Corporations

I. Organization of a Corporation
1. Formation of Corporation
 Person: Requires one or more people (or corporations or both) who execute the Articles of
Incorporation and file/deliver them with the Secretary of State.
 Articles of Incorporation are a contract between the corporation and S/H, and between
corporation and the state. Must include
o Corporate name w/ company, incorporation, inc., corp., or ltd so people know they
are dealing with a corporation and its shareholders have limited liability
o Name and address of each incorporator,
o Name of registered agent and street address of registered office in state of inc.
o It may have a duration or if none listed it is perpetual.
o Information re stock: Authorized stock (max no of shares that may be sold), no. of
shares per class of stock, voting rights and preferences of each class of stock
 Act: Incorporators must deliver NOTARIZED Articles to Secretary of State and pay required
fees. When secretary of state’s office accepts, you now have conclusive proof of valid
corporation and you are now a de jure (legal) corporation.
o Board of Directors (Board) then holds the organizational meeting where it selects
officers, adopts bylaws, and conducts other appropriate matters.
 Capital Structure
o Authorized stock: max. no of shares that can be sold
o Issued stock: Shares actually sold by corp
o Treasury stock: Issued shares repurchased by corp
o Outstanding stock: Issued stock not reacquired by corporation

2. Legal Significance of Formation of Corporation

 Internal Affairs Doctrine: Internal affairs of corporation (duties of all directors, officers, and
SH) are governed by law of state of incorporation even if it does no business in that state.
o That is why everyone incorporated in Delaware (Race to the bottom).
 Entity: Corporation is separate person with all rights of a person (except Privilege and
Immunities), and it pays taxes (double taxation in “C” Corp. – S/H taxed on distributions to
them, corp pays income tax on its profits).
o Avoid double taxation by being a S corp: < 100 shareholders, all human and US
citizens/residents, one class of stock, no public trading.
o Corporations give their shareholders limited liability.

3. De Facto Corporation and Corporation by Estoppel.

List these doctrines, but note at very end that many states have abolished these doctrines.

Generally, if you have not complied with requirements to become a corporation, S/H are
partners in a partnership and personally liable for everything (no limited liability). However, you
may assert De Facto Corporation and Corporation by Estoppel if you were UNAWARE of the
failure to form a de jure corporation.
Requirements for De Facto Corp: If applies, treated as a corp except in actions by the sstate
1. Relevant incorporation statute
2. The parties made a good faith, colorable attempt to comply with it (TRIED to file
notarized articles, got lost in mail)
3. Some exercise of corporate privileges (you have acted like a corporation).

Corporation by Estoppel
Cannot deny you are a corporation to avoid contract ability when you have held the business
out as one. E.g. writing a check as payment from “Corporate” listed bank account.

4. By-Laws
 Corp is not required to have bylaws and they are not filed with the state.
 The board creates initial bylaws at organizational meeting
 Articles of Incorporation control if there is a conflict with bylaws.

5. Pre-Incorporation Contract
 Promoter acts for corporation that is not yet formed, promoter is liable.
 Corp is only liable when it adopts the contract either expressly or implied
o Express: Board takes action adopting the contract
o Implied: Corp accepts benefit under the contract e.g. move into leased space
 Promoter always liable unless novation (agrmt btwn promotor, corp, and other contracting
party that corp replaces promotr under the contract).

6. Foreign Corps
 Any corporation transacting REGULAR business in a state it is not incorporated in.
 To qualify:
o Get certificate of authority from SS
o Gives info from articles
o Prove good standing in home state
o Appt registered agent and maintain registered office in the sate
 If it transacts business w/o qualifying: civil fine, corp cannot assert a claim in the state.
o If corporation pays back fines and registers, it can be a plaintiff.

II. Issuance of Stock

 Issuance: ONLY when a corporation sells its own stock to raise capital.
 Subscription: Written offer to buy stock from pre-incorporated corp., irrevocable for six
months unless subscription when offered says otherwise or subscribers allow revocation.
o Post-incorporation revocations always revocable subj to board acceptance of offer.
 Consideration: Stock only issued for consideration = “any tangible or intangible property or
benefit to the corporation”
o Money, tangible or intangible property, services already performed for the
corporation, discharge of a debt.
o Some states allow promissory notes or futures services
 Par value: Minimum issuance price. Set by the board, valuation conclusive if in good faith.
o Corp can get more money than par price, but must get par. No par = no min price.
o Treasury stock (issued and reacquired – authorized) can be resold at any price,
essentially no par.
o Watered stock: Sold below par, directors (if knowingly authorized the issuance) or
buyer (no defence) must make up difference.
 If buyer below sells to third party, third party w/o notice not liable
 Pre-emptive rights: Right of a S/H to maintain his percentage of ownership by buying new
stock whenever there is new issuance of stock for MONEY (not e.g. property).
o Treasury stock generally included.
o If articles are silent, no pre-emptive rights.

