrine of peculiar risk holds to the same when employer engages an incompetent I/C since Risk of loss is more fairly allocated. Under the peculiar risk doctrine, the hiring person’s liability doesn’t extend to the hired person’s employees. This is covered by worker’s compensation.
- In both Sub-contactor & borrowed employee fact patterns principal is not liable b/c control is missing.
Servant-Master Relationship i.e., here, X as an employer has actual authority and retains control over the manner in which Y employee performs service. Also, 3rd party may establish P’s liability based on:
Respondeat Superior Under the doctrine of Respondeat superior, an employer is liable for all torts committed by an employee acting within the scope of her employment. The injured party can proceed against both the employer and the employee – the employee being directly liable for his torts while the employer is vicariously liable. in majority of jrx, Respondeat superior imposes strict liability on employer.
Independent ContractorThis situation arises when a principal retains someone to do certain job or achieve specific result. The principal retains no right of control over the independent contractor as to how the work is performed. As such, employers are generally not liable for the tortious conduct of an independent contractor. However, there are several exceptions to the general rule: 1-the employer maybe held liable if he retains any control over manner or means of doing the work, or 2- independent contractor is engaged in a highly dangerous activity (break job) 3-when employer engages an incompetent contractor (negligent selection/hiring (knew or should have known) 4-Estoppel: when there is holding out of the agent which creates the appearance of agency
Franchising agreement = Actual , Apparent agency + day to day An agency relationship may result if a franchise agreement goes beyond the stage of setting standards and gives the franchiser the right to exercise control over day-to-day operation of franchisee. BZ: Factors: fact specific
1. Control over day-today operation
2. Control over details of operation
3. Who assumed risk of loss/profit?
4. Was the purpose of regulatory provision merely to achieve a system of standardization of the
business identity, quality, reputation, uniformity of service, and public good will
2) Scope of EmploymentFor Respondeat Superior to apply, the employee must have committed the tortious act within the course and scope of employment. That is, the employee must have been engaged in work for the employer of a type that he was employed to perform, during work hours. Factors that determines whether the act occurred within scope of employment or was it a frolic act of the employee are: 1) Time, Place and Purpose of the act2) act’s similarity to the kind of acts
employee is authorized to perform 3) Whether the act is commonly
performed by employees4) the extent of employee’s departure
from normal methods – customarily method? Reasonableness test
5) extent to which employer’s interest & employee’s interest was involved
Frolic vs. Detour Frolic is a new and independent journey of employee and is not within his scope of duty (employee takes company car driving 50 miles to go to a party, crashes and injures someone). Detour is departure of the assigned duties, and it is within the scope of employment (on the way back to work while picking up his dry-cleaning injures a pedestrian in parking lot), most things are mere detour, thus P is liable
Intentional Acts of Agent : As a general rule, intentional acts of agent are not within scope of employment. However, as an exception to the general rule, liability extends to intentional acts of the employee if 1.the act is specifically authorized by employer, 2.the act is natural to the nature of the job (bouncer gets paid to batter and threw out ppl), 3. the employee is motivated to act for the purpose of serving or furthering employer’s business 4. However, M/L applies foreseeability test rather than employee’s motivation to further master’s business i.e., was it foreseeable that the employee would act the way he did?
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Agency is defined as the fiduciary relationship that results from the manifestation of consent that the agent will undertake some act on behalf and subject to the control of principal. As a general rule, a principal is liable for tortious conduct of his or her agent if two things are established: 1. the existence of principal-agent relationship, 2-acts of agent within the scope of employment.
i.e., drunken seaman, i.e., baseball pitcher: it was in direct response to ’s conduct that was interfering with pitcher’s ability to pitch; it was for the purpose of furthering employer’s business; M/L: was in effect related to & was foreseeable
3) Principal’s Liability in Contract
1) Existence of P/A Relation – in KExistence of principal-agent relationship is a 3-prong test: 1-consent by principal that agent acts on his behalf, 2-subject to principal’s control, 3-agent’s consent. In this case, …
Unlike the implied authority that the agent must reasonably rely on the authority, with apparent authority and inherent authority, the 3rd party must reasonably rely
i.e., bar owner sold his bar to P &started working there as manager; ordered from cigars despite P’s order not to. Seller deals with & only knows the agent. Seller recovers from P even unknown principal to seller & despite P’s instruction; b/c selling cigar in bar is an act that is within the usual & ordinary course of bar business & is foreseeable that manager would do so
When there is authority to enter into K, there might be an issue of 3rd party beneficiary
Agency by estoppel elements:1-appearnce of authority 2-detremntal reliance by 3rd party (good faith, reasonable, change in position)
2) Authority
1. Express Actual Authority Agent’s authority may be expressly granted by the principal. Express can be oral or written. Oral express authority is generally valid unless the under underlying agreement falls within SOF. Thus, if the underlying agreement is within SOF, (i.e., transaction involving an interest in land, sale of goods over $500, or can’t be performed w/in a year) agent’s authority must also be in writing to bind principal - Agent’s authority is revocable,
thus if principal renounces agent’s authority, or either party dies, or the subject matter of contract becomes illegal, agent’s authority terminates (if agent has durable power of attorney, P’s death does not terminate his authority, thus the estate of deceased principal will be bound by agent’s agreement)
2. Implied Actual Authority Agent’s authority may be implied when agent reasonably beliefs that from 1-words or past conduct, 2-custom and usage, 3-emergency, or 4-as an incident to express authority (necessary & need), he has authority i.e., painter agent has actual authority implied from past conduct to hire assistant in painting the church. (painter is an agent of church in hiring assistant, thus church liable for assistant’ PI on job). Assume that assistant commits a tort on job, is church liable? Probably not b/c assistant is a sub-agent and is not subject to control by church
3. Apparent authority results when a principal manifests to a third party that an agent is authorized, and the third party reasonably relies on it. – There must be some holding out,
representation, manifestation, or making appearance of authority by
the principal to the 3 rd party that the agent is authorized to act.
i.e., manager (agent) has apparent authority to offer commission to salesman when president sends to work under supervisor – BZ: cloths
i.e., buyer relies on salesman’s apparent authority to bind company (company holds out the salesman as his agent)
4. Authority by Ratification requires acceptance of the results or of a prior act with intent to ratify, and with full knowledge of all the material facts. Ratification cannot be partial or pick and choose- it must be complete i.e., H contracts to sell his jointly held
property with W to buyer. W says nothing; no ratification (but in CA CP, each spouse is agent of another)
5. Authority by Estoppel : when a P negligently or intentionally (or failure to act) creates appearance of authority & causes a 3rd party to believe that agent has authority to act and 3rd party detrimentally relies on the principal’s conduct, the principal is estopped from denying agent’s authority i.e., store’s negligent surveillance & imposter salesman
6. “Inherent Authority” – (it arises in two contexts: inherent in the position of title customarily, or in Secret Principal situation: the 3rd party is unaware of the existence of principal) Rule1: Because the authority is customarily inherent in the position and title of the job & which ordinary associated and exercised by people in that position, absence specific knowledge to the contrary, the agent has inherent authority i.e., CEO, purchasing agent (dealing with US contracts, only express authority is valid) – also there must be a reasonable reliance by the 3rd party. (if there cannot be reasonable reliance by 3rd party that agent has that authority to bind & enter into this particular k, then there is no inherent authority. If there is specific knowledge to the contrary, it destroys its reliability or limits authority
Rule 2:“ Under Restatement 2nd of Agency, “an undisclosed principal who
entrusts his agent with management of his business is liable for acts of his agent done on his account, if usual or necessary in such transaction even forbidden by the principal. It is based on a reasonable foreseeability rationale and the test is whether the principal could’ve reasonably foreseen that his agent would take the action she did.
Agent’s Liability in Contract issue?An agent’s liability on a contract depends on the status of his principal. As a general rule is that if the agent purports to contract for a disclosed (& identified) principal, he is not personally liable on the contract (in such cases, the agent negotiates contract in the name of the principal and agent is not a party to the contract) On the other hand, if the fact of agency or the principal’s identity are not disclosed or partially disclosed, courts generally hold that the agent is a party to the contract and is personally liable to the 3rd parties on the contract unless otherwise agreed. (To avoid personal liability, the agent must disclose that the is acting in a representative capacity and must disclose identity of his principal)i.e., represented himself as
representative of X Corporation and bought salmon form . There was no X Corp., but there was Y Corp. is personally liable on the contract b/c had no notice of principal’s identity – agent must fully and accurately disclose the identity of his principal or he will be held liable on the contract (its agent’s duty to correctly disclose principal’s identity and its irrelevant that could have determined the name of principal by searching clerk’s record)
- Languages such as: X introduced him as “representative of” or “on behalf of” and etc would also trigger agency issue
i.e., authority may be inferred from customary powers of similar agents in the business i.e., agent is selected to engage singers for recitals of “tone test”; singer sues principal for a singing tour: there is no actual and apparent authority for tone test, but customary implication gave agent authority to engage the singers unconditionally and even offer tours.
There are two differences between apparent authority & by Estoppel: 1. In apparent authority, principal
makes manifestation to 3rd party (must make the appearance of authority known to 3rd party)
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Agency is defined as the fiduciary relationship that results from the manifestation of consent that the agent will undertake some act on behalf and subject to the control of principal. As a general rule, the principal is liable for those contracts entered into with its authority. In this case, for principal to be liable for agent’s contracts, 3 rd party must establish 1.existence of P/A relationship, & that 2. agent entered into contract w principal’s authority
In the context of agency relationship, authority to contract may exist by (must argue each in one paragraph) 1.Actual Express, or 2. Actual Implied, 3. Apparent authority, 4 by Ratification, 5. by Estoppel, or when the agent has the 6. Inherent authority to act
2. Measure of damages : Apparent authority makes the principal a contracting party with the third party with rights and liabilities on both sides. In contrast, estoppel only compensates the 3rd party for losses arising from 3rd party’s reliance.
4) Duties & Obligations – Fiduciary Obligations of Agent Every agent is a fiduciary and, as such, she owns her principal the duty to exercise the utmost good faith, loyalty, duty of care, and must avoid conflicts of interest and self-dealing.
Duty of loyalty / conflict of interest: an agent is charged with the fiduciary duty of loyalty, which includes the duty not to compete with his principal, duty not to engage self dealing. This obligation requires the agent to notify the principal of all matters affecting the agency. Anything that an agent obtains as a result of his employment belongs to the principal, thus effectively barring the retention of secret profits, advantages, & benefits absent the principal’s consent. (Principal will recover for 1-loses proximately caused by agent’s breach of fiduciary duty (such as loses for X, Y and Z) and 2-the principal can disgorge the profits made by the agent, the secret profits) (BZ: Profits made is in “connection with the agency” its an important question to ask and answer on essay: it was or was not in connection with the agencyi.e., duty to disclose info: GM employee
contracted w GM not to engage in any other buz; GM got too busy and had no capacity for more orders, set up his own buz and brokered for orders: had a fiduciary duty as agent of to exercise the utmost good faith and loyalty; must have disclosed; is liable & must disgorge the profit earned even GM had no capacity to take those orders
Duties after termination of agency: “Grabbing & leaving”: Post-termination competition with a former principal is permitted, but the former agent is barred from disclosure of trade secrets or other confidential information obtained during his employment, or soliciting former employer’s clients or using his client list (i.e., house cleaning business case)
Remedies Available to Principal:
1) Damages An agent may be liable to principal in tort for breach of fiduciary duty
2) Action for Secret Profits When an agent breaches a fiduciary duty to principal and secretly profits from it, the principal may recover the actual profits or property held by the agenti.e., sergeant got money for wearing
his army uniform to pass civilian police. “when a servant unjustly enriches himself by virtue of his service w/o master’s consent, and thereby makes a secret profit”, employer can recover the profits from servant (i.e., Afshin’s case)
3) Rescission of agent’s transactions Any transaction that violates the agent’s fiduciary duty is voidable by the principal
4) Other : other remedies include an accounting, or imposition of a constructive trust on property agent obtained in violation of his fiduciary duties
Endnotes of agency:i.e., If the uniform was stolen, the
thief is not an agent of the crown, thus there is no agency (no agency relationship for thieves)
Agency: 3part test for having agent relationship: 1. Consent by principal that the agent act on his/her behalf 2. Subject to principal’s control3. Consent of agent
Disclaimer of Specific hazard – if it is general broad release of liability it is not effective. To have an effective release of liability, you have to add specific facts and specifically inform, give examples of the hazards and name the hazards that are intended to be released i.e., give two or three examples and put few facts for making the release of liability effective. only specific exculpatory are enforceable.
Contract that expressly exculpates agency or says “no agency” are ineffective and rather must examine the existence of agency under the plausible theories
All agents owe a duty of loyalty to their principals. A fiduciary obligation; what does it mean? An agent must not put his own interest ahead of the principal’s or the interest of any third party. An agent is entitled to reasonable compensation from the principal. But the duty of loyalty forbids any other compensation. An agent may not receive secret profits.
Three common fact patterns that gives rise to fiduciary duty discussion:1. The agent receives a payment, a
kickback or bribe (or gratuity of some kind);
2. the agent makes a secret profit by he himself transacting (in other words, the agent is the third party and the principal doesn’t know it
3. the agent uses his relationship with the Principal for his advantage
Always keep the definition of agency to its 3 elements: 1-principals assent; 2-subject to P’s control; 3-agent’s consent
i.e., in franchise situations, particularly pay attention and discuss the facts; did the franchisor regulate that particular aspect? If McDonald says to its franchisee, keep the coffee 175 degree, then it is controlling the manner of day to day operation, and is liable since franchisor said do it this way – if franchisee on his own did it this way, then the franchisor would not be liable –franchisor can protect by getting insurance for its franchise business
i.e., actual express authority, P say A can do X
i.e., Implied necessary to carry out P’s express authority?, or customarily authorized and necessary to do it? i.e., renting a conference room is necessary when agent is authorized to close a deal on real estate contract, i.e., cost of getting for sale sign is an implied authority also (it is both customarily and necessary and incident to express authority)
i.e., apparent authority, there has to be some conduct or communication by principal to the 3rd party i.e., P say to 3rd party to see Agent (principals must say to the 3rd party) P manifests to 3rd party (even if P limits agent’s ability but 3rd party does not know, it is still apparent authority since the 3rd party does not know of the limitation; the P is bound by agent’s action
Cross over with evidence:What the 3rd party has to prove is different depending what the theory of authority is based on?
i.e., Authority by ratification, Knowledge, intent, receive benefit on the other hand, argue that ratification must be unequivocal and must be complete ratification and not partial or altering – can’t pick & choose
i.e., inherent authority or extensive authority; implied form the position and job title; custom and usage in the industry, i.e., buyer agent has inherit authority to buy up to for example 100K a year
i.e., agent’s duty of loyalty (can’t put interest of any body before the
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principal. the principal must come first; there must be discloser , cannot be secret profit
i.e., atty is agent of client all of the above applies. officers of a corp are agents of the corp all of the above applies. watch out for vicarious relationships
Partnership
1) Formation 1. Definition 2. No formalities – prima facie3. Partnership vs. Loan or
1. Specific PP partnership’s2. Share of profit personal3. Right to C: not transferable
2. Fiduciary Duty of Partners1. No usurping opportunities2. No self dealing 3. No secret profit 4. Remedies: ONLY accounting
for past damages + discourage profit
4) Dissolution 1. Dissolution by?2. Consequences:
1. Contribution of asset? what order?
2. Right of parties? - Damages?- Continue?
3. Fiduciary duty 4. Effect of dissolution – liability during winding up
Limited Liability Partnership?
- a lawful partnership cannot be formed for non-profit purposes
- a joint venture is an association of
tow or more members, agreeing to share profits, however joint venture is more limited than a partnership and is usually formed for a single transaction.
