handout corp eb07 (1)

8/3/2019 Handout Corp Eb07 (1)

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CORPORATIONS

TEACHING HYPOTHETICALS

By Richard D. Freer

Emory University School of Law

Six fact patterns: 1. Organization of corporation2. Issuance of stock

3. Directors and officers4. Shareholders5. Fundamental corporate changes6. Federal securities

FACT PATTERN 1: ORGANIZATION OF CORPORATIONS

I. FORMATION REQUIREMENTS (People, Paper, Act)

(1) People: Incorporators. Must have one or more.

What does an incorporator do? ____________________________________________

______________________________________________________________________

-- Can BAR/BRI, Inc. serve as an incorporator for Curl Up and Dye Beauty SupplyCorp.? Can Joan Rivers? ________________________________________________

______________________________________________________________________

(2) Paper: Articles of Incorporation.

A. (1) The articles are a contract between corporation and shareholders.(2) And also a contract between corporation and state.

B. Information in articles.

(1) Names and addresses.

a. Corporate name.

Can I form a corporation with the name Bubba=s Bountiful Biscuits?No. It must include one of these Amagic words@ (or an abbreviation

thereof): __________________________________________________

__________________________________________________________

_________________________________________________________

b. Names and addresses of incorporators and initial directors.


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c. Name of registered agent and address of registered office (registeredagent is the corporation=s official legal representativeCe.g., can receiveservice of process).

(2) Statement of duration (can be perpetual).

(3) Statement of purpose.

a. General statement of purpose.

-- Can the articles of Bubba=s Bountiful Biscuits, Inc. indicate that thecorporation=s purpose is to Aengage in all lawful activity, after firstobtaining necessary state agency approval@? _____________________

__________________________________________________________

b. Specific statement of purpose and ultra vires rules.

-- What if the articles of Bubba=s Bountiful Biscuits, Inc. indicate thatthe corporation=s purpose is to Asell Southern-style sausage biscuits@ andthe corporation later sells T-shirts as well as the biscuits? Selling T-shirts is an ultra vires act (beyond the scope of the articles). At commonlaw, the contract could be voided as beyond the corporation=s capacity.How do we handle ultra vires today? ___________________________

__________________________________________________________

__________________________________________________________

__________________________________________________________

__________________________________________________________

__________________________________________________________

__________________________________________________________

(4) Capital structure (stock).

a. Definitions of background terms (to impress friends at parties):

-- Authorized stock: maximum number of shares the corporation can sell.-- Issued stock: number of shares the corporation actually sells.-- Outstanding stock: shares that have been issued and not reacquired by the

corporation.

b. Articles must include: (1) Authorized stock, (2) number of shares perclass and (3) information on par value, (4) voting rights and (5)preferences of each class.


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(3) Act.

File articles with Secretary of State and pay required fee. Acceptance by Secretary ofState is conclusive proof of valid formation. At that point, it is a de jure corporation.

-- Then, Board holdsorganizationalmeeting, where selects officers and adopts anybylaws and conducts other appropriate business.

II. LEGAL SIGNIFICANCE OF FORMATION OF CORPORATION

(1) Internal affairs of corporation (e.g., roles and duties of directors, officers, andshareholders) are governed by the law of the state of incorporation.

(2) A corporation is a separate legal person. It can sue and be sued, hold property, be apartner in a partnership, make charitable contributions, must pay income taxes as anentity, etc.

(3) Generally, officers and directors are not personally liable for what the entity does.

Generally, shareholders (owners) are not personally liable for debts of corporation.This is the principle ofAlimited liability,@ which means that shareholders generally areliable only for the price of their stock.

(4) So who is liable for what the corporation does? _______________________________

______________________________________________________________________

-- That means that if the proprietors fail to form a de jure corporation, they will be nervousbecause they will be liable for what the business does. Then, think about:

III. DE FACTO CORPORATION DOCTRINE/CORPORATION BY ESTOPPEL

Doctrines by which a business failing to achieve de jure corporate status nonetheless is treated asa corporation (so shareholders will not be personally liable for business debts). Generally, personasserting either must be unaware of failure to form de jure corporation.

(1) De Facto Corporation: (a) there is a relevant incorporation statute; (b) the parties madea good faith, colorable attempt to comply with it; and (c) some exercise of corporateprivileges. If applicable, treated as corporation for all purposes except in an action bythe state.

-- Example: incorporators draft articles and mail them to the Secretary of State.Unbeknownst to them, the papers are lost in the mail. They are acting as a corporationin the interim, not knowing of the failure to form a de jure corporation. They have thebusiness enter a contract. Are they liable on the contract (since there is no de jurecorporation)? __________________________________________________________

_____________________________________________________________________

_____________________________________________________________________


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(2) Corporation by estoppel: one dealing with a business as a corporation, treating it as acorporation may be estopped from denying the business=s corporate status. May beinvoked against those who dealt directly with the business as a corporation. May alsobe used to prevent company from avoiding an obligation by asserting its own lack ofvalid formation. Usually available in contract, not tort, cases.

(3) Status of these two doctrines: _____________________________________________

IV. BYLAWS

(1) In most states, adoption of bylaws is not a condition precedent to formation of acorporation. But virtually every corporation has them. They are for internalgovernanceCe.g., lay out responsibilities, set regular meeting times and places,prescribe methods of giving notice.

(2) Who adopts the initial bylaws? ____________________________________________

(3) Who can repeal or amend the bylaws of a corporation? _________________________

______________________________________________________________________

_____________________________________________________________________

(4) If bylaws conflict with the articles, the articles control. Bylaws are an internaldocument, not filed with a state agency.

V. PRE-INCORPORATION CONTRACTS

(1) A promoter is a person acting on behalf of a corporation not yet formed. For example,

a promoter might enter a contract on behalf of a corporation-not-yet-formed.

(2) Liability on pre-incorporation contracts.

A. Liability of the corporation: The corporation is not liable on pre-incorporationcontracts until it adopts the contract.

On January 10, P, acting as a promoter for a corporation not yet formed, leases abuilding from Donald Trump and signs the lease AOscar de la Rental Cars, Inc.@On February 20, Oscar de la Rental Cars, Inc. is formed.

