Corporations

Duty of Care

Directors and officers must act in good faith, with the care that a person in a like position would reasonably believe appropriate under similar circumstances, and in a manner reasonably believed to be in the corporation's best interests. The duty focuses on informed decision-making and reasonable oversight, not whether the decision ultimately succeeds.

Business-Judgment Rule

The business-judgment rule presumes that disinterested directors acted on an informed basis, in good faith, and in the corporation's best interests. A court generally will not second-guess the merits of a business decision unless the plaintiff rebuts the presumption by showing a conflict, lack of good faith, grossly uninformed decision-making, or another disabling defect.

Reliance and Delegation

A director may reasonably rely on information, reports, opinions, and statements prepared by officers, employees, committees, legal counsel, accountants, or other persons reasonably believed competent, so long as the director lacks knowledge making reliance unwarranted. Directors may delegate functions but retain a duty of reasonable oversight.

Duty of Loyalty

A fiduciary must place the corporation's interests above personal interests and may not use the position for personal benefit at the corporation's expense. A transaction involving a material personal interest is subject to heightened scrutiny unless properly approved or shown to be fair.

Conflicting-Interest Transactions

A transaction between a corporation and a director or officer is not automatically voidable if the material facts are disclosed and the transaction is approved in good faith by disinterested directors or shareholders, or if the transaction is fair to the corporation.

Corporate Opportunity

A fiduciary may not take a business opportunity that the corporation has an interest or expectancy in, that is within the corporation's line of business, or that the fiduciary learned of through the corporate position, unless the fiduciary first fully discloses the opportunity and the corporation validly rejects it.

Good Faith, Waste, and Oversight

Bad faith includes intentional misconduct, knowing violation of law, conscious disregard of duties, or action for a purpose other than advancing corporate interests. Corporate waste occurs when the corporation receives consideration so inadequate that no person of ordinary business judgment could view the exchange as worthwhile. Directors may face oversight liability for consciously failing to establish or monitor reasonable reporting systems.

Controlling Shareholders

A controlling shareholder owes fiduciary duties when using control to obtain a non-ratable benefit or to cause the corporation to enter a conflicted transaction. The controlling shareholder must not exploit minority shareholders or divert value belonging proportionally to all shareholders.

LLC Fiduciary Duties

In a member-managed LLC, members generally owe duties of loyalty and care to the LLC and one another in conducting the business. In a manager-managed LLC, managers generally owe those duties, while nonmanaging members ordinarily do not owe duties solely by status. The operating agreement may modify duties to the extent permitted by the governing statute but generally may not authorize intentional misconduct or bad faith.

Exculpation and Indemnification

A corporation may often limit directors' monetary liability for certain duty-of-care breaches in its charter, but not for loyalty breaches, bad faith, improper personal benefit, or unlawful distributions. Indemnification may be mandatory when a director or officer succeeds on the merits and permissive when the person acted in good faith and reasonably believed the conduct was lawful and in the corporation's interests.

Direct Versus Derivative Claims

A shareholder brings a direct action to redress an injury suffered personally by the shareholder, with any recovery paid to the shareholder. A shareholder brings a derivative action on behalf of the corporation to redress an injury to the corporation, with any recovery ordinarily paid to the corporation. The characterization turns on who suffered the alleged harm and who would receive the benefit of the remedy, not on the label used in the complaint.

Standing to Bring a Derivative Action

A derivative plaintiff must have been a shareholder when the challenged conduct occurred, or have acquired the shares by operation of law from a person who was then a shareholder, and must ordinarily continue to own shares throughout the litigation. The plaintiff must fairly and adequately represent the corporation’s interests.

Verified Complaint and Particularized Allegations

A derivative complaint must be verified and must state with particularity the plaintiff’s efforts to obtain action from the board and the reasons the effort failed, or the reasons demand should be excused when the governing law recognizes demand futility.

Demand on the Board

Before filing a derivative action, a shareholder ordinarily must make a written demand asking the board to cause the corporation to pursue the claim. Under a universal-demand rule, demand is required in every case and the shareholder must wait the prescribed period unless the demand is rejected earlier or delay would cause irreparable injury.

Demand Futility

When demand may be excused as futile, the shareholder must plead particularized facts creating a reasonable doubt that a majority of the directors could impartially consider the demand because they are interested in the challenged transaction, lack independence from an interested person, or face a substantial likelihood of personal liability. Mere approval of the challenged act is ordinarily insufficient by itself.

