Corporations

I. Closely Held Corporation

A. Corporation not traded on public exchange with limited number of SHs owning over 50% of the outstanding stock

1. a corp. is a separate legal entity whose identity is distinct from its owners; it can enter into Ks, borrow money, own property, sue and defend, and conduct itself as a real person

2. planning, planning, planning

a. Default rules require planning

II. Corporate Characteristics – What to Look For Per Regan

A. (1) continuity of life

1. Default rule is that every corp. has perpetual duration

B. (2) centralized management – SH elect a BOD – board centric

1. MBCA § 8.01(b) – all corporate powers and business affairs are exercised and managed under the direction of its BOD.

a. In DE, statute is 141

C. (3) limited liability

1. MBCA § 6.22(b) – default rule is that a SH of a corp. is not personally liable for the acts or debts of the corp., except may be personally liable by reason of his own acts or conduct

D. (4) free transfer of interest

1. MBCA § 6.27(a) (indirect authorization) – absent any agreement, any SH can assign or sell his stake

a. This means I can transfer my shares or stocks, and no one can stop me

2. MBCA § 6.27(b) – If the corp. does restrict the transferability, the rest of the world must be put on notice  must be conspicuously on the front or back of the certificate

a. A SH thus always has constructive notice if restriction is on certificate

3. MBCA § 6.27(d) – if someone quits or leaves, the corp. does not have to buy your stock; rather, selling your stock is entirely on you. You can get more than what its worth and that is your profit

III. Formation A. MBCA § 1.20(a) –

a document must be filed to state

III. Formation B. MBCA § 2.01. Incorporators.

1. One or more persons may act as the incorporator(s) of a corp. and must deliver articles/certificate/charter of incorp. To the secretary of state for filing

C. MBCA § 2.02. Articles of Incorporation

1. (a) the articles of incorp. must set forth:

a. (1) a corporate name for the corp. that satisfies the requirements of MBCA § 4.01

i. “corporation” “incorporated” “company” or “limited” or the abbreviations of “corp.” “inc.” “co.” or “ltd.” etc.

ii. Test for determining name availability –distinguishable upon the records of the secretary of state test

b. (2) must put #, the # of shares the corp. is authorized to issue

c. (3) the street and mailing addresses of the corp.’s, initial registered office and the name of its initial registered agent at that office

d. (4) the name and address of each incorporator

2. (b) the articles of incorp. may set forth:

a. (1) the names and addresses of the individuals who are to serve as the initial directors

b. (2) provisions not inconsistent with law regarding:

i. the purpose(s) for which the corp. is organized

ii. managing the business and regulating the affairs of the corp.

iii. defining, limiting, and regulating the powers of the corp., its BOD, and SH

iv. a par value for authorized shares or classes of shares

v. the impositions of interest holder liability on SH

c. (3) any provision that under this Act is required or permitted to be set forth in the bylaws

d. (4) a provision eliminating or limiting the liability of a director to the corp. or its SH for money damages for any action taken or any failure to take by action, as a director, except liability for …

D. § 2.03. Incorporation

1. (a) unless a delayed effective date is specified, the corporate existence begins when the articles of incorp. are filed – day and min.

2. (b) the secretary of state’s filing of the articles of incorp. is conclusive proof that the incorporators satisfied all conditions precedent to incorp. except in a proceeding by the state to cancel or revoke the incorp. or involuntary dissolve the corp.

E. § 2.05. Organization of Corporation.

1. (a) after an incorporation:

a. (1) if initial directors are named in the AOI, the initial directors shall hold an organizational meeting, at the call of a majority of the directors, to complete the org. of the corp. by appointing officers, adopting bylaws, and carrying on any other business brought before the meeting; or

b. (2) if initial directors are not named in the AOI, the incorporator(s) shall hold an organizational meeting at the call of a majority of the incorporators:

i. (i) to elect initial directors and complete the organization of the corp.; or

ii. (ii) to elect a BOD who shall complete the organization of the corp.

2. (b) action required or permitted by this Act to be taken by incorporators at an organizational meeting may be taken without a meeting if the action taken is evidenced by one or more written consents describing the action taken and signed by each incorporator

3. (c) an organizational meeting may be held in or out of this state

F. § 2.06. Bylaws

1. (a) the incorporators or BOD of a corp. shall adopt initial bylaws for the corp.

2. (b) the bylaws of a corp. may contain any provision that is not inconsistent with law or AOI

3. (c) the bylaws may contain one or both of the following provisions:

a. (1) a requirement that if the corp. solicits proxies or consents with respect to an election of directors, the corp. include in its proxy statement and any form of its proxy or consent, to the extent and subject to such procedures or conditions as are provided in the bylaws, one or more individuals nominated by a SH in addition to individuals nominated by the BOD; and

b. (2) a requirement that the corp. reimburse the expenses incurred by a SH in soliciting proxies or consents in connection with an election of directors, to the extent and subject to such procedures and conditions as are provided in the bylaws, provided that no bylaw so adopted shall apply to elections for which any record date precedes its adoption

4. (d) notwithstanding §10.20(b)(2), the SHs in amending, repealing, or adopting a bylaw described in sub§2.06(c) may not limit the authority of the BOD to amend or repeal any condition or procedure set forth in or to add any procedure or condition to such a bylaw to provide for a reasonable, practical, and orderly process

G. § 3.01. Purposes

1. any corp. has the purpose of engaging in any lawful business unless a more limited purpose is set forth in the incorporation documents.

a. Removes Ultra Vires issues

H. § 3.02. General Powers

1. Unless otherwise stated, every corp. has perpetual duration, and corporate name has the same powers as an individual to do things necessary or convenient to carry out business affairs:

a. Cannot just leave, need to be bought out because of perpetual duration

b. (a) to sue and be sued

c. (b) to have a corp. seal

d. (c) to make and amend bylaws, not inconsistent with its AOI or with the laws of this state

e. (h) to lend money, invest and reinvest its funds, and receive and hold real and personal property as security for repayment

f. (l) to pay pensions and establish pension plans, etc.

g. (m) to make donations for the public welfare or for charitable, scientific, or education purposes

h. (o) to make payments or donations not inconsistent with the law

§ 3.04.Lack of Power to Act. (Ultra Vires) 

(a)Except as provided in subsection (b), the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act.