-- Is the corporation liable on the contract? Yes, if it adopted the contract. Howcan that happen?

-- (1) Express - board of directors action adopting the contract.

-- (2) Implied - ____________________________________________________

__________________________________________________________________

__________________________________________________________________


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B. Liability of the promoter.

Unless the contract clearly provides otherwise, the promoter remains liable onpre-incorporation contracts until there is a novation. That means until there is anagreement of the promoter, the corporation, and the other contracting party thatthe corporation will replace the promoter under the contract.(Assume here the contract says nothing about promoter liability.)

-- Will P be liable on the lease if Oscar de la Rental Cars, Inc. is never formed?

__________________________________________________________________

-- Will P be liable on the lease if Oscar de la Rental Cars, Inc. is formed andadopts the lease? ___________________________________________________

__________________________________________________________________

__________________________________________________________________

-- Remember: Adoption makes the corporation liable too, but does not relieve P.So on this fact pattern, both the corporation and P are liable.

VI. FOREIGN CORPORATIONS

Foreign corporations transacting business in this state must qualify.

(1) A foreign corporation is one incorporated outside this state. So is a corporation formedin Florida foreign? ____________________________________________________

_____________________________________________________________________

(2) Transacting business means the regular course of intrastate (not interstate) businessactivity. Not occasional or sporadic activity.

(3) Qualify by getting a certificate of authority from Secretary of State. Apply by givinginformation from articles and a certificate of good standing from home state. Must payfees to state.

-- Generally, must appoint registered agent here too.

(4) Consequences of foreign corporation transacting business without qualifying: civil fineand the corporation cannot sue in state (but it can be sued). There are no otherconsequences for the foreign corporation.

-- Can the foreign corporation sue once it qualifies and pays fees and fines? ________

_____________________________________________________________________


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FACT PATTERN 2: ISSUANCE OF STOCK

I. WHAT IS ISSUANCE?

Issuance of stock occurs when a corporation sells or trades its own stock. It is a way to raisecapital for the corporation.

-- Mayberry Realty Corp. sells 10,000 shares of Mayberry stock. That is an issuance, because thecorporation is selling its own stock.

-- Family Guy sells 3,000 shares of Mayberry stock. Issuance? __________________________

______________________________________________________________________________

-- So that means that all these rules in this fact pattern apply only when the corporation is sellingits own stock. NOT when you or I sell stock.

II. SUBSCRIPTIONS [written offers to buy stock from corporation]

(1) Revocation of pre-incorporation subscriptions.

On January 10, S signs a subscription, offering to buy 100 shares of C Corp., acorporation not yet formed. A week later, S changes his mind. Can S revoke? No. Apre-incorporation subscription is irrevocable for six months unless it providesotherwise or all subscribers agree.

(2) Are post-incorporation subscriptions revocable? ______________________________

_____________________________________________________________________

(3) When do the corporation and the subscriber become obligated under a subscriptionagreement? ___________________________________________________________

_____________________________________________________________________

III. CONSIDERATIONCwhat must the corporation receive when it issues stock?

(1) Form of Consideration: split of authority on this.

A. Every state agrees that these are permitted: (1) money (cash or check), (2)

tangible or intangible property, or (3) services already performed for thecorporation. _______________________________________________________

__________________________________________________________________

B. The split of authority is about two other forms. In some states these are OK butin some states they are prohibited (so using them results in Aunpaid stock,@meaning its all treated as water): ______________________________________

__________________________________________________________________


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(2) Amount of Consideration.

A. Parmeans Aminimum issuance price.@

C Corp. is selling 10,000 shares of $3 par stock. It must receive at least ________

__________________________________________________________________

B. No parmeans Ano minimum issuance price.@ Board of directors sets any price.

C. Treasury stock.

This is stock that was previously issued and has been reacquired by thecorporation. The corporation can then resell it. Treat the sale as no par.

D. Who determines the value of consideration received for an issuance? The boardof directors. And its valuation is conclusive if it was made in good faith. (Insome states, its conclusive if the board acted without fraud.)

E. Consequences of issuing par stock for less than par value; i.e., Awatered stock.@

C Corp. issues 10,000 shares of $3 par to X for $22,000. The corporation (or itscreditors if it is insolvent) wants to recover the $8,000 ofAwater.@ Who is liable?

(1) Directors? Yes, if they knowingly authorized the issuance.

(2) X (the person who bought it)? _____________________________________

(3) What if X transfers the stock to A? A is not liable if she acts in good faith

(did not know about the water).

-- But A=s status (good faith or not) has no effect on the liability of X or thedirectors.

IV. PREEMPTIVE RIGHTS

(1) Preemptive right is the right of an existing shareholder to maintain her percentage ofownership by buying stock whenever there is a new issuance of stockfor money (cashor equivalent). Some states do not include sale of treasury stock as Anew issuance.@

-- S owns 1,000 shares of C Corp. There are 5,000 shares outstanding. C Corp. isplanning to issue an additional 3,000 shares. If S has preemptive rights, then S has theright to _______________________________________________________________

______________________________________________________________________

(2) What if the bar exam question does not indicate whether the articles of C Corp. providefor preemptive rights? Split of authority. Traditionally, preemptive rights exist unlessthe articles provide otherwise. Strong trend says preemptive rights do not exist unlessthe articles provide for them.


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-- The articles of C Corp. provide for preemptive rights. C Corp. is issuing stockto G to acquire Green Acres from G. Are there preemptive rights? NO. Why?

_________________________________________________________________

_________________________________________________________________

FACT PATTERN 3: DIRECTORS AND OFFICERS

I. STATUTORY REQUIREMENTSCDIRECTORS(1) Number: one or more adult natural persons.

(2) Election: Shareholders elect directors (at the annual meeting).

(3) Shareholders can remove directors before their terms expire. Generally, majority ofshares entitled to vote must vote for removal. On what bases? ___________________

_____________________________________________________________________-- But shareholders cannot remove a director if cumulative voting is in effect andthenumber of votes against removal would be enough to elect the director. We will seecumulative voting on page ________.

(4) Who selects the person who fills a vacancy on the Board? ______________________

_____________________________________________________________________

_____________________________________________________________________--But if the shareholders created the vacancy by removing a director, the shareholders

generally must select the replacement.

