CORPORATIONS MINI OUTLINE

I. INTRODUCTION

Historical

I. SECECTION OF BUSINESS ENTERPROISE

ENTITY THEORY

 1. Legal entity created by Statute and separate from those who own and manage it

 2. Fictitious -  purpose of conducting business

 3. Can sue or be sued, can own property, etc.

 4. Managed by officers and directors

5. Recognized by those who deal with it

6. Exists perpetually until dissolved

7. Shares (stocks) freely transferable

CHARACTERISTICS

1. Shareholders' liability limited to investment

2. Formation and operation: Filed with Secretary of State

    and compliance with regulatory requirements

3. Taxed as separate entity

            a.      After - tax profits distributed to shareholders

4. Subchapter S Corp.

a. Income treated as gross income of Shareholders

b. Applies to Federal income tax

c. Qualifications

        i. Less than 35 shareholders limited to individuals, Mists  
            ii. One class of stock outstanding
       iii. Unanimous consent 
       iv File with IRS (not automatic)

REGULATION

1. REVISED MODEL BUSINESS CORPORATIONS ACT ["RMBCA" than

1. Basis for corp. statutes of more  half States

2. Federal  -  Taxes and Securities regulation

FORMATION

STATE OF INCORPORATION

1. Generally, where business is conducted  

2. Delaware Statute considered most hospitable I

a.      Simplifies problems of management i

b.     Well‑defined, predictable body of law I •

STATUTORY REQUIREMENTS

1. Filing of Articles of Incorporation with Secretary of State ‑ conclusive proof [2.03]

2. Incorporators

a. Person(s) who execute Articles
               b. Generally, no age or residency requirement i 

3. Content of Articles of Incorporation I a. Corporate name (cannot be already in use)

b. Principal officer

c. Number of shares authorized, classes and rights

i. Pre‑emptive rights option to buy up to proportionate interest)

d. Name and address of registered office and agent

i. Purpose: Service of Process

e. Address of each incorporator

f. Duration: Perpetual unless otherwise stated

g. Purposes: i.e. engaging in any lawful business

4. Powers and Ultra Vires

a. Power to do all things necessary and convenient to carry out business [3.02]

i. Purpose to authorize actions that are lawful and not against public policy

b. Generally, power to sue and be sued, to own ` property, to make contracts, to borrow and lend money, to purchase or redeem shares

          c. Ultra Vires: Acts in excess of powers

i. Common Law: U1tra Vires transaction is void since . corporation lacks power to enter into transaction

ii. Modem Statutes: Nearly abolished in all jurisdictions

5. Completing Formation

a. Preparation of By‑Laws‑rules governing corp.'s internal affairs (i.e. date for annual meetings. number of directors)

i. May be amended by Board or Shareholders

ii. Articles of Incorporation control where conflict with BY Laws  

Transactions

Promoters

1. Gather resources and personnel for Corp.
2. Fiduciary duty to act in good faith.
1. May not pursue own profit at corp.’s expense
2.  
3. Preformation Contracts

a.      Personally liable for contract made with knowledge that corp. not yet formed and 
where 3^rd party does not Know [2.04]

b.      Contract does not automatically bind corp. when formed unless corp. adopts it by 
resolution or by act or failure to act

i.        Corp. not liable for preincorporation tort of partnership [Pendergrass v. Card Care,Inc.]

c.      Novation:  specific agreement between corp., Promoter, and 3^rd party to release Promoter, 
and 3^rd party to Release Promoter from personal liability

DEFECTIVE CORPORATION

• DE JURE CORPORATION

1.  Sufficient compliance with statute 

• DEFACTO CORPORATION

1. Unsuccessful attempt to incorporate due to technical defect

2. Common Law: Incorporator could still be sheltered from liability from everyone but State if good faith attempt to comply made

3. Modem Statutes: Generally, DeFacto doctrine abolished and personal liability imposed when knowledge of no incorporation

CORPORATION BY ESTOPPEL

1.  3rd party who deals with business, believing it to be corporation, is estopped from denying its corp. status to avoid contract

