BUSINESS ORGANIZATIONS



BUSINESS ORGANIZATIONS

CORPORATIONS OUTLINE

I. Limited Liability Company

a. Hybrid – limited liability for all participants

i. Partnership taxation with no personal liability

1. LLC has pass through taxation (Corp. does not)

2. Taxed once at 39% max.

ii. Separate/distinct but artificial legal entity much like a corporation, thus Delaware counsel required to represent in Delaware proceeding (Poore v. Fox hollow)

b. Operation Agreement

i. determines management (member or manager)

ii. Defines fiduciary duties and liabilities

iii. Trumps otherwise applicable non-mandatory statutory authority (Elf Atochem v. Jaffari)

iv. May be oral

c. Management

i. Default rule – member managed

ii. Flexibility but new (thus little case law)

d. California LLC statute

i. Agency liability – each member is an agent; alter-ego liability

ii. Fiduciary duties – same as partnership; duty of manager to LLC and its members

II. Closely Held Corporations

a. Formation/Incorporation

i. Premature Commencement of Business

1. Promoters

a. Promoter founds and organizes a business organization

b. Promoters are personally liable, unless otherwise agreed (Stanley v. Boss)

c. Fiduciary duty of promoter to the corporation

i. Need full disclosure, equity and fairness

2. Defective Incorporation

a. Common Law

i. De Jure Corporation – Conformity with mandatory conditions precedent established by statute

1. no promoter liability; not subject to attack as to existence of corporation

ii. De Facto Corporation – Must have (1) a valid statute, (2) a good faith attempt to incorporate/file, and (3) actual use of corporate franchise

1. No promoter liability; the state may directly attack the existence of the corporation

iii. Corporation by Estoppel – Held out to be a corporation and reliance had

1. No promoter liability

2. Creditor dealt with the business as if it were a corporation and relied on the corporation’s credit rather than the president’s; thus creditor is estopped from asserting that the corporation was not incorporated at the time of the sales (Cranson v. IBM)

b. Statute

i. “Tough Luck” approach - the certificate of incorporation provides the cut off point; before it is issued, the individuals, and not the corporation, are liable (Robertson v. Levy)

ii. MBCA § 2.04 – persons purporting to act as or on behalf of a corporation, knowing that there was no corporation under this act, are jointly and severally liabilities created while so acting

ii. MBCA – Articles of Incorporation

1. § 4.01 – requires corporate entity name to include a suffix

2. § 2.02 – (a) mandatory provisions (name, number of shares, address of corp., name and address of incorporators); (b) permissive provisions (often better to include in a non-public document such as bylaws, shareholder agreement, or stock certificates)

3. § 3.02 – default duration in perpetuity

4. § 1.40(16) – Corp. can be an incorporator; incorporator need not have a relationship with the corporation being formed

b. Ultra Vires Doctrine

i. Companies to avoid the enforcement of contracts made beyond their powers or purposes (waning doctrine)

ii. Steps

1. Determine if the charter/articles of incorporation limit the corporation’s purposes

2. Determine who may challenge the act that seemingly violates the purpose

a. Only: Shareholder, Corporation (against officer or director) or the Attorney General (statute)

3. Look to case law to determine if Ultra Vires applies

a. “Reasonable” test at common law as to charitable gift; weighing of benefits to burdens (Theodora v. Henderson)

i. Factors – dollar amount, self-dealing concern

iii. MBCA

1. § 3.02 – corporation has the same powers as an individual to do all things necessary or convenient to carry on its business and affairs

2. § 3.04 – validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act

c. Piercing the Corporate Veil

i. Factors evaluated by courts

1. Fraud or misrepresentation

a. PCV invoked to prevent fraud or to achieve equity

i. Operating at no profit is not in and of itself fraud (Bartle v. Home Owners)

ii. When continued recognition of a corporation as a separate legal entity would produce injustices and inequitable consequences, then a court has sufficient reason to pierce the corporate veil (Baatz v. Arrow Bar)

2. Observation of corporate formalities

3. Siphoning of funds

4. Alter Ego doctrine/commingling assets

a. Shareholder treating the corporation as an alter ego rather than as a separate entity (Dewitt v. Flemming)

5. Undercapitalization

ii. Attempting to pierce through to parent company

1. Control or domination

a. Differentiate sound business practice from domination/intent to defraud (Fletcher v. Atex)

2. Wrong or unjust act

a. Need more than errors in business judgment (Radaszewskiv. Telecom)

3. Proximate cause

iii. Successor Corporations

1. Determine in corporation is new or just a continuation and restructuring of the former

d. Financial Matters

i. Shareholders elect directors → Directors manage and delegate to officers; elect officers, and control the corporation → Officers execute directions per agency authority

ii. Court will compel dividends if:

1. adequate corporate surplus exists; and

2. directors are withholding declaration of dividends in bad faith

a. Essential test of bad faith is to determine whether the policy of the directors is dictated by their personal interests rather than the corporate welfare (Gottfried v. Gottfried)

iii. A business corporation is organized and carried on primarily for the profit of the stockholders (Dodge v. Ford)

iv. Board of Directors fiduciary duties to the corporation and the shareholders (and officers have fiduciary duties as agents)