(b)A corporation’s power to act may be challenged:

(1)in a proceeding by a shareholder against the corporation to enjoin the act;

(2)in a proceeding by the corporation, directly, derivatively, or through a receiver, trustee, or other legal representative, against an incumbent or former director, officer, employee, or agent of the corporation; or

(3)in a proceeding by the attorney general under section 14.30.

(c)In a shareholder’s proceeding under subsection (b)(1) to enjoin an unauthorized corporate act, the court may enjoin or set aside the act, if equitable and if all affected persons are parties to the proceeding, and may award damages for loss (other than anticipated profits) suffered by the corporation or another party because of enjoining the unauthorized act.

I. § 6.22. Liability of Shareholders

1. No personal liability for corp, or actions from corp…Same limited liability, and still liable for negligence actions as a tortfeasor

J. § 7.32. Shareholder Agreements

2. (a) All the things that can be done even though it seems like they can’t

(1)eliminates the board of directors or restricts the discretion or powers of the board of directors;

(2)governs the authorization or making of distributions, regardless of whether they are in proportion to ownership of shares, subject to the limitations in section 6.40;

(3)establishes who shall be directors or officers of the corporation, or their terms of office or manner of selection or removal;

(4)governs, in general or in regard to specific matters, the exercise or division of voting power by or between the shareholders and directors or by or among any of them, including use of weighted voting rights or director proxies;

(5)establishes the terms and conditions of any agreement for the transfer or use of property or the provision of services between the corporation and any shareholder, director, officer or employee of the corporation or among any of them;

(6)transfers to one or more shareholders or other persons all or part of the authority to exercise the corporate powers or to manage the business and affairs of the corporation, including the resolution of any issue about which there exists a deadlock among directors or shareholders;

(7)requires dissolution of the corporation at the request of one or more of the shareholders or upon the occurrence of a specified event or contingency; or

(8)otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy.

3. (b) ALL shareholders must be on board with the radical stuff that you can do under (a)

a. Like a general partnership, all y’all “in a written agreement that is signed by all persons who are shareholders at the time of the agreement”

K. § 8.01. Requirements for and Functions of BOD

1. (a) each corp. shall have a BOD

2. (b) all corporate powers shall be exercised by or under the authority of the BOD, and the business of the corporation. shall be managed by or under the direction of the BOD

L. § 8.08. Removal of Directors by Shareholders

1. SHs may always remove a director for cause

2. Can remove without cause, but this power could be limited by AOI

§ 8.40.Officers

(a)A corporation has the officers described in its bylaws or appointed by the board of directors in accordance with the bylaws.

(b)The board of directors may elect individuals to fill one or more offices of the corporation. An officer may appoint one or more officers if authorized by the bylaws or the board of directors.

(c)The bylaws or the board of directors shall assign to an officer responsibility for maintaining and authenticating the records of the corporation required to be kept under section 16.01(a).

(d)The same individual may simultaneously hold more than one office in a corporation.

M. § 8.43. Resignation and Removal of Officers

1. (a) an officer may resign at any time by delivering a written notice to the BOD, or its chair, or to the appointing officer or secretary

2. (b) an officer may be removed at any time without cause by:

a. (i) the board

b. (ii) the appointing officer, unless bylaws or board provide otherwise, or

c. (iii) any other officer if authorized by the bylaws or the board

N. § 8.44. Contract Rights of Officers

1. (a) Election or appointment of an officer does not itself create K rights

2. Neither removal nor resignation affects K rights, if any, with the corp.

IV. Ultra Vires

A. Acting beyond the scope of its authority (power) pursuant to law or its articles of incorp.

1. Cannot be invoked by an employee

2. Not a defense to K law or breach unless within the 3 limited carve outs provided by statute

3. The DEFAULT RULE of § 3.01 is “any lawful” business,” so, ultra vires might only apply if the corp. is trying to do something that is specifically prohibited by the incorp. agreement

a. If the fact pattern says, “nothing but the minimum,” then there is NOT an ultra vires issue

4. What about an innocent 3P? Damages might be awarded (reliance damages or estoppel)

B. Recognition that a corp. may list multiple purposes without any limitation on the number of purposes specified, and without any obligation that the corp. actually pursue all the purposes contained in the articles

C. Permit incorp “for the transaction of any lawful business,” or similar language that did not require specification of particular lines of kinds of business

D. Ultra Vires used to be powerful, but now, it lost weight due to public policy considerations protecting K law and the power to K

1. Where the doctrine remains today; very limited:

a. Under MBCA § 3.04(b), a corp’s power to act may be challenged

i. Action brought by SH to enjoin corporate act

ii. Action brought by corp. itself against own officer

iii. Action brought by attorney general under § 14.30

E. 711 Kings Highway Corp. v. FIM’s Marine Repair Serv., Inc. (p. 152)

under the Ultra Vires Doctrine, a P may challenge a corp.’s act on the ground that the act is beyond the scope of powers granted to the corp. under its incorporating document

F. Sullivan v. Hammer (p. 154)

– Under the BJR, directors of a corp. are presumed to have acted on an informed basis, in good faith, and with an honest belief that their actions were in the company’s best interests.