PIERCING THE CORPORATE VEIL

(CREDITOR SEEKS TO REACH STOCKHOLDERS PERSONALLY)

• SHARES HELD BY INDIVIDUALS

1. General Rule: Shareholders not liable for corp.'s debts

• FACTORS - Basic Grounds For Piercing Corporate Veil

1. Tort - Courts willing to pierce because no element of voluntary dealing

2. Fraud - Courts more likely to pierce

3. Inadequate Capitalization- Creditor must show corp. did not have enough capital for its foreseeable 
    business needs and Creditors had no way of determining this fact

4,   Failure to follow corp. formalities (i.e., shares never issued: commingling of funds) susceptible to piercing veil

• PARENT LIABILITY FOR SUBSIDIARY

  1.  Generally parent not liable

   2. Liable for failure to maintain clear separation

ENTERPRISE LIABILITY

• EQUITABLE SUBORDINATION- DEEP ROCK DOCTRINE

1. Bankruptcy Court may disallow insider's claim entirely or make claim subordinate to claims of non‑insiders
2.  

• EQUITABLE SUBORDINATION DEEP ROCK DOCTRINE

1. Bankruptcy Court may disallow insider's claim entirely or make claim subordinate to
   claims of non‑insiders
2.  

DIRECTOR LIABILITY

1. Prohibited by statute

a. Exception: Bad Faith where dividend known to be
                    improper corp. has right to recover from director
                    within 2 - year Statute of Limitations [833]

b. Creditor may sue Dir. who negligently approves
                      improper ~dividend [NY]

• SHAREHOLDER LIABILITY

1. Common Law ‑ required to return improper dividend if
     corp. insolvent or shareholder knew dividend was improper

2 Directors right to contribution from shareholders [8.33(b)(2)]

FINANCING

EQUITY CAPITAL

1. Stock Subscriptions

2. Authorized number of shares set forth in Articles of Incorporation [RMBCA 2.02(a)(2), RMBCA 6.01]

3. Par Value - arbitrary value assigned (every State allows no par)

4. Watered Shares - issued for less than par

a. Remedies - Creditors recover difference between par value and amount actually paid based on:

i.        Misrepresentation (holding out)

ii.       Reliance -  liable to creditors subsequent to watering

iii. Trust Fund  -  all creditors recover on theory that stated capital constitutes a trust fund

iv. Statutory Obligation  -  corp.'s right to sue shareholder for unpaid balance due on shares

5. Consideration -  cash, property or services

            a. Many States (including Delaware) do not recognize promissory notes

            b. RMBCA allows any consideration provided Board of Directors acts in good faith and with reasonable care [6.21]

6. Issuance of more than a single class

a. Common Shares -  right to vote and right to distribution of net assets

b. Preferred Shares  -  priority over common as to dividends and/or liquidation and generally no voting rights

i. Non - Participating Preferred -  no further participation after preferred payment

ii. Participating Preferred- participates with common shares in additional distribution

iii. Convertible Preferred -  convertible into common

iv. Cumulative ‑ unpaid dividends carry over to following: year and are paid prior to that of common

v. Noncumulative ‑ unpaid dividends do not accumulate to

future years  !

vi. Partially Cumulative -  rolls over as long as there have been earnings; limited to earnings of that year

7. Redemption

a Redeemed shares are cancelled-  stated capital is reduced

8. Repurchase

1. Shares remain as "treasury shares"-  stated capital is not affected

DEBT FINANCING

1. Debt Securities

a. Bonds and Debentures ‑ long‑term obligation to pay bearer a specific amount at a future date