- Some states hold that corporations lack the capacity to become a partner
- A sharing of profits is considered an element, but not all profit sharing arrangements indicate the existence of a partnership. Nor is a language saying that no partnership is intended conclusive. The entire agreement will be looked at in making the determination.
1) Formation A partnership is an association of two or more person to carry on a business as co-owners for profit. Generally no specific formalities are required to form a partnership. Whether a partnership was formed as oppose to lending or employment agreement, is generally assessed under a totality of circumstances. Generally sharing of profits and losses and ownership & right to control is the prima facie evidence of a partnership. (Elements: 2 or more ppl, common enterprise-carry on buz, PROFIT SHARING, sharing OWNERSHIP & CONTROL)
i.e., In this case, while the agreement contained some terms common to partnerships, there was ample evidence that a partnership was not formed. First, the writing was entitled “agreement”, not “partnership agreement”. Second, under the agreement, X was responsible not only for advancing all money and capital investment, but also for indemnification of losses. Generally, a presumption exists that partners share equally or proportionately in partnership losses. Third, even sharing of profits is a prima face evidence of existence of a partnership and may be compelling, it is not conclusive. Fourth, the evidence revealed that, they never filed a federal or a state partnership tax return. Although partnership itself does not pay taxes, it does report & file information return. Fifth, aside from cash receipts, the relationship never generated tangible property, and determining the existence of an intention to share in tangible properties, such as client list, good will, would involve significant speculation. Lastly, by a way of defense, X will argue that even if partnership was intended, since the partnership is to continue for more than one year, the statute of frauds requires that the agreement be in writing. Thus loan agreement was created.
- a Court may also consider the effect and rights of the parties on dissolution of the relationship. In this case, the effect of the dissolution was the same as an employee quitting her employment … thus, the evidence reveals that a partnership did not exist, and that the agreement between the parties
was merely a method of compensating an employee.
Partnership by Estoppel One who holds herself out to be a partner, or expressly or impliedly consents to such representation, is liable to third party who materially changes position to her determent on reliance of the representation.
i.e., BAR Q: Paula agreed to loan Dufes 20K to buy a boat and go to sailing school. At a party Paula said to Jimmy boat-seller that, “my partner, Dufes and I are going to buy a boat and go to sailing school”. Jimmy lets Dufes try one of his fine boats. Paula and Dufes had a fight and separated. Dufes intentionally destroyed the boat. What result? Jimmy can recover from Paula under partnership by estoppel theory (but don’t just jump into partnership by estoppel theory. Start with the rule that, “each partner is personally liable for the debts and obligation of the partnership”, and thus the Q becomes whether a partnership was formed between P and D. Then give definition of partnership, then RUPA, then sharing of profit prima facie BZ, and because the fact said P loaned 20 K, reach a conclusion that there is no partnership and rather it was a lending agreement. And then go once step further and say: however, Paula can be held liable under partnership estoppel theory, give definition of partnership by estoppel and apply the facts. Your aim on the exam is to pick up all those point!! Start with general rule and then go to its exceptions. (they said P loaned D 20K for you to argue was it a partnership agreement or was it a lending agreement)
BZ: the third party materially changed position to her detriment in reliance of the representation of the partnership in extending the credit. Counters partnership by estoppel theory by arguing that: reliance must be on the representation of partnership and not on any other kind of representation like credit score or reports of financial statutes, or etc – must have solely rely to the
representation of partnership to her detriment
2) Liability to 3 rd Parties As a general rule, each partner is the agent of her co-partner, and when any partner acts within the scope of the partnership, her acts will bind the other partners (both torts committed within the scope of partnership and contracts entered into by a partner with partnership’s authority). Additionally, each partner is personally liable for debts and obligations of the partnership, i.e., partners are jointly and severally liable for partnership’s debts and obligations.- The income and losses of the
partnership are attributed to the individual partners – partnership does not pay taxes, it merely reports its income: only files an information return, and in turn individual partner pays his or her income tax
New and incoming partner is not liable for the existing debts and obligation of the partnership, however his capital contribution can be used to pay existing debts of the partnership.
Dissociating partner , a partner that is leaving the partnership, remains liable to 3rd parties for the debts and obligations of the partnership unless notice of dissociation is given to all know or potentially known creditors. However, under RUPA, if the dissociating partner files a notice of dissociation with the sate, his liability will be terminated 90 days after filing the notice.
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3) Liability between Partners:
1-Fiduciary Obligations of Partners Partners are fiduciaries of each other, and thus they owe the highest obligation of loyalty to their partners. This duty includes an obligation not to usurp opportunities, no engage in self-dealing, and a partner may not drive secret profit at the partnership’s detriment. However, partnership does not owe a fiduciary duty to dissociating or former partner. - Business judgment rule protects
existing partners from a suit by a former partner alleging negligent operation or merger
- Expulsion of partner must be in good faith and with majority vote.
- Partners have right to access to the partnership books, and accounting as to the partnership business
2-Partnership PropertyWhether a partner (or his heirs) is entitled to the property depends on whether the property is a specific partnership property, or share of profit, surplus and personal property.
1) Specific Partnership Property: all property originally brought into the partnership or can be traced to have been acquired by partnership asset for the partnership, such as land, leases and equipment are characterized as specific partnership property. (the partnership owns them). As a general rule, each partner is a tenant in partnership with her co-partners and thus, absence specific agreement to the contrary, each partner has an equal right to possession and may not transfer or convey such property without all other partners participating in the conveyance.
On the death of a partner, death partner’s right to control vests in the surviving partners. Also, partnership property is not part of the estate of the deceased partner but rather the right to control and manage such assets vests in the surviving partner, who is under a duty to account to deceased partner’s estate for the value of the decedent’s interest in the partnership
2) Personal Property: Partner’s share of profit, interest and surplus is personal property and is freely alienable, devisable and decidable a partner may assign her interest in
the partnership (unless there is a provision in the partnership agreement to the contrary), and unless the agreement provides otherwise, such an assignment will not dissolve the partnership. However, the assignee has not right to participate in the management of the partnership (he is not a partner; he only has rights to the assigning partner’s share of the profits and capital), but the assignee is liable for all partnerships obligation.
When a partner conveys her interest in a partnership, she does not convey properly held by the partnership such as land, leases and equipment of the partnership, but rather she transfers her interest in the partnership.
3) Right to Manage and Control:As a general rule, each partner is a tenant in partnership with her co-partners and thus, absence specific agreement to the contrary, each partner has an equal right to control and mange the partnership.
Right to control and mange is like partnership property, and thus cannot be assigned) (Neither specific property nor right to control can be conveyed or assigned by one partner)
The acts of a partner within the
scope of the partnership business binds all partners – one partner cannot escape responsibility for her co-partner just by notifying creditor not to extend credit (had a co-partner dissolved the partnership and given notice to creditor prior to the order by her co-partner, then he would not have been personally liable for the partnership debt).
The differences must be resolved by the majority.
Partners may fashion an agreements as to who makes all decisions. Absence such an agreement, law presumes equal right to manage
Creditor of an individual partner may not attach partnership asset. He must get a judgment against the partner and then proceed against the individual partner’s interest (by
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an assignment of future distribution, a sale fo the interest for proceed, etc)
When a partner conveys her partnership interest to another, she cannot claim as interest in a recovery resulting from a chose in action unknown to the parties at the time she conveyed her interest.
4) Dissolution Dissolution of a partnership does not immediately terminate the partnership. The partnership continues until all of its affairs are wound up. Generally, absence an agreement to the contrary, a partnership may be dissolved by:- Expiration of the partnership term
(even if the partnership is for a fixed term, partners can still terminate it at will – but it will be a breach of the partnership contract by the terminating partner, which may result in damages charged to the breaching partner. The partners can extend the partnership by creating a partnership at will on the same terms.
- Choice of Partner : disagreement: Because partnership is a personal relationship and one cannot be forced to maintain it, any partner can terminate the partnership agreement at will even if the partnership is for a term. However, if dissolution is motivated by bad faith, it may be a breach of partnership contract (agreement) for which the beaching partner may be liable for damages proximately caused.i.e., has the power to dissolve the
partnership, but not the right to do so in bad faith without subjecting himself to damages. since s acted in bad faith in seeking dissolution b/c X, he may be liable not only for breach of his fiduciary duty a as a partner, but also his conduct amounts to breach of covenants of good faith and fair dealing of the partnership agreement and thus liable for damages proximately caused – measure of damages …
- Assignment: an assignment of a partner’s interest is not an automatic dissolution, or is the levy of a creditor’s charging order against a partner’s interest. but an assignee or the creditor can get a dissolution decree on expiration of the partnership term or at any time in a partnership at will
- Withdrawal or admission of a partner: generally most partnership agreements provide that losing or
admitting a partner will not result in dissolution. New partners may become parties to the preexisting agreement by singing it at the time of admission to the partnership. When an old partner leaves, there are usually provisions for continuing the partnership and buying out the partner who is leaving
- Death or bankruptcy : without a provision in the partnership agreement to the contrary, the partnership is dissolved on the death or bankruptcy of any partner.
on the death of a partner, the surviving partners are entitled to possession of the partnership assets an are charged with winding up the partnership affairs without delay. The surviving partners are also charged with a fiduciary duty in liquidating the partnership and must account to the estate of the deceased partner for the value of the decedent’s interest
- Dissolution by court decree: a court, in its discretion, may in certain circumstances dissolve a partnership. These circumstances include insanity of a partner, incapacity, improper conduct, inevitable loss, and/or wherever it is equitable
- Illegality dissolution results from any event making it unlawful for the partners to continue in business
Consequences of Dissolution
1) Distribution of Asset As a general rule, the debts of outside creditors of the partnership must first be paid, then partner’s loan to the partnership, then capital contributions of each partner, and if there is anything left over, the partners receive their agreed share of partnership profits. If the losses and liabilities exceed assets, the partnership must contribute their agreed share to make up the difference. - Share of profit: as a general rule, in
the absence of an agreement to the contrary, it is presumed that partners and joint ventures intended to share equally in profits. Share of losses: additionally, under RUPA, a partner’s share of loss is presumed to be proportional to the partner’s share of profit.
-- if there are no partnership debts, or
where the debts can be handled from the cash account, partnership assets may not be sold, but they may be distributed in kind to the partners.
2) Right of the Parties If the dissolution does not violate the partnership agreement, then the partnership asset are distributed as set forth above, and no partner has nay cause of action against any other partner. If the dissolution does violate the partnership agreement (e.g., the fixed term of the agreement), then the innocent partners have rights in addition to those listed above:1. Right to Damages : innocent partner
have a right to damages e.g., lost profits due to dissolution, against the offending partner
2. Right to continue the business : the innocent partners also have the right to continue the partnership business i.e., not sell of and distribute the assets, by purchasing the offending partner’s interest in the partnership. alternatively, of course, the innocent partners may simply dissolve and wind up the
business, paying the offending partner her share, less damages.
3) Fiduciary obligation between the parties – same as supra
4) Effect of Dissolution The liability of partners for existing partnership debts remains until they are discharged. - Liability during winding up :
dissolution ends the power of a partner to bind the partnership except to the extent necessary to wind up its affairs. However, if 3rd
parties do not know of the dissolution, contracts entered into with a partners bind partnership. Additionally, if the partner’s act is related to winding up old business, partner is not personally liable, but if his acts related to new business he is personally liable.
- When there has been a dissolution
due to death, withdrawal, or admission of a new partner and the partnership business is continued, the new partnership remains liable for all the debts of the previous partnership
Limited Liability PartnershipLimited partnership is a partnership formed by tow or more persons and having as its members one or more general partners and one or more limited partners. General partner assumes management responsibilities and full personal liability for the debts of the partnership. Limited Partner makes a contribution of cash, other property, or service rendered to the partnership and obtains an interest in the partnership in return, but is not active in management and has limited liability for partnership debts.
- the general partner is personally liable for all obligations of the partnership. a limited partner, however, has no personal liability fro partnership debts, and her maximum loss is the amount of her investment in the limited partnership. However, if a limited
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partner takes part in the management and control of the business, she becomes liable as a general partner
- To form a LP, partners must file a
certificate of partnership with state setting forth name, character location of the partnership and both general and limited partners, their capital contribution and respective rights and priorities
Corporations
Six Fact Patterns:
1. Organization/Formation of Corp
2. Issuance of Stock
3. Right of Shareholders
4. Action by & liability of Directors & officers
5. Security Law
6. Fundamental Corporate change
1 st Fact Pattern: Formation (also, way of holding SH liable)1. De Jure2. De Facto 3. Corporation By Estoppel 4. Piercing Corporate Veil
Formation (People, Paper, Act)A corporation is a legal entity distinct from its owners, which is created by complying with state corporate law. Majority of states have adopted Revised Model Business Corporation Act (RMBCA), which governs state corporate law. Generally, once a de jure corporation is formed, its shareholders are not personally liable for the debts and liabilities incurred by the corporation.
Formation of a de jure corporation requires that 1-the incorporator(s) 2-singe and file the articles of incorporation with the secretary of state and pay the appropriate fees.
Internal affairs doctrine: internal affairs of a corporation (role and duties of directors, officers, shareholders, etc) are governed by the law of the state in which the corporation is incorporated. I.e. CA law governs CA Corps.
Legal Consequence A corporation is a legal and separate entity from it owners. Corporations have a very brad power (unless limited by the article), so they can sue and be sued, acquire and dispose of property, make reasonable contribution, etc. Charitable Donation: at one time, charitable donations were held to be outside the scope of business purpose, but today and RMBCA allow corporations to make charitable donation or loans to its employees, officers, or directors
Limited Liability Because Corps is a separate entity, the people who run it and own it usually are not liable for debts it incurs. Generally, shareholders, the people who own the corp, are not personally liable for debts of corporation. This is
the concept of limited liability, that a shareholder is generally is liable only for the price of their shares. The corporation is liabilities for its debts and liabilities.
People: Incorporators: must have one or more incorporator. An incorporator sings and files the articles of incorporation. Incorporators can a person or an entity.
Paper: Articles of incorporation:An article of incorporation is a contract between the corporation and shareholders and well as a contract between corporation and sate. It must contain:1. name & address of the corporation
– must include one of following:- Corporation or Corp.- Company or Co.- Incorporated or Inc.- Limited or Ltd
2. name and address of each incorporator – In some states, name of initial
directors is also required
3. name and address of corporation’s registered agent - Registered agent is the corp’s
official legal representative who can receive service of process
4. Capital structure and the number of shares that the corporation is authorized to issue – Article must include:
- authorized stock- number of shares per class- info about par value - voting rights and preference
of each class- Authorized stock : maximum
number of shares that corporation can sell
- Issued stock : number of shares that the corporation actually sells
- Outstanding stock : number of shares that have been issued and not reacquired by the corporation
Act: Filling of Articles & paying feeCorporate existence begins upon filing of articles with the state, thus in majority of states filing is conclusive proof of formation of a de jure corporation, however, some state hold that acceptance of the article by
secretary of state is the conclusive evidence of de jure corporation
– After the articles are filed, the corp will have an organizational meeting to
contain any provision for managing the corp that is not inconsistent with articles or law. Bylaws are adopted by directors but may be modified or repealed by a majority vote of either directors or SH
Business Purpose – Ultra Vires ActsTraditionally, corporations have included a statement of business in their articles. Absent such a statement, the RMBCA presumes that a corporation is formed to conduct any lawful business and is allowed to undertake any act that is necessary or convenient for carrying on their business purpose. However, if a corporation includes a specific business purpose in its articles, it may not undertake activities unrelated or beyond the stated business purpose. Activities beyond the scope of the stated business purpose are said to be ultra vires and at common law such acts were void and unenforceable. However, under RMBCA, ultra vires acts are generally valid and enforceable but
1. shareholders can seek an injunction to stop the ultra vires activity;
2. the corporation may sue an officer or directors for damages for approving the ultra vires act
3. the state may bring an action to dissolve a corporation for committing an ultra vires act
- Keep in mind that under modern statutes (RMBCA), the ultra vires defense is very limited. Thus, you should not allow a corporation to get out of a contract merely because the contract is outside the scope of the corporation’s stated purpose.