(5) Board action.

A. There are two ways the board can take a valid act: (1) unanimous written consentto act without a meeting, or (2) a meeting (can be held anywhere) that satisfiesquorum and voting requirements. What if neither of these is met? ____________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

-- Does a conference call qualify as a meeting (assuming all participants can heareach other simultaneously)? __________________________________________

B. Notice is required for special meetings but not regular meetings. (The time andplace of regular meetings is set in bylaws.) The method for giving notice isusually in the bylaws. If the corporation fails to give notice of a special meetingto all directors, the meeting is void unless those not given notice waive the defect.


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C. Are proxies or voting agreements OK for director voting? __________________

_________________________________________________________________

D. Quorum for meetings. We need a majority of all directors to do business (unlessbylaws require otherwise). If a quorum is present at a meeting, to pass a resolution(how the Board takes an act at a meeting) we need only a majority vote of those

present.

-- So, if there are 9 directors, at least ________ directors must attend the meetingto constitute a quorum. If 5 directors attend, at least ________ must vote yes topass a resolution.

II. ROLE OF DIRECTORS

(1) The board manages the business of corporation., e.g., it sets policy, selects andsupervises officers, declares distributions, decides when to issue stock, recommendsfundamental changes to the shareholders. So note that the shareholders do not run the

corporation. They elect the directors, who run the corporation.

(2) The board can delegate substantial management functions to a committee, but acommittee cannot: (1) amend bylaws, (2) declare dividends or (3) recommend afundamental corporate change to shareholders. _______________________________

_____________________________________________________________________

III. DUTY OF CARE (Burden on Plaintiff)

Duty of care standard: A director owes the corporation a duty of care. She must do what a

prudent person would do with regard to her own business.

(1) Nonfeasance (the director does nothing).

Justin Timberlake, a director of C Corp., fails to attend any of the board of directors=meetings or to keep abreast of the company business in any way. The corporationloses money on several deals. Will Justin be held liable for these losses for breachingthe duty of care?

--State the duty of care standard. A prudent person would attend some meetings and dosome work. Justin never did anything, so he has breached the duty of care. BUT HE IS

LIABLE ONLY IF: _____________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________


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(2) Misfeasance (the board does something that hurts the corporation).

The directors of Hedonists= Hot Tubs, Inc., vote to start a new line of hot tubs withbuilt-in wine coolers and video cameras. The idea is a disaster and the corporationloses money. Are the directors liable for breach of the duty of care?

-- State the duty of care standard. Here, the directors = action caused a loss to the

corporation. BUT, a director is not liable if she meets the business judgment rule(ABJR@). ______________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

BJR: So a court will not second-guess a business decision if it was made in good faith,was informed, and had a rational basis. _____________________________________

_____________________________________________________________________

IV. DUTY OF LOYALTY (Burden on Defendant because BJR does not apply in casesinvolving conflict of interest.)

Duty of loyalty standard: A director owes the corporation a duty of loyalty. She must act ingood faith and with a reasonable belief that what she does is in the corporation =s best interest.

(1) InterestedDirectorTransactionCany deal between the corporation and one of itsdirectors or another business of the director=s.

Martha is a director of XYZ, Inc. She sells wreaths to the corporation. That is aninterested director transaction. Is Martha in trouble?

-- State the duty of loyalty standard. Interested director transaction will be set aside

UNLESS the director shows: (1) the deal was fair to the corporation when entered, OR(2) her interest and the relevant facts were disclosed or known and the deal wasapproved by either of these: ______________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________-- Special quorum rules: interested directors count toward quorum.


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-- Directors can set their own compensation, but it must be reasonable. If excessive, it =swaste of corporate assets, and a breach of the duty of loyalty.

(2) CompetingVentures.

Sharon is a director of Ozzie's Music Co. She can also serve on the board of directorsof Home Depot because it does not compete with Ozzie's. But can Sharon start her

own music company?

-- State the duty of loyalty standard. Director cannot compete directly with hercorporation.

-- Remedy: ___________________________________________________________

_____________________________________________________________________

(3) CorporateOpportunity (Expectancy).

Cheatem is a director of C Realty Corp., which develops condo projects. Cheatemlearns of some land that has been zoned for condos and buys it for himself as aninvestment. What are C=s rights, if any, against Cheatem?

-- State the duty of loyalty standard. Director cannot USURP a corporate opportunity.That means the director cannot take it until he (1) tells the board and (2) waits for theboard to reject the opportunity.

-- What is a corporate opportunity? Some say it=s anything in the corporation=sbusiness line. ______________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

-- Is the company=s financial inability to pay for the opportunity a defense? _____

__________________________________________________________________

__________________________________________________________________

-- Remedy: If Cheatem still has it, he must sell it to the corporation at his cost. IfCheatem has sold it at a profit, the corporation gets the profit. (Constructive trust.)

V. OTHER BASES OF DIRECTOR LIABILITY

(1) Ultra vires acts. Responsible officers and directors are liable for ultra vires losses.Remember we did this back on page ________.


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(2) Improper loans.

Curly, Moe and Larry are directors of C Corp. The board of directors votes to lendCurly $100,000 of corporate funds. Generally, such a loan is OK only if the boardfinds that it is reasonably expected to benefit the corporation. ____________________

______________________________________________________________________

-- Sarbanes-Oxley Act (federal law) prohibits most loans to executives in registered(publicly traded) corporations.

(3) Improper distributions. See page ________.

(4) Which directors are liable for all the things directors be liable for?

A. General rule.

A director is presumed to have concurred with Board action unless her dissent or

abstention is noted in writing in corporate records. That means (1) in the minutesor (2) in writing to the corporate secretary at the meeting or (3) registered letter tothe corporate secretary immediately after the meeting.

-- So is an oral dissent effective? ______________________________________

__________________________________________________________________-- You cannot dissent if you voted for the resolution at the meeting.

B. Exceptions.

(1) Absent directors are not liable.

(2) Good faith reliance on (a) book value of assets or (b) opinion of a competentemployee, officer, professional, or committee of which the director relyingwas not a member, or (c) financial statements by auditors. Must have areasonable belief in the competence of the persons providing suchinformation.