1. The presumption can only be overturned if:

a. P shows that a majority of the directors expected to derive personal financial benefit from the transaction,

b. that they lacked independence,

RE – “motive for entrenchment in office” don’t need to get a vote, but the money they keep in some way lacks independence, e.g., Duke President obtaining a donation from personal career ambitions

c. that they were grossly negligent in failing to inform themselves, or

d. that the decision of the Board was so irrational that it could not have been the reasonable exercise of the business judgment of the BOD

2. there are outside and inside directors

a. inside = get salary

b. outside = do not get salary

3. DE is a RUPA state for GP law in which no FD is codified

a. Only DE allows to flatly eliminate FD in any org except DE Corp.

4. BJR is entirely judicially created and is common law p. 157

a. DE only cares about making a rational business decision

5. If there is lack of independence by a majority of the BOD, then the BJR is eliminated and the strict scrutiny and EFS applies

A. Promoter

1. Includes a person who acting alone or in conjunction with one or more other persons, directly or indirectly, takes initiative in founding and organizing the business or enterprise of an issuer. Often referred to as found or organizer

a. The founder or organizer of a company; person who sets in motion the creation of a corp.; person acting on behalf of a corp. that is not yet formed

b. Owes significant FDs to their participants in the venture (candor, loyalty, care)

i. Duties to all other promoters and investors

ii. Owe high standard of honesty and frankness  must disclose all self-dealing acts

iii. Cannot engage in secret profit making

iv. Must command the dedication of corporate funds to corporate purposes

B. Promoter Liability Rule

generally, a promoter is personally liable on pre-incorporation Ks and even when K is formed

1. Cannot get out of promoter liability by putting in the K “guaranteed by the future corp.” because the corp. does not exist yet

2. A K made by a promoter before the corp. exists does not become a K of the corp. when it is formed

3. A corp. is not liable on promoter’s K unless the corp. expressly or impliedly adopts or ratifies it

4. When the 3P starts work before the corp. is incorporated then that moves the needle way in favor of PL

E. Burden is on the promoter to show that he is not liable or show that there was an agreement with parties

C. 4 ways in which PLR can be illuminated:

1. Parties both understand that the other party is making a revocable offer to the nonexistent corporation which will result in a K if the corp. is formed and accepts the offer prior to withdrawal;

2. Parties both may understand that the other party is making an irrevocable offer for a limited time. Consideration to support the promise to keep the offer open can be found in an express or limited promise by the promoter to organize the corp. and use his best efforts to cause it to accept the offer;

3. Parties both may agree to a present contract on which is bound, but with an agreement that his liability terminates if the corp. is formed and manifests its willingness to become a party. There can be no ratification by the newly formed corp. since it was not in existence when the agreement was made; and

4. Parties both agree to a present K on which even though the corp. becomes a party, the promoter remains liable either primarily or as a surety for the performance of the corps obligation

D. 2 ways to escape promoter liability

1. Novation – an entirely new agreement with the newly formed corp. released the promoter’s liability to the prior K

2. Adoption by the Corp. – different than ratification because ratification only occurs after the corp. already exists

a. Can be express (oral or written) or implied (accepting benefits of the K)

i. Implied can be silent, just passively accepting benefits with no repudiation

b. Then the corp. is liable. Promoter is still almost always liable unless there is a novation ahead of time

F. Stanley J. How & Assoc., Inc. v. Boss

a promoter will be personally liable on his K, even if he believed that he was acting on behalf of a projected corp., unless the other party agreed to take payment from some person or fund other than the promoter

1. Specific language here is “to be formed”

2. Even asking other party, architect, if this is okay is not sufficient

A. Defective Incorporation

corp. non-existent due to an issue with the incorp. process and then a K is breached or repudiated by the corp.

1. BUT WAIT, where does the liability sit b/c corp. was defectively incorporated and did not exist?

a. MBCA § 2.04. Liability for Pre-Inc Ks – all persons purporting to act as, or on behalf of, a corp. knowing there was no incorp. under this Act, are jointly and severally liable for all liabilities created while doing so

b. Purporting to act: knowingly or deceptively acting as a corp.

i. Knowing there is a defect will make you jointly and severally liable

B. De Jure Corp –

– where there has been conformity with the mandatory condition precedent established by statute

1. As a matter of law, there is no mistake

C. De Facto Corp

– a defectively incorporated corp. and thus is not De Jure, SCOTUS requirements: (1) Good faith + (2) bona fide attempt to incorporate

1. Applies to cases where elements show:

a. A valid law under which such a corp. can be lawfully organized;

b. An attempt to organize thereunder; and

c. Actual user of corporate franchise

d. Good faith is claiming to be an in doing business as a corp. is often added as a further condition

2. If you can persuade the court to adopt de facto, then person is shielded by equity, except from the state AG

D. Corp. by Estoppel –

– an equitable principle that prevents 3Ps who contracts or does business with a person or a business as a corp. from later denying the incorp. in a subsequent dispute arising out of the K

1. Kicks in when de facto isn’t satisfied

2. Reliance by a 3P which is foreseeable and detrimental effects resulted

3. Where the courts, lacking clear standard or guideline, are willing to decide on the equities of the case despite that one or more requisites of de factor corp. are absent

E. Robertson v. Levy

an individual who incurs statutory liability on an obligation under section 139, because he acted without authority, is not relieved of that liability where, at a later time, the corp. does come into existence by complying with section 50. Subsequent partial payment by the corp. does not remove this liability

F. DE is not a Model Act jurisdiction

1. The DGCL has no provision that filing is conclusive proof of incorp.

2. DE accepts the De Facto Corp. Doctrine

VII. Piercing the Corporate Veil

A. Just because something is legal does not mean that it is equitable. Look to whether it was (1) legal; and (2) equitable.