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Formation Defects A corporation formed in accordance with all applicable laws is a de jure corporation and its owners are generally not personally liable for its debts. However, if all applicable laws have not been followed, a business may still be treated as a corporation under certain situations where there was a good faith attempts to incorporate it: De Facto Corp Doctrine, and Corps by Estoppel
– These are doctrines by which a business failing to achieve de jure corporate status nonetheless is treated as a corporation (so shareholders will not be personally liable for business debts)
– Generally, one invoking either doctrine must be unaware of failure to form a de jure corporation i.e., acting in good faith
De Facto Corporation For a de facto corporation to exist, there must be 1. a relevant incorporation statue 2. colorable compliance and good
faith attempt to comply with the statue AND
3. some exercise of corporate privilege (must act and conduct some business like corp)
- De facto corporation has all rights and powers of de jure corporation and will be treated as a corporation for all purposes except that it remains subject to direct attack by the state for exceeding its powers.
- Limitation: if persons who purports to act on behalf of a corporation know that there has been no valid incorporation, are liable for all liabilities carted in so acting. Thus, the de facto doctrine can be raised as a defense to personal liability only by a person who is unaware that there was no valid incorporation
Corporation by Estoppel – in K only Under common law doctrine of corporation by estoppel, persons dealing with a business as a corporation, treating it as a corporation may be estopped from denying the business’ corporate status. - It applies generally only in
contracts (i.e., parties with tort claims are generally free to sue the shareholders of an improperly formed corporation for damages result from tort)
- it can be invoked against those who dealt directly with the business as a corporation, or may be used to prevent a company from avoiding an obligation by asserting its own lack of valid formation.
- The de facto doctrine applies equally in contract and tort situations, but estoppel generally is applied only in contract cases (on the rational that a tort victim does not allow himself to be injured in reliance on the business’s status as a corporation).
- If there is no valid incorporation and the facts do not support a de facto or estoppel argument, generally, the courts will hold only the active business members personally liable, and their liability is joint and several
** Both Doctrines are Abolished in many states – make sure to point out and let them know that these doctrines are abolished in many states- abolished in many states, but live enough to appear on the bar:
A number of states have abolished and refuse to recognize either or both the de facto corporation and/or the doctrine of incorporation by estoppel.
Bylaws (Almost impossible for them to ask questions on bylaws)1. De jure corp can exist without
bylaws. 2. Adoption of bylaws is not a
condition precedent to formation of a corp.
3. But almost every corp has them because they establish internal procedures and responsibilities of people like officers, set forth the type of notice required for meetings, etc.
4. If bylaws are inconsistent with the certificate, the certificate controls (it is a contract with the state).
5. Bylaws are not filed with the state.6. Bylaws are internal documents
and outsiders are not bound.7. Bylaws are adopted by the
incorporators at the organizational meeting.
8. These initial bylaws have the status of a SH bylaw.
9. Who can amend or repeal the bylaws? 1-SH are the ones who can amend or repeal bylaws or adopt new ones, 2- in many states, also the BOD get to amend or repeal bylaws or adopt new ones – sometimes articles allow them.
® Generally, the power to amend, repeal, or adopt new by-laws rest in the shareholders (SH) and thus requires SH approval. However, some states allow the board of directors to amend, repeal or adopt new bylaws so long as it does not affect the directors. In most cases whether the board may amend, repeal or adopt new bylaws is set forth in the articles of incorporation or in the bylaws themselves.
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Piercing The Corporate Veil Generally, a shareholder is not liable for the debts of a corporation. However, under the doctrine of piercing the corporate veil, a court may disregard a corporate entity and hold shareholders personally liable if 1-the shareholders have abused the privilege of conduct business as corporation, and 2-giving the shareholders limited liability would be inequitable and unjust. (Fairness requires holding SH liable) Generally, a court may pierce the corporate veil if
1. Corporate formalities are ignored i.e., the corporation is acting as alter ego of owner, or “Enterprise Liability: where same SHs own stock of two Corps engaged in same enterprise, creditor of one Corp can reach Corp asset of another
2. When corporation is inadequately capitalized at the outset, or
3. to prevent fraud and unfairness
4. “Deep Rock” Doctrine: in insolvency and bankruptcy of the corporation, loans to Corp by controlling shareholders may be subordinated to claims of outside creditors when Corp is undercapitalized and bad faith, fraud or gross mismanagement is involved.
5. Lastly : Which shareholders are personally liable? – Active Involvement Rule
1) Lack of Corporate formalitiesWhen the corporation ignores corporate formalities such that it may be considered the alter ego of the shareholder or another corporation, the corporate veil may be pierced. However, mere sloppy administration is not enough to PCV. – It may be alter ego theory, or
enterprise liability theory.
1) Alter ego : SH treats assets of Corps as his own, uses Corp funds for private ends, fails to keep separate Corp books, fails to observe corporate formalities such as not holding meeting, not issuing stock. In such situations the Corp entity is mere alter ego of the shareholder and is pierced– Note: SHs can vest the power to run
the Corp in themselves rather than in the BOD. Their doing so is not a ground for disregarding the Corp veil even if it results in a failure to keep Corp records.
2) Enterprise or Affiliated Corporation theory: when the same SHs own stock of affiliated Corps that is engaged in same enterprise fails to observe formalities of each separately, affiliated corporation may be considered fragment of another, thus creditor of one may reach the asset of another- Parent- subsidy situation. i.e.,
parent Corp forms subsidiary to avoid liability: PCV unless wholly separate
i.e., X and Y are the SHs of C Corp. X is also the chief executive officer. X commingles personal and Corp funds, uses the Corp car as his own and uses Corp credit card to pay for his personal purchase (That’s an abuse of the Corp – it is suppose to have its own accounts and pay its bill from his personal account). Can a creditor of the Crop who has been unable to collect its claim from the Corp collect from either X or Y?
First, start with the general rule that SH is not liable for acts or debts of corporation. Here, a court might PCV if X’s failure to respect the separate Corp entity harmed creditors. Sloppy administration generally is not enough for PCV, but here X treated the corporation as his alter ego by commingling his money with the Corp’s and treated Corp’s assets as his personal asset as interchangeable. This is more than being sloppy and if his actions harmed the creditor, the court might PCV. If PCV, only X would be liable. Y did nothing wrong.
2) Undercapitalization A Corp is inadequately capitalized when its shareholders have not invested enough capital to meet the corporation’s prospective business risk and obligation that could reasonably be expected to arise in that business at the time of the corporation’s formation
i.e., S is shareholder of Glowco Inc, a corporation that hauls and disposes of nuclear waste. Glowco does not carry insurance. Glowco has an initial capital investment of $1,000. V is injured when one of Glowco’s trucks melt down. Can V sue S?
Answer: start with the general rule, then apply undercapitalization test. Here, a court might PCV because the corporation was undercapitalized when formed. Why? Because shareholders failed to invest enough money to cover prospective liabilities! It is undercapitalization and we can argue for PCV. They did not even have enough $ to buy insurance, and they are involved in a dangerous activity. 3) Fraud, Avoidance of Existing ObligationThe corporate veil may be pierced where necessary to prevent fraud or to prevent an individual shareholder from using the entity to avoid his existing personal obligation.- The mere fact that an individual
chooses to adopt the corporate form to avoid future personal liability is not itself a reason to PCV.
4) “Deep Rock” Doctrine Under Deep Rock doctrine, when a corporation is insolvent and some of the shareholders have claims as “creditors” against the corporation, shareholder’s claim may be subordinated to outside creditors if equity so requires (i.e., b/c of fraud, undercapitalized, bad faith, or even gross mismanagement).
5) Who is Liable? – Active involvement RuleNormally, only shareholders who were active in the operation of the business will be personally liable and the liability is joint and several. Inactive or passive shareholders who acted in good faith will not be held liable for the corps obligation.
Remember, courts are generally more willing to PCV for a tort victim than for a contract claimant since parties who contracted with the corporation has an opportunity to investigate its stability.
- Generally, creditors may PCV. Shareholder cannot PCV.
A promoter is a person who acts on behalf of a corporation not yet formed.
Promoters’ Relationship with each other – Fiduciary Absent an agreement to the contrary, promoters are joint ventures who occupy fiduciary relationship to each other. This fiduciary duty includes a duty not to make secret profit, and a duty of full disclosure, good faith and fair dealing as to all matters pertaining the corporation. i.e., A and B have agreed to form a corp
to do real estate business. A tells B that he can get Blackacre for subdividing and development for $100K. A buys Blackacre for $70K and pockets the difference. A is liable to B, his fellow promoter, for breach of fiduciary duty since the promotion began when A and B agreed to form the corporation. BZ: this fiduciary duty was breached since A secretly pursued personal gain at the expense of their fellow promoters
Promoter’s Relationship with Corporation – Fiduciary A promoter owes a fiduciary duty to the corporation. This fiduciary duty includes a duty not to make secret profit, and a duty of full disclosure, good faith and fair dealing as to all matters pertaining the corporation. – Promoter’s liabilities to the Corp.
may arise under 1-breach of fiduciary duty for secret profits, 2-fraud or misrepresentation (C/L & 10b5), 3-obtainign unpaid stocks:
Secret ProfitRule: promoter cannot make a secret profit on her dealing with the corporation. (A promoter who profits by selling property to the corporation is liable for his profit unless all material facts of the transaction were disclosed) Two fact patterns to watch out:1) Sale to Corp of property
acquired BEFORE becoming promoter:
Profit= price paid by Corp – FMVi.e., on October 4th 2006, P begins working as promoter. On December 25th 2006 P sells to corporation Green Acre for $40K. P had bough Green Acre in 1931 for $1.97. 1st, any profit? Maybe not! Apply the test: price paid by the Corp ($40K) minus FMV. So if Green Acre is worth $40K (or more), there is no profit here. (so the $1.97 that P paid for the property is irrelevant)- we don’t care how much P paid; all
we care about is what Corp paid and FMV at the time it paid for it, December 25th.
2) Sale to Corp of property acquired ATER becoming promoter
Profit= price paid by Corp – Price paid by promoter
i.e., on October 4, 2006 P began working as promoter. On December 25th P buys property for $17K and couple months later on February 1st P sells that property to Corp for $25K.1st, any Profit? $8K profit – but is P liable to the Corp? next step:2nd, is P liable to Corp for that profit? P is liable only if it was secret – if P had disclosed that he is making $8K, then he is not liable
It all comes down to disclosure. If P goes to BOD and say I’ll make a profit on this deal, it is ok. But if she does it secretly, then it is not ok.
Promoter’s Relationship with 3 rd parties : Pre-incorporation agreement
1) Liability of Promoter:Generally, unless the contract provides otherwise, the promoter remains personally liable on the pre-incorporation contracts until there has been a novation. (This liability continues after Corp is formed and even if the Corp adopts the K and benefits from it, unless there is a novation)
- Corp’s adopting pre-incorporation agreement makes the Corp liable as well but does not relieve promoter from liability (only the agreement itself, option K, or novation can relieve promoter from liability)
i.e., on January 10th P acting as a promoter for Corp not yet formed leases a building from Pee Wee and signs the lease “Oscar De La Rental Cars, Inc”. on February 20, Oscar De La Rental Cars Inc is organized1. is the Corp liable on the contract?
Yes, if it adopts the contract either expressly or impliedly
2. will P be liable on the lease if Oscar De La Rental Cars Inc is formed and adopts the lease? Yes, adoption is not enough. There must be novation
3. adoption by the Corp made it liable as well, but did not relieve the promoter of liability
Pre-incorporation agreement is a minor contract C/O issue
Remedies of PromoterA promoter who is held personally liable on a pre-incorporation contract may have a right of indemnification and seek reimbursement to the extent that Corp received benefit of the K. Also, Promoter may have a Quasi-Contractual relief for Corp’s unjust enrichment.
2) Corporations’ Liability A corporation is not liable on pre-incorporation contracts until it adopts the contract - Since the Corp entity does not exist
prior to incorporation, there is no meeting of mind, and thus the Corp is not bound on contracts entered into by the promoter in the corporate name prior to incorporation. However, the corporation may become bound by expressly or impliedly adopting promoter’s K
Express adoption e.g., BOD’s resolution expressly adopting the K Implied adoption e.g., Corp ratifies and accepts the benefit of the K i.e., Oscar De La Rental Cars Inc moved into leased premises, accepted K’s benefits
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2 nd Fact Pattern: Issuance of Stock
Issuance of stock occurs when a corporation sells or trades its own stock.- it’s a way for the Corp to raise
capital. Issuance occurs only if the Corp itself is selling or trading its own stock
i.e., Mayberry Realty Corp., sells 10,000 shares of Mayberry stock. That is an issuance b/c the company sold its own stock
i.e., Barney Fife sells 3,000 shares of
Mayberry stock. Issuance ? NO. (it is issuance only if the Corp is selling, or trading its own stock)
SubscriptionsSubscription is a written offer to buy stock from the Corp (contract 101)
Revocation of Pre-incorporation subscriptions:Pre-incorporation offers are irrevocable for six months, unless otherwise provided in the terms of the subscription agreement, or all subscribers agree. i.e.. 1/10 B signs a subscription,
offering to buy 100 shares of C Corp., a corporation not yet formed. A week later, B changes his mind. Can B revoke? NO
Revocation of Post-incorporation subscriptionsPost-incorporation subscriptions are revocable until acceptance of the subscription by the board
- What is acceptance – when do the Corporation and the subscribers become obligated under a subscription? If the board has accepted the subscription (subscription: offer to buy), the subscription becomes irrevocable. Offeror is the matter of his offer and he can revoke it anytime prior to acceptance by the offeree: here the Corp: BOD
- The Board’s call for payment must be uniform within each class or series of stock (series is just a subclass of stock)
Exam Tip: Whenever you have issuance of stock for money, think about preemptive right and flag it as an issue – regardless of whether the article gives the right or not, raise the issue and then give the
split of authority – discussed infra under SH’s rights)
Form of Consideration Under the traditional rule, shares may be paid for by: (permitted)1. Money (cash or check)2. Tangible or intangible property 3. Services already performed for
the corporation (past services)
Under traditional rule, shares cannot be paid by: (prohibited)1. Future services,2. Promissory notes (although
some states allow notes if fully secured),
3. results in “unpaid stock” which is all treated as water stock
Under Modern Trend, however, shares may be paid for by any tangible or intangible property or benefit to the corporation
Exam Tip: modern trend has expanded to allow all forms of considerations, including promise of future service and promissory notes
Amount of Consideration Traditionally, stock should not be issued by a corporation for less than the stock’s par value if the par value is stated. Par value is the minimum price for which the corporation can sell the stock.
- Par means “minimum issuance price” i.e., C Corp is selling 10,000 shares
of $3 par stock. It must receive at least 30K. This is the minimum it must receive; they can get more.
- No Par means “no minimum issuance price” (Board sets the issuance price)
- Treasury stock (=Re-acquired stock): this is stock that was previously issued and has been re-acquired by the corporation. The company may then re-sell the treasury stock, and there is no par value in sales of treasury stock. i.e., C Corp., is selling 10,000
shares of $3 par treasury stock. It must receive at least how much? There is no minimum! Even though this was originally par, always treat issuance of treasury stock as no part. So it can sell it all for 0.50
HYPO – acquiring property with par value stock Can C Corp issue 5,000 shares of $3 par stock to acquire CW’s farm?1- Is form of Consideration OK?
Yes, both C/L & M/K okay b/c its property
2- Is the amount of consideration okay? Yes, if the farm is worth at least 15K. we are giving 15k of stock, so we have to get 15k in return.