VI. OFFICERS (owe the same duties of care and loyalty as directors).

(1) Status: Officers are agents of the corporation. So they can bind the

corporation by acts for which they have authority to bind it.

-- President generally has inherent authority to bind the corporation to contracts inthe ordinary course of business.

Traditionally, must have a president, a secretary and a treasurer. Can also haveothers. Today, can one person hold multiple offices simultaneously? __________

__________________________________________________________________


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(2) Selection and removal of officers.

Officers are selected by and removed by the directors. Directors also set officercompensation.

The directors of Pharmacy Inc. appoint Tom Cruise as president. What happens ifthey fire him from the presidency?

-- Toms gone, although the corporation may be liable for breach of contractdamages. _________________________________________________________

__________________________________________________________________

-- So shareholders hire and fire directors, but directors hire and fire officers. Generally,then, shareholders do NOT hire and fire officers.

VII. INDEMNIFICATION OF DIRECTORS AND OFFICERS

(1) An officer or director gets sued by or on behalf of the corporation. She has incurredcosts, attorneys= fees, maybe even fines, a judgment or settlement. She seeksreimbursement from the corporation.

A. No indemnification; i.e., when is corporation barredfrom indemnifying?If held liable to the corporation or held to have received an improper personalbenefit.

B. Mandatory indemnification; i.e., when is a corporation requiredto indemnify?In some states, if she was Awholly successful@ (on the merits or otherwise) indefending the action. In others, Ato the extent@ she was successful. ____________

__________________________________________________________________

__________________________________________________________________

C. Permissive indemnification; i.e., when is a corporationpermittedto indemnify?

1. Situations: anything not satisfying A. and B. above. Watch for settlement.

2. Eligibility standards: she must show that she acted in good faith and with thereasonable belief that her actions were in the company =s best interests.

3. Who determines eligibility? Disinterested directors or disinterested shares orindependent legal counsel.

(2) Notwithstanding these rules, the court where director or officer was sued can orderindemnification if it is justified in view of all circumstances. Usually limited to costsand attorneys= fees (not any judgment against the director or officer).


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(3) Articles can provide for limitation or elimination of liability for damages, but not forbreach of the duty of loyalty, intentional misconduct or wrongful personal benefit. Insome states, such provisions are available for directors only, not officers.

FACT PATTERN 4: SHAREHOLDERS

I. HOLDING SHAREHOLDERS LIABLE FOR THE ACTS OR DEBTS OF THE

CORPORATION (SHAREHOLDER AS DEFENDANT)

Generally, a shareholder is not liable for the acts or debts of a corporation. But a courtmight Apierce the corporate veil@ (PCV), which means the court will hold shareholderspersonally liable for what the corporation did. To do this, two things must be true: (1) theshareholders have abused the privilege of incorporating and (2) fairness requires it. PCVhas only been used in close corporations.

-- PCV standard (when fairness requires piercing): most courts will PCV toavoid fraudor unfairness. (PCV is neverautomatic.) ______________________________________

__________________________________________________________________________

(1) Alter ego (identity of interests).

X and Y are the shareholders of C Corp. X is also the chief executive officer. Xcommingles personal and corporate funds, uses the corporate car as his own, and usesthe corporate credit card to pay for personal purchases. Can a creditor of thecorporation who has been unable to collect its claim from the corporation collect fromeither X or Y?

-- Start with general rule (shareholders not liable for acts or debts of corporation). Then

PCV standard. Here a court MIGHT PCV if X=s failure to respect the separatecorporate entity harmed creditors. Sloppy administration generally is not enough forPCV, but here X treated the corporation as his alter ego by treating the corporation andpersonal assets as interchangeable. _________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

-- If PCV on these facts, only X would be liable. Y has done nothing wrong.


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(2) Undercapitalization.

S is a shareholder of Glowco, Inc., G, a corporation that hauls and disposes of nuclearwaste. G does not carry insurance. G has an initial capitalization of $1,000. V isinjured when one of G=s trucks melts down. Can V sue S?

-- General rule; PCV standard. Here a court MIGHT PCV because the corporation was

undercapitalized when formed. Why? Because shareholders failed to invest enough tocover prospective liabilities. ______________________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________-- Instead of PCV here, a court might subordinate debt owed to the responsibleshareholders (if any) to that of other creditors.

Remember (always say this in a PCV hypo): courts are generally more willing to PCV fora tort victim than for a contract claimant.

II. SHAREHOLDER MANAGEMENT OF CORPORATION

(1) Remember that generally the board of directors manages a corporation.

(2) Shareholders can manage corporation directly in a close corporation. What are thecharacteristics of a close corporation? ______________________________________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

-- The shareholders in a close corporation can elect a board of directors, and the boardwill manage the corporation. Or they can eliminate the board of directors and run thecorporation themselves. Usually, this is done by unanimous shareholder agreement. Ifthe shareholders eliminate the board and take over management, who owes the dutiesof care and loyalty to the corporation? ______________________________________

_____________________________________________________________________

_____________________________________________________________________

(3) Shareholders in a close corporation owe each other fiduciary duties. Watch especiallya controlling shareholder who oppresses minority shareholders, e.g., selling control(without reasonable investigation of the buyer) to someone who loots the corporationor other oppression of minority shareholders. Courts may be willing to help theminority shareholder here. WHY? Because there is no public market for the shares(so the minority shareholder cannot just get out by selling shares).


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(4) Licensed professionals, including lawyers, medical professionals, and CPAs, mayincorporate as a Aprofessional corporation.@ The name must include the designationAprofessional corporation@ or Aprofessional association@ or an abbreviation of one ofthose. The shareholders must be licensed professionals and generally the P.C. maypractice only one profession. The P.C. may employ non-professionals (not to renderprofessional services). The professionals and the P.C. remain personally liable for theirown malpractice or misconduct in rendering professional services. Shareholders are

generally not liable for each other=s malpractice or for corporate obligations. Generally,the rules governing regular corporations apply to the P.C.

III. SHAREHOLDER DERIVATIVE SUITS (SHAREHOLDER AS PLAINTIFF)

(1) In a derivative suit, a shareholder is suing to enforce the corporation=s claim, not herown personal claim.