b. Notes‑short‑term negotiable instruments representing promise to pay

2. Advantages

                a. Paid before dividends to stockholders

                b. Less risk  

                c. Tax advantages

3. Third Party Debt creates leverage

4. Debt/Equity Ratio -  ratio between corp.'s liabilities and shareholder's equity

            a. Thin Capitalization -  capital inadequate in relation to, obligations

DIVIDEND AND DISTRIBUTIONS

1. Payment out of earnings by core. to shareholders of cash, property or additional shares of stock.

DISTRIBUTIONS additional shares of stock

1. Payment out of capital

PROTECTION OF CREDITORS

1. Maintain sufficient assets to cover claims

TERMS

1. Legal/Stated Capital~ Amount contributed by stockholders

            a. Balance sheet account calculated as par times issued shares

2. Earned Surplus -  Generated from profits

            a. Undistributed net profits after deducting losses

3. Capital Surplus = Assets minus liabilities and stated capital

4. Impairment of Capital statutes allow payment of dividends from earned or unearned surplus (i.e. Delaware and N.Y.)

RMBCA TESTS FOR DISTRIBUTION

1. Equity Insolvency Test -  ability to pay debts as they become due in the ordinary course of business [6.40(c)(1)]

2. Balance Sheet Test -  distribution prohibited if assets less than liabilities plus that needed to satisfy liquid‑anon rights of other classes of shares [6.40(cX2)]

FINANCING CONTINUED REVERSE SIDE

PUBLIC OFFERINGS SECURITIES ACT OF 1933

1. Governs issuance and regulates original distribution

2. section 5-prohibits sale of any security by use of mails or other means of interstate commerce unless a registered statement is filed with the S.E.C. and requires full disclosure

3. Exempted Securities – i.e. intrastate 

   a. Section 3(b) – Limited Offering

        i. Regulation D – Rule 504 allows issuer to sell up to $1 million per year          
            with  unlimited purchasers without having to register, and Rule 505 allows 
                issuer to sell up to $5 million with investors limited to 35 nonaccredited and      
           unlimited  accredited

    b. Section 4 – Sales by dealers and non-public offerings

4. “Blue Sky Laws” – State securities acts

RESTRICTIONS ON RESALE OF UNREGISTERED SECURITIES

1. Sales by those other than issuer, underwriter or dealer can resell without registering with SEC.

    a. Exception:  Rule 506 buyer who has “restricted securities”

CLOSELY HELD CORPORATIONS.

CHARACTERISTICS 

 1. Not publicly traded

  3. Few shareholders who usually manage corp.

                a. Legal certainty to Shareholder Agreements [732] 

INVOLUNTARY DISSOLUTION

  l . Cannot break deadlock, illegal act, waste (assets misapplied) (RMBCA 1430(2)]

2. Assets sold off, debts paid, and surplus distributed to shareholders

        a. Real Estate lease not terminated by dissolution [Kelly v. Alstores Realty

3. Statute sets criteria 

        a. Judicial discretion - less likely to dissolve if profitable 

4. Alternatives to dissolution

        a. Buyout:  

        b. Arbitration;

        c. Provisional directors appointed to break deadlock,

        d. Custodian appointed to run business;

        e. Receiver appointed to liquidate

DUTIES OF DIRECTORS AND OFFICERS

• DUTY OF CARE

I . Duty of management delegated to officers

2. RMBCA 830 ‑ Standard Test

        a. Discharged in good faith with care of ordinary prudent person in manner reasonably believed to be in best  interest of corp.

                     i. Must use special skills where available 
                    ii. Reliance on experts when appropriate

3. Personal liability

          a. Limited to "gross negligence" or recklessness

BUSINESS JUDGMENT RULE

1. Decisions made upon reasonable information and with some rationality do not give rise to liability

2. ALI Def. [4.01(c)]: Decision made in good faith

        a. No interest in subject

        b. Informed with respect to subject

        c. Rational belief in best interest of core.

3. Liability for "gross negligence" (Smith v. Vat Gorken or illegal act in violation of criminal statute

DUTY OF LOYALTY

l . Must not put own interests ahead of core.