1. if director determining own salary then higher burden regarding fairness; must show that compensation reasonable (Wilderman v. Wilderman)

v. Shareholder Oppression

1. Special treatment because of resemblance of closely held corporation to a partnership

a. Minority shareholder vulnerable because:

i. Capital is locked up

ii. No public market for shares

iii. Shares not attractive

2. Landmark case re: higher level of fiduciary duty of majority shareholder to minority shareholder in a closely held corporation (Donahue v. Rodd)

a. Duty of utmost faith and loyalty

e. Management and Control

i. Traditional roles of shareholders and directors

1. Old Rule – Shareholders not permitted to have an agreement allowing them to vote for officers b/c it was preventing directors from appointing officers with unfettered power (McQuade v. Stoneham)

ii. Shareholder voting and shareholder agreements

1. Modern Rule – Court will find shareholder agreements affecting management and control by directors to be valid unless there is harm to: (1) minority shareholders, (2) creditors, or (3) the public (Galler v. Galler)

2. Court finds pooling agreements to be valid (Ringling Brothers and Barnum & Bailey v. Ringling)

a. Sidesteps the need for a voting trust

iii. Action by directors and officers (Authority)

1. Directors

a. Certified resolution signed by the secretary is enough to bind the corporation even though the Board of Directors is stating that no authorization was had to guarantee a loan (Drive-In Dev Co)

i. Apparent authority based on secretary’s resolution and reliance by third party

ii. Actual authority had via bylaws or articles of incorporation

2. Officers

a. President’s actual authority to bind in “usual and ordinary” matters as contrasted to “extraordinary” matters (then must be fact-specific inquiry)

i. Generally only President has apparent authority (Lee v. Jenkins)

1. No apparent authority if third party has knowledge of the lack of actual authority

3. Corporate Signatures

a. Must be obvious that the corporation is the obligor and that the signatory has proper authority

i. Differentiate between

1. binding the corporation, and

a. ABC Corp., By ___, President

2. binding the individual

a. ABC Corp., ___, president

iv. MBCA

1. § 7.30 – Voting trusts; transfer of shares to trustee for period of 10 years (extendable)

2. § 7.31 – Voting agreements; manner of voting specifically enforceable

3. § 7.32 – Shareholder agreements; Effective even if inconsistent with MBCA

4. § 8.01 – Requirements and duties of Board of Directors

5. § 8.20 – Meetings of the board of directors

6. § 8.21 – Action without meeting; each director signs and delivers consent

7. § 8.40 – Officers; described by bylaws

8. § 8.41 – Duties of Officers; set forth in bylaws and proscribed by the board of directors

f. Dissolution/Court-ordered buy-out

i. Traditionally rigid rules – dissolution denied because the business was still solvent and operating with profits even though one shareholder was refusing to sign salary checks of other (In re Radom)

ii. Modern

1. Court may order buy-out for oppressive conduct such as a conspiracy to deprive shareholder of his interest in the corporation with acts of willful breach of fiduciary duty (Davis v Sheerin)

a. Oppressive conduct – frustration of the legitimate expectations of minority shareholders

i. Reasonable expectations depend on number of shares possessed

1. factors – voting power, seat on board, deprivation of stock, access to information, proportional financial return

iii. MBCA

1. § 7.32 – Shareholder agreement allows shareholders to run corporation as if there were no board of directors (must be noted on stock certificates)

2. § 14.30 – Grounds for judicial dissolution; only actions brought by:

a. Attorney General (for fraud or abuse of lawful authority),

b. Shareholder (for director deadlock, illegality, shareholder deadlock, or assets misapplied or wasted),

c. Creditor (for execution of judgment on insolvent corporation),

d. Corporation itself (for voluntary dissolution)

3. § 14.31 – Procedure for judicial dissolution; corporation’s principle place of business; notice to shareholders that dissolution may be avoided by electing to purchase the petitioners shares

4. § 14.32 – Receivership or custodianship; appointments to wind up and liquidate

5. § 14.33 – Decree of dissolution; specify date and direct winding up

6. § 14.34 – Election to purchase in lieu of dissolution (closely held corporations only); Corporation or other shareholders arrange to buy-out petitioner; court can determine the fair value of the shares

III. Publicly Held Corporations

a. Financial Terms

i. Articles of incorporation

1. Lists number and classes of authorized shares

2. Lists par value of shares

ii. Common Shares

1. Voting rights to elect board of directors and approve structural changes

iii. Preferred Shares

1. Dividend priority; No voting

2. Cumulative Preferred Shares

a. Accumulated priority regarding dividends

iv. Cumulative Voting

1. split shares/multiply number of shares by number of directors (allows minority voice)

a. Usually set out in bylaws

v. Financing

1. Debt – loans or bonds

2. Equity - shares

vi. Outstanding Shares

1. Number of shares issued are shares outstanding

a. If issue stock at a price lower than its par value is becomes watered-down stock which decreases the company’s value