To determine if its a derivative suit, ask: could the corporation have brought this suit?If so, it is probably a derivative suit.

-- S sues the board of directors of C Corp. for usurping corporate opportunities.Derivative suit? YESC duty of loyalty (and care) are owed to corporation. _________

_____________________________________________________________________

_____________________________________________________________________

-- S sues board of directors of C Corp. for issuing new stock without honoring herpreemptive rights. Derivative suit? NoCthis is a direct suit, to vindicate S=s personalclaim.

(2) What are the consequences of a successful derivative suit?

Generally, the recovery in any successful derivative suit goes to the corporation (not tothe shareholder (S)) who brought the suit on behalf of the corporation. ____________

_____________________________________________________________________

-- What does S receive? Costs and attorneys= fees, usually from the corporation. Afterall, the shareholder conferred a benefit on the corporation by suing and winning.

(3) What are the consequences of an unsuccessful shareholders= derivative suit?

-- Can S still recover costs and attorneys= fees? _______________________________

-- Is S liable to the people he sued for their costs and attorneys= fees? Yes, if he suedwithout reasonable cause.

-- Can other shareholders later sue X on the same transaction? ___________________

_____________________________________________________________________


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(4) What are the requirements for bringing a shareholder derivative suit?

A. Stock ownership.

The person bringing suit must have owned stock at the time the claim arose orhave gotten it by operation of law from someone who did own stock when theclaim arose. What are examples of operation of law? ______________________

__________________________________________________________________

__________________________________________________________________

B. Must also show that S will adequately represent the interest of the corporation.

__________________________________________________________________

C. Must also make a written demand on directors that the corporation bring suitUNLESS demand would be futile. Why would demand be futile? ____________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

D. Usually must plead with particularity the efforts to get the corporation to sue orwhy demand was excused.

E. Corporation can move to dismiss the derivative suit based on findings bydisinterested directors (or a committee of disinterested directors) that suit is not inthe corporation=s best interest (e.g., low chance of success or cost of litigationwould exceed recovery).

-- The court will scrutinize whether the directors making the recommendation aretruly disinterested and, if so, dismiss. In some states, the court will also make anindependent determination of whether dismissal is in the corporation=s bestinterest.

(5) Litigation.

A. The corporation must be joined as a defendant. Even though the suit asserts thecorporation's claim, the corporation did not do so, so it is joined initially as adefendant.

B. No dismissal or settlement without court approval. Court can give notice to thosewho would be affected, and get their input on whether dismissal or settlementshould be approved.


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IV. SHAREHOLDER VOTING

(1) Who votes?

General rule is that record shareholder as of record date has the right to vote.

A. The record shareholder is the person shown as the owner in the corporate records.

The record date is a voter eligibility cut-off.

C Corp. sets its annual meeting for July 7 and record date for June 6. S sells B herC Corp. stock on June 25. Who is entitled to vote the shares at the meeting, S orB? ______________________________________________________________

__________________________________________________________________

B. Exceptions to the general rule that record owner on record date votes.

1. Treasury stock. Suppose the corporation reacquires stock before record date.

So the corporation is the record owner on the record date of this treasurystock. Does the corporation vote the treasury stock? __________________.

2. Death of shareholder.

-- S owns stock in C Corp.; S is the record shareholder. After the record date,S dies. Can S=s executor vote the shares? ____________________________

3. Proxies.

A proxy is a (i) writing (fax increasingly OK; e-mail OK in some states), (ii)

signed by record shareholder, (iii) directed to secretary of corporation, (iv)authorizing another to vote the shares.

-- On February 2, 2007, S sends a letter to secretary of C Corp. authorizingCharlie Whitebread to vote her shares. Can Charlie vote S=s shares at the2007 annual meeting in July? Yes. This is a proxy.

-- This is OK in shareholder voting. Remember, proxies are not permittedfor voting by directors. Page ________.

-- Can Charlie vote S=s shares at the 2008 annual meeting in July 2008? ___

______________________________________________________________

______________________________________________________________

-- What if, prior to the 2007 meeting, S writes to the secretary of C Corp. thatshe now wants Jim Cramer to vote her shares at the 2007 meeting? _______

______________________________________________________________


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-- Can S revoke her proxy even though it states that it is irrevocable? _____

______________________________________________________________

-- S sells B her shares after the record date but before the annual meeting. Sgives B an Airrevocable proxy@ to vote the shares at the annual meeting. CanS revoke this proxy? No, because (1) it says irrevocable and (2) the

proxyholder has some interest in the shares other than voting. This is aAproxy coupled with an interest.@ ___________________________________

______________________________________________________________

______________________________________________________________

-- Here, the interest is ownership. But it could be an option, pledge, etc.

C. Voting trusts and voting agreements.

X, Y, and Z own relatively few shares of C Corp. They decide that they canincrease their influence on corporate policy by Ablock voting,@i.e., voting alike.

1. Requirements for voting trust.

a. Written trust agreement controlling how the shares will be voted;b. Copy to corporation;c. Transfer legal title of shares to voting trustee;d. Original shareholders receive trust certificates and retain all shareholder

rights except for voting. _____________________________________

__________________________________________________________

2. Requirements for voting (Apooling@) agreement.

a. Can shareholders enter into voting agreements? ___________________

b. What is required? __________________________________________

__________________________________________________________

_________________________________________________________

c. Are voting agreements specifically enforceable? __________________

(2) Where do shareholders vote?

A. There are two ways shareholders can take a valid corporate act: (1) unanimouswritten consent of the holders of all voting shares, or (2) a meeting (heldanywhere) that satisfies quorum and voting rules.


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B. Annual meeting: to elect directors. If not held, a shareholder can petition the courtto order one.

C. Special meeting can be called by (a) the Board, (b) the president, (c) the holdersof at least 10 percent of the voting shares or (d) someone else as provided in thearticles.

-- Suppose a proper person calls a shareholder meeting for the purpose ofremoving an officer. There is a problem with this. Why? __________________

________________________________________________________________

________________________________________________________________

________________________________________________________________

D. Notice requirementCmust give written notice to every shareholder entitled tovote, for every meeting (annual or special).

