Ca Bar: Corporations (2009)

CA Bar 2009: Corporations

QUESTIONS What are the 6 major test issues?

What’s a promoter? When does the corporation become liable for the promoter’s pre-corp K? What happens if the PIK is entered into but no corp is formed? What happens if there’s no novation? When can a promoter sell property to the corp? What happens if promoter sells property acquired after being a promoter, to the corp? Can an offeror revoke an offer to buy stocks pre-incorporation?

What’s an incorporator? What must the AoI contain? What is presumed about the purpose clause? If narrow purpose and corp goes beyond that scope into ultra vires activity? What is the agent? What must the name of corp have? How can a corp be a de facto corporation?

CORPORATIONS 6 Major Test Issues 1. Corporate formation 2. Issuance of stock 3. Action by and liability of directors and officers 4. Rights of shareholders 5. Fundamental corporate changes 6. Federal securities laws Part 1: Corporate Formation A. Pre-Incorporation Contracts: Promoters and Subscribers 1. Promoter: are persons acting on behalf of a corporation not yet formed a. Rule: 1) Step 1: the corporation becomes liable for the promoter’s preincorporation contract when the corporation adopts the K by either A) express board of directors resolution, or B) implied adoption by knowledge of the K and acceptance of its benefits 2) Step 2: The promoter retain liability on pre-incorporation K’s until there has been novation, ie an agreement b/t the promoter, corp and the other contracting party that the corporation will replace the promoter under the K. b. If corporation is never formed, then the promoter alone is liable on the K. c. If promoter ends a PIK, and the corp merely adopts the K  upon adoption, the corp is liable on the K but promoters still retain liability until novation. d. Promoters are fiduciaries of each other and of the corp, thus they cannot make a secret profit. 1) Sale to corporation of property acquired by promoter before becoming a promoter  can only sell to corp for fair market value 2) Sale to corporation of property acquired by promoter after becoming a promoter  any and all profit is recoverable by the corp; corp can disgorge all profits made by the promoter even if property was sold to the corp for fair market value 2. Subscriber: persons or entities who make a written offer to buy stocks from a corporation not yet formed a. Q: after signing the subscription agreement offering to buy stocks, can the offeror revoke her offer to buy stock in the corporation not yet formed? The offer is irrevocable for a 6 month period. B. Formation Requirements—De Jure Corporate States 1. Incorporator: merely signs and files the articles of incorporation w/ the state 2. Articles of Incorporation: must contain: APAIN a. # Authorized shares (the maximum number of shares – corporation cannot issue more than this number w/o amending the AoI) b. Purpose clause 1) Corp’s express statement of general purpose and perpetual duration is ok 2) In absence of such 2 statements: gen purpose + perpetual duration presumed 3) Narrow purpose and ultra vires activities A) Tip: what if you have a narrow purpose clause and then you engage in an ultra vires activity? (1) The state can enjoin the ultra vires activity. (2) Corporation may sue its own directors/officers for losses caused by the ultra vires activity. c. Agent: and address of registered office (registered agent = corp’s legal rep who can receive notice and process) d. Incorporators and addresses e. Name of Corporation: must contain indicia of corporate status 3. By-laws: need not even exist—need not be in the AoI C. De Facto Corporation Doctrine 1. Not a pure de jure corporation but can be a de facto corporation. 1

CA Bar 2009: Corporations

What’s the cardinal rule of corporation liability? Why would a court allow a V to pierce the corporate veil? What are the two piercing the corporate veil theories? How can a foreign corp engage in intrastate biz?

What is proper consideration for a corp issuing its own stock? What is treasury stock? Can a corp use par value stocks to buy property? What happens if stock is issued for less than par value?

What are preemptive rights? What if you can’t tell whether there are preemptive rights? What are the 4 statutory requirements of directors? What is necessary for a valid Board meeting?