Effect of Making Demand

A shareholder who makes demand ordinarily concedes that the board is capable of considering the demand and generally may not later argue that demand was futile. If the board rejects the demand, the court usually reviews the rejection under the business-judgment rule unless the shareholder shows lack of good faith, reasonable investigation, independence, or due care.

Special Litigation Committee

An independent committee of disinterested directors may investigate a derivative claim and seek dismissal if it concludes in good faith after a reasonable investigation that continuation is not in the corporation’s best interests. The court evaluates the committee’s independence, good faith, and investigative process and, under some approaches, may also exercise its own business judgment.

Corporate Control of the Claim

Because a derivative claim belongs to the corporation, the corporation is ordinarily named as a nominal defendant but is the real beneficiary. The corporation may seek dismissal, settlement, or other disposition subject to the court’s protection of shareholders and the corporation.

Settlement or Dismissal

A derivative action may not ordinarily be voluntarily dismissed or settled without court approval. Notice must be given to shareholders when the court directs, and the court must determine that the disposition is fair, reasonable, and in the corporation’s interests.

Recovery and Litigation Expenses

Recovery in a derivative action ordinarily belongs to the corporation. A successful or substantially successful derivative plaintiff may receive reasonable litigation expenses, including attorney’s fees, from the recovery or from the corporation because the action conferred a substantial benefit. A plaintiff who proceeds without reasonable cause or for an improper purpose may be liable for the opposing party’s expenses.

Inspection Rights

A shareholder may inspect specified corporate books and records at a reasonable time if the shareholder makes a proper demand and states a proper purpose reasonably related to the shareholder’s interest. The requested materials must be relevant to that purpose. A desire to investigate credible suspected mismanagement or value shares is generally proper; harassment or pursuit of a purely personal objective is not.

Promoter

A promoter acts on behalf of a corporation that has not yet been formed by arranging capital, property, contracts, or other steps necessary to organize the business. Promoters owe fiduciary duties of loyalty, good faith, and disclosure to the corporation and to persons solicited to invest.

Promoter Liability on Preincorporation Contracts

A promoter who enters a contract for a not-yet-formed corporation is personally liable on the contract unless the agreement clearly provides that the promoter is not liable or the parties later execute a novation. The promoter remains liable even after the corporation is formed and adopts the contract unless a novation releases the promoter.

Corporation’s Liability Before Formation

A corporation generally cannot be bound by or ratify a contract made before it legally existed. Before formation, there is no principal capable of authorizing the promoter or being bound as an undisclosed principal.

Adoption of a Preincorporation Contract

After formation, a corporation may adopt a preincorporation contract expressly, such as by board approval, or impliedly, such as by knowingly accepting the contract’s benefits. Adoption makes the corporation liable from the time of adoption but does not, without more, release the promoter.

Novation

A novation is an agreement among the promoter, the corporation, and the other contracting party substituting the corporation for the promoter and releasing the promoter from liability. Adoption alone is not a novation.

Promoter’s Secret Profit

A promoter must disclose material facts and may not obtain a secret profit from dealings with the corporation. If the promoter acquired property before undertaking to promote the corporation, recovery is generally measured by the promoter’s profit; if acquired after becoming a promoter, the corporation may generally recover the profit or rescind the transaction.

De Jure Incorporation

A corporation is formed when articles of incorporation satisfying statutory requirements are filed with the state. Once formed, the corporation is a separate legal person, and shareholders ordinarily are not personally liable for corporate obligations.

Defective Incorporation

A person who purports to act for a corporation knowing that no corporation was formed may be personally liable for resulting obligations. Some jurisdictions protect good-faith organizers under de facto corporation or corporation-by-estoppel principles, but statutory filing rules often limit those doctrines.

Limited Shareholder Liability

A shareholder ordinarily risks only the amount invested and is not personally liable for corporate debts merely because the shareholder owns or controls the corporation. A sole shareholder is entitled to the same general protection as any other shareholder.

Piercing the Corporate Veil

A court may disregard the corporate form and hold a shareholder personally liable when the shareholder so dominated the corporation that it lacked a separate existence and respecting the entity would sanction fraud, promote injustice, or defeat a strong policy. Relevant facts include commingling assets, siphoning funds, gross undercapitalization, treating corporate assets as personal assets, and failure to observe basic separateness. No single factor is automatically controlling.

Contract and Tort Creditors

Courts are generally more reluctant to pierce for a voluntary contract creditor who could investigate or negotiate protections than for an involuntary tort creditor. Gross undercapitalization and diversion of assets are especially significant when the corporation exposes the public to foreseeable tort risks.