1. Contents of the notice: always must tell them when and where and must statepurpose. Why is statement of purpose important? Because that is the onlybusiness that can be transacted at that meeting. _______________________

______________________________________________________________

2. Consequence of failure to give proper notice to all shareholdersCactiontaken at the meeting is voidunless those not sent notice waive the noticedefect.

How does waiver occur?

-- (1) ExpressCin writing and signed any time; or-- (2) ImpliedCattend the meeting without objection.

(3) How do shareholders vote?

There must be a quorum represented at the meeting. Determination of a quorumfocuses on the number ofshares represented, not the number of shareholders.Generally, a quorum requires a majority of outstanding shares.

-- X Corp. has 120,000 shares outstanding. X Corp. has 700 shareholders. What or whoconstitutes a quorum? ___________________________________________________

______________________________________________________________________

______________________________________________________________________

-- If quorum requirement is met, a majority may act to bind the corporation unless thearticles or the bylaws require higher vote. But Amajority@ of whatCshares present orshares actually voting?


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-- X Corp. has 120,000 shares outstanding. 62,000 shares are represented at themeeting, but only 50,000 shares vote on a particular proposal. How many shares mustvoteforthe proposal for it to be accepted by the shareholders? ___________________

______________________________________________________________________

______________________________________________________________________

(4) How and when do shareholders use cumulative voting?

A. Cumulative voting is only available in voting for directors. It is a device to givesmall shareholders a better chance of electing someone to the Board.

B. Multiply number of shares times number of directors to be elected.You own 1,000 shares of stock in C Corp. C Corp. has nine directorships open forelection. You believe that Napleon Dynamite should be director of C Corp. Undercumulative voting, how many votes can you cast for Napoleon? ______________

__________________________________________________________________

__________________________________________________________________

C. The articles of C Corp. are silent as to whether shareholders can votecumulatively. Can C=s shareholders still vote cumulatively? Generally noCthisexists in most states only if the articles provide.

V. STOCK TRANSFER RESTRICTIONS

One nice thing about stock is that it is freely transferable you can sell it, will it, give it

away. Sometimes people want to impose restrictions on the transferability of stock. Often,this is in a close corporation, to keep outsiders out. Example:

Federline is a shareholder of Famous For No Reason, Inc. His stock is subject to a stocktransfer restriction that requires him to offer it first to the corporation (this is a Aright of firstrefusal@). Federline sells the stock to Paris Hilton in violation of the agreement.

A. Stock transfer restrictions will be upheld provided they are reasonable under thecircumstances, which means not an undue restraint on alienation. The right of firstrefusal is OK, assuming the corporation offers a reasonable price. ____________

__________________________________________________________________

__________________________________________________________________

B. Action against the transferee of the stock.

Even if the restriction is reasonable and thus valid, it cannot be invoked againstthe transferee unless either (a) it is conspicuously noted on the stock certificate or(b) the transferee had actual knowledge of the restriction.


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VI. RIGHT OF SHAREHOLDER (PERSONALLY OR BY AGENT) TO INSPECT (AND

COPY) THE BOOKS AND RECORDS OF THE CORPORATION

(1) Standing: who can demand access? Generally, any shareholder.

(2) Procedure: written demand stating a proper purpose, which means: _______________

_____________________________________________________________________

_____________________________________________________________________

_____________________________________________________________________

(3) What are the consequences if the corporation does not allow inspection after properdemand? Shareholder moves for court order. If successful, also generally recoverscosts and attorneys= fees incurred in making the motion.

(4) Directors dont have to make any showing to get access to the books and records.

Because of their management responsibilities, they have unfettered access. ________

_____________________________________________________________________

VII. DISTRIBUTIONS (Payments to shareholdersCcan be (1) a dividend or (2) to repurchasea shareholder=s stock or (3) to redeem stock (redemption is a forced sale to corporation ata price set in the articles).)

(1) Distributions are to be declared in the Board=s discretion. An action to compeldeclaration of a distribution is tough to win. Can win only on a very strong showing ofabuse of discretion. For example, if the corporation consistently makes profits and the

board refuses to declare a dividend while paying themselves a bonus.

(2) Which shareholders get dividends? (Preferred, Participating, Cumulative, Common)

-- The board of directors of C Corp. decides to declare dividends totalling $400,000. Who receives dividends if the outstanding stock is:

1. 100,000 shares of common stock. ______________________________________

__________________________________________________________________

2. 100,000 shares of common and 20,000 shares of preferred with $2 dividendpreference. Preferred means pay first. 20,000 preferred shares multiplied by $2preference equals a total preference of $40,000. That is paid first. That leaves$360,000, which goes to the common shares. Because there are 100,000 of those,each common share gets $3.60. _______________________________________

__________________________________________________________________

__________________________________________________________________


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3. 100,000 shares of common and 20,000 shares of $2 preferred that is participating.Participating means pay again. So these 20,000 shares get paid first (because theyare preferred) and also get paid again (because they are participating). Work thepreferred aspect same as in hypo #2: 20,000 shares multiplied by $2 equals$40,000 total preference. Pay that first. That leaves $360,000, as in hypo #2.

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

4. 100,000 shares of common and 20,000 shares of $2 preferred that is cumulative(and no dividends have been paid in the three prior years).Cumulative means add

them up. A cumulative dividend accrues year-to-year. So the corporation owes thecumulative holders for the three prior years, plus this year (when the dividend wasdeclared). That means the corporation owes them four years= worth of a $2preference. Four years multiplied by $2 equals $8 per share. So the corporationowes $8 to each cumulative preferred share. There are 20,000 such shares.

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

(3) For any distribution (dividend, repurchase, redemption), which funds can be used?

1. Earned surplus: this is generated by business activity.

a. How is earned surplus computed? All earnings minus all losses minusdistributions previously paid.

b. How can earned surplus be used? __________________________________

__________________________________________________________________

__________________________________________________________________


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2. Stated capital: this is generated by issuing stock. (So is capital surplus, below.)

--So when we have an issuance, the consideration will be allocated between statedcapital and capital surplus.

a. Can stated capital be used for distributions? __________________________

b. How is stated capital computed?