2. Rule: if organizers have made a good faith, colorable attempt to comply w/

corporate formalities and have no knowledge of the lack of corporate status  can be a de facto corp D. Legal Significance of Formation of Corp 1. Corporation is a separate legal person 2. Cardinal Rule: Generally, shareholders are not personally liable for the debts of corporations. This is the principle of limited liability, which means that they shareholders are liable only for the price of their stocks. E. Piercing the Corporate Veil (Equity Doctrine) 1. Rule: generally, shareholders are not liable for the debts of a corporation 2. Issue: can shareholders be held liable for third party tort/K victims? Yes, if the court is willing to pierce the corporate veil to avoid fraud or unfairness and to render that shareholder to the third party V 3. When can the veil be pierced? a. Alter Ego Rule: the owners have failed to maintain sufficient corporate formalities and have treated the corp as their alter ego 1) Ie, commingling personal and corporate funds can lead to undercapitalization b. Undercapitalization: failure to maintain sufficient funds to cover foreseeable liabilities 4. Innocent third party tort V are more likely to get piercing than K victims. Pierce the veil against the controlling shareholder. F. Foreign Corporations: Outside of the Forum State 1. Foreign corporations, incorporated in another state, but wants to engage in regular intrastate biz must qualify by filing a certificate of authority w/ the Secretary of State including all requirements of the Articles of Incorporation. Part 2: Issuance of Stock by the Corporation A. Consideration 1. How much value can the corp receive for selling its own stock? 2. Par Value: minimum issuance price  corporation can never receive less than the par value as consideration (# of Stocks * par value) 3. No par: no minimum issuance price—is valid 4. Treasury Stock:stock that in the past, was previously issued by the corp and has since that time been repurchased or reacquired and corp wants to re-sell its treasury stock. Treasury stock is like no par, thus any valid consideration deemed adequate by the Board is proper consideration. 5. Can you use par value stock to buy property? Yes: any valid consideration may be received for the stocks if Board values the property for at least the par value of the stocks. 6. If stock is issued for less than par value: a. Directors, who have the authority to issue stocks, can be held personally liable b/c they don’t have the authority to do a below par issuance b. The shareholder who bought the below-par stock can held liable c. Corporation can elect to sue either the directors or the shareholder but not both. B. Preemptive Rights 1. Def: the right of an existing shareholder to maintain her percentage of ownership by buying stock whenever there is a new issuance of stock for cash 2. Default rule: preemptive rights do not exist unless they are expressly granted in the Articles Part 3: Action by and Liability of Directors and Officers A. Statutory requirements of Directors 1. Corporations must have a Board w/ at least 1 member 2. Shareholders elect directors 3. Shareholders can remove a director before his term expires on the basis of cause or without cause. 4. Valid meeting a. Unless all directors consent in writing to act w/o a meeting, a meeting is required 2

CA Bar 2009: Corporations

b. c.

What are the areas of liability of directors for DoC?

What are the types of violations of the DoL?

What are the 4 officer duties?

What are the 3 indemnification rules? What are the 4 routes to permissive indemnity?

What are the requirements for standing for a derivative suit?

Which stockholders vote?

Notice of directors’ meetings can be set in bylaws Proxies for board voting are not allowed. Also no voting agreements but conferences are generally valid. d. Quorum: must have a majority of all directors to take an action unless bylaws specify otherwise e. Vote: to pass a resolution, must pass by a majority vote of those present f. Each director is presumed to have concurred in Board activities unless her dissent or abstention is recorded in writing, ie minutes or letter to corp secretary B. Liability of Directors to their Own Corporation and Shareholders 1. Directors have a duty to manage the corp though they can delegate management functions to a committee of directors who make recommendations 2. Biz Judgment Rule: directors not liable for innocent mistakes; presumption that directors are managing in good faith 3. Fiduciary Duties: directors owe duties of care and loyalty 4. Duty of Care: director must act w/ the care that a prudent person would use in running his own biz unless the Articles have limited director liability for a breach of the DoC 5. Duty of Loyalty: directors may not receive an unfair benefit to the detriment of the corp/shareholders unless there has been disclosure of all material facts and independent ratification a. Self Dealing: a director who receives an unfair benefit in a txn w/ their own corporation (or another one of her businesses, or a familial interest etc.) b. Usurping corporate ops c. Ratification: can absolve that director of liability: 1) Majority vote of independent directors 2) Majority vote of a committee of at least 2 independent directors, or 3) Majority vote of shares held by independent shareholders 6. Essay Analysis: a. Dir have a duty to manage. b. They are protected by the BJR. c. But they are fiduciaries and thus owe a DoL and DoC. d. DoL: self dealing/usurpation/ratification C. Officers 1. Owe same duty of care and loyalty as directors 2. Are agents of the corp and bind the corp by their authorized activities 3. Must have a Prez, Secretary and Treasurer 4. Have virtually unlimited power to select officers and can remove at any time—but the corp will be liable for breach of K damages D. Indemnification of Directors and Officers 1. If Dir/Officer has incurred costs, attorney’s fees, fines, judgments or settlements in the course of corp biz, and he seeks reimbursement: a. Never repay dir: if he has lost a lawsuit to his own corp b. Always repay dir: if he has won a lawsuit against any party (incl. corp itself) c. May repay dir if: 1) Liability to third-parties or settlement w/ corporation 2) Dir shows that he acted in good faith and believed that conduct was in corp’s best interest 3) Who decides whether to grant permissive indemnity? A) If a majority of independent directors approves B) If a committee of at least 2 independent directors approves C) If a majority of shares held by independent shareholder vote for it D) A special lawyer’s opinion could recommend it Part 4: Rights of Shareholders A. Shareholder Derivative Suits 1. To enforce the corp’s cause of action (always ask if the corp could’ve brought the suit, if so it’s derivative) 2. Requirements of a derivative suit: a. Contemporaneous stock ownership—at least 1 stock owned when claim arose and throughout entire litigation 3