III. Directors and Corporations.

1. Statutory requirements: Directors
 Number: Only requires initial directors or officers named in articles. After that SH select at
annual meeting.
 Election: Elected yearly unless staggered – pursuant to articles, board divided into ½ or
1/3, and ½ or 1/3 elected each year.
 Removal: SH can remove directors with or without cause, but in a staggered elected board,
removal only with cause.
o If there is vacancy before term is up, board or S/H can elect new director, but if S/H
removed director, generally they choose the new director.
 Acting as a group: Board may act through unanimous agreement in writing, or at a meeting
which satisfies quorum and voting requirements.
o Directors may act through individual conversations but such acts are void unless
ratified by valid act (thru meeting or unanimous written consent).
o Conference call works as meeting, you are not required to meet in person.
o If board meeting called, method for giving notice set in the bylaws/articles
 Regular (set time in bylaws) meeting: No notice required,
 Special meeting: 2 days notice required, must list state time & place (no
purpose required). Failure to give notice voids meeting and all acts.
 UNLESS waived by directors not notified – in writing or by attending
the meeting w/o objecting at the outset.
 Delegation: Non-delegable FD owed to corporation. Directors cannot generally give proxies
or enter voting agreements for how they will vote as directors.
 Quorum for board meetings: Majority of all directors unless subj to bylaws.
o If quorum present, majority of present directors required to pass resolution.
o Quorom of board CAN be lost if people leave, only ends when meeting ends.

2. Role of directors
 Board manages business of corporation: set policy, supervises officers, declares distrib,
determines when stock is issued, recs fundamental corp changes to S/H.
 Board can delegate to committee of one or more directors, but committee cannot declare
distribution, approve fundamental change, or fill a board vacancy. (But can make recs)
3. Fiduciary duties owed to the corporation
A director must discharge her duties in good faith and with the reasonable belief that her
actions are in the best interest of the corporation. She must also use the care that a
prudent person in like position would reasonably believe appropriate under the
circumstances.

 Business judgment rule: Legal presumption that the decisions of the board will not be
challenged if they are shown to be made in good faith, in the reasonable belief that the
decision is in the best interests of the corporation, and that a reasonably prudent person in a
like position would have exercised the same level of care.
o Good faith reliance on statements made by reasonably competent professionals and
corporate insiders may allow the BJR presumption to be met
 Duty of care: The director must act in good faith and do what a prudent person in like
position would reasonably believe appropriate under the circumstances.
o Nonfeasance: Director liable if absence/laziness caused the loss.
o Misfeasance: P must rebut presumption under BJR.
 Duty of loyalty: A director owes the corporation to act in good faith and with a reasonable
belief that what she does is in the best interest of corp. BOP on D director. BJR N/A.
o Self-dealing (interested director transaction): Director has personal interest in
the transaction – any deal between corporation and one of its directors (or a close
relative), or another business of the director.
 Interested director transaction set aside or director liable in damages unless:
 Deal was fair to corporation when entered OR
 Director’s interest and the relevant facts were disclosed/known and
majority of either disinterested directors or disinterested shares
approved. [Special quorum rule: Majority of at least 2 disint directors]
 Even if deal is approved, some states require approval and fairness.
 Directors may set their own compensation, if reasonable and in good faith. If
excessive, wasting corporate assets = breach of DOL.
o Competing Ventures: Director cannot directly compete with her corporation.
 Remedy: Court raises CT on profits from competing venture, w/ ben to corp
o Corporate Opportunity: Director cannot USURP a corporate opportunity: in the
corp’s business line, something the company has an interest/expectancy in, or that
the director found on company time/resources.
 Director can only take the corporate opp if he tells board about opportunity
and board rejects it.
 Financial inability of board to act on opportunity is not defense.
 May argue corp is not in same business line as opportunity as a possible
defense.
 Penalty: Disgorgement of profits to corp.
 Exclusion of liability: Articles of incorporation may limit or eliminate directors’ personal
liability for money damages to S/H or corp for actions taken, except TTE director
o Received benefit to which he was not entitled,
 o Intentionally inflicted harm on the corporation/S/H,
o Approved unlawful distributions, or
o Intentionally commited a crime.

4. Other state law bases of director liability

 Ultra vires act
 Improper distributions
 Improper loans: loan money to someone, ok if reasonably expect corporation to benefit).