2. If corporation buys shares back they are no longer outstanding – they become Treasury Stock/Shares

vii. Dividends

1. Permissible to issue additional shares as dividends

b. Proxy Regulation/Disclosure Requirements

i. Regulation S-K, Item 303

1. Requirement that Management Discussion and Analysis of Financial Conditions and Results of Operations (MD&A) be included in annual and quarterly reports

a. Registrant must provide such other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition, and results of operations [303(a)]

i. Describe any unusual or infrequent events or transactions that materially affected the amount of reported income from continuing operations and in each case indicate the extent to which income was so affected [303(a)(3)(i)]

ii. Discuss any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations [303(a)(3)(ii)]

b. SEC action brought for failure to disclose information regarding

i. The impact of Brazilian operations on overall results, and

ii. Known uncertainties (Caterpillar)

ii. Rule 14a-9 (False or Misleading Statements)

1. Private right of action had for alleging proxy fraud (JI Case v. Borak)

a. Purpose of investor protection

b. SEA §27 – federal courts have exclusive jurisdiction regarding proxy fraud

2. State common law cause of action for breach of fiduciary duty or fraud require intent, thus much harder to prove

a. Proxy Fraud per Rule 14a-9 does not require intent and includes omissions

b. State causes of action require knowledge, intent and reliance

3. An omitted fact is “material” if there is a substantial likelihood that a reasonable shareholder would consider it in deciding how to vote (TSC Indust. V. Northway)

iii. Securities of 1934, § 14

1. § 14(a) Solicitation of proxies in violation of rules and regulations

a. Rule 14a-9 as such a rule or regulation

b. Regulation S-K as such a rule or regulation

c. Shareholder Proposals

i. Certain shareholder proposals by shareholders owning a certain amount of shares are to be included in proxy statements

1. Usually involve issues of policy and practice including corporate social responsibility

2. Proposals that pass are still only proposals to the board of directors (non-binding)

3. Exceptions per SEA rules

a. Everyday business functions are left to directors

b. Shareholders should not be telling directors/the company what to do

ii. SEA

1. Rule 14a-7 – Obligations of registrants to provide a list of, or mail soliciting material to security holders

2. Rule 14a-8 – Shareholder proposals; must own $2,000 of 1% for at least one year; allows a company to exclude a proposal if it relates to an election to office of the company’s board of directors

3. Rule 14a-9 – False or misleading statements prohibited

d. Duty of Care

i. Duties of:

1. Good faith

2. Best interests of the corporation

3. Decisions made on an informed basis

ii. Business Judgment Rule – Judicial presumption that officer and directors have exercised the duty of care (judicial “hands off” attitude). Thus if duty of care factors present, errors in business judgment are not questioned

1. Overcoming the BJR presumption

a. Fraud (via abuse of discretion), illegality or conflict of interest (Shlensky v. Wrigley)

i. Or lack of rational business purpose

b. Gross negligence

i. Demonstrated by neglecting to make an informed business decision based on information that was reasonably available to them (Smith v. Van Gorkom)

iii. Remedy for breach of fiduciary duty – directors and officers are individually and personally liable

iv. MBCA

1. § 8.30 – Standards of conduct for directors; act in good faith, in a manner the director reasonably believes to be in the best interest of the corporation, become informed

2. § 8.31 – Standards of liability for directors; director liable to the corporation if action not in good faith, not in best interests of corporation, not informed, or based upon an lack of objectivity due to director’s familial, financial or business interest in the challenged conduct

a. Plaintiff burden to show harm to corp. or shareholders, and proximate cause

3. § 8.42 – Standards of conduct for officers; good faith, duty of care, best interests of corporation

e. Duty of Loyalty

i. Self-dealing transactions

1. Court may set aside such transactions unless:

a. The transaction is fair to the corporation (terms, price, arm’s length), or

b. Transaction is approved or ratified by a disinterested majority of directors or shareholders after disclosure (Weinberger v. UOP)

2. Remedies

a. Equitable – rescind transaction

b. Law - damages

ii. Usurpation of Corporate Opportunity

1. Director may not usurp corporate opportunity for his or her own benefit unless the corporation consents/must offer opportunity to corporation first (Northeast Harbor Golf Club v. Harris)

a. Corporate opportunity is something a director “happens upon”

b. Includes opportunities offered in belief that they are being offered to the corporation, or which arise out of use of corporate information or property

2. Tests (common law since not a transaction)

a. American Legal Institute – must offer to corp. first upon evaluation of opportunity as

i. Closely related, and

ii. In light of the capacity of officer when information was obtained

b. Other tests

i. Different line of business test (in some jx)

ii. Fairness test (vague)

iii. MBCA – Subchapter F – Directors’ Conflicting Interest Transactions

1. § 8.60 – Definitions; conflicting interest, director’s conflicting interest transaction, related person, required disclosure, time of commitment

2. § 8.62 – Directors’ Action

3. § 8.63 – Shareholder’s Action

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