CA Bar 2009: Corporations

b. Demand: ask Board to sue first and get rejection or 90 days have passed since

What is required for a valid proxy?

Can proxies be revoked? Where do shareholders vote? What are the steps at the meeting to vote? What are the 2 ways to pool votes?

What is straight voting? What’s cumulative voting? What’s the default rule for choosing among the two?

When can’t dividends be issued? What is the order of priority?

What are the steps to eliminating corp formalities?

demand was made  then sue B. Voting 1. Only the record date owner of stock votes. (record date = voter eligibility cutoff date set by the Board, a day falling w/in the 70 day period before meeting day) a. Thus you can own shares on the record date, sell later, but retain the right to vote b/c you were a record date owner. 2. Voting by Proxy a. Valid proxy requires: 1) Writing: fax/email is ok 2) Signed by the record owner 3) Directed to Secretary of Corp 4) Authorizing another to vote your shares 5) Valid only for 11 months b. Proxies are revocable unless they are labeled irrevocable and coupled w/ an interest (ie the proxy holder owns the shares after record date) c. Where do shareholders vote? 1) Properly noticed (time and place) annual meeting where at least 1 director slot is open for election 2) Specially noticed meeting (called by the Board, Prez or by holders of 10% of voting shares) called to vote on fundamental corp changes or on proposals. A) Notice must describe special purpose of meeting and can’t do anything that’s not in the notice d. Steps at the meeting: 1) Quorum: a majority of all shares must be represented when meeting starts 2) Vote: votes cast in favor must exceed votes cast against e. Pooled or Block Voting: 1) Voting Trust: formal delegating of voting power to a voting trustee for 10 years A) Written trust agreement B) Typically filed w/ corp C) Transfer shares to voting trustee D) Shareholders get trust certificates E) Shareholders retain all other rights except for voting F) Duration: generally 10 years unless extended by agreement 2) Agreement: in writing, to vote shares as required by the agreement f. Cumulative voting for Directors 1) Traditional, straight voting: 1 share = 1 vote per election, and each open slot is a separate election 2) Cumulative voting: multiply the number of shares by the number of open slots = total number of votes, but only one election no matter the number of open slots 3) Default rule: cumulative voting doesn’t exist unless it is expressly granted in the AoI C. Right of Shareholder to examine the books and records of corporation—any shareholder shall have access upon notice and at proper times D. Dividends – brutal in CA 1. Shareholders have no right to receive dividends at all. BoD has almost total discretion to decide whether or not to declare dividends. 2. Rule: but Board cannot declare dividends if corp is insolvent or rendering dividends would render corp insolvent. a. If they do that, Board members become personally liable for unlawful dividends. b. Board defense: good faith reliance 3. Types of shares: a. Common shares: paid last, and paid equally b. Preferred: pay these shares first c. Participating: get paid twice, once as participating and once as common d. Cumulative: have the right to be paid prior years’ payments + this year’s E. Shareholder Agreements to Eliminate Corporate Formalities (Closely-Held Corps) 4

CA Bar 2009: Corporations

What are the elements of a PC?

When can shareholders be held liable?

What are the recognized fundamental changes? What are the procedural steps to getting an FC? (5) When can the Board engage in a type of merger? How does a dissenter perfect his right of appraisal?