-- C Corp. has issued 10,000 shares of $2 par stock for $50,000. Of that,$20,000 goes to stated capital and $30,000 goes to capital surplus. Why?

On a par issuance, the par value goes to stated capital. Here thats $20,000.

______________________________________________________________

______________________________________________________________

-- And the excess over par goes to capital surplus. Here, thats $30,000.

______________________________________________________________

______________________________________________________________

If we had a no-par issuance, the board allocates the consideration betweenstated capital and capital surplus. __________________________________

3. Capital surplus: this is also generated by issuing stock.

a. How is capital surplus computed? Payments in excess of par plus amountsallocated on a no-par issuance.

b. Can capital surplus be used for distributions? _________________________

_____________________________________________________________

(4) Instead of the foregoing fund requirements, many states now simply say thecorporation can declare a distribution as long as the corporation is not insolvent or ifthe distribution would render it insolvent. Insolvent means either:

a. the corporation is unable to pay debts as they come due OR

b. its assets are less than its liabilities (and liabilities include liquidation (ordissolution) preferences); we will see liquidation preferences on page 29.

(5) Directors are personally liable for unlawful distributions, as are shareholders whoknew the distribution was unlawful when they received it. In some states, directorliability here is strict; in some, directors are only liable if the distribution is made inbreach of a duty. Remember, however, directors= possible defense of good faithreliance. Cross-reference page _________ .


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FACT PATTERN 5: FUNDAMENTAL CORPORATE CHANGES

I. CHARACTERISTICS OF FUNDAMENTAL CORPORATE CHANGE

(1) Unusual occurrences, so they require board of director action and

(2) Approval by __________________________ of the shares entitled to vote. So this is

different from shareholder voting before. Here its not enough to get a majority of theshares present or that actually vote we need a majority of those entitled to vote.

(3) Possibility ofdissenting shareholder right of appraisal.

A. The right of appraisal is the right of a shareholder to force the corporation to buyher shares at fair value. This is the shareholders sole remedy for thesefundamental changes unless there is fraud.

B. When will a shareholder have a dissenting shareholder right of appraisal?

1. Actions by corporation to trigger right -- any of these:

a. merger or consolidation;b. transfer of substantially all assets not in the ordinary course of business;c. transfer of shares in a share exchange.

2. Actions by shareholder to perfect right:

a. Before shareholder vote, file with the corporation written notice ofobjection and intent to demand payment;

b. Abstain or vote against the proposed change; and

c. After the vote, make written demand to be bought out.

C. If the shareholder and the corporation cannot agree on fair value of the shares,what happens? _____________________________________________________

__________________________________________________________________

D. Some states do not grant the right of appraisal if the company=s stock is listed on anational exchange or has a large number of shareholders (e.g., 2,000 or more).This makes sense, because in such a large corporation, there is a public market forthe shares, so the disgruntled shareholder can just sell on the market. She doesnt

need to force the corporation to buy her out.

II. AMENDMENT OF THE ARTICLES

(1) Board of director action andnotice to shareholders.

(2) Shareholder approval.

If there are 4,000 outstanding shares entitled to vote, how many must vote for theamendment? __________________________________________________________


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-- What if only 2,400 shares showed up to vote on the amendment? _______________

_____________________________________________________________________

_____________________________________________________________________

(3) If approved, file amended articles with Secretary of State.

(4) Are there dissenting shareholder rights of appraisal? No. But if the amendment harms aclass of stock, the amendment must be approved by the shares of that class itself aswell as by the overall majority of all shares entitled to vote. This is Aclass voting.@

III. MERGERS [B, Inc. merges into A Corp.] OR CONSOLIDATIONS [A Corp. and B,

Inc. form C Corp.]

(1) Board of director action (both corporations), andnotice to shareholders.

(2) Shareholder approval (generally both corporations). ___________________________

______________________________________________________________________

(3) If approved, file articles of merger (or consolidation) with Secretary of State.

(4) REMEMBER DISSENTING SHAREHOLDER RIGHT OF APPRAISAL.

(5) Effect of merger or consolidation: _________________________________________

______________________________________________________________________

______________________________________________________________________

-- This rule makes sense because the constituent corporation disappeared. So a creditorof that corporation can sue the survivor.

IV. TRANSFER OF ALL OR SUBSTANTIALLY ALL OF THE ASSETS NOT IN THE

ORDINARY COURSE OF BUSINESS OR SHARE EXCHANGE (one company

acquires all the stock of another)

(1) Are these fundamental changes for the transferring corporation? _________________

(2) Are these fundamental changes for the buying corporation? _____________________

So the shareholders of the buying corporation DO NOT VOTE ON THESE.

-- S Corp. wants to sell all of its assets to B, Inc. or B, Inc. wants to buy all the shares of SCorp. We need:

(1) Board of director action (both corporations), andnotice to selling corporation=sshareholders.


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(2) Approval by transferring corporation=s shareholders.

A. Number of shares of S Corp. that must approve the sale? _______________

_________________________________________________________________

_________________________________________________________________

B. Number of shares of B, Inc. that must approve the sale? NONE. THEYDON'T VOTE, BECAUSE IT'S NOT A FUNDAMENTAL CHANGE FORTHE BUYING CORPORATION.

(3) Are there dissenting shareholders= rights of appraisal? Yes, for shareholders of thetransferring corporation only.

(4) File articles of exchange with the Secretary of State in share exchange. Usually,no filing in transfer of assets.

(5) Generally, acquiring company is not liable for debts of the acquired companyunless the deal says otherwise or unless the company purchasing assets is merelya continuation of the selling corporation. This makes sense, because thecorporation that sold its assets still exists, so a creditor can still sue it.

V. DISSOLUTION

(1) Voluntary.

A. Board of directors action and approval by a majority of the shares entitled to vote.

B. File articles of dissolution and give notice to creditors.

(2) Involuntary (by court order).

A. Shareholder can petition because of: (1) director abuse, waste of assets,misconduct; or (2) director deadlock that harms the company; or (3) shareholderdeadlock and failure for at least two annual meetings to fill a vacant boardposition.

-- Alternative to dissolution: the court might order the corporation or majorityshareholders to: ____________________________________________________

__________________________________________________________________

-- This is especially likely in a close corporation.