2. No Self- dealing

        a. Director's interest must not influence decision

        b. Common Law  -  transaction is voidable

        c. Modem View - ALI Section5.02 requires disclosure and fairness 

                i. Transaction authorized by disinterested Directors or shareholders

                ii. Intrinsic fairness test

        d. Remedies - rescission or restitution

3. No excessive compensation constituting waste

4. No seizing of corporate opportunity

        a. Interest or Expectancy Test - Corp. has contractual right regarding opportunity

        b. Line of Business Test - closeness of opportunity to type of business of core.

        c. Fairness Test - unfairness of fiduciary taking advantage of opportunity

        d. Full Disclosure - if corp. rejects opportunity. then fiduciary duty no longer exists

            i. Liable for penalties for failure to fully disclose all facts [Thorpe v. CERBCO, DE]

        e. Non -competition clause for departing employee can not be overboad -Nalco Chenical Co. v. Hydro Technologies,]

        f. Not an opportunity if corp. not financially capable of taking advantage of it and no obligation to acquiring corp.   [Broz v. CIS, DE]

POWERS

MANAGEMENT AND SHAREHOLDERS

SHAREHOLDERS

1. Shareholder Agreements

        a. Common Law ‑ power to elect Directors

            i. Board must be free to exercise its own business judgment 
               (McOuade v. Stoneham)

        b. Relaxation of Common Law where shareholders agree on certain 
            business matters and there is no injury (Clark v. Dodge)

        c. Modern View ‑ Shareholder Agreements that substantially interfere 
            with discretion of Board Will be upheld if there is no injury nor violation of statute

2. Power to Remove Directors

        a. Common Law -  removal for cause

        b. Statutes -  removal with or without cause

3. Power to make recommendations to Board

4. Power to amend or replace By-Laws [RMBCA 10.20]

5. Right to approve fundamental corp. changes in conjunction with Board 
       [RMBCA 10.03. 11.03, 1,2.02, 14.02]

6. Right to inspect records

    a. Common Law -  reasonable time. in good faith, and in interest of shareholders

    b. Statutes - notice and/or proper purpose required

• EXERCISE OF SHAREHOLDER POWER

1. Shareholder's Meetings

        a. Annual Meetings‑elect Directors, conduct business

        b. Special Meetings ‑Called by Board, President, or 10% shareholders 
            [RMBCA  7.02]

        c. Notice - Written [RMBCA 7.05]

                i. Purpose of special meeting must be stated. and business limited 
                   to stated purpose

        d. Quorum required - generally majority [RMBCA 7.25]

                i. Proxy - written authorization for another to vote for shareholder, 
                   generally revocable

        e. Voting by majority present

                i. Plurality vote to elect [RMBCA 7.28J

2. Actions without Meetings by written consent of majority

3. Eligibility to vote determined by "record ownership" on "record date"

        a. Straight Voting - Each share has one vote per director (i.e. owner of 20 
            shares may cast 20 votes for each director)

        b. Cumulative Voting - Shareholder can cast aggregate number of shares 
            for single candidate (owner of 20 shares may cast ail 60 votes for one 
            director if three director slots need to be filled)

                i. Formula: Total # of shares voting                  + 1  
                                 # of Directors to be elected +1

4. Shareholder Voting Agreements

        a. Pooling Agreements ‑ 2 or more shareholders agree to vote together 
            as a unit [RMBCA 7.31]

        b. Voting Trusts - Trustee holds voting rights and shareholders are 
            beneficial owners

                i. Statutory -  in writing, valid for 10 years, registered with corp. and subject
                   to  right of inspection

                ii. Must have valid purpose

• DIRECTORS

1. Traditional Powers

            a. Management of business- many decisions delegable to officers or 
             agents[RMBCA8.01]

            b. Election and removal of officers  

              c. Determine distributions

2. Statutory Rules

    a. Vote at properly called meeting

        i. Conference call generally valid [8.20(b)]

        ii. Unanimous written consent generallyvalid[8.21]

        iii. May rely on opinion of others (legal, financial) in good faith [ 8.30]