B. A corp. is properly formed, but equity steps in and treats the actor against whom something is being sought as non-corporate, therefore, getting rid of the liability shield provided by the corp. This does not destroy the corp.; rather, the veil is pierced only for the purposes of seeking personal liability

1. All 50 states have a corporate law statute and 0 of them have altered it to eliminate the doctrine of piercing the corp. veil

2. The person must have been honest and innocent in their mistake

3. Balance of equities – ESSAY QUESTION

a. Ideal P is an innocent tort victim, not a sophisticated lender or knowing risk taker

b. Fraud is the easiest route, but not required to prove! Less than fraud but more than using a corporate structure for a liability shield

c. Cooperative Corporation – an entity that has a corporate existence, but it is primarily for the purpose of providing services and profits to its members and not for corporate profit

C. Woodruff Factors (non-exhaustive list):

1. corporation is grossly undercapitalized

a. RE – look to adequacy of the capital at the time of formation

b. Exceptions permitting examination of capitalization after formation might include a change in nature of the business, an inadequately capitalized expansion, capital transfers to the controlling shareholder which renders the initial adequacy irrelevant, or losses resulting from fraudulent manipulation of the corp.

2. it lacks separate books

a. Co-mingling – same account used for personal and business finances

3. its finances are not kept separate from individual finances, or individual obligations are paid by the corp.

4. the corp. is used to promote fraud or illegality

a. RED FLAG

5. corporate formalities are not followed

a. No minutes are kept, no board meetings, no bylaws, no SH ledger, etc.

6. the corp. is a mere sham

a. It’s a corp. in name only, no business or corporate purpose present

7. gross negligence

D. statistically speaking, piercing the corporate veil is entirely a phenomenon of closely held corporations, and predominantly one-person corporations.

1. The corporate form is simply never pierced to impose liability against SHs in a public traded corporation

2. Passive investors are shielded

E. The veil should only be pierced with good reason, such as:

1. to bring corporate actors’ behavior into conformity with a particular statutory scheme, such as social security or state unemployment compensation;

2. to avoid fraud or misrepresentation by SHs trying to obtain credit; a

3. to promote accepted bankruptcy values of eliminating favoritism among claimants to the cash flows of a firm.

F. Bartle v. Home Owners Co-Op

a P may pierce the corp. veil of a corp., and imposed liability on its SHs, to prevent fraud or to achieve equity

G. Woodruff Constr., LLC v. K.W. “Casey” Clark

egregious use of corporate funds to pay personal debts warrants piercing the corporate veil

H. Radaszewski v. Telecom Corp

a P may ordinarily pierce the corporate veil and bring a parent corp. into a case against a subsidiary where the subsidiary was operating while undercapitalized

VIII. Equitable Subordination

A. Changing the absolute priority rule in a bankruptcy case, the court uses equity powers to place a creditor below another creditor that they would normally be ahead of
C. This principle only pops up with one or more creditors – one of the creditors is an insider trying to gain an advantage inequitably and the other creditor is an innocent actor

D. The essence of this test is whether, under all the circumstances, the transaction carries the earmarks of an arm’s length bargain

B. Pepper v. Litton

RULE – a court may, for equitable purposes, disregard the corporate entity and disallow or subordinate an officer or stockholder’s claim against a corp.

1. Entire fairness – arm’s length bargain, fiduciary duties are imputed to SHs in a BK case

2. The salary claim was asleep for years and Litton only piped up because he wanted to jump the line and extract more money out of the BK estate

3. Litton used his influence to get preferred creditor treatment, not fair or arm’s length

E. Deep Rock Doctrine

– the claim of a stockholder and especially a stockholder with controlling interest who makes a loan to his own corp. will be subordinated to the claims of outside creditors if the corporation is deemed undercapitalized

F. Substantive Consolidation –

an equitable doctrine that permits a bankruptcy court, in appropriate circumstances, to disregard the legal separateness of a debtor and a related but distinct legal entity, which may or may not itself be a debtor in bankruptcy, and to merge their respective assets and liabilities for bankruptcy purposes

IX. Successor Liability

a corp. which acquires all or part of the assets of another corp. does not acquire liabilities and debts of the predecessor unless:

1. There is an express or implied agreement to assume liabilities;

2. The transaction amounts to a consolidation or merger;

3. The successor entity is a mere continuation or reincarnation of the processor entity; or

4. The transaction was fraudulent, made in bad faith, or made without sufficient consideration

C. Minority of jurisdictions employ employ the continuity of enterprise exception which would have held Nissen liable under these facts

D. Nissen Corp. v. Miller

a successor corp. does not acquire its predecessor’s liabilities and debts, unless there is an [express or implied] agreement to assume liabilities, the transaction is merely a consolidation or merger, the successor is merely a continuation or reincarnation of the predecessor, or the transaction was fraudulent, made in bad faith, or made without sufficient consideration

A. 3 ways to obtain capital:

1. Borrowing funds

2. Selling shares in company

3. Retaining earnings of the business

B. Debt

1. Must be repaid at some point

2. Interest on the principal borrowed must be paid periodically

3. Repayment of principal and interest is not contingent on the success of business

4. Debt claims are fixed claims; entitled to be repaid principal and interest owed to them on loans they have made

C. Equity

1. Value of owner’s equity in a piece of property = (MV of Prop) – (MV of Debts that are liens against that prop)

2. Composed of contributions by the original entrepreneurs of the firm, capital contributed by subsequent investors usually in exchange for ownership interests, and retained earnings of enterprise