B. Creditor can petition because the corporation is insolvent and the creditor eitherhas an unsatisfied judgment against the corporation or the corporation admits thedebt in writing.


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(3) After filing articles of voluntary dissolution, or after court order of involuntarydissolution, corporation stays in existence to wind up. Winding up: (a) gather all assets,(b) convert to cash, (c) pay creditors, and (d) distribute remainder to shareholders pro-rata by share unless there is a dissolution (or liquidation) preference.

-- What's a liquidation preference? Works like a dividend preference; pay first.

______________________________________________________________________

FACT PATTERN 6: FEDERAL SECURITIES LAW

I. SECURITIES ARE INVESTMENTS.

(1) Debt. Investor lends capital to the corporation, to be repaid (usually with interest) asspecified in the agreement. Shes a creditor, not an owner, of the corporation.

A. Secured by corporate assetsCAbond@B. UnsecuredCAdebenture@

(2) Equity. Investor buys stock, and has an ownership interest in the corporation. Thisstatus carries various rights, e.g., to inspect records, bring derivative suits. Shes anowner, not a creditor, of the corporation.

II. RULE 10b-5CAIMED AT DECEITFUL BEHAVIOR.This federal law prohibits fraud and misrepresentation (or nondisclosure) in connection with thepurchase or sale of any security (debt or equity).

(1) AInstrumentality of interstate commerce@ (telephone, mail or if deal goes through

national exchange)

(2) Type transactions

A. Misrepresentation of material information.

B. Trading on inside information when duty to disclose exists (relationship of trustand confidence with shareholders of the corporation). This means insiders cannottrade on secrets. They must abstain or disclose so everybodys on the samefooting.

C. Tipping (passing along material inside information for a wrongful purpose).

(3) Materiality. The misrepresentation or omission must concern a Amaterial@ factConethat a reasonable investor would consider important in making an investment decision.

(4) Possible plaintiffs:

A. SEC

B. Private action for damages by buyer or seller of securities


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Widget Corp. issues a press release that Buffett has expressed an interest inacquiring a major block of its stock. The release fails to indicate that it is JimmyBuffett and not Warren Buffett who is interested. Because of this press release,Duffy does not sell his Widget stock. Does Duffy have a 10b-5 cause of action?

__________________________________________________________________

__________________________________________________________________

(5) Possible defendantsCAany person@ (including entities).

A. Company that issues a misleading press release.B. Buyer or seller of securities who misrepresents material information.C. Buyer or seller of securities who trades on material inside information (when

there is a duty to abstain or disclose, which comes from relationship of trust andconfidence with shareholders of the corporation).

D. Tipper or tippee.

1. L, a lawyer for X Co., learns that X Co. is planning to merge with Y Corp.She telephones her son-in-law Joe about this, and urges him to buy X Co.stock. Acting on the tip, Joe buys the stock. Any violations of Rule 10b-5?

L is a tipper because: (1) she passed inside information in breach of a duty toX Co., and (2) she benefitted. How did she benefit? ___________________

_____________________________________________________________

-- Joe is a tippee because (1) he traded on the tip and (2) knew or should

have known that the information was improperly passed. _______________

______________________________________________________________

2. D is a director of C Corp. While waiting for a concert to start, D tells herhusband about a new, secret processing method that C Corp. has justdeveloped. Bobbitt, who is sitting in the next row, overhears the conversationand buys C Corp. stock on a national exchange. Any violations of 10b-5?No. At worst, D was merely negligent, which is not enough for 10b-5liability.

-- So D is not a tipper. UNDER 10B-5, IF THERE IS NO TIPPER, THERECANNOT BE A TIPPEE. ________________________________________

______________________________________________________________

(6) Scienter. D must have an intent to deceive, manipulate or defraud. Recklessness maysuffice.

(7) Reliance. Said to be a separate element, as in fraud, but is presumed in publicmisrepresentation and nondisclosure cases.


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III. SECTION 16BCAIMED AT SPECULATION BY DIRECTORS, OFFICERS, ANDTEN PERCENT SHAREHOLDERS. THIS IS STRICT LIABILITY! INTENT IS

IRRELEVANT.

This federal law provides for recovery bythecorporation (so it could be a shareholderderivative suit) ofAprofits@ gained by certain insiders from buying and selling the company=sstock.

The theory is that it is bad for market confidence to have these insiders buying and sellingtheir own corporation=s stock.

(1) When does 16b apply?

A. AReporting@ corporationC(i) listed on a national exchange or (ii) at least 500shareholders and $10 million in assets.

B. Type defendant.

-- Director (either when she bought or sold) or-- Officer (either when she bought or sold) or-- Shareholder who owns more than 10 percent of the corporations stock (to becovered, she must own this much both when she bought andsold)

C. Type transaction.

Buying and selling stock within a single six-month period (short-swing trading)

(2) What happens when 16b applies?

All Aprofits@ from such Ashort-swing trading@ are recoverable by the corporation. If,within six months before or after any sale, there was a purchase at a lower price, thereis a profit.

-- D is a director of Acme, Inc., which is a reporting corporation. In 2005, D bought700 shares of Acme stock for $10 a share. In January 2007, D sold 700 shares for $6.In March 2007, D bought 200 Acme shares for $1 a share. What result? Doesnt seemlike theres a profit but there is a $1,000 profit under 16B. D owes the corporation$1,000. KEY TO 16B -- FOCUS ON THE SALE. HERE THE SALE WASJANUARY 2007, D SOLD AT $6. ________________________________________

--Did she buy at less than $6 within 6 months before the sale in January 2007? ______

____________________________________________________________________

--Did she buy at less than $6 within 6 months afterthe sale in January 2007? _______

____________________________________________________________________

____________________________________________________________________


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-- Multiply $5 profit times 200 shares. Why 200? Because that is the largest numberof shares she both bought and soldwithin the six months._______________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

______________________________________________________________________

LAST POINT: If you have questions, call me. Please do not e-mail; e-mail is not a goodoption for me. Call and if Im not there, leave your question and your phone number and I will

call you back. My phone number is: _______________________________________________

handout corp eb07 (1)

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