5. Determining director liability

 Directors presumed to concur with Board action unless dissent or abstention in writing
o Writing: Noted in minutes, delivered in writing to presiding officer at meeting, or
written dissent to corporation after meeting.
o Exceptions: Absent director not liable for stuff done at meeting missed, or good faith
reliance on info provided by an employee, officer, committee, or professional
reasonably believed competent

6. Officers
 Status: Owe same duties of loyalty and care (look also for agency rules).
o President has inherent auth to bind corp to contracts in ord course of business.
 Has power to enter extraord transactions if authorized by Board, but Board
cannot give power that it itself does not have.
o Officers may hold more than one office.
 Selection and removal: Officers selected and removed by Board ONLY who also sets
officer compensation.
o If Board fires officer, corporation may still be liable to him under contract liability.

7. Indemnification of directors/officers
 No indemnification for director/officer who was held liable to the corporation or who received
an improper benefit. [There must be a litigation]
 Must indemnify director or officer successful in defending, on the merits of otherwise. [There
must be a judgment]
 Permissive indemnify for litigation expenses if showed that she acted in good faith with the
reasonable belief that she acted in the best interests of the company (DOL satisfied)
o Disinterested directors, shares, or independent legal council decides.

IV. Shareholders
1. General
 Shareholders gen do not manage corp, unless close corp [few S/H, not publicly traded]
 Shareholder management agreement: Sets up alternative management.
o Modify articles and seek approval by all S/H, OR
o Unanimous written shareholder agreement.
o Agreement must be expressly noted on stock certificate.
o Management by S/H or manager: Manager owes DOL and DOC to the corp
 Special fiduciary duties in close corps: FD owed to other S/H – duty of utmost good faith
o FD not to oppress minority shareholders.
 Licensed professionals: Incorporate as “professional corporation/association”.
o Include “PA”/”PC” on the name
o Include purpose of practicing in partic profession in articles.
o Still personally liable for malpractice, but generally not liable for corporate obligs or
other professional’s malpractice.
o Can hire non-professionals, but not to practice the profession.

2. Liability for corporate debts

 No S/H liability unless corporate veil pierced (generally in close corps)
o S/H abused privilege of incorporating
o Fairness requires holding them liable
 Alter ego (identity of interests): Commingling of personal and corporate funds/assets.
 Undercapitalization: Failure to invest sufficiently to cover prospective liability (esp torts)

3. Shareholder Derivative Suit

 Derivative suit: S/H sues to enforce corp’s claim, not her own personal claim.
o E.g. breach of duties owed to corporation.
o Corp wins money, S/H wins attorney fees. If S/H loses, responsible for D’s cost if suit
unreasonable. Claim preclusion prevents shareholders bringing similar suits.
 Requirements of derivative suits
o Stock ownership when the claim arose and throughout the lawsuit
 Cannot be owner from operation of law (e.g. inheritance or divorce).
o S/H must provide adequately representation of the corp’s interest.
o S/H must make written demand on corporation to bring suit, and cannot bring suit for
90 days (if demand is futile, it may be excused e.g. sitting director are Ds in suit).
o Corporation must be joined as a D
o Parties may not settle or dismiss dispute without court approval in which court may
ask for other SH input.
 Corp may move to dismiss if indep investigation concludes that suit is not in the corp’s
best interest.
o Investig made by indep directors (usually special litigation committee) or court-
appointed panel or 1 or more indep persons.
o Court will dismiss if ascertains that board was truly independent and made a
reasonable investigation
 Direct suit: Injury to S/H individually, may make class action suit.
o E.g. Issuance of new stock w/o honoring preemptive rights, failure to declare
dividends, oppression in close corporation.

4. Shareholder voting
 General rule: Each outstanding share is entitled to one vote. Only shareholders of
outstanding stock of record on the record date votes.
o Record S/H: Person shown as owner in corporate records.
 o Record date: voter eligibility cut-off; ownership acquired after date N/A
 Exceptions:
o Treasury stock: Not outstanding
o Death of S/H: Executor votes
o Voting by proxy: Writing, signed by record owner, directing secretary of corp,
authorizing another to vote shares.
 SH can gen revoke proxy by writing to the corp secretary or by attending
meeting in person.
 Proxy good only for 11 months unless it says otherwise.
 Only proxy coupled with an interest are irrevocable: states irrevocable AND
prox-holder has some other interest in the shares other than voting (i.e.
option to buy record owner’s stock, or purchased underlying shares).
 Voting Trusts: 4 Requirements with a 10-year maximum.
o Written trust controlling how the shares will be voted
o Copy to corporation
o Transfer legal title to the voting trustee
o Original SH receive trust certificates and retain all shareholder rights except voting.
 Voting (pooling) agreements: Must be in writing and signed.
o Increasingly specifically enforceable enforceable, but not in many states. If SP
granted, no need to use voting trust.