3. Equity claims are residual claims; residual claimants (equity owners) have a claim only everything that is left over after fixed claimants have been paid

D. Assets and Liabilities

1. Assets – liabilities = net worth

1. Shares Generally

a. § 1.40(6) – shares are the units into which the proprietary interests in a domestic or foreign corporation are divided

i. Classes of shares – designations or rights are set forth in AOI

b. § 6.01(a) – the AOI must set forth any classes of shares and series of shares within a class, and the # of shares of each class and series, that the corp. is authorized to issue

c. § 6.01(b) – 2 fundamental rights of holders of common shares

i. (1) entitled to vote for the election of directors and on the other matters coming before the SHs; and

ii. (2) entitled to the net assets (after debts are paid) of the corp. upon dissolution

iii. At least one class of authorized shares must have unlimited voting rights, and at least one class, which may be the same class as the class with unlimited voting rights, must have a right to share in the company’s assets upon dissolution

a. Secured creditors get paid first, then common SHs get paid last once everyone has been paid and if anything is left

d. § 6.01(c)(3) – when a board calls dividends, the profits go to the SHs … preferred stocks do not exit unless AOI say, but if AOI have minimum, then it does not exist

e. § 6.03 – Issued and Outstanding Shares.

i. A corp. may issue as many shares as of many classes and series of stock as are authorized in the AOI

2. Common Shares –

a class of shares that have the fundamental rights of voting for directors and recovering net assets of the corp.

a. Pros and Cons:

i. 1 vote per share

ii. No guaranteed dividend

iii. Unlimited upside in stock price

b. Holders have non-financial rights as well:

i. A right to look at the books and records

ii. A right to sue on behalf of the corp.

iii. A right to financial info

c. SCOTUS characteristics associated with common stock:

i. Right to receive dividends contingent upon an apportionment of profits;

ii. Negotiability;

iii. Ability to be pledged or hypothecated;

iv. Conferring of voting rights in proportion of the # of shares owned; and

v. Capacity to increase in value

3. Preferred Shares –

a class of shares with rights that are preferential to those assigned to the common share but limited in some way

a. Usually (but not always) non-voting

i. only gets to vote if dividend is not paid

ii. dividend is set and must be paid unless the company cannot pay it

iii. stock price stays stable because of the limited on the dividend

b. entitle holders to a priority or preference in payment as against the holders of common shares

c. precise scope of rights of a preferred SH is traditionally established by detailed provision in the AOI

i. provision called preferred SH’s K

1. Share Subscriptions and Agreements to Purchase Securities

a. May be used to a limited extent in connection with the capitalization of a closely held business with a small # of investors

i. Modern practice is to use simple K agreement to purchase securities rather than a formal subscription agreement

b. May be revocable by their own terms, after a fixed period, or with the consent of the corp. or other subscribers

2. Authorization and Issuance of Common Shares Under the MBCA

a. Any # of shares may be issued at any price so long as the combination totals $10k

b. The # of shares authorized in the corp.’s AOI must be at least equal to the # of shares that the corp. plans to issue

a. Par Value

is an arbitrary dollar value assigned to shares of stock which, after being assigned, represents the minimum amount for which each share may be sold (we no longer have this, we have 6.21 now)

i. Remedy at law

ii. i.e., a message to the world that no one else is going to pay less than that

iii. Goal – people from great distances could commit financially with the assurance that no one is going to dilute them later by coming in on the cheap

iv. Only relevant when the company is issuing stock

v. A purchaser of par value stock may sell the stock at any price they deem fit

vi. No maximum or minimum value must be assigned

b. Two concerns:

i. Internal existing SHs who buy in early want to be protected

ii. Creditor financing is important, creditors won’t lend if assets are not protected, i.e., if they could disappear

a. Lenders look at cash flow and earnings

c. All 3 types of shares are lumped into “water stock”

i. Bonus Shares – when par value shares are issued, and nothing is paid for them at a later date

ii. Watered Shares – shares issued for property worth less than their par value

iii. Discount Shares – shares issued for cash, but less than par value

d. § 6.21. Issuance of Shares

i. Shares must be validly issued, fully paid, and nonassessable

ii. (a) SHs and (b) board

iii. (c) SHs are protected by BOD FDs .. the BOD has the final decision, as long as its informed, the judgment is conclusive

iv. Comment 2 –

e. § 6.40. Distribution to Shareholders

i. SHs have no right to receive distributions unless the BOD has authorized a dividend

f. Hanewald v. Bryan’s, Inc.

corporate SHs must pay for their shares of stock as a prerequisite for their limited personal liability

XI. Debt Financing

A. Must look like actual financing with real loan behavior, otherwise, the debt will be reclassified as equity and not given debt treatment

1. Income tax implications: debt is given a break, income is not. If you try and reclassify equity as debt, then you’re essentially cheating the system

2. Associated with C corps, where income is zeroed out

B. Must pay taxes on interest gained from shares

C. Leverage – debt owed to 3Ps creates leverage; leverage is using debt to grow a business and build a corporate profile

D. Tax advantages to debt – interest paid on loans is a deductible business expense which lowers the corporate tax

E. Forms of debt securities

1. Debenture – an unsecured corporate obligation

2. Bond – secured by a lien or mortgage on corporate property; collateral in the event of default

a. Interest on bonds need to be paid no matter what

b. Junk Bonds – below investment-grade debt instruments; dangerous and promote failure