3- How do we know if the property is worth 15k?One way is a board’s valuation, and it is conclusive if made in good faith
- Outstanding share is what is already sold and SH hold together.
** Consequence of issuing par stock for less than par value i.e., “watered stock”Water stock simply means selling par stock for less than par valuei.e., C Corp issues 10,000 shares of $3
par to X for $22,000
The issue is 1-who can sue for water stock, and 2- who would be liable for $8,000?
1) The corporation (or creditors if the company is insolvent) can sue for $8,000 of “water.”
- Derivative suit if SH is suing - BOD’s breach of duty of L & C
2) Parties liable: Directors are liable for water
stock if they knowingly authorized the issuance for less than par.
Buyer is SH: SH are liable if they bought watered stock regardless of whether they had actual notice of par value. They will be charged with notice of par value.
What if X transfers the stock to A?A is not liable if she acted in good faith, i.e., did not know of the water.
A’s status has no effect on liability of X and the board. Both X (SH) and directors are still liable, but BFP is not. A does not have to be a BPF. All that matter is that she did not know about it.
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3 rd Fact Pattern: SHs 1. SH personally liable issue?
- Its formation issues: de jure, de facto, by estoppel, & PCV
2. Generally no power to manage 1. SH agreement?
- Committing to an issue?- Close Corps?
3. SH derivative suit 4. Inspection Rights of SH5. Distribution 6. Stock transfer restriction 7. Voting Rights8. Voting trust 9. Proxy contest
Shareholders
SH Management of Corp
Rule: There is a strong public policy that the power to manage the Corp is generally vested in the directors and not the shareholders. Thus, SH generally have no direct control over management of Corp’s business, except if there is SH agreement to dispense with the board and vest the management power in themselves.
SH agreement SH have always been allowed to enter into agreements to vote their shares to elect each other to the board of directors. But an agreement as to what they would do once they are on the board violates the public policy that management is vested in the board:
At common law, no SH agreement could affect management because such an agreement would violate this public policy. Today, HOWEVER, there is a judicial trend toward upholding SH agreement that binds directors’ discretion if 1. no minority SH objects2. no harm to public or company’s
creditors, and3. the management affects
relatively minor issue
Bar Tip: if the bar exam question asks about the power of shareholder to run the day-to-day affairs of their corporation, unless the corporation’s article or a SH agreement provides otherwise, you should generally respond that the SH have no such power; that power is vested in the board of directors, and the SH have the power to elect the board, and can exercise indirect control over the Corp through their voting power, by which they elect and remove directors, adopt and modify bylaws, and approve fundamental change in the Corp structure
Close Corporation- in addition, many states have enacted statutes that allow SH to mange a close corporation directly if:1. the articles provide it is a close (or
closely held) corporation, and 2. the articles or unanimous SH
agreement provide for SH management
if so, the Corp need not have a board of directors. The SH run the Corp. the managing SHs owe the duties of care and loyalty.
A close Corporation A close Corp has few SH and the shares are not publicly traded. Modern trend is toward imposing fiduciary duties on SHs in their dealing with each other. Then there is a SH agreement to manage the corporation. Any time we have a majority
SH oppressing minority SH in a close Corp, there is breach of fiduciary duty
Watch especially for actions by controlling SHs that oppress or harm the minority SHs. Courts may protect minority SH from oppression, in part because there is no public market, so she cannot sell her shares and get out.
Is this a close corporation? Rule: close corporation is typified by 3 characteristics: 1-small number of shareholders (35 or less, usually half a dozen- if it has above 35 SH, it is not close corporation), 2-no ready market for stocks, 3-the majority of shareholders participate in management
SH owe a fiduciary duty to each other in close corporation. They have to act in good faith and loyalty. (Unlike BOD’s fiduciary duty that is to the corporation, in close corporation the fiduciary duty is owed to other shareholders)
Board seat and officers seat is by SH and get salary. There are no dividends in close corporation.
To fire another SH from BOD and management, there has to be a “legitimate business purpose” or there is breach of fiduciary duty to the fired SH (ex-Board member) – personal reasons (i.e., lower tax) are not legitimate business purpose.
Consider fraud, insider trading (C/L basis of liabilities, not FR) whenever SH breaches fiduciary duty to other SHs, or there is no legitimate business purpose
Make sure to look for issues of selling to looters and etc, discussed infra with securities liabilities
Controlling shareholders owes fiduciary duty to minority SHs
Make sure to distinguish business purpose vs. personal purpose – personal purpose is never considered legitimate
Business judgment rule is an argument in legitimate business purpose
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Shareholder Suit
Direct ActionA direct action may be brought for a breach of a fiduciary duty owed to the SH by an officer or director.
SH Derivative SuitA derivative suit is an action brought by SH on behalf of the corporation to enforce the corporation’s claim. Recovery of derivative suit generally goes to the Corp, nevertheless the Corp is named among s. however, SH may be entitled to reimbursement for his expenses of litigation.
the test is “could the Corp have brought this suit”? if so, it is probably depravities suit
i.e., S, SH of C Corp., sues X for breaching its contract with C Corp. Derivative suite? Yes, b/c C Corp could sue X. it is the Corp’s claim
i.e., S sues the board of directors of C Corp. for usurping corporate opportunities. Derivative suit? Yes, b/c this is for breach of duty of loyalty. Remember, the duty of loyalty and then duty of care are owned to the corporation, so breach of either hurts the Corp
i.e., S sues board of director of C Corp. for issuing new stock without honoring her preemptive right. Derivative suit? No. that’s a direct suit, brought to vindicate S’s personal claim.
i.e., SH is denied to gets SH list or inspect book and records upon showing proper purpose, SH’s suit is a direct suit.
i.e., SH sues the BOD for drop in stock value. It’s a derivative suit since SH is suing for BOD’s mismanagement which damaged the Corp in whole, not SH personally.
it is only derivative if we are vindicating the Corp’s claim
To distinguish between direct and derivative is to ask: 1) who suffers the most immediate and direct damages, the Corp or SH2) to whom did the ’s duty run, the Corp or the SH. In a SH direct action, any recovery is for the benefit of the individual SH
Requirements for brining a SH derivative suit: - Standing For a SH to have standing to bring a derivative suit, the following requirements must be met:
1) Stock ownership The SH must have owned stock at the time claim arose AND maintain ownership throughout the litigation (until judgment)- If he has gotten it by operation of
law (inheritance, divorce decree), it must be form someone who did own the stock when the claim arose
- If the complaint concerns a continuing wrong, must’ve owned stock sometime during the continuing wrong
2) Adequate Representation SH must adequately represent interest of Corp and SHs (like class action in civ pro, DP issue for inadequacy of reprehension, and res judicata issue)
3) Written Demand Required SH must make a written demand that the directors bring suit unless demand is excused because it would be futile
All demands for breach of fiduciary duty will be futile because the board itself will be the . Hence, all derivative suits for breach of fiduciary duty will be futile Please with Particularity
4) Verified Complied (under oath) Alleging with specificity efforts to get corporation to take action and bring the suit, or why demand is excused
5) Can be required to post security (Bond) for cost -To avoid “strike suits.” we want SH to have a stake in i
6) Corporation can move to dismiss The Corp can move to dismiss the suit if independent directors, or a committee of independent directors, find in good faith after reasonable inquiry that the suit is not in the Corporation’s best interest, e.g., low chance of success or
expenses of litigation would exceed recovery
Court will scrutinize independence of those who investigated and may
scrutinize merits of their recommendation
Defense 1. Substantive defenses that could
have been raised against the corporation i.e., X claims a Statute of Frauds
defense because there was no written agreement w/ the C Corp
2. Plaintiff disqualification defense i.e., board of directors claim that S knew of, assented to, and benefited from this ultra viras activities of the Corporation
No dismissal or settlement of derivative suit without court approvalCourt can give notice to SH, similar to class action (in civ pro) (just like a class action in civ pro, you cannot dismiss or settle a derivative suit without court’s permission)
What are the consequences of successful derivative suit? Generally, recovery in any successful derivative suit goes to the Corp (it was Corp’s claim, and award goes to the Corp). However, when the derivative suit is successful, SH is entitled to reimbursement for the cost of litigation i.e., attorney’s fees from the Corp. (she has conferred a benefit on the corporation by suing and wining, and Corp will reimburse his cost) i.e., S, a SH of C Corp, sues X for
breaching it contract with C Corp. the court find a breach of contract and award damages of $50K. who receives the $50K? General answer is that C Corp receives the damages, since this was C Corp’s claim and SH will be reimbursed for expenses from the Corp
However, in certain situations, the court might allow the SH to recover directly if corporate recovery would return money to the bad guys. i.e., Close Corp with three SH (each
owning 1/3), one of whom engages in a competing venture, which obviously breaches a duty to the corporation. If a judgment against the bad guys goes to the corporation, one-third of it would go to the bad guy. In this case we might allow the SH to recover so the $ does not go to the bad guy.
What are the consequences of unsuccessful SH’s derivative suit? When SH suit is unsuccessful, the SH will not be entitled to reimbursement for cost and attorney’s fees. Is SH liable for X for its cost?
Yes, and liable for X’s attorney’s fees if S sued without reasonable cause
Can other SHs later sue X on the same transaction?No, because of Res judicata (C/O w Civ pro)
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SH Voting
Who Votes Rule is that Shareholders of record as of record date has the right to vote the SH meeting.
Record SH as of record date has the right to vote
The record SH is the SH who is shown as the owner of the share in the corporate records on record date.
The record date is a voter eligibility cut-off, generally to be set between 10-60 days before the meeting.
i.e., C Corp set the annual meeting for 7/7 and record date for 6/6. S her C Corp stock to B on 6/25. who is entitled to vote the shares at the meeting, S or B?S, b/c she owned the stock on 6/6: if you own it on the record date, you get to vote on that share even if someone else owns it.
Cumulative Voting vs Straight voting If the articles specifically provide for cumulative voting and it is not inconsistent with state law, SH may use cumulative voting in electing directors. Under cumulative voting, each SH is entitled to a number of votes equal to the number of his/her shares multiplied by the number of directors to be elected. Formula = # of his Shares x # of Dir
Cumulative voting is a device to help small SHs get representation on the board.
Cumulative voting exists only if article allow it. Majority view
i.e., You own 1,000 shares of stock in C Corp. C Corp has nine directorship open for election. You believe that Bob Baker should be director of C Corp. under cumulative voting, how many votes can you cast for Bob? 9,000. Don’t have to cast 1,000 shares per each seat on the board.
i.e., the articles of C Corp. are silent as to whether SHs can vote cumulatively. Can C’s shareholders vote cumulatively? No, b/c cumulative voting exists only if the articles allow it. there must be straight voting: one SH one vote
Exceptions:
1. Corporation does not vote treasure stock even though it is the record owner as of the record date Treasury stock - stock that the Corp issued at some point and bought back. Corp does not vote treasury stock, even though it owns the stock on the record date.
2. Death of SH i.e., S owns stock in C Corp. S is the record SH. After the record date, S dies. Can S’s executor vote the same share? Yes
3. Proxies A proxy is a power of attorney given by a SH to someone else to exercise the voting rights attached to his shares. The person to whom this authority is given (proxy holder) becomes SH’s agent to vote the shares in question.
Requirement to have a proxy, is that there must be a writing (fax or e-mail ok), 2) signed by record SH, 3) directed to secretary of corporation 4) authorizing another to vote the shares. Proxies are generally valid for 11 months unless provided otherwise. A proxy is generally revocable by the SH unless made irrevocable. A proxy is irrevocable only if it states that it is irrevocable AND is coupled with an interest or given as security. See the i.e.,
Other issues Proxies do not work for directors
of the corporation. Also, SH can use proxies to vote in SH meeting, but Directors cannot use proxy to vote at director’s meetings
also watch out for agency cross over: proxies are agent’s of SH
with proxy, consider these issues: proxy solicitations re proxy contest, SH proposal in proxy material (rule 14a)
i.e., on 2/2/2006 S send letter to secretary of Corp. authorizing Gomer Pyle to vote her shares. Can Gomer vote S’s shares at the 2006 annual meeting in July? Yes. This is a proxy issue.
i.e., can Gomer vote S’s share at 2007 annual meeting? Yes. If the proxy is silent as to duration, it is good for 11 months, unless it says otherwise
i.e., what if, prior to 2007 meeting, S writes to the secretary of C Corp that she now wants Rossi to vote her shares at the 2007 meeting? A proxy is revocable by SH unless made irrevocable, and since S did not make Gomer’s proxy irrevocable, apponing Rossi as proxy revoked Gomer’s proxy.
i.e., what if, Gomer’s proxy by its terms states that it is irrevocable? is it revoked? Yes. Even it says it is irrevocable, it can still be revoked b/c it was not coupled with an interest or given as security
i.e., S sells B her shares after the record date but before the annual meeting. S gives B an irrevocable proxy to vote the shares at the annual meeting. Can S revoke this proxy? No, because:1. it say it is irrevocable, AND2. the proxy-holder has some
interest in the shares other than voting, a proxy coupled with an interest. Here, the interest is ownership. It could be an option, pledge, or any interest etc
3. this is the only irrevocable proxy (both stated and coupled with an interest, ownership or alike)
Don’t forget, interest can be ownership, pledge… any interest
Voting Trust e.g., X,Y and Z decide that they can increase their influence on Corp policy by “block voting,” so they appoint a trustee to vote for them and vote alike i.e., always voting alike (they are specifically enforceable)
Rule: a voting trust is a 1. written trust agreement
controlling how the shares will be voted
2. a copy of trust agreement must be given to Corp (can’t be secret)
3. transfer legal title of shares to voting trustee
4. original SHs receive trust certificates and retain all SHs rights except for voting
5. 10 years max
Voting Agreement Rather than creating a trust, SH may enter into a written & singed agreement providing for the manner in which they will vote their shares i.e., pooling agreement (they are specifically enforceable)
Voting agreement is a1. written AND 2. signed agreement between SHs 3. providing for the manner in
which they will vote their shares 4. there is a split among jurisdictions
as to whether voting agreements are specifically enforceable. some say jrx say yes, some say no
- SHs can all enter into these kinds of agreements and they are all enforceable, but directors cannot enter into such agreements. Directors cannot contract as to how they are going to vote. (Director’s agreement to vote is void and invalid on public policy grounds) directors cannot agree
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beforehand as to what or how they would do.
Proxy Solicitation re Proxy ContestsSolicitation of proxies by corporate management is its most effective way of maintaining control of the corporation. Insurgent group, who may or may not be shareholders, may attempt to obtain control of the corporation through proxy solicitation instead of purchasing a majority of shares.
Expense of Proxy Contest - (who bears the cost):1. A losing proxy insurgent has no
right to reimbursement for his expenses incurred during the course of the campaign.