Where the shareholders vote?

 Generally vote at meeting; need not be in incorporation state
 Can act through unanimous writing consent signed by holders of all voting shares.
 Two types of meetings
o Annual: Required every 15 months. If not held, S/H can petition court order. S/H
elect directors at the annual meeting.
o Special meetings: May be called by 1) Board, 2) President, 3) holders of 10% of
shares, 4) anyone else authorized in the bylaws. SH still cannot remove officer.
 Notice requirement: Delivered to every S/H entitled to vote within 10-60 days of vote.
o State date, time, place
o Special meetings: State the purpose of meeting (limits authority)
o Failure to provide proper notice to all S/H voids all actions at meeting unless waived:
 Expressly in writing or implied by attending meeting w/o obj at the outset.

How do shareholders vote?

 S/H generally vote to elect directors, remove directors, or on fundamental corp changes.
 Quorum: Requires majority of outstanding shares, counted by no. of shares NOT no. S/H.
o SH quorum NOT lost if people leave meeting.
 Pass resolution:
o Elect director: Plurality
o Fundamental corp change/remove director: Majority of shares entitled to vote.
o Other matters: Majority of shares actly voting on issue (incr, remove directors)
  E.g. 12,000 shares outstanding, 7k represented, 5k actually voting. Only
requires 2,501 majority of shares actally voting.
 Cumulative voting: available only when S/H elect directors and as provided in the articles.
o At-large election: No. of votes = no. of shares x no. of directors to be elected. Top x
finishers are elected to the board.
o Cf. Straight voting: Separate election for each seat on the board being elected

5. Stock Transfer Restrictions

 Present shareholders from selling or transferring stock, esp in close corp.
 Enforceable if reasonable – not an undue restraint on alienation.
 Enforcing valid restriction against transferee:
o Restriction conspcicuosuly noted on the stock cert, or
o Transferee had actual knowledge of the restriction.

6. Right of S/H personally/by agent to inspect and copy books and records of the corp
 Any S/H has standing to demand access.
 Non-controversial material: S/H makes written request at least 5 days in advance, no
need to state a proper purpose.
o E.g. Articles, bylaws, minutes of S/H meetings in past 3 years, names and addresses
of current directors and officers, most recent annual report of corp.
 Controversial material: State proper purpose related to S/H interest as S/H.
o E.g. Board meeting minutes, accounting records, record of S/H.
 If corp fails to allow proper inspection, S/H seeks court orders.
o Wining S/H entitled to costs and attorney fees incurred in making the motion.
 NB. Directors have unfettered access due to managerial position.

7. S/H Distributions
 Traditional view: Dividends, repurchasing S/H stock, or redemption (forced sale to
corporation at price set in articles).
o Board discretion to make distribution, at their declaration.
o Compelling declaration of distribution is a direct suit.
 Which S/H getting dividends:
o Common: Divide total dividends by no. of common stock.
o Preferred: If $2 preference, pay total preference ($2 x no. of preferred stock).
Common stock paid after (may be paid more).
o Cumulative preferred: Accures year-to-year. If $2 preferred that is cumulative, and
no dividends paid in prior three years, paid $2 x 4 x no. of shares. Remainder goes
to the common stock.
 Funds used for distribution (traditional view)
o Earned surplus: Generally profits from business activities (earnings – losses –
distrib prev paid) – proper fund for paying distributions.
o Stated capital: Issued stock for par value – may NEVER may be used.
 If 10k shares of $2 par stock issued for $50,000, $20k par value goes to
stated capital, $30k goes to capital surplus.
  On a no par issuance, board allocates consideration between stated capital
and capital surplus.
o Capital surplus: Payments in excess of par + amts allocated in a no-par issuance –
may be used for distribution if all SH (incl. new ones) are informed that distrib comes
from surplus.
 Modern view re funds: Corp only prevented from making distribution if it is insolvent or if
distrib renders it insolvent.:
o Insolvent: Unable to pay debts as they come due, or total assets less than total
liabilities (incl. preferential liquidation rights).
 Directors jointly and severally liable for improper distribution unless good faith defense.
 S/H are liable only if they knew distributions are improper.