F. Sources of debt financing

1. The bank (loan arrangement)

2. Bond market

a. Bonds do not trade up and down in value like stock

b. Instead of borrowing from 1 or 2 sources, offer multiple pieces to the people

c. Issued in a single transaction (a bond transaction)

d. Tradable

A. Public Offerings –

IPOs are raising substantial amounts of capital by making a public offering of securities through the services of an underwriter

1. Security = stock and bond

2. IPOs reduce the need to rely on bank debt, but most closely held corps. Can be fine using retained earnings or smaller loans

3. IPO earnings are typically used to pay down pre-existing debt

4. SHs gain liquidity by selling securities during the IPOs

5. DISCLOSURE – if you do not disclose something important, i.e., material, in an IPO, it could be a federal securities law violation

a. Without being asked, must disclose all material information before going public

B. Securities Act of 1933 § 77a

a. § 3: Classes of Securities Under This Title

i. (a)(11) exemption intrastate

ii. (b) small issues exemptive authority, cannot exceed $5M

b. § 4: Exempted Transactions

i. (a)(2) not on wall street, but offering to people not in the public; rather, just offering it to mall private groups

c. § 5: Prohibitions Relating to Interstate Commerce and the Mails Heart of 1933

i. (a)

a. (1)

b. (2)

ii. If get cleared by SEC, this does not protect you from any liability by arguing that this information is true and accurate

d. § 11: Civil Liabilities on Account of False Registration Statement

i. Satisfies FQJ

ii. (a) who is liable

iii. (b) can get off the hook if meet this BOP; only corp. would be liable under strict scrutiny

a. Due diligence defense

b. Exempt under §§ 3, 11

C. Securities Exchange Act of 1934 § 78l

1. Made to update ongoing information for trading purposes

2. Protects purchasers and sellers if they are defrauded

3. § 10: Manipulative and Deceptive Devices (creates a cause of action)

a. (b) mens rea act of intentional fraud, negligent is not deceptive or manipulative

i. Also applies to local businesses not on the registered exchange if you can prove fraud and go through interstate commerce via text, email, calls

4. § 12: Registration Requirements for Securities

5. § 13: Periodical and Other Reports

a. (a) every issuer of a security registered

i. (1)

ii. (2) certified, annual report

A. Preemptive Rights and Dilution

1. Dilution – when someone does not pay a fair price for a share

a. Problem may arise when a property is given instead of money

2. Preemptive Rights – (a type of first refusal) an anti-dilution measure for close corps.

a. the right of existing SH to the first purchase of new issuances of stock in proportion to their share of ownership

3. § 6.30. Shareholders’ Preemptive Right

a. DEFAULT RULE – (a) the SHs of a corp. do not have a preemptive right to acquire the corp’s unissued shares (b) except to the extent that the AOI so provide

b. (b)(2) preemptive rights may be waived

4. Stokes v. Cont’l Trust Co. of the City of New York

Stockholder has the right to vote in proportion to the # of his shares, and this right cannot be curtailed by the directors, officers, or other SHs of the co.

B. Distributions by Closely Held Corporations

1. It is rare for a court to order a corp. to pay a dividend

2. Challenges to a corporation’s dividend policy is often brought as a SH oppression action

3. Factors alluding to motivating causes and, therefore, bad faith:

a. Intense hostility of the controlling fraction against the minority

b. Exclusion of the minority from employment by the corp

c. High salaries, or bonuses or corporate loans made to the officers in control

d. The fact that the majority group may be subject to high personal income taxes if substantial dividends are paid

e. The existence of a desire by the controlling directors to acquire the minority stock interests as cheaply as possible

4. Essential Test – determine whether the policy of the directors is dictated by their personal interests rather than the corporate welfare

a. Practical part of this two-part test:

i. Was there money there? cannot win a dividend case with no surplus there

ii. Is the decision not to make a dividend in bad faith?

3. Factors alluding to motivating causes and, therefore, bad faith:

a. Intense hostility of the controlling fraction against the minority

b. Exclusion of the minority from employment by the corp

c. High salaries, or bonuses or corporate loans made to the officers in control

d. The fact that the majority group may be subject to high personal income taxes if substantial dividends are paid

e. The existence of a desire by the controlling directors to acquire the minority stock interests as cheaply as possible

4. Essential Test – determine whether the policy of the directors is dictated by their personal interests rather than the corporate welfare

a. Practical part of this two-part test:

i. Was there money there? cannot win a dividend case with no surplus there

ii. Is the decision not to make a dividend in bad faith?

5. Dodge v. Ford Motor Co

– company cannot take actions that harm its SHs and are motivated solely by humanitarian concerns, not by business concerns. Can compel dividend.

6. Shareholder Primary Principle

– a business corp. is organized and carried on primarily (not exclusively) for the profits of the SHs

C. Public Benefit Corp in DE Title 8 Del. C. Chapter 1 sub. XV

– for profit but intended to help the public in some way

1. Balances the pecuniary interests of the SHs against the stated goal of helping a certain class of people

a. BJR applies in a SH lawsuit on these types of issues as long as rational, informed, and disinterested = did not breach FD

b. § 362 – Public Benefit Corporation Defined; Contents of Certificated of Incorporation

i. (a) for profit for public benefit

a. (b) defines “public benefit”

c. § 365. Duties of Directors

i. Managed by board

ii. The board does the balancing act – what were created for vs. costs and such for plans

D. Penn. BCL §1715 Handout

1. (a) General rule. --In discharging the duties of their respective positions, the BOD, committees of the board and individual directors of a business corp. may, in considering the best interests of the corp., consider to the extent they deem appropriate: (another constituency statute)

a. (1) The effects of any action upon any or all groups affected by such action, including SHs, employees, suppliers, customers and creditors of the corp., and upon communities in which offices or other establishments of the corp. are located.

b. (2) The short-term and long-term interests of the corp., including benefits that may accrue to the corp. from its long-term plans and the possibility that these interests may be best served by the continued independence of the corp.

c. (3) The resources, intent and conduct (past, stated and potential) of any person seeking to acquire control of the corp.

d. (4) All other pertinent factors.