2. Management (incumbent) may always use corporate funds to wage proxy campaigns to defend corporate policy
3. the wining insurgents have the right, upon election of themselves to the board of directors to vote themselves recovery for the reasonable expenses of the proxy solicitation
4. the wining insurgents may allow the old management to recover their reasonable expenses of their defenses as long as the fight was over policy
5. use the business judgment test to determine if the cost awarded are unreasonable
look to corporate policy rather than personal purpose
Beware of SH unqualified right to inspect SH lists for the purpose of solicitation proxies, but a proper purpose must be shown to inspect books/records
Insurgent: uprising, incoming group
Incumbent: presently in charge
Insurgent gets reimbursed for the cost of proxy solicitation if 1-they win, 2-it was a reasonable amount, 3-it was for proper business purpose and not personal purpose, 4- must be approved by majority of disinterested shares
Incumbent gets reimbursed regardless of whether they lose or will so long as they spend the money in proxy contest to defend a corporate policy and not personal interest, and the amount spend was reasonable
SH Proposal SH may include SH proposal in proxy materials to be discussed at SH meeting. (i.e., request to provide SH with a list – burden is on management to show why rejected)
However, the following are not proper subject for SH proposal:1. matters of ordinary business
operation (ordinary business operation is BOD’s job to decide, and not SH to tell BOD what to do)
2. social or political issues not significantly related to business of corporation
3. not within Corporate control
Section 14 prevents abuse in proxy solicitation
Jump On My Little Red Raft 1. J urisdiction : same as rule 16. any
proxy solicitation must be accompanied by proxy statement and filed with SEC
2. O mission/Misstatement : of a writing or a continuous plan leading to or preparing for solicitation
3. M aterial : would omitted fact have any actual significance in deliberations of reasonable SH
4. L iability : Negligence may suffice
5. R eliance : look for materiality
6. R emedy : Injunction / private suit
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SH’s Action: SH meetingShareholders can take action either by 2) Unanimous written consent of the
holders of all voting shares, OR by3) Meeting , satisfying 1-quorum and
2-voting requirement
Kinds of SH meetings:1. Annual meeting
The annual meeting is where SH elect directors. The annual meeting is required. Court can order SH annual meting if not held.
2. Special meeting Special meetings may be called by 1. board of director or president,2. holder of 10% voting share or 3. anyone authorized in article 4. However , special meeting must
be for a proper SH purpose. The special meeting must be regarding something which the SH have a right to do.
i.e., BAR Q, whether the court was correct in granting Polly’s request for calling a special meeting to remove the Dr. Jim, the CEO of the Corp. Polly is 10% shareholder entitled to vote, however, calling special meeting must be for proper SH purpose, a purpose for which they have a right to do so. SH cannot have a right to remove officers. If it was for removing director, that would’ve been a proper SH purpose for which they have aright to do so, but special meeting cannot be called for removing officers – that’s not a proper SH purpose b/c that’s not something that SH have a right to do. Directors are the ones that remove officers.
Notice Requirement for meetings Rule: notice must be given to every shareholder entitled to vote, for every meeting, annual or special. Content of notice: The notice must state 1-the place & 2-time of the meeting, and 3- the purpose for which the meeting is being held - Why is statement of purpose
important? Because it limits what can be done at the meeting. Cannot do anything else
Consequence of failure to give proper notice to all shareholders
If notice is not given to all shareholders, action taken at the meeting is VOID, unless those not given notice waive the notice defect either by express writing or by attendance - Waiver of notice defect
Either express (in writing and signed at anytime), or implied: attend without objection. If SH shows up to the meeting, that is waiver.
Quorum – (SH Quorum) There must be a quorum represented at the meeting. A quorum is usually a majority of outstanding shares that are entitled to vote. The article or bylaws can require a grater number of share, but cannot set it at fewer than one-third of shares entitled to vote. - Determination of a quorum focuses
on the number of shares represented, not the number of shareholders – we never care about the # of people, we just care about the # of shares. I.e., majority of shares must be represented, not the majority of shareholders presence
i.e., X Corp has 120,000 shares outstanding. X Corp has 700 shareholders. What or who constitutes quorum? 60,001, at least b/c this is the majority of shares which constitutes quorum (maybe 5 shareholders be present out of 700 but their shares totals 60,001 and that’s quorum.
for SH, unlike directors, once a quorum, always a quorum
Unlike director voting, a quorum cannot be lost or broken if shares leave the meeting. We can loose a director quorum, but not a shareholder quorum Article can set quorum
requirementCan the articles of X Corp provide that a quorum requires that 90% of the shares entitled to vote be present at the meeting? Yes. Can the articles provide that a quorum requires 32% of shares entitled to vote be present at meeting? NO - Article can never seta quorum
at fewer than one-third of the shares entitled to vote
If quorum is present, a majority of the shares present may act to bind the corporation (unless the articles or bylaws require higher vote) - In many states today, however, all
that is required is a majority of the shares actually voting
i.e., X Corp has 120,000 shares outstanding. 62,000 shares are represented at the meeting, but only 50, 000 shares vote on a particular proposal. How many shares must vote for the proposal for it to be accepted by the shareholders?Traditional view: at least 31,001 shares because we need a majority of shares present. Modern view: at least 25,001, because all we need is a majority of shares that voted.
- Shareholders are referred to as “present” vs. shares are referred to as “represented” (shareholders are present, shares are represented)
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Shareholder Cont’d
Restrictions on Transfer of Stock (Right of first refusal – common in close Corps)-hit in 96’ – 2 issues for liability: 1-action against the selling SH, 2-action against the buyer of the stock:
Action against seller SH: (look to the validity of the restriction):Rule: stock transfer restriction will be upheld provided that they are reasonable under the circumstances, which means, not an undue restraint on alienation. Right of first refusal is generally valid provided the Corp pays a reasonable price.
Action against buyer of the stock: (look for buyer’s knowledge or notice)
Rule: Even if the restriction is reasonable and thus valid, it cannot be invoked against the transferee unless either:1. it is conspicuously noted on the
certificate, OR2. transferee had actual notice of the
restriction
SH’s right to obtain SH list Any SH may inspect the following records regardless of purpose: the corporation’s articles and bylaws, board resolutions regarding classification of shares, minutes of SH’s meeting from the past three year, communications sent by the Corp to SH over the past 3 years, a list of the names and business addresses of the current directors and officers, a copy of the corp’s most recent annual report, a list of SH’s name and address
SH’s right to Inspect (& Copy) the books & Records A SH may inspect the corporation’s books and records if she makes a 1-written demand, 2-stating proper purpose. Traditionally SH had to own at least 5% of outstanding shares or own stocks for at least 6 months to have standing to inspect books and records of the corporation. However, under modern trend, any SH can have access to the books and record so long as she 1-makes a written demand and 2-states a proper business purpose for such inspection.
Proper purpose is one which is related to the status of the individual as SH (and not any other purpose)- Proper business purpose can be
hostile to the BOD i.e., to elect someone new. This is OK; SH do elect directors
- But if we want to get an officer removed, that’s not a proper business purpose b/c SH cannot remove officers. Also, social issues are not proper purpose to inspect books and records.
Standing: who can demand access assuming proper purpose exists?
Traditionally HS had to own at least 5% of outstanding shares or own stock for at least 6 months
Modern trend is that any SH can have access to book and records upon showing of proper purpose
Consequences if the Corp does not allow inspection SH can move for court order. If successful, he can generally recover cost and attorney’s fees incurred in making the motion Once proper purpose and standing exists, the SH need no personally conduct the inspection; he may send an attorney, accountant, or other agent
- if SH sues the Corp for not allowing her to inspect the books and records upon showing proper purpose, SH’s suit is a direct suit.
Pre-emptive Rights 1) Preemptive rights allows a SH to maintain his/her percentage of ownership when there is a new issuance of stock for money (i.e., cash, or check only)
2) Generally, SH do not have a preemptive right to purchase newly issued shares unless the articles of incorporation provide the right.
3) In many states, “new issuance” of stock does not include sale of treasury shares, or issuing originally authorized but not yet issued shares. (also SH do not have preemptive right in shares issued for consideration other than cash i.e., service for an employee)
Tip: always raise it when you have new issuance of stock for money, and flag it as an issue, the split of authority, some say preemptive right exists unless the article take them away, some say that they do not exist unless the articles provides for it
i.e., S owns 1,000 shares of C Corp. there are 5,000 shares outstanding. C Corp is planning to issue an additional 3,000 shares. If S has preemptive rights, then S has the right to buy 600 shares (20% of new issuance)
What if the question does not indicate whether the articles of the corporation provide for preemptive rights? Split of authority; Always raise it as an issue when you have new shares of stock for $, then give the split:- In many states, preemptive rights
exit unless the article take them away
- The modern trend is that they do not exist unless the article give them
What if Corp is issuing stock to G to acquire Blackacre from G?No preemptive rights. Why not? Because this is not an issuance for money; This is an issuance of property.
Remember, preemptive rights exist only if the issuance is new issuance and it is for money. There is no preemptive right for issuance for property.
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SH’s Inspection Rights:
Shareholder Cont’d
Distributions – 2xs in the 90’sDistribution is generally payment to SHs. (it can be distribution of dividends, payment to repurchase shares, a redemption: forced sale to the Corp at price set in article, etc).
The Rule is that declaring distributions is solely within the discretion of BOD. SH have no right to distribution until it is declared. Even if articles authorize distribution, the decision whether or not to declare distributions is generally within the board’s discretion (SH do not have a right to compel a distribution-there is no absolute right to dividend distribution even if legally available funds exist)
Suits to compel declaration of a distribution are very tough to win, and require a very strong showing of abuse of discretion o i.e., consistent profits with no
dividends while the board pays itself bonuses, or controlling SH oppressing minority (e.g., corporation repurchases majority SH’s stock but not minority SH’)
Corporation can make distribution even though it lost money last year
However, Corporation cannot make distribution if 1-it is insolvent, or 2-the distribution would render it insolvento Insolvent means unable to pay
as they come due, or assets are less than liabilities (liabilities include preferential dissolution rights)
Remember, whenever dividends are involved or any other transaction involving board’s decision, your second party of analysis is to discuss validity of the act: the duty of loyalty and duty of care Don’t forget the Possibility
that director can raise defense of good faith reliance of what the financial people tell him
- Dividends are subject to double taxation. If there is no income, corp cannot declare dividends.
Which funds may be used for any distribution: dividend, repurchase, and redemption – hit 2x in 90’s
Earned Surplus : retained earnings, which is generated by business activity can be used to pay distributions Formula:[(all earnings)-(all losses)] – (distributions previously paid)
Capital Surplus: paid-in surplus which is also generated by issuing stock = the excess over par- Capital surplus can be used for
distribution if the BOD informs the SH (here we are paying them out of $ they used to buy their stock w/)
Formula: payments in excess of par plus amounts allocated on a no-par issuance
Nimble dividend – hit in 83, 93(net profit from current year) Dividend paid out of current earnings when there is not sufficient surplus for a dividend. - There is no capital surplus yet,
but Corp has made some money and they declare that as divided
- Many states don’t allow these, rational is that the company does not have $ to give as a dividend
Stock dividends, property dividends, cash dividends can be used for distribution
Stated Capital cannot be used for
distribution. Stated capital is generated by issuing stock=the par value of the stock issued.
i.e., C Corp has issued 10,000 shares of $2 par stock for $50,000 and 4,000 shares of no par stock for $70,000. how much of this is stated capital?
Stated capital is 20K. it is the par value. The 10K shares at $2 par and any amount allocated by the board for no par stock - par stock: the amount received
for par stock
- no par stock: it is up to the board to allocate it
Capital surplus is 30k. the excess of the funds over what went into stated capital goes into capital surplus
Liability for unlawful distributionDirectors are personally liable for unlawful distribution, as well as SH who knew the distribution was unlawful when they received it. Liability is for the amount of distribution that exceeds what could have been distributed. The liability of Directors, under
traditional rule is one of strict liability. Modern Trend requires showing of at least negligence.
NEXT, regardless of whether distribution is made or not, the second party of your answer must be review of validity of the act: i.e., “Next issue is whether BOD breached its fiduciary duty to SH by making/not making/improperly making/distribution”, DOL & DOC! Don’t forget arguing the defense of
well-informed, independent good faith business judgment rule to counter breach of fiduciary duty, and, also:“A director is not liable for
distributions approved in good faith: 1-based on financial statements prepared according to reasonable accounting practices, or 2-by relying on information form officers, employees, legal counsel, accountants, etc, or a committee of the board of which the director is not a member.”
A director who is held liable for an unlawful distribution is entitled to contribution form 1-every other director who could be held liable for the distribution (i.e., whose who voted in favor of the distribution), and 2-each shareholder, for the amount she accepted knowing that the distribution was improper.
Which SH get dividends -rarely tested E.g., the BOD of C Corp. decides to declare dividends totaling $400,000
1) Common Stock Only i.e., outstanding stock is 100,000 shares of common stock and BOD declares dividends totaling $400,000:Answer: they get $4 a share Here, there is only one class of stock: common stock, and BOD is declaring $400,000 dividends: each common stock gets $4 a share
2) Common + Preferred i.e., there are 100,000 shares of common and 20, 000 shares of preferred with $2 dividend preference. (Preference means “pay first”)Answer: 20,000 preferred shares multiplied by $2 preference equals a total preference of $40,000. This paid first (each of the preferred stock is getting its $2 preference). That leaves $360,000, which goes to the common shares. Because there are 100,000 of those, each common share gets $3.60
3) Common + Participating Preferred i.e., 100,000 shares of common and 20,000 shares of $2 preferred that is participating. (Participating means “pay again”)
Answer: Participating preferred gets first and it gets paid twice: first in their preferred capacity and then again in their participating capacity. Thus, the preferred aspect, just like previous hypo, is 20,000 shares multiplied by $2 preference equals a total preference of $40,000. the preferred stock gets this first, and leaves $360,000, just like previous.
But now, the 360K gets divided by 120,000 shares because the preferred shares are participating. So common gets $3, whereas preferred participating gets $5 per share. 4) Common + Cumulative Preferred i.e., 100,000 shares of common and 20,000 shares of $2 preferred that is cumulative. No dividends have been paid in the three prior years. Cumulative means “add them up” for years in which no dividend was paidAnswer: For cumulative preferred, the Corp owes them for the three prior years PLUS this year (the year the dividend is declared). So they get four years’ worth of a $2 preference:
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4 x $2 = $8 a share x 20,000 =160,000
Then: 400K – 160K = 240 divided by 100,000 common shares and each get $2.4 a share. The preferred don’t get paid again b/c they are not participating
Redemption Generally, if provided in the articles or bylaws, a corporation can acquires some or all of a class of outstanding shares by paying stipulated redemption price, which is generally in excess of par to the shareholders, who must then surrender their certificate. (If there is a right to redemption, the corporation must redeem for a property purpose. if articles or bylaws do not provide for redemption, SH and corp may enter into a repurchase transaction by mutual consent)
- The redeemed shares are usually canceled and the stated capital (outstanding shares) reduced accordingly. (The main purpose of redemption is to retire shares with preferences for the benefit of the common shares)
- Right usually belongs to Corp. Right to Redemption must be expressed in articles/bylaws. If not expressed in the articles or bylaws, corporation cannot require redemption. However, this does not stop the corp and SH from entering into a repurchase transaction by mutual consent – consensual transaction
- Corporation must redeem for a proper purpose
- Beware of fiduciary duty breach. After talking about legal act (whether redemption was or was not valid), you must then talk about validity of the act: whether DOB’s decision in redeeming /not was a breach of fiduciary duty; DOL & DOC
- Generally right only applies to preferred shares
Repurchase of Shares (considered inherent power) Repurchase of shares is when the corporation obligates itself to buy back shares at option of SH.
- Corporation must be solvent - Directors can cause repurchase to
thwart a takeover if corporate purpose is served as opposed to personal purpose
- Directors personally liable for improper repurchase (must act in good faith)
- The source of funds for repurchase can only come from surplus
- Minority SH cannot be excluded unless valid business purpose exists. Beware of fiduciary duty breach - corporate transaction excluding minority
Note: Rule 10b-5: where directors cause the corporation to repurchase or redeem shares for the personal benefit of the directors, the corporation as purchaser of the shares is deemed defrauded and is entitled to maintain a 10b-5 action against the parties to the fraud
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4 th Fact Pattern: Director & Officer 1. Power, number and qualifications 2. Election, removal of BOD3. Directors Meeting – Quorum4. Delegation of authority 5. Directors’ right to inspect 6. Liabilities of directors:
1. Duty of care – Business judgment rule 2. Duty of loyalty
1. Interested director 2. Competing Business 3. Corporate opportunity Doct.
3. Other state law basis of Liability 1. Ultra Vires acts 2. Improper Distribution 3. Securities Liabilities4. Improper Loans
7. Which Directors are Liable?8. Officers duties and liabilities 9. Indemnification of director/officer
Directors
Management of the CorpThe right to manage the property and affairs of the corporation is vested in the BOD.