Parent and Subsidiary Corporations

A parent corporation is not liable for a subsidiary’s obligations merely because it owns the subsidiary. Veil piercing may be appropriate when the parent dominates the subsidiary, disregards separateness, and uses the subsidiary to commit fraud or injustice. Ordinary oversight, shared officers, and consolidated accounting do not alone establish liability.

Board Management

A corporation’s business and affairs are managed by or under the direction of its board of directors, subject to the articles, bylaws, and valid shareholder agreements. Individual directors ordinarily have no authority to bind the corporation merely by holding office; board action requires action at a meeting or valid unanimous written consent.

Director Meetings and Notice

A regular board meeting may generally be held without special notice if scheduled according to the bylaws. A special meeting requires the notice specified by statute or bylaws. Notice need not describe the meeting’s purpose unless required. A director may waive notice expressly or by attending without timely objection.

Board Quorum and Voting

Unless governing documents validly provide otherwise, a majority of the authorized directors constitutes a quorum, and an act approved by a majority of directors present at a meeting with a quorum is board action. A director may ordinarily not vote by proxy.

Unanimous Written Board Consent

Directors may act without a meeting by unanimous written consent unless the governing statute or documents provide otherwise. The consent must describe the action and be signed or electronically assented to by every director.

Election and Removal of Directors

Shareholders elect directors at the annual meeting. Directors may generally be removed by shareholders with or without cause unless the articles or a classified-board rule require cause. Removal of a director elected by cumulative voting may be limited when removal would defeat the voting rights of the electing minority.

Officer Authority

Officers have the authority granted by the bylaws, board resolutions, their position, and ordinary agency law. A corporation may be bound by an officer’s actual or apparent authority, and may ratify an unauthorized act.

Shareholder Meetings and Notice

Corporations must hold annual shareholder meetings for director elections and other business. Special meetings may be called by persons authorized by statute or the governing documents. Shareholders entitled to vote must receive timely notice stating the date, time, place or remote means, and, for a special meeting, the purpose.

Shareholder Quorum and Voting

Unless validly altered, a majority of shares entitled to vote constitutes a quorum. Ordinary matters generally pass by a majority of votes cast or shares represented as the statute provides; fundamental changes ordinarily require board approval and a specified shareholder vote.

Proxies and Voting Agreements

A shareholder may vote in person or by proxy. A proxy is generally revocable unless it states that it is irrevocable and is coupled with an interest. Shareholders may enter valid voting agreements, and may create a voting trust by transferring legal title to a trustee under a written agreement.

Cumulative Voting

When cumulative voting is authorized, a shareholder may multiply shares by the number of directors to be elected and cast the resulting votes for one or more candidates. Cumulative voting protects minority representation but is not available unless the statute or articles provide for it.

Preemptive Rights

A preemptive right allows an existing shareholder to maintain proportional ownership by purchasing a proportionate share of certain new issuances. Modern statutes generally provide no preemptive right unless the articles grant it, and the right ordinarily does not apply to specified compensatory, conversion, or noncash issuances.

Distributions

A corporation may make dividends or other distributions only if, after the distribution, it can pay debts as they become due and its assets meet the applicable balance-sheet test. Directors who approve an unlawful distribution may be liable if they fail to comply with their duties, subject to contribution and reliance defenses.

Fundamental Corporate Changes

A merger, share exchange, conversion, dissolution, or amendment of the articles generally requires board adoption of a plan or resolution, written notice to shareholders, and shareholder approval. Under the MBCA the default is approval when the votes cast in favor exceed those cast against with a quorum present, and a separate voting-group vote may also be required; Delaware and many states instead require a majority of all shares entitled to vote.Transfers in the ordinary course, and mortgages or pledges of assets, never require shareholder approval.

Successor Liability in Asset Acquisitions

A corporation that buys the assets of another does not, as a general rule, assume the seller's liabilities, and the seller's creditors must look to the seller. Liability passes to the buyer only if one of four exceptions applies: the buyer expressly or impliedly agrees to assume the debts; the transaction is in substance a de facto merger (continuity of ownership, with the seller's shareholders taking an ownership interest in the buyer, together with continuity of enterprise, the buyer's assumption of liabilities needed for uninterrupted operations, and dissolution of the seller); the buyer is a mere continuation of the seller (same management, ownership, and business, with the seller reduced to an empty shell); or the transaction is a fraudulent effort to escape the seller's obligations. Some jurisdictions additionally impose liability on a buyer that continues the seller's product line, chiefly in strict products-liability cases.