What are the elements of a 10(b) action?

1. 2. 3.

Step 1: unanimous shareholder election to eliminate in writing, and Step 2: some reasonable share transfer restriction Upsides: a. No piercing even if you fail to observe formalities b. Possible Subchapter S Corp status 1) S Corps are deemed partnerships for tax purposes 2) S Corp: up to 100 shareholders and only 1 class of stock F. Professional Corporation 1. Licensed profs may incorporate as a PC, containing only 1 profession 2. Requirements: a. Organize and file Articles designating themselves as a PC b. Shareholders may be licensed professionals c. May practice only 1 profession d. Liable for personal malpractice e. But not liable for each other’s malpractice or obligations of the corp itself G. Shareholder Liabilities 1. Generally, shareholders not liable for corp obligations 2. Exceptions: a. Piercing corp veil b. Controlling shareholders owe a fiduciary duty of care to minority shareholders c. Controlling shareholders are liable for selling corp to a party who loots the corp, unless reasonable measures were taken to investigate the buyer’s rep and plans for the corp Part 5: Fundamental Corporate Changes A. Recognized fundamental changes: 1. Merger, Consolidation and Dissolution 2. Fundamental (not ministerial) amendment (ie increasing stocks) of the Articles or sale (not purchase) of substantially all of the corp’s assets B. Procedural Steps: 1. Board resolves to change at a valid meeting 2. Notice of special meeting 3. Approval by a majority of all shares entitled to vote (not just quorum) and by a majority of each voting group that is adversely affected by the change a. Exception: no shareholder approval is required for a “short form” merger where a parent corp that owns 90%+ of the stock in its subsidiary merges w/ the subsidiary—can be done by the Board 4. Possibility of dissenting shareholder right of appraisal a. A shareholder who doesn’t vote for the FC has the right to force the corporation to buy her shares at fair value b. To perfect this right: 1) Before vote itself, dissenter has to file objection 2) At vote, cannot vote for the change (either abstain or reject) 3) Make prompt demand to be bought out after vote c. What if you can’t agree on fair value? A court has the power to appoint an expert appraiser to value the shares and appraisal will be binding on the parties. 5. Must file notice w/ the state, ie Articles of Merger Part 6: Fed Securities Laws Considerations A. Section 10(b) of the’34 Act 1. It’s the General Anti-Fraud provision of the securities laws 2. Elements of a 10(b) Action: a. Scienter: intent to deceive b. Deception: 1) Liar: misrepresent a material fact or failure to disclose material facts in breach of their fid duty to disclose 2) Insider trading A) Misappropriate: steals, converts, material nonpublic info and uses it to purchase or sell securities B) Tippers: one who tips inside info for personal benefit to another and trades on it 5

CA Bar 2009: Corporations

C) Tippees: those who receive inside info and trade on it w/ the

What are the requirements of 16(b)? What happens when 16(b) applies?

knowledge that the info was disclosed in breach of the tipper’s fid duty c. Affirmative act: in connection w/ the actual purpose or sale of securities not refraining from buying/selling 3. Private action for damages, investors must also prove: a. Reliance on the fraud or bought at a price infected by the fraud (fraud on the market) b. Loss causation: fraud not only induced the purchase or sale but also caused their economic losses B. Section 16(b) of the ’34 Act: Short Swing Trading Profits 1. Only applies to: a. Big corps that report: 1) Listed on a national exchange 2) At least 500 shareholders and 10M in assets b. Big shot D—officer/director ore more than 10% shareholder c. Type of txn: no buying or selling stock w/in a single 6 month period (short swing trading) 2. When 16(b) applies: a. All profits from such short swing trading are recoverable by the corporation, b. If w/in 6 months, before or after any sale, there was a purchase at a lower price than the sale price, there is a profit. C. SOX 1. Applies to reporting companies 2. CEO and CFO must certify that based on the officer’s knowledge, reports filed w/ the SEC: a. Do not contain material misrepresentations or omissions, and b. Fairly presents the financial position of the company 3. Willfully certifying a false report could bring $5M fine and 20 year jail sentence 4. If false reports have to be restated, the corp (directly or derivatively) may recover Officer’s profits made from trading the company’s securities w/in the 12 months after the false reports were filed and may receive incentive based comp received in that period.

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