2. (b) Consideration of interests and factors. -- The BOD, committees of the board and individual directors shall not be required, in considering the best interests of the corp. or the effects of any action, to regard any corporate interest or the interests of any particular group affected by such action as a dominant or controlling interest or factor. The consideration of interests and factors in the manner described in this sub§ and in sub§ (a) shall not constitute a violation of §1712 (relating to standard of care and justifiable reliance).

A. McQuade v. Stoneham

A K is void if it requires directors of a corp. to refrain from changing officers, salaries, policies, or retaining individuals in office without consent of the contracting parties. Put different, directors cannot pre-commit how they will elect officers, how much you’ll pay them, or vote about a merger.

1. There was an agreement that stipulated how SHs were going to vote in the future; however, cannot do this because it is a violation of the FD of care

2. An agreement among SHs whereby it is attempted to divest the directors of their powers to discharge an unfaithful employee of the corp. is illegal as against public policy

3. SHs may not, by agreement among themselves, control the BOD in the exercise of judgment vested in them by virtue of their office to elect officers and fix salaries

4. SHs may combine to elect directors. The power to unite, however, is limited to the election of directors and it is not extended to Ks whereby limitations are placed on the powers of directors to manage the business of the corp. by the selection of agents at defined salaries

5. Directors cannot contractually agree in advance on how to vote; however, SHs can. See § 7.31

a. EXCEPTION – when the directors are the sole SHs, there seems to be no objection to enforcing an agreement among them to vote for certain people as officers. Clark v. Dodge

B. Control comes with several benefits that cause controlling blocks of stock to be worth more than non-controlling blocks

1. Allows for a choice of, and domination of, boards

2. Risks associated (ways that violate the duty of loyalty):

a. Could vote oneself into the role of CEO and pay yourself a high salary

b. Could sell your controlling block to an inappropriate buyer

C. SHs do not have day-to-day management rights

1. They vote according to the amount of stock owned

2. Major transactions must be approved by a majority of the SHs

D. § 7.32. Shareholder Agreements

1. (a) an agreement among the SHs of a corp. that complies with this § is effective among the SHs and the corp. even though it is inconsistent with one or more other provisions of this Act in that if: [when the directors are the sole SHs, there seems to be no objection to enforcing an agreement among them to vote for certain people as officers]

a. (1) eliminates the BOD or restricts their powers

b. (2) govern discretion on dividends

c. (3) Board picks officers but you can do so by other methods (contract)

d. (6) transfer to one or more SHs the power to manage the business

e. (7) requires dissolution of the corp. at the request of one or more SHs or upon the occurrence of a specified event or contingency

i. Provided an exit strategy like in partnerships

2. (b) an agreement authorized in this § shall be: [all SHs must consent]

a. (1) set forth (i) in the AOI or bylaws and approved by all persons who are SHs at the time of the agreement [one veto denies it], or (ii) in a written agreement that is signed by all persons who are SHs at the time of the agreement and is made known to the corp.

b. (2) subject to amendment only by all persons who are SHs at the time of the amendment, unless the agreement provides otherwise

c. (3) valid for 10 years unless the agreement provides otherwise

3. (c) the certificate of stock itself must put on alert the buyer to the agreements already in place; must be conspicuous

A. Main Things a Shareholder Can Do:

1. Sue; Sell (exit); Vote (voice (most powerful))

a. Think authorizing mergers, sales of the business, amendments to the articles and bylaws, bankruptcy, etc.

b. Before the corp. issues shares of stock, the BOD has exclusive authority to amend the AOI

c. After the corp. issues the stock, the SHs have exclusive authority to amend the AOI

d. If a lot of SHs sell their stocks, that has a depressive effect on the stock price, which makes managers lose stock options and therefore are disciplined in the market

e. SHs can even run for office, contested election, proxy contest

B. § 7.01. Annual Meeting.

1. (a) SHs must have an annual SHs meeting each year and established the date in the bylaws

2. DEFAULT RULE – directors are elected yearly; they must account for profits or losses and then are reelected or ousted

C. § 7.07. Record Date for Meeting.

1. Applicable to large non-closely held corp., voting date must be available to everyone but not everyone is eligible to vote

D. § 7.20. Shareholders’ List for Meeting. No advantage for incumbents

1. (a) a corp. shall prepare an alphabetical list of the names of all its SHs who are entitled to notice of a SHs’ meeting

2. (b) the SHs’ list must be available for inspection by any SH, beginning 2 days after notice of the meeting is given, (to make sure no one is voting who should not be) at the corp’s expense

3. SHs can use this list to organize if they want to challenge a vote

E. § 7.21. Voting Entitlement of Shares.

1. 1 share 1 vote; however, can be altered to create weighted classes of voters

A. § 7.22. Vote by Proxy.

1. Votes can be communicated through an eligible voter to someone else who then votes on their behalf

G. § 7.28. Voting for Directors; Cumulative Voting.

1. (a) DEFAULT – BOD elected by plurality [more than the other people; who has the most votes] (not majority) of the votes casted by the shares entitled to vote in the election at a meeting at which a quorum is present

a. Needs most out of all candidates, but not absolute majority

b. Need a quorum to vote; majority of shares eligible to vote are present

H. § 7.29. Inspectors of Election.

1. (a) any shares of a national securities exchange shall appoint one or more inspectors to count votes, i.e., publicly held corps do not inspect votes