- Number of directors: one or more natural persons, however, the articles or bylaws may require as many directors as desired, without limitation.
- Election of Directors: shareholders
elect directors at the annual shareholder’s meting (unless there is contrary provisions in the article) (not all directors need to be elected every year. There can be a classified board, with 2,3, or 4 classes of directors, with one class elected each year i.e., “staggered terms”.
- Vacancies on BOD: i.e., director
dies, resigns or removed: Generally, board or shareholders may select the person who fills the vacancy on the board. However, if vacancy is caused by creation of new Board position or was due to removal l by shareholder, then only shareholders can select the successor. (also, if director was elected by a particular class of shares, that class should select the successor)
- Removal of Directors: shareholders can remove directors before their terms expires, generally with or without case, by majority of shares entitled to vote- Court may also remove director for
fraud or gross abuse of authority or discretion, especially in a close corporation
Directors’ MeetingWith respect to Board’s meeting, there are generally two ways in which the board can take a valid act: 1.unanimous written consent to act without a meeting, OR 2. a meeting satisfying quorum and voting rules. If neither is met, any “act” is void unless later ratified by a valid corporate act.
– Conference call : a meeting by conference call is valid only if the directors can hear all participating directors simultaneous
– Notice Requirement for meeting :
Notice is not required for regular meetings (usually time and place is set in the bylaws), but notice is required for special meetings. If notice for a special meeting is not given, any action at the meeting is void unless the director not given notice waive the notice defect. A director can waive a notice defect either in signed writing at any time OR by attending the meeting without objection
– Proxy voting : a director cannot give a proxy for director voting. Such proxy voting of directors is void as it is against public policy. On the other hand Shareholders can give proxy vote.
BAR TIP: Bar often ask about formalities of directors’ meetings by setting up facts where there is no meeting. That is, the facts tell you that a director has entered into an extraordinary contract with another entity on the corporation’s behalf, either on his own accord or with the approval of some of the directors, or with the approval of some of the directors, or with the approval of all of the directors, who were called individually. You must state that a director does not have the power to bind the corporation in contract unless the director’s action was valid and had actual authority to act. Here, actual authority can arise only if 1) Proper notice was given for directors’ meeting, a quorum was
present, and a majority of directors approved the action OR, 2) There was unanimous written consent of the directors 3) Or alternatively BOD ratified it
– Quorum : A majority of the board of directors constitutes a quorum meeting (unless different percentage is required by the articles or bylaws, but quorum canto be fewer than one third of the board members). if quorum is present, to pass a resolution, the resolution must be approved by the majority of directors present.
this means that to validly pass a resolution, not only there must be quorum to have a valid meeting, but also the resolution must be approved by the majority that is present at the meeting. (Majority of majority) i.e., if there are 9 directors, at least 5 directors must attend the meeting to have quorum. If 5 directors are present, at least 3 must vote for a resolution to pass – If there is no quorum , any action
taken is void, unless it is later ratified.
– If someone leaves during quorum , meaning there is less than a majority of the BOD present to constitute quorum, the quorum is broken and the BOD cannot do business i.e., any action taken after quorum is broken is void, unless it is later ratified (unlike shareholder, a director can break the quorum by withdrawing from a meeting) i.e., in the example above, if the 5 turns into 4, any action taken at the meeting is void unless it is later ratified.
– Action by unanimous written consent: Any action required to be taken by the directors at a formal meeting may be taken by unanimous consent, in writing, without a meeting
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Delegation of Authority As a general rule, the BOD can delegate substantial management function of the board to one or more committees. In some states this power is assumed while in other states it has to be provided in the articles or bylaws. In either way, however, the BOD cannot delegate all powers and responsibilities to a committee– A committee cannot:
1. Declare dividends, 2. amend bylaws, 3. recommend a fundamental
corporate change to SH4. fill a board vacancy5. set director compensation 6. however, a committee can recommend these things for board action
- Watch out, SH derivative suits are a particularly important area in which committees are used
– Director’s right of inspection Directors have an unqualified right to inspect corporate books at any reasonable time – former directors have only a qualified right upon showing of a good cause to inspect.
Indemnification of directors/ officers/ and employees Indemnification refers to the promise of the corporation to reimburse its officers and directors for expenses incurred in defending suits brought against such individuals based on conduct undertaken while acting in their representative capacity on behalf of the corporation. Such claims generally fall into one of 3 categories: 1.barred, 2.mandatory, and 3.permitted.
A corporation is prohibited from indemnifying its directors/officers whenever a judgment is issued against those directors/officers. A corporation must indemnify when the director/ officer obtain a judgment on the merits in their favor. In all other instances, indemnification is allowed if director/officer were under a reasonable belief that their actions would benefit the corporation and a majority if disinterested directors and shareholders approves the indemnification
Directors will not be reimbursed if their conduct was willful, intentional, criminal, or was a breach of DOL
A claim for indemnification will fall within one of the 3 categories:
(1) Barred If officer is held liable to the corporation or held to have received an improper personal benefit, the corporation is barred from indemnifying her. Not just accused, but a holding that
he is liable
(2) Mandatory indemnification Generally, if officer is “wholly successful” on the merits and prevails in defending the suit, (must win the suit), the corporation is required to indemnify the director or officer.
(3) Permissible indemnification If the officer/director is not wholly successful in defending the suit (i.e., settlement, or lost the case), the corporation may indemnify her only if she: 1. acted in good faith and 2. reasonably believed that her act
was in the Corp’s best interest. – Must met the duty of loyalty
Who determines eligibility for meting this permissive standard (i.e., director did not breach DOL)? 1. disinterested directors, or 2. disinterested shares, or 3. independent legal counsel
Court has power to award reimbursementNotwithstanding these indemnification previsions, the court in which the director or officer was sued can order reimbursement if it’s justified in view of all circumstances
- Such reimbursement usually is limited to expenses and attorney’s fees, and cannot include judgments against the officer/director or settlements paid by her.
(Judgment or settlements paid by officer is not reimbursable)
- Limitation on indemnification in the article/ bylaws: Articles can provide for limitation or elimination of liability for damages and reimbursement. On the other hand, the articles cannot provide for limitation or elimination of liability for breach of duty of loyalty, intentional misconduct or improper personal benefit.
- Liability insurance : Corporation can purchase liability insurance to indemnify directors for actions against them (even if the directors would not have been entitled to indemnification under the above standards)
- Advances A corporation may advance expenses to a director defending an action as long as the director furnished the corporation a statement that the director believes he met the appropriate standard of conduct and that he will repay the advance if he is later found to have not met the appropriate standard
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Duty of Care & Loyalty1. Prudent Investor Rule 2. Business Judgment Rule 3. Conflict of Interest4. Interested Director 5. Interlocking Directorate 6. Corporate Opportunity Doctrine7. Director/Creditor of Corporation
The standard of review for director’s (and/or officer’s) action is fiduciary duty, broken down into two components: duty of care, and duty of loyalty. (must discuss both of them for each board or director transaction, make sure to head note each separately)
Duty of Care:
- Must put this rule in every duty of care fact pattern! (Burden is on )
2 ways Duty of Care comes up:
1- Nonfeasance (director does nothing)1. State the duty of care standard.
i.e.., an ordinarily prudent person would attend some meeting and would stay abreast of the business
2. Liable only if: her breach caused loss to the corp. it is not enough for to show
breach. Must show causation, which is very hard to show
i.e., AI Bundy, a director of C Corp, fails to attend any board of director’s meeting. Will he be held liable for breach of duty of care? Answer: a director owns the corporation a duty of care as a matter of law. she must do what a prudent person would do with respect to her own business affairs. A prudent person would attend some meetings. - Al Bundy attends no meetings,
so he has breached the duty of care. But, he is liable only if his breach caused a loss to the Co. – There is breach of duty of care but it is not enough to show only breach of duty; must show the breach was the cause of loss, i.e., causation
- Note: if a person is an expert in an area, and the corporation losses money in that area, then causation is met. i.e., antitrust expert missing meetings where they deliberated about an important antitrust matter
- Just because the Corp incurred loss does not mean that the directors will be liable – must show causation
2- Misfeasance (board does something - here causation is clear – the main issue is business judgment rule):
1. State the duty of care standard i.e., the directors’ decision caused the crop to lose money
2. Ask:a. Did BOD deliberate about the
transaction?b. Did they analyze and inquire
about the transaction?c. If BOD deliberated, inquired and analyzed the transaction, studied & did homework, there is no breach of duty of care if it meets business judgment rule. On the other hand, if BOD did not deliberate, inquire and analyzes the transaction, it is automatic breach of duty of care
3. Business Judgment Rule:Under BJR, a court will not second guess a business decision provided it was made in good faith, was reasonably informed, and has a rational basis. (=BOD must do his homework: Prudent people do appropriate preparation before making a business decision) BZ: well-informed, independent, good faith decision in the best interest of corp
i.e., the directors of Hot Tubs Inc vote to start a new line of hot tubs with build-in wine coolers and video cameras. The idea is a disaster and the company loses money. Is BoD liable for breach of duty of care?
Answer: a director owes the corporation a duty of care. she must do what a prudent person would o with respect to her own business affairs. Here, the directors’ action causes a loss to the corporation….But a director is not liable if she meets BJR…was it well informed? Deliberated? Inquired about? Etc?
TIP it is only trouble if BOD was irrational or grossly negligent
i.e., no inspection of the property they are buying, or in a merger offer, the BOD did not get valuations as to the price of the company. Both are breach of duty of care and the BOD is not protected by the business judgment rule.
Defenses 1. Business judgment rule (is a
defense to liability for board of directors and/or officers when the cause of action is for breach of duty of care) – Make sure to examine the decision making process to determine if the decision was in fact well informed, independent, good faith decision in the best interest of the corp – directors who meet this standard will not be liable for corporate decisions that in hindsight turn out to be erroneous
2. Reasonable and good faith Reliance on expert advice or on management, or other information:In discharging her duties, a director is entitled to rely on information, opinions, reports or statements (including financial statements), if prepared or presented by corporate officers or employees whom the director reasonably believes to be reliable and competent, or legal counsel, accountant, or other persons as to matters the director reasonably believes are within such person’s professional competence, or a committee of the board for which the director is not a member, if the director reasonably believes the committee merits confidence
ERIC Pommer:Duty of care standard in corporation: based on reasonable prudent businessman standard, in light of a director’s experience, particular expertise, and familiarity of corporate affairs. The director must discharge his duty1- in good faith 2- with care an ordinary prudent
business person, and 3- in a manner reasonably believed to
be in the corporation’s best interest
- in the absence of fraud, illegality, conflict of interest, or neglect the court will not interfere with directors business judgment Don’t forget the remedies
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Officers/directors owe a fiduciary duty to the Corp as a matter of law. This fiduciary duty includes the Duty of Care, which means that a director must discharge her duties with the degree of diligence, care and skill that an ordinary prudent business person would exercise with respect to her own business affairs under the same or similar circumstances (DOC is trot: negligent standard, then consider causation issue)
- BZ: generally accepted accounting principals
Duty of Loyalty – conflict of interest *
BJR does not apply b/c these involve conflict of interest
3 places that duty of care applies:
1) Interested Director Transactions First state the rule for duty of loyalty (a director owns …) then: Any deal between the corporation and one of its directors (or a director’s close relative or another business of the director’s) will be set aside unless the interested director can show either:1. The deal was fair to the
corporation at the time it was entered, OR
2. Her interest and relevant facts1. were fully disclosed (or known)
and2. the deal was approved by
majority of disinterested directors or disinterested shares
Fairness Factors: in determining
whether the transaction is fair, court generally look to 1.adequacy of consideration, 2.corporate need to enter into the transaction, 3.financial position of the corporation, 4.available alternatives, and 5.director’s good faith belief in acting in corporation’s best interest. If it was a waste of corporate asset, it will be set aside!
The presence of the interested director(s) at the meeting at which the directors or shareholders vote to approve the conflicting interest transaction doe not affect the transaction. For quorum purposes of the meeting, quorum consists of a majority of disinterested directors or majority of disinterested shares
If the transaction is approved by majority of either board or shares, it cannot be set aside; they will be estopped from later complaining.
Any dealing or selling anything to corporation by director may trigger duty of loyalty, conflict issue.
Interlocking directors : i.e., same person is director of two contracting corporations, or is an officer, employee or an agent of one the corporations and is on the BOD of another corp, or his close relative (family) is an agent,
employee or officer of the other corporation.
Inside trading liability Hidden issue! See Q#1
Setting Director’s Compensation Despite the appearance of conflict of interest, directors can set their own compensation as directors or officers provided they are reasonable. Any excessive compensation is waste of corporate asset and is a breach of duty of loyalty.- Generally, director compensation
should be set before services are rendered. Officer compensation may be set before or after services are rendered.
Remedies for breaching duty of loyalty by interested director: possible remedies for an improper conflicting interest transaction include enjoining the transaction, setting aside the transaction, disgorging the profit, and constructive trust
i.e. BAR Q: Monica is a director of Interns, Inc. if she sells X to the corporation, it is an interested director transaction. Is Monica in trouble? Answer: start with the general rule: a director owes the corp. a duty of loyalty. She must act in good faith and in a manner she reasonably believes to be in the corporation’s best interest. In the case, Monica is an interested director b/c …[plug in the facts …. relate X to Monica / or Monica is making profit by selling X to Corp…]. as a general rule, any deal between the corporation and its director, directors close relative, or another business of director’s, will be
set aside unless the interested director, here Monica, can prove ….
2) Competing Ventures First state the rule for duty of loyalty (“ a director owns the corporation the duty of loyalty. He must act in good faith and in a manner he reasonably believes to be in the corporation’s best interest”), then: A director cannot compete directly with his corporation because he owns his corporation a fiduciary duty of loyalty. Lastly, Remedies available include imposition of construction trust on profits made by the director, and damages, if any, that harmed the corporation.i.e., Drew Carey is an officer and
director of Cool Hairstyles, Inc., a hair styling salon. He may also serve on the board of directors of Sierra Club, because it does not compete with Cool Hairstyles, Inc. but, can Drew start his own hair styling salon? That is conflict of interest. If he goes into competition, he has breached the duty of loyalty. If he made a profit, a constructive trust is created giving the Cool Hairstyle Inc the profit that Drew made, and if he injured the Corp, i.e., less customers go there or its reputation is damages etc, the corp can collect damages.
BAR TIPUsurpation of a corporate opportunity is a very common corporation’s exam issue (usurping corporate opportunity) Whenever the facts of a question mention that a director learns of a business opportunity, be sure to discuss whether te corporation would be interested. If so, she must present the opportunity to her corporation, disclosing all material facts, and can take advantage of the opportunity personally only if the corporation decides not to pursue it. if the corporation is not given a chance to take advantage of the opportunity, the director can be forced to turn over the opportunity and/or any profit derived from the opportunity to the corporation.
- Bar exam favorite combo:
Director 1-usurping corporate opportunity AND 2-interested director transaction (by selling it back to the corp)
3) Corporate Opportunity First state the general rule for duty of loyalty, (“a director owes the corporation a duty of loyalty. She must act in good faith and in a manner she reasonably believes to be in the corporation’s best interest) then: A director cannot usurp a corporate opportunity. That means a director cannot take advantage of business opportunities in which the corporation may have interest, expectancy or which relates to corporation’s line of business until she 1-disclose the opportunity to the board, and 2-waits for the board to reject it.
First, does X qualify as a corp opportunity? Courts use various tests to define corporate opportunity. Under majority view, X qualifies (/not) as corp opportunity because it is a kind of business that the corporation has an interest or expectancy and is legally related to the corp’s line of business.