V. Fundamental Corp Changes

1. Characteristics of fundamental corporate change
 Extraordinary event that Board cannot do it alone.
o E.g. Amend articles, merge/consolidate into another company, transfer significantly
all assets/have stock acquired in “share exchange”, convert to another form of
business, dissolve.
 Required actions:
o Board action adopting reso of fund change (call Board meeting, pass a resolution)
o Board submits proposal to S/H with written notice.
o S/H approval: majority of all shares entitled to vote (some require states just
require majority of shares that actly vote)
o Deliver document to Secretary of State.
 Dissenting shareholder right of appraisal: Right to force corp to buy stock for fair value.
o Can request right of appraisal only if corporation is 1) merging or consolidating, 2)
transferring substantially all assets not in the ordinary course of business or 3)
transferring its stock in a share exchange.
o No right of appraisal if publicly traded or > 2,000 S/H. I.e. only close corps.
 To perfect right of appraisal SH:
o Before or at S/H meeting, file objection to the transfer and intent to demand payment
o Abstain or vote against the proposed change
o After the vote, within time set by corp, make written demand for fair value of shares
o Deposit stock with corp.
o If no agreement on fair value, corp sues and court appoints appraiser.
o NB. Mere S/H right; cannot force corp to take a diff course unless controls majority.

2. Amendment of the Articles

 Board of director action and notice to shareholders
 Shareholder approval: Majority of entitled votes must vote for the amendment.
 If approved, deliver amended articles to Sec. of State. No rights of appraisal.

3. Mergers or Consolidation
 Board of director action (both corporations) and notice to shareholders
 Shareholder approval (gen both corporations): Majority of entitled votes must approve.
o No S/H approval needed if short-form merger: 90% or more owned subsidiary
merged into parent corp.
 If approved, surviving corp delivers new articles to Secretary of State.
 Right of appraisal for dissenting SH even in short-form merger (S/H of subsidiary entitled).
 Successor liability: Surviving corp succeeds to all rights and liabilities of constituents.

4. Transfer of all/substantially all assets not in the ordinary course of business

 Transfer of at least 75% assets. Constitutes fund. Corp change for the seller, not the buyer.
 Board action of both corps required but only notice to selling company’s S/H
 S/H approval: Majority of entitled shares of S corporation required.
o No vote required for buying corporation, directors decide.
 Dissenting S/H right of appraisal for S/H of selling corporations.
 No need for filing. Deliver to Sec of State articles in exchange in share exchange.
 No successor liability for buying corp: selling corp continues to exist.
o Exception: If buyer is mere continuation of the seller – same management,
shareholders, etc, OR if disguised (de facto) merger.

5. Dissolution
 Voluntary: Board action and approval of majority of shares ENTITLED to vote.
o File notice of intent to dissolve w/ SS.
o Corporation in existence during wind-up. Notify creditors to make claims
 Involuntary: By court order pursuant to S/H or creditor petition.
o S/H can petition if
 Director abuse, waste of assets, misconduct
 Director deadlock that harms the corporation
 S/H have failed at consecutive annual meetings to fill a board vacancy.
o In close corporation, court may order buyout of objecting SH.
o Creditor can petition if corporation is insolvent and (1) he has an unsatisfied
judgment or (2) the corporation admits the debt in writing.
 Dissolution ≠ end of corp: // partnership wind-up
o Winding up: Gatherin all assets, converting to cash, paying creditors, distributing
remainder to shareholders, pro-rata by shares unless liquidation preference.
o Liquidation preference in class of shares (operates similarly to preferred stock).

VI. Securities Laws.

 Debt securities: Secured by assets (bond), unsecured (debenture)
 Equity securities: Buying stock - owner not creditor
 Rule 10b-5: Federal law prohibits fraud or misrepresentation or nondisclosure in connection
with the purchase or sale of any security (debt or equity).
o Instrument of interstate commerce: mail/phone/internet, NOT verb comm in meeting
o Fraud, insider trading (person w/ a rls of trust and confidence with S/H) or tipping
o Material misrepresentation/omission
 o Plaintiff can be private party or SEC
o Defendant can be any person including company
o Scienter: D must have intent to deceive, manipulate or defraud (recklessness suff)
o Reliance in sale or purchase (presumed in public cases)
 Tipping: Insider passes along info to tippee in breach of duty to corp AND insider benefits.
o Family benefit, reputation, or gift giving is enough.
o Inadvertent disclosure ≠ tipping.
 Rule 16(b): Officers, directors, and 10% S/H must pay to corporation any profits from buying
and selling equity securities within 6-month period.
o Prevents directors, officers, and 10% ownership S/H making profits.
o Rule 16(b) suit usually a derivative suit
o 10% s/h must account for profits only if 10% beneficial owner immediately prior to
purchase. Officer/director must be officer at the time of first purchase.