2. (e) subject to de novo review by courts

I. § 7.31. Voting Agreements.

1. (a) 2 or more SHs may provide for the manner in which they will vote their shares by signing an agreement for that purpose. A voting agreement created under this § is not subject to the provisions of § 7.30

2. (b) a voting agreement created under this is specifically enforceable

A. § 6.27. Restriction on Transfer of Shares.

1. Important with closely held corps, you can limit or control who gains shares in the company

2. A share-transfer restriction is enforceable if a company:

a. (1) authorizes the restriction;

b. (2) provided proper notice of the restriction;

c. (3) has a valid purpose for the restriction; and

d. (4) has valid means to enforce the restriction

K. § 8.04. Election of Directors by Certain Classes or Series of Shares.

1. Can opt out to create, in the AOI, multiple classes of stock that ensure that the minority SHs can elect a certain # of directors to the board

XVI. Oppression of Minority SHs: Common Law and Statutory Remedies

A. Normally only issue in closely held corporations because if company is public, can sell and get out

B. Oppressive conduct often involves interference with a minority SH’s employment, management, and/or dividend expectations.

C. Statute default rules do not fall in favor of minority SHs, so you must alter incorp. agreement to protect OR use the Doctrine of Oppression (separate from FDs, separate cause of action)

D. Freeze-Out or Squeeze-Out Techniques by Majority SHs:

1. Termination of a minority SH’s employment

2. Refusal to declare dividends (starvation); only time “oppression” appears in DE case law

3. Removal of a minority SH from the BOD

4. Siphoning off corporate earnings through high compensation to the majority SH

E. Doctrine of Oppression (Common Law & Majority): 2 things evaluated by the court:

1. Test - Would the conduct of the majority SHs substantially defeat any reasonable expectations of the minority SHs at the time they invested

a. Ask: is the majority group using their power in an extreme way?

i. Evidence on the record is evaluated

2. Delaware does not follow this common law doctrine (minority); thus, it is not a COA here. DE leans on FD of loyalty jurisprudence rather than developing oppression case law (common law) to protect minority SHs in closely held corporations

F. Davis v. Sheerin

(1) dissolution is harshest and applies when the bad/oppressive behavior will likely continue, per the court; and
(2) expectations of the minority SHs are the most important, but their expectations obviously need to have been reasonable ones; and
(3) conspiring to deprive one of his ownerships of stock in a. corp., especially when the corp. records clearly indicate such ownership, is more oppressive than freeze-out techniques

G. When Conduct Becomes Oppressive:

1. Unjust or cruel exercise of authority or power, substantially defeats the reasonable expectations of the minority at the start of the enterprise

2. The majority can act in self-interest, but there must be a balance against the interest of the minority SHs

3. Incorporated Partners: closely held corps. SHs

H. Equitable Remedies

1. Forcing a buyout of the minority SH’s interest;

2. Ordering an accounting by the majority for funds alleged to have been misappropriated;

3. Enjoining future acts of oppression;

4. Ordering the declaration of a dividend [compel] or a reduction and distribution of capital; and

5. Authorizing minority SHs to purchase additional stock under specific conditions

A. MBCA § 14.30. Grounds for Judicial Dissolution.

1. (a) the [name or describe court or courts] may dissolve a corp.:

a. (2) in a proceeding by a SH if it is established that:

i. (i) the directors are deadlocked [50/50 vote], and SHs can’t break it, and irreparable harm will be done to the corp if unable to break it

ii. (ii) the directors or those in control of the corp. have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent

iii. (iv) the corporate assets are being misapplied or wasted

a. RA – not unusual for controlling SHs to extract financial gain for themselves but not for minority, e.g., salaries, bonuses that are excessive, self-dealing with other companies and siphoning money out

A. MBCA § 14.32. Receivership or Custodianship.

1. In a proceeding brought to dissolve a corp., a court can appoint an [independent, neutral party to pay off assets] receivership or custodian to wind up and liquidate or manage the businesses and affairs of the corp.

2. If liquidation is ordered by a judge, receiver might be appointed to oversee the liquidation because the actual corporate actors cannot be trusted

3. RA – Ford, PA statute  if oppression is proven, then [1] appoint a custodian to try to save it, and if not, then [2] liquidate it

4. Receiverships liquidate and a custodian manages

a. DE is similar with its statute

C. MBCA § 14.34. Election to Purchase Instead of Dissolution.

1. Oppressing Directors can just buy-out unhappy SHs rather than go through the hassle of dismantling the entire company unless court decides in equity to set aside or modify the election

2. Does not order a court ordered buy-out, but instead provides options if a suit is brought under § 14.30

3. (a) 1 or more SHs may elect to purchase all shares owned by the petitioning SH at the fair value of the shares

a. This only gives rights to Directors when the P-SH first files a dissolution COA. SHs can aggregate together to get rid of this. They must prove seriously bad acts, gross abuse of power, etc.

4. (d) if the parties cannot determine fair value, the court can

D. MBCA § 8.09. Removal of Directors by Judicial Proceeding.

1. (a) the court may remove a director from office, including barring director from reelection, in a proceeding commenced by or in the right of the corp. if the court finds that (i) the director engaged in fraudulent conduct with respect to the corp. or its SHs, grossly abused its position, or intentionally inflicted harm on the corp.; and (ii) considering the course of conduct and inadequacy of other remedies, removal or such other relief would be in the best interest of the corp.

a. E.g., Mexican food recipe in another business is breach of FDL

XVIII. Directors’ Fiduciary Duties

A. An equitable claim

B. The BOD owes FDs to:

1. The corp., including other Ds

2. Investors and SHs

3. NO FDs to laborers