– Lack of Financial Ability: The corporation’s lack of financial ability to take advantage of the opportunity is not a defense. The director should still offer the opportunity to the corporation and allow it to decide whether it can take advantage of the opportunity or not. - No duty to finance:
When the corporation is unable to finance the business opportunity, and request the director to loan and finance it, since the director has no duty lend money to the corporation, she may take the opportunity herself once corporation decided not to pursuit it.
RemedyFailure of the director to first offer the business opportunity to corporation and wait until the board rejects before she took it renders the director liable for breach of duty of loyalty. The remedy for such usurpation includes imposition of constructive trust. If the director still has it, he must sell it to the corporation at cost. If the
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A director owes the corporation a duty of loyalty. A director/officer must act in good faith and in a manner she reasonably believes to be the in the corporation’s best interest. (thereby avoids conflict of interest) The burden is on the director/officer (opposite to duty of care) to show that the transaction did not violate her duty of loyalty (i.e., it was fair)
person has sold it at a profit, the corporation gets the profit. (The purpose is to put the corporation in the place it should have been in)
Next issue: which directors are liable? see next page
Other basis for Director’s Liability
Ultra Vires acts – Supra Improper Distributions – Infra
Securities Liabilities – Infra
Improper Loans
I.e., Curly, Moe and Larry are directors of C Corp. the board of directors votes to lend Curly $100,000 of corporate funds. Are Moe and Larry liable?
Rule: Traditionally, loans needed shareholder approval. However, the modern trend holds that such loans are valid so long as directors acted in good faith and reasonably believed that it would benefit the corporation (corporation’s best interest)
Sarbanes-Oxley Act prohibits most loans to executives in registered and publicly traded corporation (never on bar)
Which Directors Are Liable? tested*As a general rule, a director is presumed to have concurred with board action unless her dissent or abstention is noted in writing in corporate records. Oral dissent is never enough to
exculpate a director of board’s improper action. to be valid, dissent or abstention must be noted in records, which means:1. entering dissent in the minutes of
the meeting (i.e., directors says, please note my dissent in record)
2. getting dissent in writing to the corporate secretary at the meeting (i.e., director writing a letter of dissent to secretary)
3. sending registered letter of dissent to the corporation immediately after the meeting
A director cannot dissent if she had
voted for the resolution at meeting. Exceptions to the general rule1- Absent directors are not liable.
Some states, however require that the absent director registers her written dissent within reasonable time after learning of the board’s action, (ensuring that the dissent is filed with the minutes for the meeting)
2- Good Faith Reliance on info, opinion or reports prepared by auditors, competent and reliable employee and professionals, or committeei.e., a. Officers or employees of the
corp whom the director or officers believe is competent and reliable
b. Lawyers or public accountant whom the director or officer believes are acting within their competent, or
c. A committee of which the person relying is not a member, as to matters within its designated authority
Note: this exception (GF reliance) might be especially likely in cases involving an improper distribution
Officers Officers owe the corporation the same DOL & DOC as directors. (Same standard & argument) Additionally, Officers are agents of corporation and thus they can bind the corporation if they have agency authority to do so. Authority to bind the principal (Corp) might be actual, apparent, or inherent, by ratification, or by estoppel.
This is Agency C/O, watch out for both agent’s tort & contract liability
Actual authority – can be actual express authority given in the articles, bylaws, or by Board resolution, or may be actual implied as incident to express authority, custom practice, etc Apparent authority When the Corp “holds out” an officer as having authority and a third parties reasonably believes and relies on such manifestation, the officer has apparent authority to act and bind the Corp even though there is no actual authority.
Inherent authority – authority by virtue of their office:i.e., President of Corp has inherent
authority to enter into Ks binding the Corp in the ordinary course of corporate affairs. Vice president has inherent authority to act when president is unavailable b/c he is dead, ill or other incapacities.
Authority by ratification - see agency supra Authority by estoppel – see agency supra
Which officers required? Generally, must have president, secretary and treasurer. One person can hold more than one office simultaneous, except traditionally, one person could not be president and secretariat the same time.
Selection and RemovalGenerally, Board of directors selects and removes the officers (SH do no hire & fire Officers unless article allow. if SH elect them, only SH can fire them. Even then, for cause, directors can suspect an officer’s authority to act)
Liability for firing officer *: officers can be removed with or without cause. However, if officer is removed without cause, the corporation may be liable for damages for breach of the contract. (If officer resigns, the officer may be liable for breach of K. Either way there is no specific performance). BOD fire & hire officers. SH CANNOT fire & hire officers.
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5 th Fact Pattern: Security Exchange Violations – HOT REDIs it Securities?1- C/L law liability
1. Sale of Controlling SH’s interest2. C/L Fraud3. Insider Trading –minority, majority
– Special fact doctrine 4. Duty to Corporation
2-Federal liability1. 10b5 – Fraud 2. 16b – Short Swing Profits3. 14a – Proxy Rules: see SH
Securities Security is an investment in a common enterprise where profit is generally made by effort of another
Debt Securities When the corporation borrows from an investor, the corporation agrees to repay the loan, usually by a given date with specific interest. The debt holder is a creditor of the corporation Secured – if the corporation has
pledged collateral to secure repayment, it is usually called a mortgage bond
Unsecured – if the corp. has not pledged collateral to secure repayment, is it usually called debenture – (it is an IOU; there is no pledge to repay it, not secured by anything)
- Debt instrument can make debt security convertible into stock at the option of the holder. Can also be made redeemable at option of corporation at price in debt instrument
Equity Securities An ownership interest in the corporation – the equity holder is an owner of the corporation (=SH) Shareholder status carries various rights, i.e., to inspect books and records (upon showing of proper purpose), bring derivative suits. - Articles can make equity security convertible, i.e., to another class of stock, at option of holder or redeemable at option of corporation - Redemption is a forced sale
- Conversion gives the security holder the right to covert i.e., from preferred to common
- A put option is an option to sell securities at a set price
- A call option is an option to purchase securities at a set price
1- C/L Liability
1. Sale of Controlling SH’s Interest Controlling shareholder is one with a majority of the shares or one who has a minority of shares but in a situation giving her working control over the Corporation Controlling SH can be SH(s) or
could be parent Corp. Because of this control, the SH can often sell her shares at a control premium.
Rule: (on BAR in 95, 96, and 98): Traditionally, courts did not impose a duty on a controlling shareholder who wanted to sell her interest at premium. However, increasingly, courts hold that controlling SH owes a fiduciary duty to the minority SH and the corporation and thus the dominant SH cannot use her position for individual advantage at the expense of minority SH. Generally, controlling SH may sale her share at the premium with no liability except: 1) Sale to Looters Controlling SH is liable if she sells her share to looters without making a reasonable investigation.- Controlling SH selling her share to
looters is liable for ALL damages to the corporation, including amount looted and other harms, e.g., damage to earnings
- Watch for facts that puts a reasonable person on notice that buyer could be a looter!i.e., a controlling SH about to sell,
but he hears the buyer is a looter. If SH sells, he is liable b/c he made no further investigation.
2) Sale of corporate assets Controlling SH sells to someone that is not interested in the corporation, but rather interested in the asset of the corporation only (i.e. machinery, technology, formula, secrets, etc)- Buyer pays premium to get his
hands on an asset of the Corp.- All shareholders share in this
premium AND seller has to disgorge his profit
Note: This situation usually comes up with looting case. The buyer takes the machines and other assets
and lets the Corp run into the ground
3) Sale of a board position Rule: Fiduciary cannot get paid to relinquish office. Watch for controlling shareholder
selling her control stock and then resigning from BOD w/ her pals.
4) Controlling SHs cannot subject minority SHs to detriment (Application not limited to sale of security – Especially a problem in close corporation since minority SH cannot sell his SH to public: there is no market for her stock)
Rule: Entire Fairness Test Controlling SH (could be parent Cop.) must satisfy the “entire fairness test” (fair price and fair dealing) in its dealing with minority SHs. To meet this standard, the action must have a legitimate corporate purpose; it cannot be simply to oppress SH. Fair price is not enough. The overall dealing w/ them must be fair. There must be a fair course of dealing. i.e., controlling SHs have
corporation A produce widgets and sell them for no profit to corporation B (which they own). The minority SH of corporation A is being oppressed – he owns stock in a company that is not being allowed to make any money, and which is providing cheap widgets for a company in which he is not a SH. This is a
breach of fiduciary duty to the minority shareholders.
Make sure to point out the traditional view which held the controlling SH is generally free to sell her shares at a premium, vs increasingly crts imposed duty in close corp situations.
2. C/L Fraud Director, officer or controlling SH may be liable in tort for common law fraud for misrepresentations (lies or half truth), made to a trading partner (his seller or buyer). - If the insider knowingly lies or tells
a half truth, he will be liable under ordinary deceit principals
- It allows suit by the defrauded buyer or seller (the trading partner)
3. Insider Trading ( Duty to SH : 3 views: minority , vs majority & Non-disclosure of “ Special Facts ”
At common law, the corporate insiders, directors and officers owned no special duty to investors to disclose inside information and could deal with them at arm’s length. Modern state courts have developed a sate cause of action for insider purchase and sales without disclosure. Thus under, modern approach, the corporate insider had a fiduciary duty to disclose special facts to the outsider before trading. Additionally, second majority applies:– Special Facts Doctrine Majority of court adopted special facts doctrine, which held that if privity exists between buyer and seller (i.e., existing SH & face to face transaction), an insider with knowledge of special facts has an affirmative duty to disclose such facts to his seller when the insider is buying company stock. Modern trend extends it to insiders buying or selling company stock. - First, is it a special fact ? Special
facts are those facts that a reasonable investor would consider important in making an investment decision
- Who can sue ? It is intended to protect existing SHs from directors and officers that have knowledge of special facts. Thus SH with whom the insider dealt can sue. Some courts allow prospective SH to sue.
- Measure of damages: difference between price paid and value of stock a reasonable time after public disclosure
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- Must be direct dealing, face to face or through common intermediary
4. Duty to Corporation Officer & director are fiduciaries of the Corp as a matter of law and they cannot use material non-public info regarding Corp’s business to make a profit or avoid a loss. - Watch out, it can be derivative suit
2- Federal Liability
1. Rule 10b-5
1- Jurisdiction : “Instrumentality of interstate commerce”:
At some point, the transaction must involve instrumentality of interstate commerce – Telephone, mail, if the purchaser or
sale is on national exchange, or even if payment is by check that goes through national banking channels
– If no ISC is present, then it is a common law special fact case i.e., face to face transaction
2- Omission / Misstatement The must show that the engaged in some fraudulent conduct. This can be shown by either making a material misstatement or making an omission of material fact. “ In this case, the question is whether “X ” is a material fact for omission/or misstatement of which would give rise to fraudulent conduct. next head-note:
3- Materiality A statement or omission will be considered material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision. Here, …
4- Scienter To be actionable under rule 10b-5, the conduct complained of must have been undertaken with an intent to deceive, manipulate, or defraud. Additionally, Recklessness as to truth is sufficient under the majority view, but mere negligent is not. Here, because subjectively entertained serious doubt as to (truth or falsity / disclosure or nondisclosure) of the statement, he acted with the requisite state of mind for
recklessness, which satisfies scienter element under majority view.- Some one overhears it buy accident
and trades on it, that’s negligent and not scienter, thus no liability for eavesdropper
5- Standing – in connection with the purchase or sale by - Causation
For the private to have standing, there must be a causal connection between ’s fraudulent conduct and ’s damages. In other word, ’s fraudulent conduct must be in connection with ’s purchase or sale of security.
There must be a buy or sell by . If did not buy or sell (e.g., refrained from buying or selling b/c of ’s fraudulent conduct) he/she does not have standing. i.e., BAR Q: Polly, Potential
purchaser, has no standing (she neither bought nor sold stock)
Note : The focus is on a sale or purchase by the plaintiff. does not need to buy or sell. A non-trading that intentionally publishes a misleading press releases, is liable to a person who purchased or sold securities on the basis of the press release. may also be a private or Corp insider making false statement when selling or buying or a Corp
BAR TIP : Possible s: - “Any person” (human or entity)- Company that issues a misleading
press release – i.e., about its own stock or another Corp’s stock
- Any buyer or seller of securities, private individual or Corp, who misrepresents material info
- Any buyer or seller of securities who fails to disclose inside info (when there is a duty to disclose or abstain – comes from relationship of trust and confidence w/ SH of corp)
BAR TIP : Possible bad acts of - Misrepresentation of material
info, including company’s issuance
of stock, or misleading press release
- Omission or Failure to disclose material inside information – this is insider trading – whenever the basis of ’s fraudulent conduct is omission of material fact, or there is non-public info, there is insider-trading issue!
6- Reliance A private must buy or sell security in reliance of ’s fraudulent statement. However, in cases based on omission (non-disclosure), reliance is generally presumed.
However, when did not buy or sell in reliance of ’s fraudulent statement, but rather based on a well-defined market (i.e., national stock exchange), reliance may be presumed based on the fraud on the market theory:
Under this theory, an investor who buys or sells stock at the price set by the market does so in reliance on the integrity of the stock, which in turn is based on publicly available information
- if it is a face to face transaction, you must show reliance, if there was a press release, then you can argue fraud on the market theory
- Reliance is said to be a separate element (as in fraud), but is presumed in cases of non-disclosure & public misrepresentation
Rebuttal of Presumption The presumption of reliance may be rebutted by showing that the would have acted the same way even with full disclosure, or that the price was not affected by the misrepresentation, or that the did not trade in reliance on the integrity of the market.
7- Privity Privity not required.
8- Remedies A private must show that ’s fraudulent conduct caused ’s damages. Damages for private is limited to the difference between the price paid (or received) and the
average share price in the 90 day period after corrective information was disseminated, and out of pocket damages if any. Other remedies for private party may include injunction, rescission, and constructive trust. SEC may get an injunction, penalty of triple the profits, and criminal prosecution
Insider Trading Rule 10b-5 also prohibits most instances of trading securities on the basis of inside information. Inside information is information not disclosed to the pubic that an investor would consider it important in making an investment decision. Early insider trading cases focused on the duty of the trader to disclose or abstain from trading. Modern view holds that one can be held liable for violating rule 10b-5 if by trading he/she breaches a duty of trust and confidence owed to 1-the issuer, 2-shareholders of issuer, or 3-in the case of mis-appropriators
Insider : Anyone who breaches a duty not to use inside information for personal benefit can be held liable under 10b-5i.e., Insiders: director, officers, CEO
controlling SH, employees of issuer; Constructive insider: issuer’s CPAs, attorneys, accountant, bankers: they all owe a duty of trust & confidence to Corp and it is breached by trading on inside info (watch out for PR C/O)
- Non-of them can purchase company stock before the info is made public, unless they disclose the information to the seller.
Tippers and Tippees 1) If an insider breaches her fiduciary duty by giving a tip of inside info to someone who trades on the basis of the inside info, the tipper can be liable under 10b-5 if he made the tip for improper purposei.e., in exchange for $, kickback, gift, reputational, family member’s benefit,
2) The tipee is also liable if 1-traded on the tip and 2-knew or should have know that tipper breached a duty to her corp - Eavesdropper can buy w/o liability.