Appraisal Rights

A shareholder entitled to appraisal may demand payment of the fair value of shares when the corporation undertakes specified fundamental transactions. The shareholder must strictly follow notice, objection, demand, and ownership procedures and generally may not both accept the transaction consideration and pursue appraisal. Market-out and other statutory exceptions may apply.

Voluntary Dissolution and Winding Up

A corporation may dissolve through the required board and shareholder approvals and filing of articles of dissolution. Dissolution does not instantly terminate the entity; it continues for winding up, including collecting assets, paying or providing for claims, disposing of property, and distributing remaining assets.

LLC Formation and Separate Entity

An LLC is formed by filing the required organizational document. It is a separate legal entity, and members and managers ordinarily are not personally liable for LLC obligations solely because of their status.

Member-Managed LLC

In a member-managed LLC, each member ordinarily has equal management rights and is an agent for acts apparently carrying on the LLC’s ordinary business. Matters in the ordinary course generally require a majority of members, while acts outside the ordinary course and amendments to the operating agreement generally require unanimity unless the agreement provides otherwise.

Manager-Managed LLC

In a manager-managed LLC, managers control ordinary business and members are not agents merely because they are members. Manager decisions generally follow the statutory or operating-agreement voting rule; extraordinary acts remain subject to any required member approval.

LLC Operating Agreement

The operating agreement governs relations among members, managers, and the LLC to the extent permitted by statute. It may modify many default rules but ordinarily may not eliminate core duties of loyalty and care, the contractual obligation of good faith and fair dealing, or statutory rights beyond the limits the statute permits.

LLC Distributions and Dissociation

A member has no right to a distribution except as provided by the operating agreement, statute, or an authorized decision. A dissociated member generally loses management rights but retains the economic interest and may have a right to payment only when the statute or agreement provides.

LLC Veil Piercing

Members generally receive limited liability, but a court may pierce the LLC veil under principles similar to corporate veil piercing when members abuse the entity’s separate existence and respecting it would promote fraud or injustice. Failure to observe corporate-style formalities alone is usually less significant for an LLC.

Preincorporation Share Subscriptions

A written preincorporation subscription to buy shares is generally irrevocable for the statutory period unless the subscription provides otherwise or all subscribers consent. After formation, the board may accept the subscription and enforce it according to its terms.

Authorized, Issued, and Outstanding Shares

The articles state the classes and number of shares the corporation may issue. Authorized shares are available for issuance; issued shares have been sold or distributed; outstanding shares remain held by shareholders and generally carry voting and distribution rights. Treasury shares have been reacquired and are not outstanding.

Consideration for Shares

The board determines the adequacy of consideration for shares, which may include money, property, services performed, or other benefits permitted by statute. Once the corporation receives the authorized consideration, the shares are fully paid and nonassessable.

Preferred Shares and Classes

The articles may create classes or series with different voting, distribution, liquidation, conversion, redemption, or preference rights. The corporation must respect class rights, and an amendment adversely changing a class generally requires a separate class vote.

Share Redemptions and Repurchases

A corporation may redeem or repurchase its shares when authorized and when the distribution tests are satisfied. A redemption is compulsory or optional according to the share terms; a repurchase is a negotiated acquisition. The transaction may not improperly discriminate or be used to breach fiduciary duties.

Close-Corporation Agreements

Shareholders of a closely held corporation may enter a valid agreement altering ordinary governance, restricting transfer, allocating management power, or resolving deadlock when statutory requirements are met. Persons exercising director-like power under such an agreement may assume corresponding duties and liabilities.

Transfer Restrictions

A restriction on transfer of shares is enforceable when authorized, reasonable, and conspicuously noted on the certificate or otherwise known to the transferee. Valid restrictions may require a first offer, consent, or purchase by the corporation or other shareholders, but may not amount to an unreasonable restraint on alienation.

Corporate Deadlock

A court may order equitable relief, appoint a custodian, or dissolve a corporation when directors or shareholders are deadlocked and the business is suffering or cannot be conducted to the shareholders’ advantage. A valid buy-sell or other deadlock agreement may provide an alternative remedy.

Debt and Equity Financing

A corporation may raise capital through equity interests, debt, or hybrid securities. Shareholders hold residual ownership and generally no right to repayment; creditors hold contractual repayment rights and priority over shareholders on liquidation. Labels do not control when the substance differs.

Issuance of Securities

The board ordinarily authorizes issuance of shares and debt within powers granted by the articles and statute. Directors must act consistently with fiduciary duties and may not issue securities primarily to entrench control or dilute a shareholder for an improper purpose.