                [a] Liability of professional advisors governed by State law 
                     [O'MelvenL& Myers v. FDIC]

    b. Board may consist of one or more members

        i. Established by Articles of Incorporation or at incorporators organizational
            meeting[2.05]

c. Shareholder or residency requirement ‑eliminated by RMBCA 8.02

3. Meetings and quorum specified in By‑Laws

OFFICERS

1. Authority derived from Statutes. Articles of Incorporation, By‑Laws. Board of Directors

2. President ‑ subject to control of Board, handles business and executes contracts.

    a. Implied and Apparent authority

PUBLIC CORPORATIONS

• CHARACTERISTICS

1. Large number of shareholders

2. Pubic market for shares

3. Subject to reporting and disclosure requirements under securities acts

*CONTROL

l . Institutions ‑ increasing ownership

2. take‑over Bids

a. Trend to merge through purchase of controlling stock

• REGULATION

1. Securities and Exchange Act of 1934

a. Section 12 requires registration of shares and updating

b. Section 14(a)regulatessolicitationofproxiesthrough mail with exemptions

i. Actions by SEC include injunction and prevention of voting of improper proxy

ii. Private action for violation

2. Tender Offers

a. Premium price over current market

b. Cash offer used for "hostile takeovers" because Board does not have to approve

c. Williams Act, 13(d) and 14(d)‑(f) amends S.E.A.

    i. Requires disclosure

     ii. Prohibits false and misleading statements; 
    iii. Imposes rules of "fair play"

d. Delaware class action settlement Judgment is entitled to full faith and credit in federal court

3. Private Securities Litigation Reform Act o 199

a. Limitations placed on shareholder class action suits

i. Sanctions imposed for unsupported claims

b. Corporations granted safe harbor for certain projections of future performance

INSIDER TRADING

• DEFINITION

1. Transaction based on information unknown to public

• STATE COMMON LAW RULES

1. Majority Rule ‑ Insider has fiduciary obligation to

        i corp. -  not to shareholders

a. No liability for silent trading, except for fraud

2. Government's Burden of Proof [US, v. Liberal ]

a. Breach by Tipper of duty owner of non ‑public info.

b. Recipient's knowledge that Tipper breached duty

3. Shareholder Deceit Action

a. Plaintiff justifiably relied to his detriment on a misrepresentation of material fact made by Defendant with knowledge of falsity or with reckless disregard for its truth.

4. Recovery by Corporation‑must show direct injury '

a. Inside must turn over profits made or losses avoided.

• RULE 1Ob-5 ‑ SECURITIES AND EXCHANGE ACT.

1. Unlawful to employ fraud or make untrue statement of material fact or omission in connection with purchase or sale of security

a. Disclose or Abstain Rule" (Texas Gulf Sulphur)

i. Must wait until information widely disseminated before trading

b. Damages

    i. Disgorgement‑ difference between price following public disclosure;

    ii. Out‑of‑pocket; 

    iii. Rescission;

    iv. Implied right of contribution among Defendants [ Musick v. Employers  Insurance OF Wausau]

2. Requirements

a. Information must be non‑public and must be material 

b. Standing‑ Plaintiff must buyer/seller during time of non‑disclosure

i. No private right to sue aiders and abettors ‑[Central Bank of Denver v, First Interstate bank of Derived

c. Defendant must be insider or knowing tippee

i. Temporary Insider‑ person given information to perform services for issuer. 

ii. Liability of tippee derives from  liability of TIPPER

d. Scienter‑ .Defendant must act with intent to deceive

3. "Fraud on the Market Theory"

a. Defendant makes deceptive statement to public, thereby affecting  market price, and Plaintiff relies on integrity of lace

4. Mere non‑disclosure without accompanying transaction is not violation of l0b‑5

5. 10b-5 does not regulate mismanagement‑ realm of State court  

• INSIDER TRADING SANCTIONS ACT OF 1984

1. SEC may recover treble damages

• SECTION 16(b) ‑ SECURITIES AND EXCHANGE ACT

1. Insider who buys and sells within 6 mos. must return profits to co

2. Applies to officers. Directors, and 10% + Shareholders of public companies at one end of transaction

a. Insider - only transactions between c . and officer or director is exempt [Rule 16b‑33 as well as certain qualified plans and awards

3. 16(b) insiders must file statement with SEC within 10 days after every month in which stock bought or sold