Misappropriator theory
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Rule 10b-5, promulgated by SEC, is an anti-fraud provision, which prohibits any manipulative or deceptive device in connection with the purchase or sale of any security. A violation of the rule can result in a private suit for damages, an SEC suit for injunctive relief, or criminal prosecution. In order for the private to prevail in his lawsuit against for violation of 10b-5 rule, must show the following elements:
Jeff Once Made Some Spicy Revolting Pork Rice
Under the misappropriator doctrine, the government can prosecute a person under 10b-5 for trading on market information in breach of a duty of trust and confidence owed to the source of the information. The duty need not be owed to the issuer or shareholders of the issuer. (argue split, from example 4) Watch out for PR cross over
Example 1:Jim is a director of X Co., and has just learned that he company has developed a new machine that will revolutionize the market. The company’s stock is now selling at $10 per share. Internal reports indicate that the stock will go up to $50 per share within weeks of announcement of the new machine. Sam, a shareholder, calls Jim to complain about the company, and says he wishes he’d never bough stock. Jim offers to take the stock off Sam’s hand for $20 per share. Sam sells. After the announcement, the stock goes to $50. can Sam sue Jim? Equity securities are used here Element 1? Yes, phone call was
used and this is an instrumentality of ISC
Element 2? Yes, Jim failed to disclose. He has a duty to disclose or abstain. He cannot trade on this info
Element 3? Yes, this is a material fact b/c a reasonable investor would want to know stock will go up
Element 4? Yes, Jim intended to deceive, he has scienter
Element 5? Yes, Sam sold the stock, so he could bring a private COA
Element 6? Yes, b/c Sam relied on Jim’s silence, but note that reliance is presumed in non-disclosure cases
Element 7? privity not required Element 8? Damages: difference
between price paid ($20) and privet at a reasonable time after news goes public ($50), so $30 per share
Inside trader – Yes, Jim is an insider with inside information. He qualifies as a
If question asked about common law liability, special fact liability would apply
Example 2:Ronco issues a press release that Buffett has expressed an interest in acquiring a major block of its stock. The release fails to indicate that it is Jimmy Buffett and not Warren Buffett. Because of the press release, Conviser does not sell Ronco Stock. Does Conviser have a federal security cause of action? Answer: no because he did not buy or
sell; 10b-5 protects a buyer or a seller. Element 5 is lacking!
Example 3:Laura, a lawyer for X Co., learns that X Co. will merge with Y Co. she calls her son-in law Joe about this and urges him to buy X Co. Stock and Joe does so. Discuss.
Answer?Insider Trading 1- Laura is a Tipper because:
1. She passed along inside information in breach of a duty to X Co and
2. She benefited – how did she benefit? Making a gift or enhancing a reputation is enough for a benefit
2- Joe is Tippee because:1. he traded on the tip and2. knew or should have known
Laura breached a duty to her company
3- result: disgorge Joe’s profit
Then, Professional Responsibility issue Laura, as an attorney for X Co., breached her fiduciary duty, duty of loyalty & care, by disclosing Client’s confidential information this case is the class constructive insider who has a special relationship w/ the corporation
Example 4:Laura, a lawyer for X Co., learns that X Co will merge with Y Co. She buys stock of Y Co., on national exchange. Discuss.
Answer:1) Laura is a lawyer of X Co., and as
so she only owed a duty to X Co., and not to Y Co., thus, under minority view, there is no violation of rule 10b-5 (Laura is an insider of X Co., and owed no duty to Y Co.) (Traditional notion of duty: only owed to the Corp)
2) However, many courts, will hold Laura liable under the Misappropriation theory In a case brought by the Gov (criminal), the Supreme Court has adopted the “misappropriation theory” but refused to address whether it would apply in private action for violation of 10b-5 (civil)
3) PR Laura’s breach of fiduciary duty to the Co as its attorney
Example 5: is a director of C Corp. While waiting for a concert to start, she tells her husband about a new, secret processing method that C Corp has just developed. Bobit, who is sitting n the next row, overhears the conversation and buys C Corp stock on a national exchange. What result?
Answer: no violation of 10b-5 b/c has no scienter and gained no benefit. is not a tipper. For 10b-5, if there is no tipper, cannot have tippee, thus Bobit is Ok and he can use that information
C/O issues w/ PR (atty on facts)- Duty of Confidentiality
/confidential communication - Duty of care- Duty of Loyalty - Duty of fairness/Candor- duty to uphold the law - atty-client privilege - duty not to engage in deceit,
fraud in personal dealing - duty to maintain dignity of
profession - throw in kitchen sink
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2. Rule 16-b – Short Swing Profit (strict liability: do not need slimy people)Generally, rule 16b provides for recovery by the corporation of profits gained by certain insiders (any director, officer or SH owning more than 10% of a class of stock) from buying or selling the company’s stock (not debt) within 6 months. In order for the corporation (or derivative suit brought by SH on behalf of the Corp) to prevail over for violation of rule 16-B, the following requirements must be met:
1) The Corp must be a “Reporting” Corp – jurisdiction
Rule 16-B applies only to publicly held Corps listed on national exchange (pursuant to section 34 of securities exchange act) or Corps that have at lest 500 shareholders and more than $10 million in asset
is the corporation or shareholder suing on behalf of the corporation – derivative suit
- The theory for 16b is that it is bad for the market to have certain insiders buying and selling their own company’s stock
- Watch out for depravities suite: 16b provides recovery by the Corp….., thus it can be a derivate suit
2) Rule 16-B applies only to officers, directors, or more than 10% SH, or one who has deputized to so act.
1- Timing issue
Officer and Directors To come within the purview of rule as an officer or director, the individual must be director or officer either when she bough or sold stocks
this means that transactions occurring before one becomes an officer or director are not covered by the rule, but transactions occurring within six months after ceasing to be an officer or director are covered
More than 10% Shareholder To come within the purview of the rule as owner of more than 10% shares, the individual must be owner of more than 10% share both when she buys and sells- For this category, we need 10%
owner when bough AND sold. - Look at the ownership immediately
before buying or selling. ownership must be over 10% right before that particular transaction. If that transaction made him owner of more than 10%, that transaction will not be considered i.e., S owns no stock and then buys
12%. Is that purchase covered? No b/c immediately before that event she was at 0%.
2- Deputized issue Any officer or person who is deputized to perform a policymaking
function for issuer is considered to be an officer and subject to 16b.This was a BAR issue: promotional or honorary title given by Corp… we don’t know whether such titles are officers or not but must make the argument that if such person “performs a policymaking function for issuer” is likely to be officer and thus subject to 16b. if great number of ppl hold that title of that job and are not deputized to have policy making function for the issuer, they are not officer thus not subject to 16b rule
3) must have bough and sold Equity securities
An equity security includes options, warrants, preferred stock, common stock, distribution of dividends etc - Equity includes pretty much
everything except pure debt
4) Short-Swing– Six months 16-b applies to buying and selling within a single six-month period
- No fraud or inside information is required
- Buy and sell or sell and buy must be within 6 months
5) Profit Realized – Calculation!All profits from short swing trading are recoverable by the corporation, which is determined by matching the highest sale against the lowest buy. In this case, ….
Example: is a director of Acme Inc., which is listed for trading on a national exchange. In November 8, 2003 bought 700 shares of Acme stock at $10 per share. In January 2006, she sold 700 shares for $6 per share. In May 2006, she bough 200 shares for $1 per share. What result?- Nov 2003 – bought 700 @10- Jan 2006 – sold 700 @6 - May 2006 – bough 200 @1
There is a $5 profit. $1000 owed to Corp. Here is the trick: Focus is on the sale. Match highest sale with lowest buy within 6 months. Here is how to calculate the profit:1- did she buy at less that $6 within 6
months before the sale in Jan 2006? NO
2- did she buy at less than $6 within 6 months after the sale in Jan 2006? Yes, in May she bought at $1
3- that’s $5 per share profit, BUT HOW DO WE GET $1000 TOTAL PROFIT?
Multiply $5 profit times 200 shares, because 200 is the largest number of shares that she bought AND sold within 6 months period
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Note: you only get hit for the common denominator of shares bought and sold within 6 months
6 th Fact Pattern: Fundamental Corporate Change
Requirements: Fundamental corporate changes are unusual occurrences in the ordinary course of business and require: 1-Board action, 2-Notice to all shareholders entitled to vote and 3-Approval by majority of shares entitled to vote.
** Dissenting Shareholder Right of Appraisal – hit in 95, feed boilerplate:When a corporation approves a fundamental change, SH who dissents from the change may have the right to force the corporation to buyer her shares at fair value. - i.e., she does not like the fundamental
change and wants to get out When will a SH have a dissenting shareholder right of appraisal?Actions by corporation to triggers the right:1. combine with another Corp
(merger), OR,2. transfer of all or substantially all
assets (not in the ordinary course of business) or of shares in a share exchange - no dissenting SH right of
appraisal for amending the articles even though it is a fundamental corp change and requires SH’s approval
Actions by Shareholder to perfect the right:1. before SH votes, she must file a
written notice of objection and intent to demand payment;
2. Abstain or vote against the proposes change AND
3. After the vote, make a written demand to be bough out
ValueThe Corp must pay the dissenters the fair value of the shares, plus accrued interest. If the SH is dissatisfied with the Corp’s determination of fair value, the SH has 30 days in which to send the corp her own estimate of value and demand payment of that amount. Lastly, if the SH and the corporation cannot agree on the fair value, the
corporation must file an action with court requesting appointment of appraiser to determine the fair value of the shares.
However, some states do not provide for a right of appraisal if the stock is listed on a national exchange or has a large number of SH (i.e., 2000 or more) - If listed on national exchange, there is
a public market for shares, and the disgruntled shareholder can simply sell her shares at open market
Different types of change:
Amendment of the ArticlesAmendment of the articles is a fundamental corporate change and requires 1-Board of director approval, 2-notice to the shareholders, and 3-shareholder approval (: majority of shares entitled to vote, not majority of shares present)i.e., if there are 4,000 outstanding
shares entitled to vote, how many must vote for the amendment?
Answer: At least 2,001 b/c we need a majority of those 4,000 shares.- Common fact issue: what if only
2,400 shares vote on the amendment? We still need 2,001 since we need a majority of shares entitled to vote, not majority of shares present
File amended articles with Secretary of StateOnce the change are approved, the amended articles must be filed it with the state
Additionally, there is NO dissenting shareholders right of appraisal for amending the articles. However in many states, if an amendment affects a class, that class must also approve the change. So such an amendment must be approved by a majority of shares in the affected class as well as by a majority of all shares entitled to vote.
Mergers (A Corp & B Inc from A Corp), OR Consolidations (A Corp & B Inc from C Corp) A merger involves the blending of one or more corporations into another with the merging corporation cease to exit following the merger. (A consolidation involves the blending of one or more corporations into another forming a new corporation). Merger and consolidation are fundamental corporate change and require that: 1-board of directors of both companies must approve the act, 2-notice to shareholders, 3-shareholder approval (usually of both companies)i.e., A Corp has 6,000 outstanding
shares entitled to vote. How many shares must vote for the proposal merger of A Corp with B, Inc? At least 3,001
“Short Form” merger of Subsidiary A parent Corp owning at least 90% shares of a subsidiary Corp may merge the subsidiary into itself without the approval of the shareholders of the parent or the subsidiary corporation; however, the parent corporation is subject to a duty of entire fairness. (See infra)
Must file article of merger or consolidation with secretary of state if the deals goes through
Dissenting Shareholder right of appraisal Shareholders of both companies in a regular merger and in a consolidation; as well as shareholders of subsidiary in short form merger have dissenting shareholder right of appraisal even if they had no right to vote.
- This means that in mergers and consolidation, shareholders of each company have the right to be bough out even if they had no right to vote. Also in short form merger, the SH of the subsidiary have this SH right of
appraisal (=to be bought) even if they had no right to vote
Effect of merger or consolidation on LiabilitiesThe surviving company succeeds to all rights and liabilities of the constituent companies
Sale, Lease, Transfer (one company acquires all or substantially all of asset or property of another) OR Share Exchange (one Corp acquires all of the stock of another) A sale (not just mortgage), lease, share exchange, or other disposition of all or substantially all of a Corp’s property outside the usual and regular course of business is a fundamental corporate change for the selling corporation only, not for the buying corporation. These are not fundamental change
for acquiring (: buying, purchaser) company b/c it is merely expanding)
i.e., 1-S Corp wants to sell all of its assets to B Inc, OR 2-B Inc want to acquire all the shares of S Corp. Each Corp has 12,000 outstanding shares entitled to vote. What result?There has to be:- director approval of both
companies, and - notice to selling company’s
shareholders, and - approval by selling corporation’s
shareholders - number of shares of S Corp that
must approve the sale is at least 6,001. it is a fundamental Corp change for them and thus we need their approval
- number of shares of B, Inc that must approve the sale is non because they don’t vote since it is not a fundamental corporate change for the buying Corp.
Dissenting SH’s right of appraisal exists only for SHs of the selling corporation
Filing requirement In share exchange, the buying corporation must file articles of share exchange with the secretary of state, while in transfer of assets, usually no filing is required.
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Effect on Liabilities The general rule is that the buying Corp does not become liable for the seller’s liabilities unless 1-the agreement provides otherwise, or 2-the company buying assets is a “mere continuation” of the selling company (i.e., it’s the same Co as the seller). Also, if the disposition of the property is really a disguised (hidden) merger, a court might treat it as a merger under the facto merger doctrine and hold the buyer liable for the seller’s obligations just as if a merger had occurred.
Dissolution: 2 kinds:
Voluntary dissolution A corporation may be dissolved by a corporate act approved under the fundamental change procedure. Requirements for voluntary dissolution are: 1. Board resolution, 2. Notice to shareholders, and 3. Shareholder approval (either by
majority of the shares entitled to vote or unanimous written shareholder agreement
4. Filing articles of dissolution and giving notice to creditors
Effect of dissolution A corporation that has been dissolved continuous its corporate existence for winding up and liquidating its affairs, but is not allowed to carry on any new business.
Claim against dissolving CorpA claim can be asserted against a dissolved corporation, even if the claim does not arise until after dissolution, to the extent of the corporation’s undistributed assets. If the assets have been distributed to the shareholders, a claim can be asserted against each shareholder for his pro rata share of claim, to the extent of the assets distributed to him.
However, a corporation can cut short the time for brining known claims by notifying claimants in writing of the dissolution and giving them a deadline of not less than 120 days in which to file their claim. The time for filing unknown claims can be limited to five years by publishing notice of the dissolution in a newspaper in the county where the corporation’s known place of business in located. - Revocation of voluntary
dissolution: the corporation may revoke a voluntary dissolution by using the same procedure that was
used to approve the dissolution (the 4 step set supra)
Involuntary dissolution (Court order)
1) Shareholders can petition court for judicial dissolution on the ground of:1) director abuse, waste,
misconduct, illegal or oppressive act - directors conduct gives a
bunch of COA’s, including dissolution.
2) Shareholder failure to fill a vacant board position
3) Director deadlock causing irreparable harm to the company
Note: when directors are doing bad things, in addition to all of other remedies and COAs, this involuntary dissolution is also available.
Buy-out - additionally, instead of dissolution, the court may order buy-out of complaining shareholder (specially in close corporation)
2) Creditor can petition the court for judicial dissolution if the corporation is insolvent and either the creditor has an unsatisfied judgment or the corporation admits its debt in writing (unpaid creditor revenging of an insolvent corp is to dissolve it)
3) Attorney General – the attorney
general may seek judicial dissolution on the ground that the corp fraudulently obtained its articles of incorporation or that the corporation is exceeding or abusing its authority i.e., ultra vire act
Administrative Dissolution –the state may bring an action to administratively dissolve a corporation for reasons such as the
failure to pay fees or penalties, failure to file an annual report, and failure to maintain a registered agent in the state. The state must sever the corp with written notice of the failure. If the corp does not correct the ground for dissolution within 60 days, the state can effectuate the dissolution by singing a certificate of dissolution.
Winding UP processAfter filing articles for voluntary dissolution, or after court order of dissolution, corporation stays in existence to wind up its business affairs. Winding up process includes: 1) gathering all assets 2) converting them to cash 3) paying creditors and4) distributing remainder to
shareholders, pro-rata by shares unless there is a dissolution preference - Dissolution preference works
